10-Q 1 gwre-10312018x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________________
FORM 10-Q
______________________________________________________________
(Mark one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 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 every Interactive Data File required to be submitted 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 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
 
¨
 
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 November 30, 2018, the registrant had 81,032,052 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 section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as 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 may 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, revenue, 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 “Part II - Other Information - 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)
 
 
October 31,
2018
 
July 31,
2018
 
 
 
 
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
391,322

 
$
437,140

Short-term investments
693,265

 
630,008

Accounts receivable, net of allowances of $1,300 and $1,062, respectively
84,928

 
124,849

Unbilled accounts receivable, net
54,423

 

Prepaid expenses and other current assets
28,024

 
30,510

Total current assets
1,251,962

 
1,222,507

Long-term investments
144,359

 
190,952

Property and equipment, net
19,031

 
18,595

Unbilled accounts receivable, net
10,676

 

Intangible assets, net
88,346

 
95,654

Deferred tax assets, net
80,811

 
87,482

Goodwill
340,877

 
340,877

Other assets
32,731

 
22,525

TOTAL ASSETS
$
1,968,793

 
$
1,978,592

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
22,720

 
$
30,635

Accrued employee compensation
30,540

 
60,135

Deferred revenue, net
84,792

 
114,138

Other current liabilities
11,066

 
20,280

Total current liabilities
149,118

 
225,188

Convertible senior notes, net
308,114

 
305,128

Deferred revenue, net
22,643

 
23,758

Other liabilities
1,195

 
774

Total liabilities
481,070

 
554,848

STOCKHOLDERS’ EQUITY:
 
 
 
Common stock
8

 
8

Additional paid-in capital
1,321,878

 
1,297,979

Accumulated other comprehensive loss
(8,713
)
 
(7,748
)
Retained earnings
174,550

 
133,505

Total stockholders’ equity
1,487,723

 
1,423,744

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
1,968,793

 
$
1,978,592

See accompanying Notes to Condensed Consolidated Financial Statements.

3


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except shares and per share amounts)
 
 
Three Months Ended October 31,
 
2018
 
2017
Revenue:
 
 
 
License and subscription
$
94,269

 
$
30,093

Maintenance
21,003

 
18,930

Services
64,411

 
59,148

Total revenue
179,683

 
108,171

Cost of revenue:
 
 
 
License and subscription
13,330

 
6,715

Maintenance
3,868

 
3,467

Services
65,261

 
52,712

Total cost of revenue
82,459

 
62,894

Gross profit:
 
 
 
License and subscription
80,939

 
23,378

Maintenance
17,135

 
15,463

Services
(850
)
 
6,436

Total gross profit
97,224

 
45,277

Operating expenses:
 
 
 
Research and development
45,496

 
35,711

Sales and marketing
32,319

 
23,610

General and administrative
18,345

 
18,671

Total operating expenses
96,160

 
77,992

Income (loss) from operations
1,064

 
(32,715
)
Interest income
6,851

 
1,912

Interest expense
(4,244
)
 
(4
)
Other expense, net
(1,489
)
 
(262
)
Income (loss) before income taxes
2,182

 
(31,069
)
Benefit from income taxes
(3,307
)
 
(22,155
)
Net income (loss)
$
5,489

 
$
(8,914
)
Net income (loss) per share:
 
 
 
Basic
$
0.07

 
$
(0.12
)
Diluted
$
0.07

 
$
(0.12
)
Shares used in computing net income (loss) per share:
 
 
 
Basic
80,821,227

 
75,187,430

Diluted
82,209,988

 
75,187,430


                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
See accompanying Notes to Condensed Consolidated Financial Statements.

4


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

 
Three Months Ended October 31,
 
2018
 
2017
Net income (loss)
$
5,489

 
$
(8,914
)
Other comprehensive income (loss):
 
 
 
Foreign currency translation adjustments
(812
)
 
(696
)
Unrealized losses on available-for-sale securities, net of tax benefit of $47 and $45, respectively
(153
)
 
(90
)
Reclassification adjustment for realized gains included in net income (loss)

 
15

Other comprehensive loss
(965
)
 
(771
)
Comprehensive income (loss)
$
4,524

 
$
(9,685
)

See accompanying Notes to Condensed Consolidated Financial Statements

5


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
 
Three Months Ended October 31,
 
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income (loss)
 
$
5,489

 
$
(8,914
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
 
Depreciation and amortization
 
9,653

 
6,634

Amortization of debt discount and issuance costs
 
2,986

 

Stock-based compensation
 
23,333

 
19,623

Charges to bad debt and revenue reserves
 
238

 

Deferred income tax
 
(3,985
)
 
(23,708
)
Amortization of premium on available-for-sale securities, and other non-cash items
 
(1,790
)
 
210

Other non-cash items affecting net income (loss)
 
374

 

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
28,612

 
855

Unbilled accounts receivable
 
(25,661
)
 

Prepaid expenses and other assets
 
4,749

 
(3,575
)
Accounts payable
 
(7,931
)
 
1,868

Accrued employee compensation
 
(29,048
)
 
(23,953
)
Other liabilities
 
(1,691
)
 
(356
)
Deferred revenue
 
(32,575
)
 
68

Net cash used in operating activities
 
(27,247
)
 
(31,248
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchases of available-for-sale securities
 
(253,469
)
 
(66,843
)
Sales and maturities of available-for-sale securities
 
238,389

 
93,039

Purchases of property and equipment
 
(2,945
)
 
(1,899
)
Capitalized software development costs
 
(459
)
 
(517
)
Net cash provided by (used in) investing activities
 
(18,484
)
 
23,780

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Proceeds from issuance of common stock upon exercise of stock options
 
689

 
365

Net cash provided by financing activities
 
689

 
365

Effect of foreign exchange rate changes on cash and cash equivalents
 
(776
)
 
(674
)
NET DECREASE IN CASH AND CASH EQUIVALENTS
 
(45,818
)
 
(7,777
)
CASH AND CASH EQUIVALENTS—Beginning of period
 
437,140

 
263,176

CASH AND CASH EQUIVALENTS—End of period
 
$
391,322

 
$
255,399

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
 
Cash paid for income taxes, net of tax refunds
 
$
853

 
$
1,283

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
 
Accruals for purchase of property and equipment
 
$
1,591

 
$
374

Accruals for capitalized software costs
 
$
22

 
$


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
Company

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; insights into data that can improve business decision making; and digital sales, service and claims experiences for policyholders, agents, and other key stakeholders. The Company’s customers are primarily property and casualty insurance carriers.
Basis of Presentation and Consolidation
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 intercompany 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, 2018. There have been no changes in the Company’s significant accounting policies from those that were disclosed in the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2018, except changes to revenue recognition resulting from the adoption of Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers” (“ASC 606”).
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 revenue 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, fair value of convertible senior notes, valuation of goodwill and intangible assets, software development costs to be capitalized, 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.

Foreign Currency

The functional currency of the Company’s foreign subsidiaries is their respective local currency. The Company translates all assets and liabilities of foreign subsidiaries to U.S. dollars at the current exchange rate as of the applicable balance sheet date. Revenue and expenses are translated at the average exchange rate prevailing during the period in which the transactions occur. The effects of foreign currency translations are recorded in accumulated other comprehensive income (loss) as a separate component of stockholders’ equity in the accompanying condensed consolidated balance sheets. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are recorded as other income (expense) in the condensed consolidated statements of operations.
Cash and Cash Equivalents
Cash and cash equivalents are comprised of cash and highly liquid investments with remaining maturities of 90 days or less at the date of purchase. Cash equivalents primarily consist of commercial paper and money market funds.

7


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 income (loss).

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets. Maintenance and repairs that do not extend the life or improve an asset are expensed in the period incurred.

The estimated useful lives of property and equipment are as follows:
Computer hardware
 
3 years
Purchased software
 
3 years
Furniture and fixtures
 
5 years
Leasehold improvements
 
Shorter of 10 years or remaining lease term
 
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. If any of these criteria cease being met before the software reaches its intended use, any capitalized costs related to the project will be impaired. When the software reaches its intended use, capitalized costs are amortized to expense over the estimated useful life of the related assets, 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 condensed consolidated statements of operations. Capitalized software development costs are recorded in property and equipment on the Company’s condensed consolidated balance sheets.
Impairment of Long-Lived Assets, Intangible Assets, and Goodwill
The Company evaluates its long-lived assets, consisting of property and equipment and intangible assets, for indicators of possible impairment when events or changes in circumstances indicate that the carrying amount of certain assets may not be recoverable. Impairment exists if the carrying amount of such assets exceed the estimates of future net undiscounted cash flows expected to be generated by such assets. Should impairment exist, the impairment loss would be measured based on the excess carrying value of the assets over the estimated fair value of the assets.
The Company tests goodwill for impairment annually, during the fourth quarter of each fiscal year, and in the interim whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company evaluates qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. In performing the qualitative assessment, the Company considers events and circumstances, including but not limited to, macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers, changes in the composition or carrying amount of a reporting unit’s net assets, and changes in the price of the Company’s common stock. If, after assessing the totality of events or circumstances, the Company determines that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then the two-step goodwill impairment test is not performed. There have been no goodwill impairments during the periods presented.
Convertible Senior Notes

8


In March 2018, the Company issued $400.0 million aggregate principal amount of 1.25% Convertible Senior Notes due 2025 (the “Convertible Senior Notes”). The Company accounts for the liability and equity components of the issued Convertible Senior Notes separately. 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 as the difference between the initial proceeds less the fair value of the liability component. The liability and equity components will not be remeasured as long as the conversion option continues to meet the requirements for equity classification. The equity component is net of issuance costs and recorded in additional paid-in capital.
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 condensed consolidated statements of operations.
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 condensed consolidated balance sheets 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 revenue for the three months ended October 31, 2018. One customer individually accounted for 10% or more of the Company’s revenue for the three months ended October 31, 2017. No customer individually accounted for 10% or more of the Company’s accounts receivable as of October 31, 2018 and July 31, 2018.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded at invoiced amounts and do not bear interest. The Company does not require collateral, performs ongoing credit evaluations of its customers and provides for expected losses. The Company maintains an allowance for doubtful accounts based upon the expected collectability of its accounts receivable. The expectation of collectability is based on historical loss patterns, the number of days that billings are past due, and an evaluation of the potential risk of loss associated with delinquent accounts.
Revenue Recognition
The Company’s revenue is derived from contracts with customers. The majority of the Company’s revenue is derived from licensing arrangements that can span multiple years, and implementation and other professional services arrangements. The Company accounts for revenue in accordance with ASC 606, which the Company adopted on August 1, 2018 using the modified retrospective method. Refer to the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2018 for a description of the Company’s revenue recognition policy prior to August 1, 2018. The core principle of ASC 606 is to recognize revenue upon the transfer of services or products to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services or products. The Company applies the following framework to recognize revenue:
Identification of the contract, or contracts, with the customer
The Company considers the terms and conditions of written contracts and its customary business practices in identifying its contracts under ASC 606. The Company determines it has a contract with a customer when the contract is approved, the Company can identify each party’s rights regarding the services and products to be transferred, the Company can identify the payment terms for the services and products, the Company has determined that the customer has the ability and intent to pay, and the contract has

9


commercial substance. In general, contract terms will be reflected in a written document that is signed by both parties. At contract inception, the Company evaluates whether two or more contracts should be combined and accounted for as a single contract. The Company also evaluates the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer.
Identification of the performance obligation in the contract
Performance obligations promised in a contract are identified based on the services or products that will be transferred to the customer that are both:
i.
capable of being distinct, whereby the customer can benefit from the service or product either on its own or together with other resources that are readily available from third parties or from the Company’s services or products, and
ii.
distinct in the context of the contract, whereby the transfer of the services or products is separately identifiable from other promises in the contract.
To the extent a contract includes multiple promised services or products, the Company applies judgment to determine whether promised services or products are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised services or products are accounted for as a combined performance obligation.
The Company generates revenue from the following sources, which represent the performance obligations of the Company:
i.
On-premise software licenses related to term or perpetual agreements;
ii.
Maintenance activities that consist of email and phone support, bug fixes, and unspecified software updates and upgrades released when, and if, available during the maintenance term;
iii.
Subscription services related to the Company’s Software-as-a-Service (“SaaS”) offerings; and
iv.
Services related to the implementation and configuration of the Company’s software, reimbursable travel, and training.
Term licenses generally have a two-year initial term with a customer option to renew on an annual basis after the initial term. The related maintenance for term licenses follow the same contract periods. Subscriptions are typically sold with a three- to five- year initial term with a customer option to renew on an annual basis after the initial term. Professional services typically are time and materials contracts that last for a period of approximately one year.
Determination of the transaction price
The transaction price is determined based on the consideration to which the Company expects to be entitled in exchange for transferring services and products to the customer. Variable consideration is estimated and included in the transaction price if, in the Company’s judgment, it is probable that there will not be a significant future reversal of cumulative revenue under the contract.
On-premise software licenses and subscription services may be subject to either fixed or variable installments. Variable installments are generally subject to changes in a customer’s Direct Written Premium (“DWP”) or a customer’s Gross Written Premium (“GWP”). When consideration is subject to variable installments, the Company estimates variable consideration using the expected value method based on historical DWP or GWP usage to the extent that a significant revenue reversal is not probable to occur. When consideration is subject to a customer termination right, the Company estimates the total transaction price using the most likely method, and defers consideration associated with the customer’s termination right until it expires.
The Company evaluates whether a significant financing component exists when the timing of revenue recognition occurs in advance of invoicing. This timing difference occurs when control of the software license is transferred at a point in time, usually at the contract onset, but the customer payments occur over time. A significant financing component generally does not exist under the Company’s standard contracting and billing practices. For example, the Company’s typical time-based licenses have a two-year initial term with the final payment due at the end of the first year.
Allocation of the transaction price to the performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on its standalone selling price (“SSP”) in relation to the total fair value of all performance obligations in the arrangement. The majority of the Company’s contracts contain multiple performance obligations, such as when licenses are sold with maintenance, implementation or training services. Some of the Company’s performance obligations, such as maintenance, implementation services, and training services, have observable inputs that are used to determine the SSP of those distinct

10


performance obligations. Where SSP is not directly observable, the Company determines the SSP using information that may include market conditions and other observable inputs. In the circumstances when available information to determine SSP is highly variable or uncertain, such as for our term licenses, the Company will use the residual method.
Recognition of revenue when, or as, the Company satisfies a performance obligation
The Company recognizes revenue when control of the services or products are transferred to the customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services or products. The Company is principally responsible for the satisfaction of its distinct performance obligations, which are satisfied either at a point in time or over a period of time.
Performance obligations satisfied at a point in time
On-premise software licenses
On-premise term and perpetual software licenses comprise the majority of distinct performance obligations that are satisfied at a point in time, and revenue is recognized at the point in which the on-premise software licenses are made available to customers. Consideration for on-premise software licenses is typically billed in advance on an annual basis over the license term.
Performance obligations satisfied over a period of time
Subscriptions, maintenance activities, and professional service arrangements comprise the majority of distinct performance obligations that are satisfied over a period of time.
Subscription arrangements
Revenue from subscription arrangements is recognized ratably over the subscription period using a time-based measure of progress as customers receive the benefits from their subscriptions over the contractually agreed-upon term. The Company’s subscription periods are generally three to five years. Consideration from subscription arrangements is typically billed in advance on an annual basis over the contract period.
Maintenance activities
Revenue from maintenance activities associated with on-premise licenses is a stand-ready obligation, and is recognized over the contractually agreed-upon term using a time-based measure of progress as customers receive benefits from the availability of support technicians over the support period. Consideration for maintenance activities is typically billed in advance on an annual basis. The Company’s maintenance activities are consistently priced as a percentage of the associated on-premise software license.
Services
Revenue from professional service arrangements is recognized over the respective service period as the underlying services are performed.
In substantially all of the Company’s professional service contracts, services are separately identifiable performance obligations for which related revenue and costs are recognized according to when each respective service obligation is delivered. Substantially all professional services engagements are billed and recognized on a time and materials basis. In select situations, the Company will contract professional services on a fixed fee basis, where the Company generally recognizes services revenue over time, using an input method. The measure of progress of the professional services being provided under these fixed fee arrangements is based on hours incurred compared to estimates of the total hours to complete the performance obligation.
When professional services are sold with an on-premise license or subscription arrangement, the Company evaluates whether the performance obligations are distinct or separately identifiable, or whether they constitute a single performance obligation. In the limited cases where professional services are not considered to be distinct from the on-premise license or subscription services, the Company will recognize revenue based on the nature of the combined performance obligation when control of the combined performance obligation is transferred to the customer.

11



Contract Costs

Contract costs consists of two components, customer acquisition costs and costs to fulfill a contract.

Customer acquisition costs are capitalized only if the costs are incrementally incurred to obtain a customer contract, and mainly consist of sales commissions paid to sales personnel and their related taxes. Capitalized customer acquisition costs related to software licenses, subscriptions, and support services are amortized over the anticipated period of time that such goods and services are expected to be provided to a customer, which the Company estimates to be approximately five years. Capitalized customer acquisition costs related to professional services are amortized over the expected term of the services that are to be provided. The amortization of customer acquisition costs are classified as sales and marketing expense in the condensed consolidated statement of operations.

Costs to fulfill a contract, or fulfillment costs, mainly consist of royalties payable to third-party software providers that support both the Company’s software offerings and support services. Fulfillment costs are only capitalized if they relate directly to a contract with a customer, the costs generate or enhance resources that will be used to satisfy performance obligations in the future, and the costs are expected to be recoverable. Fulfillment costs would be generally amortized over the same period of time as the customer acquisition costs. The amortization of fulfillment costs are classified as a cost of revenue.
Advertising Costs
Advertising costs are expensed as incurred and amounts incurred were not material during the three-month periods ended October 31, 2018 and 2017.
Stock-Based Compensation

The Company accounts for stock-based compensation using the fair value method, which requires the Company to measure 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 or assumed 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 is equal to 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 that 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 stock options and TSR PSUs are estimated at the grant date using the Black-Scholes model and Monte Carlo simulation method, respectively. The assumptions utilized under these methods require judgments and estimates. Changes in these inputs and assumptions could affect the measurement of the estimated fair value of the related compensation expense of these stock options and stock awards. Compensation expense associated with 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 estimates of the achievement of the performance conditions. All TSR PSUs will vest at the end of a three-year period.

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 and tax basis 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 the Company’s 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.

12


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; 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; acquisition-related expenses; and provisions under the Tax Cuts and Jobs Act (“Tax Act”), including a provision to tax global intangible low-taxed income of foreign subsidiaries, a special deduction for foreign-derived intangible income, and a base erosion anti-abuse tax that may tax certain payments between a U.S. corporation and its foreign subsidiaries.
The Company records interest and penalties related to unrecognized tax benefits as income tax expense in its condensed consolidated statement of operations.
Recently Adopted Accounting Pronouncements
Revenue from Contracts with Customers (Topic 606): Revenue Recognition
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASC 606, which supersedes the revenue recognition requirements in Accounting Standards Codification Topic 605, “Revenue Recognition” (“ASC 605”) as well as other industry-specific guidance. The core principle of ASC 606 is that an entity should recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services.
The Company adopted ASC 606 as of August 1, 2018 using the modified retrospective transition method and applied ASC 606 to those contracts that were not completed, as defined under ASC 606, as of August 1, 2018. The results for reporting periods beginning after August 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be presented under ASC 605. The main difference in reporting between ASC 605 and ASC 606 is that under ASC 606, the Company recognizes the revenue associated with term licenses not when payments 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, whereas under ASC 605, revenue associated with term software licenses was recognized over time in the earlier of the period in which the payments are due or are actually made because of extended payment terms. As a result, under ASC 606, all contractually obligated payments under a term license that the Company reasonably expects to collect would be recognized upon the transfer of control of the on-premise software licenses, which is generally when made available to a customer. Under ASC 606, costs to obtain a contract and costs to fulfill a contract are capitalized as an asset and amortized on a basis that is consistent with the pattern of transfer of performance obligations with which the asset relates. In contrast, under ASC 605, costs to obtain and costs to fulfill a contract were historically expensed as incurred.
The Company recorded a net increase to opening retained earnings of $35.6 million as of August 1, 2018 due to the cumulative impact of adopting ASC 606 using the modified retrospective method. The cumulative impact results from the differences between applying ASC 606 as opposed to applying ASC 605 to existing contracts that were not yet completed as of the date of initial adoption. For contracts completed before August 1, 2018, the Company does not retrospectively apply ASC 606 to the contracts.
Under ASC 606, contracts with customers are reflected in the condensed consolidated balance sheets as follows:

Accounts receivable, net represents amounts billed to customers in accordance with contract terms for which payment has not yet been received. It is presented net of the allowance for doubtful accounts as part of current assets on the condensed consolidated balance sheets.
Unbilled accounts receivable, net represents revenue recognized for performance on a portion of the contract in advance of receiving consideration as of the end of the reporting period. Under ASC 606, this balance represents our contract assets.
Contract costs include deferred commissions and their related taxes, royalties, and referral fees. The short-term portion is presented as prepaid and other current assets, and the long-term portion is presented as other assets.
Deferred costs represent costs related to our professional services that have been deferred to align with revenue recognition. The short-term portion is presented as prepaid and other current assets, and the long-term portion is presented as other assets.
Deferred revenue represents amounts received as consideration from the Company’s customers in advance of performance on a portion of the contract as of the end of the reporting period. Under ASC 606, this balance represents our contract liabilities.

13


The Company may receive consideration from its customers in advance of performance on a portion of the contract and, on another portion of the contract, perform in advance of receiving consideration. Contract assets and liabilities related to rights and obligations in a contract are interdependent and should be recorded net in the condensed consolidated balance sheets. Therefore, contract assets and liabilities are presented net at the contract level, as either a single contract asset or a single contract liability.
The following table summarizes the impact to the financial statement line items within the condensed consolidated balance sheets as a result of the initial adoption of ASC 606 (in thousands):
 
Balances reported as of July 31, 2018
 
Cumulative effect adjustment due to adoption of ASC 606
 
Adjusted beginning balance as of August 1, 2018
Unbilled accounts receivable, net
$

 
$
28,762

 
$
28,762

Contract costs

 
12,932

 
12,932

Deferred tax asset, net
87,482

 
(10,612
)
 
76,870

Prepaid expenses and other assets
53,035

 
(239
)
 
52,796

Other liabilities
21,054

 
7,055

 
28,109

Deferred revenue, net
137,896

 
(2,341
)
 
135,555

Retained earnings
133,505

 
35,558

 
169,063


The cumulative effect adjustment on unbilled accounts receivable is driven by revenue that is recognized in advance of billings under ASC 606. The Company’s on-premise software license arrangements result in revenue being recognized at the point in which the software license is transferred to customers, while agreed-upon contractual terms generally provide for billings to occur over a stated licensing period.
The cumulative effect adjustment on contract costs is driven by the requirement in ASC 606 to capitalize incremental, direct costs of either obtaining or fulfilling a contract. In prior periods, these costs were expensed as incurred under ASC 605.
The cumulative effect adjustment on deferred revenue is primarily driven by the requirement under ASC 606 to recognize revenue upfront rather than over the contract period as described in the paragraph above related to unbilled accounts receivable.
The following table summarizes the financial statement line items within the condensed consolidated balance sheets as of October 31, 2018 that were impacted as a result of the adoption of ASC 606 (in thousands):
 
As Reported
 
Change
 
As if presented under ASC 605
Unbilled accounts receivable, net
$
65,099

 
$
(65,099
)
 
$

Contract costs
13,579

 
(13,579
)
 

Deferred tax asset, net
80,811

 
27,516

 
108,327

Prepaid expenses and other assets
47,176

 
1,342

 
48,518

Other liabilities
12,261

 
7,776

 
20,037

Deferred revenue, net
107,435

 
36,019

 
143,454

Retained earnings
174,550

 
(89,434
)
 
85,116


The difference between the 'As Reported' amounts and the 'As if presented under ASC 605' amounts within the condensed consolidated balance sheets is due to the same considerations described above with respect to the transition adjustments as a result of the adoption of ASC 606.
The following table summarizes the financial statement line items within the condensed consolidated statement of operations that were impacted as a result of the adoption of ASC 606 for the three months ended October 31, 2018 (in thousands):

14


 
As Reported
 
Change
 
As if presented under ASC 605
Revenue:
 
 
 
 
 
License and subscription
$
94,269

 
$
(71,157
)
 
$
23,112

Maintenance
21,003

 
637

 
21,640

Services
64,411

 
(90
)
 
64,321

Total revenue
179,683

 
(70,610
)
 
109,073

Total cost of revenue
82,459

 
(42
)
 
82,417

Gross profit
97,224

 
(70,568
)
 
26,656

Total operating expenses
96,160

 
321

 
96,481

Income (loss) from operations
1,064

 
(70,889
)
 
(69,825
)
Other income (expense), net
1,118

 
108

 
1,226

Benefit from income taxes
(3,307
)
 
(16,908
)
 
(20,215
)
Net income (loss)
$
5,489

 
$
(53,873
)
 
$
(48,384
)
Net income (loss) per share
$
0.07

 
$
(0.67
)
 
$
(0.60
)

The difference between the 'As Reported' amounts and the 'As if presented under ASC 605' amounts within revenue is primarily due to term license fees for the entire committed term being recognized upfront as reported under ASC 606 rather than annually or ratably under ASC 605 and subscription arrangements with escalating annual fees that are recognized ratably over the committed term under ASC 606, rather than as escalating fees in each year under ASC 605, partially offset by the difference in revenue recognized associated with a fixed fee contract. Also, hosting fees associated with our subscriptions included as subscription revenue under ASC 606 instead of services revenue under ASC 605.
The impact to the condensed consolidated statements of cash flows for the three months ended October 31, 2018 as a result of adopting ASC 606 was not significant.
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 instruments. The Company adopted this standard beginning August 1, 2018, using the measurement alternative election, and the adoption did not result in a significant impact.
Recent Accounting Pronouncements Not Yet Adopted
Interim Disclosure Requirement: Changes in Stockholders’ Equity
In August 2018, the SEC issued SEC Final Rule 33-10532, Disclosure Update and Simplification, which requires public companies to disclose the changes in each caption of stockholders’ equity and non-controlling interests for the current and comparative year-to-date periods, with subtotals for each interim period and the amount of dividends per share for each class of shares. This rule is effective for interim periods, beginning after November 5, 2018, with early adoption permitted. The Company plans to make the new required disclosures starting with its fiscal quarter ending January 31, 2019.
Intangibles, Goodwill and Other (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract
In August 2018, the FASB issued ASU No. 2018-15, Intangibles, Goodwill and Other (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract (“ASU 2018-15”), which requires implementation costs incurred by customers in cloud computing arrangements to be deferred and recognized over the term of the arrangement, if those costs would be capitalized by the customer in a software licensing arrangement under the internal-use software guidance in ASC 350-40. ASU 2018-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019, with early adoption permitted. The Company will evaluate the impact of adopting the new standard for its 2021 fiscal year and subsequent periods.

15


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 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 2020 fiscal year and subsequent periods.
Leases (Topic 842): Accounting for Leases

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) and subsequent amendments to the initial guidance: ASU No. 2017-13, ASU No. 2018-10, and ASU No. 2018-11 (collectively, “ASC 842”), 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. ASC 842 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, and earlier adoption is permitted. The Company is evaluating the impact this update will have on its 2020 fiscal year and subsequent periods, and currently expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon our adoption of ASC 842, which will increase total assets and total liabilities that the Company reports relative to such amounts prior to adoption.

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.
Revenue

Disaggregation of Revenue
Revenue for the three months ended October 31, 2018 by revenue type and by geography is as follows (in thousands):
 
License and subscription
Maintenance
Services
Total
Geography:
 
 
 
 
United States
$
38,535

$
13,121

$
43,711

$
95,367

Canada
9,422

2,149

2,717

14,288

Other Americas
588

1,081

1,921

3,590

Total Americas
48,545

16,351

48,349

113,245

United Kingdom
8,487

1,131

2,700

12,318

Other EMEA
17,376

1,863

9,500

28,739

Total EMEA
25,863

2,994

12,200

41,057

Total APAC
19,861

1,658

3,862

25,381

Total revenue
$
94,269

$
21,003

$
64,411

$
179,683

Revenue for the three months ended October 31, 2018 by major product or service type is as follows (in thousands):
 
Total
 License and subscription
 
Term license
$
78,951

Subscription
15,318

Perpetual license

 Maintenance
21,003

 Services
64,411

 Total revenue
$
179,683


16


Customer Contract - Related Balance Sheet Amounts
The Company generally invoices customers in annual installments payable in advance. The difference between the timing of revenue recognition and the timing of billings and cash collections results in the recognition of unbilled accounts receivable and deferred revenue in the condensed consolidated balance sheets. Amounts related to customer contract - related arrangements are included on the condensed consolidated balance sheets as of August 1, 2018 and October 31, 2018 as follows (in thousands):
 
Beginning balance as of August 1, 2018 as adjusted
 
Ending balance as of October 31, 2018 as reported
Unbilled accounts receivable, net
$
28,762

 
$
65,099

Contract costs
12,932

 
13,579

Deferred revenue, net
135,555

 
84,792


Unbilled accounts receivable
Unbilled accounts receivable includes those amounts that are unbilled due to agreed-upon contractual terms in which billing occurs subsequent to revenue recognition. This situation typically occurs when the Company transfers control of time-based software licenses to customers up-front, but bills customers annually over the term of the license, which is typically two years. Unbilled accounts receivable is classified as either current or non-current based on the duration of remaining time between the date of the condensed consolidated balance sheets and the anticipated maturity date of the underlying receivables.
As of October 31, 2018, $2.4 million related to the Company's unbilled contract revenue balance as of August 1, 2018 became an unconditional right to payment and was billed to its customers.
Contract costs
Contract costs consist of customer acquisition costs and costs to fulfill a contract, which includes commissions and their related taxes, royalties, and referral fees. Contract costs are classified as either current or non-current based on the duration of time remaining between the date of the condensed consolidated balance sheets and the anticipated amortization date of the associated costs. The current portion of contract costs in the amount of $2.5 million is included in prepaid and other current assets on the Company’s condensed consolidated balance sheets. The non-current portion of contract costs in the amount of $11.1 million is included in other assets on the Company’s condensed consolidated balance sheets. The Company amortized $1.0 million of contract costs during the three months ended October 31, 2018.
Deferred revenue
Deferred revenue consists of amounts that have been invoiced and for which the Company has the right to bill, but that have not been recognized as revenue because the related goods or services have not been transferred. Deferred revenue that will be realized during the 12-month period following the date of the condensed consolidated balance sheets is recorded as current, and the remaining deferred revenue is recorded as non-current. During the three months ended October 31, 2018, the Company recognized revenue of $50.2 million related to the Company’s deferred revenue balance reported as of August 1, 2018.
Performance Obligations
Remaining performance obligations represent contracted revenue that has not yet been recognized, which includes deferred revenue and amounts that will be invoiced and recognized as revenue in future periods. The Company applied the practical expedient in accordance with ASC 606 to exclude amounts related to professional services contracts that are on a time and materials basis. The aggregate amount of consideration allocated to performance obligations either not satisfied or partially satisfied was $173.4 million as of October 31, 2018. Subscription services are typically satisfied over three to five years, maintenance services are generally satisfied within one year, and professional services are typically satisfied within one year.

17


3.
Fair Value of Financial Instruments
Available-for-sale investments within cash equivalents and investments consist of the following (in thousands):
 
October 31, 2018
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
U.S. Government agency securities
$
7,041

 
$

 
$
(28
)
 
$
7,013

Commercial paper
449,549

 
1

 
(179
)
 
449,371

Corporate bonds
488,531

 
58

 
(927
)
 
487,662

U.S. Government bonds
73,582

 

 
(20
)
 
73,562

Foreign government bonds
9,323

 

 
(7
)
 
9,316

Certificates of deposit
86,750

 
49

 
(9
)
 
86,790

Money market funds
65,610

 

 

 
65,610

     Total
$
1,180,386

 
$
108

 
$
(1,170
)
 
$
1,179,324

 
July 31, 2018
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
U.S. Government agency securities
$
9,000

 
$

 
$
(27
)
 
$
8,973

Commercial paper
471,966

 
4

 
(141
)
 
471,829

Corporate bonds
432,234

 
69

 
(763
)
 
431,540

U.S. Government bonds
89,986

 

 
(55
)
 
89,931

Foreign government bonds
9,306

 
7

 
(1
)
 
9,312

Certificate of deposit
81,985

 
53

 
(8
)
 
82,030

Money market funds
90,766

 

 

 
90,766

    Total
$
1,185,243

 
$
133

 
$
(995
)
 
$
1,184,381

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses, aggregated by investment category and the length of time that individual securities have been in an unrealized loss position (in thousands):
 
October 31, 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
U.S. Government agency securities
$
7,013

 
$
(28
)
 
$

 
$

 
$
7,013

 
$
(28
)
Commercial paper
449,371

 
(179
)
 

 

 
449,371

 
(179
)
Corporate bonds
357,408

 
(694
)
 
130,254

 
(233
)
 
487,662

 
(927
)
U.S. Government bonds
73,562

 
(20
)
 

 

 
73,562

 
(20
)
Foreign government bonds
5,221

 
(7
)
 
4,095

 

 
9,316

 
(7
)
Certificate of deposit
76,779

 
(9
)
 
10,011

 

 
86,790

 
(9
)
     Total
$
969,354

 
$
(937
)
 
$
144,360

 
$
(233
)
 
$
1,113,714

 
$
(1,170
)

As of October 31, 2018, the Company had 224 investments in a gross unrealized loss position. The unrealized losses on its available-for-sale securities were primarily a result of unfavorable changes in interest rates subsequent to the initial purchase of these securities. The Company does not intend to sell, nor does it believe it will need to sell, these securities before recovering the associated unrealized losses. The Company does not consider any portion of the unrealized losses at October 31, 2018 to be other-than-temporarily impaired, nor are any unrealized losses considered to be credit losses. The Company has recorded the securities

18


at fair value in its condensed consolidated balance sheets, with unrealized gains and losses reported as a component of accumulated other comprehensive income (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 (in thousands):
 
October 31, 2018
 
Less Than 12 Months
 
12 to 24 Months
 
Total
U.S. Government agency securities
$
7,013

 
$

 
$
7,013

Commercial paper
449,371

 

 
449,371

Corporate bonds
357,408

 
130,254

 
487,662

U.S. Government bonds
73,562

 

 
73,562

Foreign government bonds
5,221

 
4,095

 
9,316

Money market funds
65,610

 

 
65,610

Certificates of deposit
76,779

 
10,011

 
86,790

     Total
$
1,034,964

 
$
144,360

 
$
1,179,324

 
Fair Value Measurement
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.
    

19


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 (in thousands):
 
October 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
     Corporate bonds
$

 
$
1,148

 
$

 
$
1,148

     Commercial paper

 
274,941

 

 
274,941

     Money market funds
65,611

 

 

 
65,611

Total cash equivalents
65,611

 
276,089

 

 
341,700

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

 
7,013

 

 
7,013

     Commercial paper

 
174,431

 

 
174,431

     U.S. Government bonds

 
73,562

 

 
73,562

Foreign government bonds

 
5,221

 

 
5,221

     Corporate bonds

 
356,259

 

 
356,259

Certificates of deposit

 
76,779

 

 
76,779

Total short-term investments

 
693,265

 

 
693,265

Long-term investments:
 
 
 
 
 
 
 
Certificates of deposit

 
10,011

 

 
10,011

     Corporate bonds

 
130,253

 

 
130,253

Foreign government bonds

 
4,095

 

 
4,095

Total long-term investments

 
144,359

 

 
144,359

       Total
$
65,611

 
$
1,113,713

 
$

 
$
1,179,324



20


 
July 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Commercial paper
$

 
$
269,654

 
$

 
$
269,654

Corporate bonds

 
3,001

 

 
3,001

     Money market funds
90,766

 

 

 
90,766

Total cash equivalents
90,766

 
272,655

 

 
363,421

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

 
1,999

 

 
1,999

     Commercial paper

 
195,376

 

 
195,376

U.S. Government bonds

 
89,931

 

 
89,931

Foreign government bonds

 
4,448

 

 
4,448

     Corporate bonds

 
277,248

 

 
277,248

Certificate of deposit

 
61,006

 

 
61,006

Total short-term investments

 
630,008

 

 
630,008

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

 
6,974

 

 
6,974

     Certificate of deposit

 
21,024

 

 
21,024

     Corporate bonds

 
151,291

 

 
151,291

Commercial paper

 
6,799

 

 
6,799

Foreign government bonds

 
4,864

 

 
4,864

Total long-term investment

 
190,952

 

 
190,952

      Total
$
90,766

 
$
1,093,615

 
$

 
$
1,184,381


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 October 31, 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 condensed consolidated balance sheets. For further information on the Convertible Senior Notes, see Note 6.


21


4. Balance Sheet Components
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following (in thousands):
 
October 31, 2018
 
July 31, 2018
Prepaid expenses
$
11,807

 
$
14,704

Contract costs
2,477

 

Deferred costs
7,362

 
9,120

Deposits and other receivables
6,378

 
6,686

Prepaid expenses and other current assets
$
28,024

 
$
30,510

Property and Equipment, net
Property and equipment consist of the following (in thousands):
 
October 31, 2018
 
July 31, 2018
Computer hardware
$
24,711

 
$
24,879

Purchased software
4,757

 
4,664

Capitalized software development costs
3,920

 
3,978

Furniture and fixtures
4,487

 
4,217

Leasehold improvements
12,240

 
10,751

      Total property and equipment
50,115

 
48,489

Less accumulated depreciation
(31,084
)
 
(29,894
)
      Property and equipment, net
$
19,031

 
$
18,595

As of October 31, 2018 and July 31, 2018, no property and equipment was pledged as collateral. Depreciation expense, excluding the amortization of software development costs, was $1.9 million for each of the three months ended October 31, 2018 and 2017.
The Company capitalizes software development costs for technology applications that the Company will offer solely as cloud-based subscriptions, which is primarily comprised of compensation for employees who are directly associated with the software development projects. The Company begins amortizing the capitalized software development costs once the technology applications are available for general release over the estimated lives of the applications, generally three years. The Company recognized approximately $0.2 million in amortization expense in cost of revenue - license and subscription on the accompanying condensed consolidated statements of operations during the three months ended October 31, 2018. There was no such amortization during the three months ended October 31, 2017.
Other assets
Other assets consist of the following (in thousands):
 
 
October 31, 2018
 
July 31, 2018
Prepaid expenses
 
$
2,002

 
$
2,476

Contract costs
 
11,102

 

Deferred costs
 
8,955

 
9,377

Strategic investments
 
10,672

 
10,672

Other assets
 
$
32,731

 
$
22,525



22


The Company’s other assets include a strategic equity investment in a privately-held company. 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. In accordance with ASU 2016-01, the Company elected to measure this strategic investment at cost less impairment and adjusted for subsequent observable price changes. As of October 31, 2018 and July 31, 2018, there were no changes in the investment’s carrying value of $10.7 million.
Goodwill and Intangible Assets
Changes in the carrying amount of goodwill during the three months ended October 31, 2018 was as follows (in thousands):
Goodwill, July 31, 2018
$
340,877

Changes in carrying value

Goodwill, October 31, 2018
$
340,877

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

 
$
39,135

 
$
54,465

 
$
93,600

 
$
34,189

 
$
59,411

Customer contracts and related relationships
35,700

 
8,116

 
27,584

 
35,700

 
6,633

 
29,067

Partner relationships
200

 
57

 
143

 
200

 
52

 
148

Trademarks
2,500

 
357

 
2,143

 
2,500

 
268

 
2,232

Order backlog
8,700

 
4,689

 
4,011

 
8,700

 
3,904

 
4,796

Total intangible assets
$
140,700

 
$
52,354

 
$
88,346

 
$
140,700

 
$
45,046

 
$
95,654

Amortization expense was $7.3 million and $4.8 million for the three months ended October 31, 2018 and 2017, respectively. The aggregate amortization expense for existing intangible assets as of October 31, 2018, based on their current useful lives, is as follows (in thousands):
 
Future Amortization
Fiscal year ending July 31,
 
2019 (remainder of fiscal year)
$
21,804

2020
26,834

2021
19,965

2022
11,143

2023
3,799

Thereafter
4,801

     Total future amortization expense
$
88,346

Accounts Receivables
Accounts receivable, net consists of the following (in thousands):
Accounts receivable
$
86,228

Allowance for doubtful accounts
(1,300
)
Accounts receivable, net
$
84,928

Allowance for Doubtful Accounts

23


Changes in the allowance for doubtful accounts during the three months ended October 31, 2018 was as follows (in thousands):
Allowance for doubtful accounts as of July 31, 2018
$
1,062

Charges to bad debt and revenue reserves
238

Write-offs, net

Allowance for doubtful accounts as of October 31, 2018
$
1,300

Accrued Employee Compensation
Accrued employee compensation consists of the following (in thousands):
 
October 31, 2018
 
July 31, 2018
Bonus
$
8,169

 
$
31,273

Commission
689

 
7,287

Vacation
13,826

 
13,132

Salaries, payroll taxes and benefits
7,856

 
8,443

     Total accrued employee compensation
$
30,540

 
$
60,135

Accumulated Other Comprehensive Income (Loss)
Changes in accumulated other comprehensive loss by component during the three months ended October 31, 2018 were as follows (in thousands):
 
Foreign Currency Translation Adjustments
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Total
Balance as of July 31, 2018
$
(7,197
)
 
$
(551
)
 
$
(7,748
)
Foreign currency translation adjustments
(812
)
 

 
(812
)
Unrealized loss on available-for-sale securities

 
(200
)
 
(200
)
Tax effect

 
47

 
47

Balance as of October 31, 2018
$
(8,009
)
 
$
(704
)
 
$
(8,713
)

5. Net Income (Loss) Per Share
The following table sets forth the computation of the Company’s basic and diluted net income (loss) per share (in thousands, except share and per share amounts): 
 
Three Months Ended October 31,
 
2018
 
2017
Numerator:
 
 
 
   Net income (loss)
$
5,489

 
$
(8,914
)
Net income (loss) per share:
 
 
 
   Basic
$
0.07

 
$
(0.12
)
   Diluted
$
0.07

 
$
(0.12
)
Denominator:
 
 
 
Weighted average shares used in computing net income (loss) per share:
 
 
 
   Basic
80,821,227

 
75,187,430

     Weighted average effect of dilutive stock options
317,378

 

     Weighted average effect of dilutive stock awards
1,071,383

 

   Diluted
82,209,988

 
75,187,430


24


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 October 31,
 
2018
 
2017
Stock options to purchase common stock

 
545,470

Stock awards
497,069

 
2,556,366


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 income (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 October 31, 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 1.25% 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 Indenture, dated as of March 13, 2018, between the Company and U.S. Bank National Association, as trustee (the “Trustee”) (the “Base Indenture”), as amended and supplemented by the First Supplemental Indenture, dated as of March 13, 2018, between the Company and the Trustee (together with the Base Indenture, the “Indenture”). 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 1.25% per year, on March 15th and September 15th of each year, from 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 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 three 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 the Company provides notice of redemption. No sinking fund is provided for the Convertible Senior 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 Convertible Senior 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

25


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, unamortized debt discount and issuance costs of the Convertible Senior Notes was as follows (in thousands):
 
October 31, 2018
Principal
$
400,000

Less:


Unamortized debt discount
82,613

Debt issuance cost
9,273

Net carrying amount
$
308,114

    

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

 
Three Months Ended October 31,
Contractual interest expense
$
1,250,000

Amortization of debt discount
255,000

Amortization of debt issuance costs
2,731,000

Total
$
4,236,000

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 Convertible Senior 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, 2018. See the Annual Report on Form 10-K for the fiscal year ended July 31, 2018 for additional information regarding the Company’s contractual obligations.

Leases

26


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 the terms of the various leases, was $2.4 million and 1.9 million for the three months ended October 31, 2018 and 2017, respectively.
In December 2017, the Company entered into a new lease agreement for its 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 are $126.7 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 October 31, 2018 or July 31, 2018. The Company expenses legal fees in the period in which they are incurred.
Indemnification
The Company sells software licenses and services to its customers under contracts (“Software Licenses”). Each Software License contains the terms of the contractual arrangement with the customer and generally includes certain provisions for defending the customer against any claims that the Company’s software infringes upon a patent, copyright, trademark, or other proprietary right of a third party. Software Licenses also indemnify the customer against losses, expenses, and liabilities from damages that may be assessed against the customer in the event the Company’s software is found to infringe upon such third-party rights.
The Company has not had to reimburse any of its customers for losses related to indemnification provisions and no material claims against the Company were outstanding as of October 31, 2018 or July 31, 2018. 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.


27


8. Stock-Based Compensation Expense and Shareholders’ Equity
Stock-Based Compensation Expense
Stock-based compensation expense related to options and Stock Awards is included in the Company’s condensed consolidated statements of operations as follows (in thousands):
 
Three Months Ended October 31,
 
2018
 
2017
Total stock-based compensation
$
23,210

 
$
19,614

Net impact of deferred stock-based compensation
123

 
9

 Total stock-based compensation expense
$
23,333

 
$
19,623

Stock-based compensation expense was charged to the following categories:
 
 
 
 Cost of license and subscription revenue
$
334

 
$
174

 Cost of maintenance revenue
534

 
455

 Cost of services revenue
5,968

 
5,226

 Research and development
6,404

 
4,912

 Sales and marketing
4,621

 
4,217

 General and administrative
5,472

 
4,639

 Total stock-based compensation expense
$
23,333

 
$
19,623


Total unrecognized stock-based compensation cost for our options and Stock Awards were as follows:
 
 As of October 31, 2018
 
Unrecognized Expense
 
Weighted Average Expected Recognition Period
 
(in thousands)
 
(in years)
Stock Options
$
4,881

 
2.1
Stock Awards
221,699

 
2.6
 
$
226,580

 
 

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, 2018
2,932,155

 
$
69.43

 
$
252,752

Granted
955,237

 
$
102.38

 

Released
(490,740
)
 
$
69.31

 
$
50,471

Canceled
(122,287
)
 
$
79.94

 

Balance as of October 31, 2018
3,274,365

 
$
80.01

 
$
291,320

Expected to vest as of October 31, 2018
3,274,365

 
$
80.01

 
$
291,320

(1)
Aggregate intrinsic value at each period end represents the total market value of Stock Awards at the Company’s closing stock price of $88.97 and $86.20 on October 31, 2018 and July 31, 2018, respectively. Aggregate intrinsic value for released Stock Awards represents the total market value of released Stock Awards at date of release.

28


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. The weighted average grant date fair value is based on the market value of our common stock on the date of grant.
The Company recognized stock-based compensation of $3.7 million and $3.0 million that were related to these performance-based and market-based stock awards for the three months ended October 31, 2018 and 2017, respectively.

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, 2018
537,064

 
$
21.45

 
4.3
 
$
34,774

Granted

 
 
 
 
 
 
Exercised
(74,698
)
 
$
9.26

 
 
 
$
6,511

Canceled
(3,080
)
 
 
 
 
 
 
Balance as of October 31, 2018
459,286

 
$
23.51

 
4.3
 
$
30,067

Vested and expected to vest as of October 31, 2018
459,286

 
$
23.51

 
4.3
 
$
30,067

Exercisable as of October 31, 2018
384,501

 
$
25.78

 
3.6
 
$
24,295

(1) 
Aggregate intrinsic value at each period end represents the difference between the Company’s closing stock prices of $88.97 and $86.20 on October 31, 2018 and July 31, 2018, respectively, and the exercise price of outstanding options. Aggregate intrinsic value for exercised options represents the difference between the Company’s stock price at date of exercise and the exercise price.
Valuation of Awards
    
TSR PSUs
    
The fair values of our TSR PSUs were estimated at the date of grant using the Monte Carlo simulation model which included the following assumptions:
 
Three Months Ended October 31,
 
2018
 
2017
Expected term (in years)
2.88
 
2.88
Risk-free interest rate
2.8%
 
1.4%
Expected volatility of the Company
27.2%
 
28.0%
Average expected volatility of the peer companies in the S&P Index
33.0%
 
34.7%
Expected dividend yield
—%
 
—%

The number of TSR PSUs that may ultimately vest will vary based on the relative performance of the Company’s total shareholder return rankings relative to the software companies in the S&P Index for a specified performance period or specified performance periods. The Monte Carlo methodology incorporates into the valuation all possible outcomes, including that the Company’s relative performance may result in no shares vesting. As a result, stock-based compensation expense is recognized

29


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 and Public Equity Offering
As of October 31, 2018 and July 31, 2018, 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, 81,009,507 and 80,611,698 shares of common stock were issued and outstanding, respectively. As of October 31, 2018 and July 31, 2018, the Company had reserved shares of common stock for future issuance as follows:
 
October 31, 2018
 
July 31, 2018
 Exercise of stock options to purchase common stock
459,286

 
537,064

 Vesting of stock awards
3,274,365

 
2,932,155

 Shares available under stock plans
20,713,656

 
21,592,494

      Total common stock reserved for issuance
24,447,307

 
25,061,713


In March 2018, the Company completed a public offering of 2,628,571 shares of its common stock, including the sale of shares in connection with 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.

9. Income Taxes
The Company recognized an income tax benefit of $3.3 million and $22.2 million for the three months ended October 31, 2018 and 2017, respectively. The decrease in tax benefit for the three months ended October 31, 2018 compared to the same period a year ago was due to an income position before income taxes in the current period compared to a loss position before income taxes for the same period a year ago. The effective tax rate of (152)% for the three months ended October 31, 2018, differs from the statutory U.S. federal income tax rate of 21% 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, and certain non-deductible expenses including executive compensation.
During the three months ended October 31, 2018, unrecognized tax benefits increased by $0.3 million. As of October 31, 2018, the Company had unrecognized tax benefits of $5.6 million that, if recognized, would affect the Company’s effective tax rate.
 
On December 22, 2017, the Tax Act was enacted into law which substantially changed U.S. tax law, including a reduction in the U.S. corporate income tax rate to 21% effective January 1, 2018 and several provisions that may impact the Company in current and future periods.
The Tax Act includes a provision to tax global intangible low-taxed income (“GILTI”) of foreign subsidiaries, a special deduction for foreign-derived intangible income, and a base erosion anti-abuse tax measure that taxes certain payments between a U.S. corporation and its foreign subsidiaries. Under U.S. GAAP, the Company can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into its measurement of deferred taxes. The Company has elected the current period expense method. These provisions of the Tax Act became effective for the Company beginning on August 1, 2018 and had no impact on the tax benefit for the three months ended October 31, 2018.
The Internal Revenue Service and the U.S. Treasury Department may issue guidance or an interpretation of the Tax Act that is different from the Company’s interpretation. As additional guidance is issued, the Company may need to revise its estimates in future periods.

30


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 revenue information for the Company’s term license, perpetual license, subscription, maintenance, and 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.
Revenue by country and region based on the billing address of the customer is as follows (in thousands):
 
 
Three Months Ended October 31,
 
 
2018
 
2017
United States
 
$
95,367

 
$
69,834

Canada
 
14,288

 
10,195

Other Americas
 
3,590

 
4,742

Total Americas
 
113,245

 
84,771

United Kingdom
 
12,318

 
9,337

Other EMEA
 
28,739

 
6,624

Total EMEA
 
41,057

 
15,961

Total APAC
 
25,381

 
7,439

Total revenue
 
$
179,683

 
$
108,171


No country or region, other than those presented above, accounted for more than 10% of revenue during the three months ended October 31, 2018 and 2017.
The Company’s long-lived assets, including intangibles and goodwill, net by geographic region is as follows (in thousands):
 
October 31, 2018
 
July 31, 2018
Americas
$
442,075

 
$
449,588

EMEA
6,124

 
5,491

APAC
55

 
47

Total
$
448,254

 
$
455,126


31


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 provide a technology platform, composed of software, services, and a partner ecosystem, for the global Property and Casualty (“P&C”) insurance industry.
Guidewire InsurancePlatformTM consists of cloud and on-premise 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 (PolicyCenter, BillingCenter, and ClaimCenter) 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. 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 license and maintenance fees are typically invoiced annually in advance. Substantially all term licenses are sold with an initial two-year committed term, with optional annual renewals commencing after the initial term. A small portion of our revenue is derived from perpetual licenses. Term and perpetual license revenue is typically recognized when software is made available to the customer, provided that all revenue recognition criteria have been met.
We also offer cloud-based subscriptions. Generally, these subscriptions have an initial term of three to five years, and are typically billed annually in advance, although in some instances additional fees may be assessed in arrears as customers increase their DWP. Revenue 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 is made available to customers. We anticipate that sales of subscriptions will increase as a percentage of annual new sales as we sell more cloud-based services. As a result of the ratable recognition of revenue 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.

32


To extend our technology leadership in the global market, we continue to invest in product development and cloud operations 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 obtain their IT goals, maintain our competitive advantage, grow our revenue, 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 allow 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. The results of Cyence’s operations have been included in our results of operations since November 1, 2017, the date of acquisition.
Seasonality
We have historically experienced seasonal variations in our license and subscription revenue 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 ending July 31, due to efforts by our sales team to achieve annual incentives. This seasonal pattern, however, may be absent in any given year. Additionally, the adoption of ASC 606 could heighten or change the seasonal impact on our new term licenses that are multi-year in nature with more revenue recognized upfront upon delivery of our software. For example, in the first quarter of fiscal year 2019, we experienced license revenue growth due to the remediation of contracts in anticipation of the transition to ASC 606 and a 10-year term license deal under which revenue was recognized upfront under ASC 606, which will mask our usual positive seasonal impact in our second quarter of fiscal year 2019. On an annual basis, our maintenance revenue which is recognized ratably, may also be impacted in the event that seasonal patterns change significantly. Additionally, as subscriptions increase as a percentage of total sales, the revenue we can recognize in the initial fiscal year of the order will be reduced, deferred revenue will increase, and our reported revenue growth will be adversely affected due to the ratable nature of these arrangements. The seasonal nature of our sales and the concentration of such sales in our fiscal fourth quarter increases this impact.
Our services revenue is also subject to seasonal fluctuations, though to a lesser degree than our license revenue. Our services revenue is impacted by the number of billable days in a given fiscal quarter. The quarter ending January 31 usually has fewer billable days due to the impact of the Thanksgiving, Christmas, and New Year’s holidays. The fiscal quarter ending July 31 usually has fewer billable days due to the impact of vacation times taken by our professional staff. Because we pay our services professionals the same amount throughout the year, our gross margins on our services revenue is usually lower in these quarters. This seasonal pattern, however, may be absent in any given year.

33



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 1.25% 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 issuance costs, we received 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. We present select United States Generally Accepted Accounting Principles (“U.S. 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 operating cash flows and capital expenditures.
Operating Cash Flows and Capital Expenditures
We monitor our cash flows from operating activities and cash used for capital expenditures, as a key measure of our overall business performance, which enables us to analyze our financial performance without the effects of certain non-cash items such as depreciation, amortization and stock-based compensation expenses. Additionally, operating cash flows take into account the impact of changes in deferred revenue, which reflects the receipt of cash payment for products before they are recognized as revenue, and unbilled accounts receivable, which reflects revenue that has been recognized that has yet to be invoiced to our customers. Our operating cash flows are significantly impacted by the timing of invoicing and collections of accounts receivable, the amount of annual bonus payments, as well as payments for payroll and other taxes. As a result, our operating cash flows fluctuate significantly on a quarterly and annual basis. Cash used in our operations were $27.2 million and $31.2 million for the three months ended October 31, 2018 and 2017, respectively. Additionally, cash used for capital expenditures was $3.4 million and $2.4 million for the three months ended October 31, 2018 and 2017, respectively. Our capital expenditures consisted of purchases of property and equipment, most of which was computer hardware, software, capitalized software development costs, and leasehold improvements. For a further discussion of our operating cash flows, see “Liquidity and Capital Resources - Cash Flows.”
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. Accounting policies, methods, and estimates are an integral part of the preparation of condensed consolidated financial statements in accordance with U.S. GAAP and, in part, are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the condensed consolidated financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. While there are a number of accounting policies, methods, and estimates affecting our condensed consolidated financial statements, which are described in Note 1 “The Company and Summary of Significant Accounting Policies and Estimates” to our condensed consolidated financial statements, areas that are particularly significant include:
Revenue recognition policies; and
Business combinations.
While we continue to evaluate our significant accounting policies to determine which ones involve the most judgment and complexity, aside from revenue recognition, as described herein, there have been no changes to our business combinations or other significant accounting policies as described in our Annual Report on Form 10-K for the fiscal year ended July 31, 2018 that have had a material impact on our condensed consolidated financial statements and related notes.
During our first fiscal quarter of 2019, we adopted ASC 606 using the modified retrospective method. The net cumulative effect adjustment of $35.6 million was recorded to our retained earnings balance as of August 1, 2018. Revenue recognition requires judgment and the use of estimates, especially in identifying and evaluating the various terms and conditions in our contracts with customers as to their effect on reported revenue under ASC 606. Our new revenue policy as a result of the adoption of ASC 606 is as follows:
Revenue Recognition

34


Our revenue is derived from contracts with customers. The majority of our revenue is derived from licensing arrangements that can span multiple years, and implementation and other professional services arrangements. On August 1, 2018, we adopted ASC 606 using the modified retrospective method. Refer to our Annual Report on Form 10-K for the fiscal year ended July 31, 2018 for a description of our revenue recognition policy prior to August 1, 2018. The core principle of ASC 606 is to recognize revenue upon the transfer of services or products to customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services or products. We apply the following framework to recognize revenue:
Identification of the contract, or contracts, with the customer
We consider the terms and conditions of written contracts and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the contract is approved, we can identify each party’s rights regarding the services and products to be transferred, we can identify the payment terms for the services and products, we have determined that the customer has the ability and intent to pay, and the contract has commercial substance. In general, contract terms will be reflected in a written document that is signed by both parties. At contract inception, we evaluate whether two or more contracts should be combined and accounted for as a single contract. We also evaluate the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer.
Identification of the performance obligation in the contract
Performance obligations promised in a contract are identified based on the services or products that will be transferred to the customer that are both:
i.
capable of being distinct, whereby the customer can benefit from the service or product either on its own or together with other resources that are readily available from third parties or from our own services or products, and
ii.
distinct in the context of the contract, whereby the transfer of the services or products is separately identifiable from other promises in the contract.
To the extent a contract includes multiple promised services or products, we apply judgment to determine whether promised services or products are capable of being distinct and distinct in the context of the contract. If these criteria are not met, the promised services or products are accounted for as a combined performance obligation.
We generate revenue from the following sources, which represents our performance obligations:
i.
On-premise software licenses related to term or perpetual agreements;
ii.
Maintenance activities that consist of email and phone support, bug fixes and unspecified software updates and upgrades released when, and if, available during the maintenance term;
iii.
Subscription services related to our Software-as-a-Service (“SaaS”) offerings; and
iv.
Services related to the implementation and configuration of our software, reimbursable travel, and training.
Term licenses generally have a two-year initial term with a customer option to renew on an annual basis after the initial term. The related maintenance for term licenses follow the same contract periods. Subscriptions are typically sold with a three- to five- year initial term with a customer option to renew on an annual basis after the initial term. Professional services typically are time and materials contracts that last for a period of approximately one year.
Determination of the transaction price
The transaction price is determined based on the consideration to which we expect to be entitled in exchange for transferring services and products to our customer. Variable consideration is estimated and included in the transaction price if, in our judgment, it is probable that there will not be a significant future reversal of cumulative revenue under the contract.
On-premise software licenses and subscription services may be subject to either fixed or variable installments. Variable installments are generally subject to changes in a customer’s DWP or a customer’s Gross Written Premium (“GWP”). When consideration is subject to variable installments, we estimate variable consideration using the expected value method based on historical DWP or GWP usage to the extent that a significant revenue reversal is not probable to occur. When consideration is subject to a customer termination right, we estimate the total transaction price using the most likely method, and defer consideration associated with the customer’s termination right until it expires.

35


We evaluate whether a significant financing component exists when the timing of revenue recognition occurs in advance of invoicing. This timing difference occurs when control of the software license is transferred at a point in time, usually at the contract onset, but the customer payments occur over time. A significant financing component generally does not exist under our standard contracting and billing practices. For example, our typical time-based licenses have a two-year initial term with the final payment due at the end of the first year.
Allocation of the transaction price to the performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on its standalone selling price (“SSP”) in relation to the total fair value of all performance obligations in the arrangement. The majority of our contracts contain multiple performance obligations, such as when licenses are sold with maintenance, implementation or training services. Some of our performance obligations, such as maintenance, implementation services, and training services, have observable inputs that are used to determine the SSP of those distinct performance obligations. Where SSP is not directly observable, we determine the SSP using information that may include market conditions and other observable inputs. In the circumstances when available information to determine SSP is highly variable or uncertain, such as for our term licenses, we use the residual method.
Recognition of revenue when, or as, the Company satisfies a performance obligation
We recognize revenue when control of the services or products are transferred to the customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those services or products. We are principally responsible for the satisfaction of our distinct performance obligations, which are satisfied either at a point in time or over a period of time.
Performance obligations satisfied at a point in time
On-premise software licenses
On-premise term and perpetual software licenses comprise the majority of distinct performance obligations that are satisfied at a point in time, and revenue is recognized at the point in which the on-premise software licenses are made available to customers. Consideration for on-premise software licenses is typically billed in advance on an annual basis over the license term.
Performance obligations satisfied over a period of time
Subscriptions, maintenance activities, and professional service arrangements comprise the majority of distinct performance obligations that are satisfied over a period of time.
Subscription arrangements
Revenue from subscription arrangements is recognized ratably over the subscription period using a time-based measure of progress as customers receive the benefits from their subscriptions over the contractually agreed-upon term. Our subscription periods are generally three to five years. Consideration from subscription arrangements is typically billed in advance on an annual basis over the contract period.
Maintenance activities
Revenue from maintenance activities associated with on-premise licenses is a stand-ready obligation, and is recognized over the contractually agreed-upon term using a time-based measure of progress as customers receive benefits from the availability of support technicians over the support period. Consideration for maintenance activities is typically billed in advance on an annual basis. Our maintenance activities are consistently priced as a percentage of the associated on-premise software license.
Services
Revenue from professional service arrangements is recognized over the respective service period as the underlying services are performed.

36


In substantially all of our professional service contracts, services are separately identifiable performance obligations for which related revenue and costs are recognized according to when each respective service obligation is delivered. Substantially all professional services engagements are billed and recognized on a time and materials basis. In select situations, we will contract professional services on a fixed fee basis, where we generally recognize services revenue over time, using an input method. The measure of progress of the professional services being provided under these fixed fee arrangements is based on hours incurred compared to estimates of the total hours to complete the performance obligation.
When professional services are sold with an on-premise license or subscription arrangement, we evaluate whether the performance obligations are distinct or separately identifiable, or whether they constitute a single performance obligation. In the limited cases where professional services are not considered to be distinct from the on-premise license or subscription services, we will recognize revenue based on the nature of the combined performance obligation when control of the combined performance obligation is transferred to the customer.

Contract Costs

Contract costs consists of two components, customer acquisition costs and costs to fulfill a contract.

Customer acquisition costs are capitalized only if the costs are incrementally incurred to obtain a customer contract, and mainly consist of sales commissions paid to sales personnel and their related taxes. Capitalized customer acquisition costs related to software licenses, subscriptions, and support services are amortized over the anticipated period of time that such goods and services are expected to be provided to a customer, which we estimate to be approximately five years. Capitalized customer acquisition costs related to professional services are amortized over the expected term of the services that are to be provided. The amortization of customer acquisition costs are classified as sales and marketing expense in the condensed consolidated statement of operations.

Costs to fulfill a contract, or fulfillment costs, mainly consist of royalties payable to third-party software providers that support both of our software offerings and support services. Fulfillment costs are only capitalized if they relate directly to a contract with a customer, the costs generate or enhance resources that will be used to satisfy performance obligations in the future, and the costs are expected to be recoverable. Fulfillment costs are generally amortized over the same period of time as the customer acquisition costs. The amortization of fulfillment costs are classified as a cost of revenue.

37


Results of Operations
The following tables set forth our results of operations for the periods presented. The data has been derived from the unaudited condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly present the financial position and results of operations for the interim periods presented. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2018, filed with the Securities and Exchange Commission (the “SEC”) on September 19, 2018.
 
Three Months Ended October 31,
 
2018
 
As a % of total revenue
 
2017
 
As a % of total revenue
 
(in thousands)
Revenue:
 
 
 
 
 
 
 
License and subscription
$
94,269

 
52
 %
 
$
30,093

 
28
 %
Maintenance
21,003

 
12

 
18,930

 
18

Services
64,411

 
36

 
59,148

 
54

Total revenue
179,683

 
100

 
108,171

 
100

Cost of revenue:
 
 
 
 
 
 
 
License and subscription
13,330

 
7

 
6,715

 
6

Maintenance
3,868

 
2

 
3,467

 
3

Services
65,261

 
37

 
52,712

 
49