GWRE - 4.30.2014 - 10Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________________
FORM 10-Q
______________________________________________________________
(Mark one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2014
OR
¨  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             .
Commission file number: 001-35394
 ______________________________________________________________
Guidewire Software, Inc.
(Exact name of registrant as specified in its charter)
 ______________________________________________________________
Delaware
36-4468504
(State or other jurisdiction of
Incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
1001 E. Hillsdale Blvd., Suite 800
Foster City, California
94404
(Address of principal executive offices)
(Zip Code)
 
(650) 357-9100
(Registrant’s telephone number, including area code)
 ______________________________________________________________
N/A
(Former name, former address and former fiscal year, if changed since last report)
 ______________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x    No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes x     No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
 
x
 
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (do not check if a smaller reporting company)
 
Smaller reporting company        
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨     No x
On April 30, 2014, the registrant had 68,557,084 shares of common stock issued and outstanding.


Table of Contents

Guidewire Software, Inc.
Index

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


Table of Contents

FORWARD-LOOKING STATEMENTS

The “Management's Discussion and Analysis of Financial Condition and Results of Operations” section and other parts of this Quarterly Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, which are subject to risks and uncertainties. The forward-looking statements include statements concerning, among other things, our business strategy (including anticipated trends and developments in, and management plans for, our business and the markets in which we operate), financial results, operating results, revenues, gross margins, operating expenses, products, projected costs and capital expenditures, research and development programs, sales and marketing initiatives and competition. In some cases, you can identify these statements by forward-looking words, such as “will,” “may,” “might,” “should,” “could,” “estimate,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan” and “continue,” the negative or plural of these words and other comparable terminology. Actual events or results may differ materially from those expressed or implied by these statements due to various factors, including but not limited to the matters discussed below, in the section titled “Item 1A. Risk Factors,” and elsewhere in this Quarterly Report on Form 10-Q. Many of the forward-looking statements are located in “Management's Discussion and Analysis of Financial Condition and Results of Operations.” Examples of forward-looking statements include statements regarding:
growth prospects of the Property & Casualty (“P&C”) insurance industry and our company;
trends in our future sales, including seasonality;
opportunities for growth by technology leadership;
competitive advantages of our platform of software application solutions;
our market strategy in relation to our competitors;
competitive attributes of our software application solutions;
opportunities to further expand our position outside of the United States;
risk of exposure to product liability;
our research and development investment and efforts;
satisfying our future liquidity requirements;
our gross margins and factors that affect gross margins;
our provision for tax liabilities and other critical accounting estimates;
our exposure to market risks; and
future payments required pursuant to lease agreements and commitments.

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. All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements.

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

_____________

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





Table of Contents

PART I – Financial Information
 
ITEM 1.
Financial Statements (unaudited)
GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands)
 
 
April 30,
2014
 
July 31,
2013
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
159,336

 
$
79,767

Short-term investments
271,033

 
76,932

Accounts receivable
58,319

 
40,885

Deferred tax assets, current
2,917

 
2,897

Prepaid expenses and other current assets
11,589

 
9,612

Total current assets
503,194

 
210,093

Long-term investments
169,780

 
51,040

Property and equipment, net
12,459

 
12,914

Intangible assets, net
5,799

 
6,879

Deferred tax assets, noncurrent
31,786

 
21,091

Goodwill
9,205

 
9,048

Other assets
1,485

 
1,205

TOTAL ASSETS
$
733,708

 
$
312,270

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
6,418

 
$
6,517

Accrued employee compensation
24,214

 
26,302

Deferred revenues, current
52,746

 
37,351

Other current liabilities
5,088

 
4,614

Total current liabilities
88,466

 
74,784

Deferred revenues, noncurrent
5,552

 
3,845

Other liabilities
4,695

 
5,212

Total liabilities
98,713

 
83,841

STOCKHOLDERS’ EQUITY:
 
 
 
Common stock
7

 
6

Additional paid-in capital
657,027

 
237,769

Accumulated other comprehensive loss
(1,386
)
 
(1,558
)
Accumulated deficit
(20,653
)
 
(7,788
)
Total stockholders’ equity
634,995

 
228,429

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
733,708

 
$
312,270

See accompanying Notes to Condensed Consolidated Financial Statements.

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GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except share and per share amounts)
 
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
License
$
31,927

 
$
22,918

 
$
86,012

 
$
74,482

Maintenance
10,440

 
9,110

 
29,969

 
27,690

Services
39,668

 
36,222

 
116,058

 
101,567

Total revenues
82,035

 
68,250

 
232,039

 
203,739

Cost of revenues:
 
 
 
 
 
 
 
License
845

 
139

 
3,394

 
436

Maintenance
2,238

 
2,079

 
6,192

 
5,430

Services
34,259

 
33,774

 
106,397

 
89,071

Total cost of revenues
37,342

 
35,992

 
115,983

 
94,937

Gross profit:
 
 
 
 
 
 
 
License
31,082

 
22,779

 
82,618

 
74,046

Maintenance
8,202

 
7,031

 
23,777

 
22,260

Services
5,409

 
2,448

 
9,661

 
12,496

Total gross profit
44,693

 
32,258

 
116,056

 
108,802

Operating expenses:
 
 
 
 
 
 
 
Research and development
20,634

 
16,854

 
58,444

 
47,503

Sales and marketing
17,968

 
11,915

 
53,871

 
36,680

General and administrative
9,489

 
7,851

 
27,567

 
23,962

Total operating expenses
48,091

 
36,620

 
139,882

 
108,145

Income (loss) from operations
(3,398
)
 
(4,362
)
 
(23,826
)
 
657

Interest income, net
415

 
137

 
919

 
359

Other income (expense), net
190

 
(268
)
 
372

 
(104
)
Income (loss) before benefit from income taxes
(2,793
)
 
(4,493
)
 
(22,535
)
 
912

Benefit from income taxes
(1,435
)
 
(1,823
)
 
(9,670
)
 
(2,366
)
Net income (loss)
$
(1,358
)
 
$
(2,670
)
 
$
(12,865
)
 
$
3,278

Earnings (loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.02
)
 
$
(0.05
)
 
$
(0.20
)
 
$
0.06

Diluted
$
(0.02
)
 
$
(0.05
)
 
$
(0.20
)
 
$
0.05

Shares used in computing earnings (loss) per share:
 
 
 
 
 
 
 
Basic
68,261,964

 
57,017,856

 
64,718,852

 
55,887,786

Diluted
68,261,964

 
57,017,856

 
64,718,852

 
61,732,623

See accompanying Notes to Condensed Consolidated Financial Statements.

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

 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Net income (loss)
$
(1,358
)
 
$
(2,670
)
 
$
(12,865
)
 
$
3,278

Other comprehensive income (loss):
 
 
 
 
 
 
 
      Foreign currency translation adjustments
546

 
(214
)
 
109

 
(215
)
      Unrealized gains on available-for-sale securities, net of tax of $10 and $0; $42 and $0
58

 
38

 
102

 
58

      Reclassification adjustment for gains realized on available-for-sale securities, included in net income (loss)
(19
)
 

 
(39
)
 

Other comprehensive income (loss)
585

 
(176
)
 
172

 
(157
)
Comprehensive income (loss)
$
(773
)
 
$
(2,846
)
 
$
(12,693
)
 
$
3,121

See accompanying Notes to Condensed Consolidated Financial Statements

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GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
 
Nine Months Ended April 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
(12,865
)
 
$
3,278

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
4,978

 
3,182

Stock-based compensation
47,520

 
28,430

Excess tax benefit from exercise of stock options and vesting of RSUs
(498
)
 
(323
)
Deferred taxes
(10,712
)
 
(4,779
)
Other noncash items affecting net income (loss)
2,227

 
272

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(17,820
)
 
(15,949
)
Prepaid expenses and other assets
(2,187
)
 
403

Accounts payable
135

 
700

Accrued employee compensation
(2,279
)
 
(5,049
)
Other liabilities
382

 
1,959

Deferred revenues
17,172

 
(4,012
)
Net cash provided by operating activities
26,053

 
8,112

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of available-for-sale securities
(521,005
)
 
(170,513
)
Sales and maturities of available-for-sale securities
206,046

 
57,256

Purchase of property and equipment
(3,669
)
 
(7,061
)
Acquisition of business, net of cash acquired
(157
)
 

Decrease in restricted cash

 
3,520

Net cash used in investing activities
(318,785
)
 
(116,798
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock upon exercise of stock options
7,354

 
7,964

Taxes remitted on RSU awards vested
(25,654
)
 
(14,695
)
Proceeds from issuance of common stock in connection with public offering, net of underwriting discounts and commissions
389,949

 

Costs paid in connection with public offerings
(408
)
 

Excess tax benefit from exercise of stock options and vesting of RSUs
498

 
323

Net cash provided by (used in) financing activities
371,739

 
(6,408
)
Effect of foreign exchange rate changes on cash and cash equivalents
562

 
(94
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
79,569

 
(115,188
)
CASH AND CASH EQUIVALENTS—Beginning of period
79,767

 
205,718

CASH AND CASH EQUIVALENTS—End of period
$
159,336

 
$
90,530

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
2,036

 
$
1,569

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Accruals for purchase of property and equipment
$
409

 
$
953

See accompanying Notes to Condensed Consolidated Financial Statements.

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

1.
The Company and Summary of Significant Accounting Policies and Estimates
Business
Guidewire Software, Inc., a Delaware corporation, was incorporated on September 20, 2001. Guidewire Software, Inc., together with its subsidiaries (the “Company”), provides Internet-based software platforms for core insurance operations, including underwriting and policy administration, claim management and billing. The Company’s customers include insurance carriers for property and casualty and workers’ compensation insurance. The Company has wholly-owned subsidiaries in Australia, Canada, China, France, Germany, Hong Kong, Ireland, Italy, Japan, Poland and the United Kingdom.
The Company offers a suite of applications to enable core property and casualty (“P&C”) insurance operations comprised of the following products: PolicyCenter, ClaimCenter and BillingCenter. The Company also provides maintenance support and provides professional services to the extent requested by its customers.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements and accompanying notes include the Company and its wholly-owned subsidiaries, and reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for a fair presentation of the interim periods presented. All inter-company balances and transactions have been eliminated in consolidation. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted under the rules and regulations of the Securities and Exchange Commission (“SEC”).
These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s audited 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, 2013. There have been no changes in the Company’s significant accounting policies from those that were disclosed in the Company’s audited consolidated financial statements for the fiscal year ended July 31, 2013 included in the Company’s Annual Report on Form 10-K.
Use of Estimates
The preparation of the accompanying condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions about future events that affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Significant items subject to such estimates include revenue recognition, the useful lives of property and equipment and intangible assets, allowance for doubtful accounts, valuation allowance for deferred tax assets, stock-based compensation, annual bonus attainment, income tax uncertainties, valuation of goodwill and intangible assets, and contingencies. These estimates and assumptions are based on management’s best estimates and judgment. Management regularly evaluates its estimates and assumptions using historical experience and other factors; however, actual results could differ significantly from these estimates.

Cash, Cash Equivalents, Investments, and Restricted Cash
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. The Company classifies investments as short-term when they have remaining contractual maturities of less than one year 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. Cash equivalents are comprised of money market funds and short-term investments with an investment rating of either of the following: Moody's of A3 or higher or Standard & Poor's of A- or higher. The Company is exposed to credit risk in the event of default by the financial institutions or the issuers of these investments to the extent the amounts recorded on the balance sheet are in excess of amounts that are insured by the Federal Deposit Insurance Corporation (“FDIC”). Restricted cash is held in certificates of deposit pursuant to lease agreements, and, in prior periods, pursuant to secured letter of credit agreements as well.

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The Company's investment policy is consistent with the definition of available-for-sale securities. From time to time, the Company may sell certain securities but the objectives are generally not to generate profits on short-term differences in price.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, short-term and long-term investments, and accounts receivable. The Company maintains its cash, cash equivalents and short-term and long-term investments with high quality financial institutions with investment grade ratings.
No customer accounted for 10% or more of the Company’s revenues for the three and nine months ended April 30, 2014 or 2013. Two customers accounted for 10% or more of the Company's total accounts receivable as of April 30, 2014. The Company had one customer that accounted for 10% of total accounts receivable as of July 31, 2013.
Revenue Recognition
The Company enters into arrangements to deliver multiple products or services (multiple-elements). The Company applies software revenue recognition rules and allocates the total revenues among elements based on vendor-specific objective evidence ("VSOE") of fair value of each element. The Company recognizes revenue on a net basis excluding taxes collected from customers and remitted to government authorities.
Revenues are derived from three sources:
(i)
License fees, related to term (or time-based) software license revenue which includes enterprise cloud-based applications and technology cross-licensing revenue from a strategic partnership and perpetual software license revenues;
(ii)
Maintenance fees, related to email and phone support, bug fixes and unspecified software updates and upgrades released when, and if, available during the maintenance term; and
(iii)
Services fees, related to professional services related to implementation of our software, reimbursable travel and training.
Revenues are recognized when all of the following criteria are met:
Persuasive evidence of an arrangement exists. Evidence of an arrangement consists of a written contract signed by both the customer and management prior to the end of the period.
Delivery or performance has occurred. The Company’s software is delivered electronically to the customer. Delivery is considered to have occurred when the Company provides the customer access to the software along with login credentials.
Fees are fixed or determinable. Arrangements where a significant portion of the fee is due beyond 90 days from delivery are not considered to be fixed or determinable. Revenues from such arrangements is recognized as payments become due, assuming all other revenue recognition criteria have been met. Fees from term licenses are generally due in annual or, in certain cases, quarterly, installments over the term of the agreement beginning on the effective date of the license. Accordingly, fees from term licenses are not considered to be fixed or determinable until they become due.
Collectability is probable. Collectability is assessed on a customer-by-customer basis, based primarily on creditworthiness as determined by credit checks and analysis, as well as customer payment history. Payment terms generally range from 30 to 90 days from invoice date. If it is determined prior to revenue recognition that collection of an arrangement fee is not probable, revenues are deferred until collection becomes probable or cash is collected, assuming all other revenue recognition criteria are satisfied.
VSOE of fair value does not exist for the Company’s software licenses; therefore, for all arrangements that do not include services that are essential to the functionality of the software, the Company allocates revenues to software licenses using the residual method. Under the residual method, the amount recognized for license fees is the difference between the total fixed and determinable fees and the VSOE of fair value for the undelivered elements under the arrangement.
The VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for those elements when sold separately. VSOE of fair value for maintenance is established using the stated maintenance renewal rate in the customer’s contract. The Company generally enters into term licenses ranging from 3 to 7 years. For term licenses with duration of one year or less, no VSOE of fair value for maintenance exists. The Company began using stated maintenance renewal rates in customers’ contracts during fiscal year 2008. Prior to that, customers’ contracts did not have stated maintenance renewal rates and the Company was unable to establish VSOE of maintenance. VSOE of fair value for services is established if a substantial majority of historical stand-alone selling prices for a service fall within a reasonably narrow price range.

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If VSOE of fair value for one or more undelivered elements does not exist, the total arrangement fee is not recognized until delivery of those elements occurs or when VSOE of fair value is established.
If the undelivered elements are all service elements and VSOE of fair value does not exist for one or more service element, the total arrangement fee is recognized ratably over the longest service period starting at software delivery, assuming all the related services have been made available to the customer.
When implementation services are sold with a license arrangement, the Company evaluates whether those services are essential to the functionality of the software. Prior to fiscal year 2008, implementation services were determined to be essential to the software because the implementation services were generally not available from other third party vendors. By the beginning of fiscal year 2008, third-party vendors were providing implementation services for ClaimCenter and it was concluded that implementation services generally were not essential to the functionality of the ClaimCenter software. By the beginning of fiscal year 2011, third-party vendors were providing implementation services for PolicyCenter and BillingCenter and it was concluded that implementation services generally were no longer essential to the functionality of the PolicyCenter and BillingCenter software. In certain offerings sold as fixed fee arrangements, the Company recognizes services revenues on a proportional performance basis as performance obligations are completed by using the ratio of labor hours to date as an input measure compared to total estimated labor hours for the consulting services.
In cases where professional services are deemed to be essential to the functionality of the software, the arrangement is accounted for using contract accounting until the essential services are complete. If reliable estimates of total project costs and the extent of progress toward completion can be made, the Company applies the percentage-of-completion method in recognizing the arrangement fee. The percentage toward completion is measured by using the ratio of service billings to date compared to total estimated service billings for the consulting services. Service billings approximate labor hours as an input measure since they are billed monthly on a time and material basis. For term licenses with license fees due in equal installments over the term, the license revenues subject to percentage-of-completion recognition includes only those payments that are due and payable within the reporting period. The fees related to the maintenance are recognized over the period the maintenance is provided.
When VSOE for maintenance has not been established and the arrangement includes implementation services which are deemed essential to the functionality of the software and it is reasonably assured that no loss will be incurred under the arrangement, revenues are recognized pursuant to the zero gross margin method. Under this method, revenues recognized are limited to the costs incurred for the implementation services. As a result, billed license and maintenance fees and the profit margin on the professional services are generally deferred until the essential services are completed and then recognized over the remaining term of the maintenance period.
If the Company cannot make reliable estimates of total project implementation and it is reasonably assured that no loss will be incurred under such arrangements, the zero profit margin method is applied whereby an amount of revenues equal to the incurred costs of the project is recognized as well as the incurred costs, producing a zero margin until project estimates become reliable. The percentage-of-completion method is applied when project estimates become reliable; resulting in a cumulative effect adjustment for deferred license revenues to the extent of progress toward completion, and the related deferred professional service margin is recognized in full as revenues. Such cumulative effect adjustment for license revenues was nil for the three and nine months ended April 30, 2014, and nil and $3.2 million for the three and nine months ended April 30, 2013, respectively, and for service revenues was nil for the three and nine months ended April 30, 2014, and nil and $1.7 million for the three and nine months ended April 30, 2013, respectively.
Deferred Revenues
Deferred revenues represent amounts billed to or collected from customers for which the related revenues have not been recognized because one or more of the revenue recognition criteria have not been met. The current portion of deferred revenues represents the amount that is expected to be recognized as revenues within one year from the balance sheet date. The Company generally invoices fees for licenses and maintenance to its customers in annual or, in certain cases, quarterly installments payable in advance. Accordingly, the deferred revenues balance does not represent the total contract value of annual or multi-year, non-cancellable arrangements.

Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets related to excess tax benefits are recorded when utilized. The effect on

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deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company records a valuation allowance to reduce deferred tax assets to an amount of which realization is more likely than not.
Accounting guidance related to accounting for uncertainties in income taxes provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. This accounting guidance also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company records interest and penalties related to unrecognized tax benefits as income tax expense in its condensed consolidated statement of operations.
Stock-Based Compensation
The Company recognizes compensation expense related to its stock options and restricted stock units (“RSUs”) granted to employees based on the estimated fair value of the awards on the date of grant, net of estimated forfeitures. The RSUs are subject to time-based vesting, which generally occurs over a period of 4 years. Compensation cost for RSUs is generally recognized over the time-based vesting period. The options expire 10 years from the grant date. The Company estimates the grant date fair value, and the resulting stock-based compensation expense, of our stock options using the Black-Scholes option-pricing model. The grant date fair value of the stock-based awards is recognized using the accelerated multiple option approach over the requisite service period, which is generally the vesting period of the respective awards.
Public Offering
On October 28, 2013, the Company closed its follow-on public offering of 8,306,291 shares of its common stock, including the underwriters’ partial exercise of their over-allotment option from the Company. The public offering price of the shares sold in the offering was $48.75 per share. The Company received aggregate proceeds of approximately $389.9 million from the follow-on offering, net of underwriters’ discounts and commissions applicable to the sale of shares by the Company, but before deduction of offering costs of approximately $0.4 million payable by the Company. No shares were sold by the Company’s shareholders in this follow-on offering.
Recent Accounting Pronouncement
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) which provides guidance for revenue recognition. This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets. This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts. The standard will be effective for the Company beginning August 1, 2017. The Company is currently evaluating the impact of the adoption of this accounting standard update on its condensed consolidated financial statements.
Presentation of Unrecognized Tax Benefits
In July 2013, the FASB issued authoritative guidance that requires an entity to present an unrecognized tax benefit ("UTB"), or a portion of a UTB, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the UTB should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The guidance is effective prospectively for fiscal years and interim reporting periods within those years, beginning after December 15, 2013. The Company does not expect this guidance to have a material impact on its condensed consolidated financial statements.

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2.
Fair Value of Financial Instruments

Available-for-sale investments within cash equivalents and investments consist of the following:
 
April 30, 2014
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. agency securities
$
86,042

 
$
50

 
$
(9
)
 
$
86,083

Asset-backed securities
5,173

 

 

 
5,173

Commercial paper
166,318

 
17

 
(1
)
 
166,334

Corporate bonds
237,430

 
118

 
(41
)
 
237,507

U.S. government bonds
4,996

 
2

 

 
4,998

Foreign government bonds
2,770

 

 
(17
)
 
2,753

Money market funds
51,837

 

 

 
51,837

Certificate of deposit
2,700

 

 
(2
)
 
2,698

Municipal debt securities
14,341

 
14

 
(2
)
 
14,353

     Total
$
571,607

 
$
201

 
$
(72
)
 
$
571,736

 
July 31, 2013
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. agency securities
$
37,087

 
$
21

 
$
(4
)
 
$
37,104

Asset-backed securities
4,522

 

 
(1
)
 
4,521

Commercial paper
35,777

 
11

 
(1
)
 
35,787

Corporate bonds
63,281

 
23

 
(14
)
 
63,290

Foreign government bonds
776

 

 
(1
)
 
775

Money market funds
33,216

 

 

 
33,216

Municipal debt securities
9,105

 
4

 
(14
)
 
9,095

     Total
$
183,764

 
$
59

 
$
(35
)
 
$
183,788


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The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
 
April 30, 2014
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
(in thousands)
Commercial paper
$
11,098

 
$
(1
)
 
$

 
$

 
$
11,098

 
$
(1
)
Asset-backed securities
999

 

 

 

 
999

 

U. S. Agency Securities
27,995

 
(9
)
 

 

 
27,995

 
(9
)
Corporate bonds
74,350

 
(41
)
 

 

 
74,350

 
(41
)
Foreign government bonds
2,753

 
(17
)
 

 

 
2,753

 
(17
)
Certificate of deposit
2,698

 
(2
)
 

 

 
2,698

 
(2
)
Municipal debt securities
5,895

 
(2
)
 

 

 
5,895

 
(2
)
     Total
$
125,788

 
$
(72
)
 
$

 
$

 
$
125,788

 
$
(72
)

As of April 30, 2014, the Company had 45 investments in an unrealized loss position making up the unrealized losses of $72 thousand. The unrealized losses on our 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 believes it will need to sell, these securities before recovering the associated unrealized losses. The Company does not consider any portion of the unrealized losses at April 30, 2014 to be an other-than-temporary impairment, nor are any unrealized losses considered to be credit losses. The Company has recorded the securities at fair market value in its condensed consolidated balance sheets, with unrealized gains and losses reported as a component of accumulated other comprehensive income. Upon sale, amounts of gains and losses reclassified into earnings are determined based on specific identification of the securities sold.
The following table summarizes the contractual maturities of the Company’s available-for-sale securities as of April 30, 2014:
 
 
Expected maturities for the year ending April 30,
 
2015
 
2016
 
Total
 
(in thousands)
U.S. agency securities
$
27,105

 
$
58,978

 
$
86,083

Asset-backed securities
4,601

 
572

 
5,173

Commercial paper
166,334

 

 
166,334

Corporate bonds
134,731

 
102,776

 
237,507

U.S. government bonds
4,998

 

 
4,998

Foreign government bonds

 
2,753

 
2,753

Money market funds
51,837

 

 
51,837

Certificate of deposit

 
2,698

 
2,698

Municipal debt securities
12,350

 
2,003

 
14,353

     Total
$
401,956

 
$
169,780

 
$
571,736


 
Fair value is defined as the exchange price that would be received for an asset or an exit price paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The current accounting guidance for fair value measurements defines a three-level valuation hierarchy for disclosures as follows:
Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities;

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Level 2—Inputs other than quoted prices included within Level I that are observable, unadjusted quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; and
Level 3—Unobservable inputs that are supported by little or no market activity, which require the Company to develop its own assumptions.
The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The carrying value of the Company's accounts receivable, accounts payable and accrued liabilities approximates their fair value due to the short-term nature of these instruments.
We base the fair value of our Level 1 financial instruments, which are in active markets, using quoted market prices for identical instruments.
We obtain the fair value of our Level 2 financial instruments, which are not in active markets, from a third-party professional pricing service using quoted market prices for identical or comparable instruments, rather than direct observations of quoted prices in active markets. Our professional pricing service gathers observable inputs for all of our fixed income securities from a variety of industry data providers (e.g. large custodial institutions) and other third-party sources. Once the observable inputs are gathered, all data points are considered and an average price is determined.
We validate the quoted market prices provided by our primary pricing service by comparing their assessment of the fair values of our Level 2 investment portfolio balance against the fair values of our Level 2 investment portfolio balance provided by our investment managers. Our investment managers use similar techniques to our professional pricing service to derive pricing as described above.
We did not have any Level 3 financial assets or liabilities as of April 30, 2014 or July 31, 2013.

The following tables summarize the Company's financial assets measured at fair value on a recurring basis, by level within the fair value hierarchy as of April 30, 2014 and July 31, 2013:
 
April 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
Cash equivalents:
 
 
 
 
 
 
 
     Commercial paper
$

 
$
79,086

 
$

 
$
79,086

     Money market funds
51,837

 

 

 
51,837

Short-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
27,105

 

 
27,105

     Asset-backed securities

 
4,601

 

 
4,601

     Commercial paper

 
87,248

 

 
87,248

     Corporate bonds

 
134,731

 

 
134,731

     U.S. government bonds

 
4,998

 

 
4,998

     Municipal debt securities

 
12,350

 

 
12,350

Long-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
58,978

 

 
58,978

     Asset-backed securities

 
572

 

 
572

     Corporate bonds

 
102,776

 

 
102,776

Foreign Government Bond

 
2,753

 

 
2,753

Certificate of deposit

 
2,698

 

 
2,698

     Municipal debt securities

 
2,003

 

 
2,003

       Total assets
$
51,837

 
$
519,899

 
$

 
$
571,736



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July 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
Cash equivalents:
 
 
 
 
 
 
 
     Commercial paper
$

 
$
20,597

 
$

 
$
20,597

     Corporate bonds

 
2,003

 

 
2,003

     Money market funds
33,216

 

 

 
33,216

Short-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
9,097

 

 
9,097

     Asset-backed securities

 
2,421

 

 
2,421

     Commercial paper

 
15,190

 

 
15,190

     Corporate bonds

 
47,572

 

 
47,572

     Foreign government bonds

 
775

 

 
775

     Municipal debt securities

 
1,877

 

 
1,877

Long-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
28,007

 

 
28,007

     Asset-backed securities

 
2,100

 

 
2,100

     Corporate bonds

 
13,715

 

 
13,715

     Municipal debt securities

 
7,218

 

 
7,218

       Total assets
$
33,216

 
$
150,572

 
$

 
$
183,788


3.
Balance Sheet Components
Property and equipment consist of the following:
 
 
April 30, 2014
 
July 31, 2013
 
(in thousands)
Computer hardware
$
10,972

 
$
8,820

Software
5,447

 
4,460

Furniture and fixtures
2,676

 
2,666

Leasehold improvements
6,635

 
6,536

      Total property and equipment
25,730

 
22,482

Less accumulated depreciation and amortization
(13,271
)
 
(9,568
)
      Property and equipment, net
$
12,459

 
$
12,914

As of April 30, 2014 and July 31, 2013, no property and equipment was pledged as collateral against borrowings. Amortization of leasehold improvements is included in depreciation and amortization expense.
The following table presents changes in the carrying amount of goodwill:
 
Total
 
(in thousands)
Goodwill, July 31, 2013
$
9,048

Changes in carrying value
157

Goodwill, April 30, 2014
$
9,205



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Intangible assets consist of the following:
 
April 30, 2014
 
July 31, 2013
Acquired technology:
(in thousands)
Cost
$
7,200

 
$
7,200

Accumulated amortization
(1,401
)
 
(321
)
Net
$
5,799

 
$
6,879

Amortization expense was $0.4 million and $1.1 million for the three and nine month period ended April 30, 2014, respectively, and nil for the three and nine month period ended April 30, 2013. Estimated aggregate amortization expense for each of the next five fiscal years is as follows:
 
Future Amortization
 
(in thousands)
Fiscal year ending July 31,
 
2014 (remainder of fiscal year)
$
360

2015
1,440

2016
1,440

2017
1,440

2018
1,119

Total
$
5,799

Accrued employee compensation consists of the following:
 
April 30, 2014
 
July 31, 2013
 
(in thousands)
 Accrued bonuses
$
11,257

 
$
13,072

 Accrued commission
1,045

 
2,043

 Accrued vacation
7,880

 
7,335

 Payroll accruals
4,032

 
3,852

     Total
$
24,214

 
$
26,302

Changes in accumulated other comprehensive loss by component during the nine month period ended April 30, 2014 were as follows:
 
Foreign Currency Items
 
Unrealized gain (loss) on available-for-sale securities
 
Total
 
(in thousands)
Balance as of July 31, 2013
$
(1,582
)
 
$
24

 
$
(1,558
)
Other comprehensive gain (loss) before reclassification
109

 
144

 
253

Amounts reclassified from accumulated other comprehensive gain (loss) to earnings

 
(39
)
 
(39
)
Tax effect

 
(42
)
 
(42
)
Balance as of April 30, 2014
$
(1,473
)
 
$
87

 
$
(1,386
)


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4.
Earnings per Share
The following table sets forth the computation of the Company’s basic and diluted earnings per share for the three and nine months ended April 30, 2014 and 2013:
 
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands, except share and per share amounts)
Numerator:
 
 
 
 
 
 
 
   Net income (loss)
$
(1,358
)
 
$
(2,670
)
 
$
(12,865
)
 
$
3,278

Earnings (loss) per share:
 
 
 
 
 
 
 
   Basic
$
(0.02
)
 
$
(0.05
)
 
$
(0.20
)
 
$
0.06

   Diluted
$
(0.02
)
 
$
(0.05
)
 
$
(0.20
)
 
$
0.05

Denominator:
 
 
 
 
 
 
 
  Weighted average shares used in computing earnings (loss) per share:
 
 
 
 
 
 
 
   Basic
68,261,964

 
57,017,856

 
64,718,852

 
55,887,786

     Weighted average effect of dilutive stock options

 

 

 
3,659,929

     Weighted average effect of dilutive restricted stock units

 

 

 
2,184,908

   Diluted
68,261,964

 
57,017,856

 
64,718,852

 
61,732,623


The following outstanding shares of common stock equivalents were excluded from the computation of diluted earnings per share for the periods presented because including them would have been antidilutive:
 
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
Stock options to purchase common stock
2,543,620

 
4,411,791

 
3,038,569

 
302,144

Restricted stock units
3,911,941

 
4,391,477

 
4,322,264

 
46,971

 
5.
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, 2013. See the Annual Report on Form 10-K for the fiscal year ended July 31, 2013 for additional information regarding the Company's contractual obligations.

Leases
The Company leases certain facilities and equipment under operating leases. On December 5, 2011, the Company entered into a seven-year lease for a facility to serve as its corporate headquarters, located in Foster City, California, for approximately 97,674 square feet of space which commenced on August 1, 2012. In connection with this lease, the Company opened an unsecured letter of credit with Silicon Valley Bank for $1.2 million.
Lease expense for all worldwide facilities and equipment, which is being recognized on a straight-line basis over terms of the various leases, was $1.5 million and $4.4 million during the three and nine months ended April 30, 2014, and $1.4 million and $3.8 million for the three and nine months ended April 30, 2013.

Letters of Credit
In addition to the unsecured letter of credit noted above, the Company had an unsecured letter of credit agreement related to a customer arrangement for Polish Zloty 10.0 million (approximately $3.3 million as of April 30, 2014) to secure contractual commitments and prepayments. No amounts were outstanding under the Company's unsecured letters of credit as of April 30, 2014 or July 31, 2013. The Company had no outstanding secured letters of credit as of April 30, 2014 or July 31, 2013.

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Legal Proceedings
In December 2007, Accenture Global Services GmbH and Accenture LLP (collectively, “Accenture”), a competitor, filed a lawsuit against the Company in the U.S. District Court for the District of Delaware (the “Delaware Court") (Accenture Global Services GmbH and Accenture LLP v. Guidewire Software, Inc., Case No 07-826-SLR). Accenture alleged infringement of U.S. Patent No. 7,013,284 (the “ '284 patent”), among others, by the Company's products; trade-secret misappropriation; and tortious interference with business relations. In October 2011, the Company agreed with Accenture to resolve all outstanding litigation concerning the parties' respective insurance claims management software. As part of the settlement, the parties agreed to a royalty free cross license of all then-current patents and patent applications. In connection with the settlement, the Company has paid $10.0 million to Accenture with a potential additional payment based on the final outcome of Accenture’s appeal regarding the validity of its '284 patent.
In May 2011, the Delaware Court granted the Company's motion for summary judgment, finding that Accenture's '284 patent was invalid. In September 2013, the United States Court of Appeals for the Federal Circuit (the "Appeals Court") affirmed the decision of the District Court and held the '284 patent invalid. In December 2013, Accenture's request for a rehearing of the Appeals Court’s affirmation by the full Federal Circuit sitting en banc was denied. In January 2014, Accenture requested United States Supreme Court review; the Company is opposing the request. If Accenture is allowed to appeal and is ultimately successful, then the Company has agreed to pay Accenture an additional $20.0 million. Otherwise, no further payments would be due in connection with the settlement. The Company will continue to vigorously defend the favorable decision of the District Court and the affirmation of the Appeals Court, by opposing any requests for further review, as well as defending any such appeal if allowed.
In addition to the matters described above, from time to time, the Company is involved in various other legal proceedings and receives claims, arising from the normal course of business activities. The Company has accrued for estimated losses in the accompanying condensed consolidated financial statements for matters with respect to which it believes the likelihood of an adverse outcome is probable and the amount of the loss is reasonably estimable.
Indemnification
The Company sells software licenses and services to its customers under contracts (“Software License”). Each Software License contains the terms of the contractual arrangement with the customer and generally includes certain provisions for defending the customer against any claims that the Company’s software infringes upon a patent, copyright, trademark, or other proprietary right of a third party. Software Licenses also indemnify the customer against losses, expenses, and liabilities from damages that may be assessed against the customer in the event the Company’s software is found to infringe upon such third party rights.
The Company has not had to reimburse any of its customers for losses related to indemnification provisions and no material claims against the Company are outstanding as of April 30, 2014 and July 31, 2013. 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.
6.
Stockholders’ Equity and Stock-based Compensation
Stock-based Compensation Expense
Stock-based compensation expense related to all stock-based awards is as follows:
 

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Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014 
 
2013 (1)
 Stock-based compensation expenses:
(in thousands)
 Cost of license and other
$
41

 
$

 
$
245

 
$

 Cost of maintenance revenues
309

 
313

 
932

 
914

 Cost of services revenues
3,927

 
3,150

 
13,869

 
9,205

 Research and development
3,075

 
2,056

 
10,147

 
6,544

 Sales and marketing
3,440

 
676

 
12,153

 
4,269

 General and administrative
3,121

 
2,077

 
10,174

 
7,498

 Total stock-based compensation expenses
$
13,913

 
$
8,272

 
$
47,520

 
$
28,430


(1) Expenses shown include $1.0 million of expense recognized in 2013 related to the modification of RSUs upon accelerated vesting terms for the retirement of one of the Company's executives.

As of April 30, 2014, total unrecognized compensation cost, adjusted for estimated forfeitures, was as follows:
 
 As of April 30, 2014
 
Unrecognized Expense
 
Average Expected Recognition Period
 
(in thousands)
 
(in years)
 Restricted stock units
$
64,759

 
1.2
 Stock options
4,464

 
1.1
 
$
69,223

 
 

RSUs

RSU activity under the Company's equity incentive plans is as follows:
 
 RSUs Outstanding
 
 Number of RSUs Outstanding
 
 Weighted Average Grant Date Fair Value
Balance as of July 31, 2013
4,027,601

 
$
19.27

Granted
1,543,578

 
44.47

Released
(1,491,302
)
 
18.04

Cancelled
(245,458
)
 
29.83

Balance as of April 30, 2014
3,834,419

 
$
29.21


The fair value of RSUs released during the three and nine month periods ended April 30, 2014 was $28.0 million and $71.6 million, respectively, and $14.9 million and $40.4 million for the three and nine month periods ended April 30, 2013, respectively.


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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, 2013
3,763,228

 
$
6.74

 
5.7
 
$
139,315

Granted
215,930

 
47.10

 
 
 
 
Exercised
(1,383,388
)
 
5.31

 
 
 
 
Cancelled
(8,561
)
 
21.75

 
 
 
 
Balance as of April 30, 2014
2,587,209

 
$
10.82

 
5.7
 
$
71,667

Vested and expected to vest as of April 30, 2014
2,543,086

 
$
10.44

 
5.7
 
$
71,281

Exercisable as of April 30, 2014
1,972,111

 
$
5.60

 
4.9
 
$
63,699

(1) 
Aggregate intrinsic value represents the difference between the Company's closing stock price of $37.76 and $43.76 on April 30, 2014 and July 31, 2013, respectively, and the exercise price of outstanding, in-the-money options.

The options exercisable as of April 30, 2014 include options that are exercisable prior to vesting. The total intrinsic value of options exercised was approximately $9.9 million and $58.8 million for the three and nine months ended April 30, 2014, respectively, and $23.3 million and $76.4 million for the three and nine months ended April 30, 2013, respectively.
Valuation of Awards
The per share fair value of each stock option was determined on the date of grant using the Black-Scholes option-pricing model and the following weighted average assumptions:

 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
Expected life (in years)
5.3
 
6.1
 
5.0 - 6.1
 
5.1 - 6.1
Risk-free interest rate
1.7%
 
1.2%
 
1.5% - 2.0%
 
0.6% - 1.2%
Expected volatility
42.3%
 
46.9%
 
41.3% - 46.2%
 
45.1% - 48.7%
Expected dividend yield
—%
 
—%
 
—%
 
—%
Common Stock Reserved for Issuance
As of April 30, 2014 and July 31, 2013, the Company was authorized to issue 500,000,000 shares of common stock with a par value of $0.0001 per share. As of April 30, 2014 and July 31, 2013, the Company had reserved shares of common stock for issuance as follows:
 
 
April 30, 2014
 
July 31, 2013
 Exercise of stock options to purchase common stock
2,587,209

 
3,763,228

 Vesting of restricted stock units
3,834,419

 
4,027,601

 Issuances of shares available under stock plans
11,591,985

 
9,194,058

      Total common stock reserved for issuance
18,013,613

 
16,984,887


7.
Income Taxes

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The benefit from income taxes for the three and nine month periods ended April 30, 2014 was $1.4 million and $9.7 million, respectively. The benefit for income taxes for the three and nine month periods ended April 30, 2013 was $1.8 million and $2.4 million, respectively. The decrease in tax benefit recognized in the three month period is primarily due to an increase in profitability in the current period. The increase in tax benefit recognized in the nine month period is primarily due to a decrease in profitability in the nine month period. The effective tax rate of 51.4% and 42.9% for the three and nine month periods ended April 30, 2014 differs from the statutory U.S. federal income tax rate of 35% mainly due to the benefit for the permanent differences for stock-based compensation, the impact of state income taxes, the tax rate differences between the United States and foreign countries, and research tax credits.
The Company provides U.S. income taxes on the earnings of foreign subsidiaries, unless the subsidiaries’ earnings are considered indefinitely reinvested outside the United States. As of April 30, 2014, U.S. income taxes were not provided for on the cumulative total of $14.8 million undistributed earnings from certain foreign subsidiaries. As of April 30, 2014, the unrecognized deferred tax liability for these earnings was approximately $1.5 million.
During the nine month period ended April 30, 2014, the change in unrecognized tax benefits from the beginning of the period was $1.4 million. Accordingly, as of April 30, 2014, the Company had unrecognized tax benefits of $4.1 million that, if recognized, would affect the Company’s effective tax rate.
8.
Segment Information

The Company operates in one segment. The Company’s chief operating decision maker (the “CODM”), its Chief Executive Officer, manages the Company’s operations on a consolidated basis for purposes of allocating resources. When evaluating the Company’s financial performance, the CODM reviews separate revenues information for the Company’s license, maintenance and professional services offerings, while all other financial information is reviewed on a consolidated basis. All of the Company’s principal operations and decision-making functions are located in the United States.
The following table sets forth revenues by country and region based on the billing address of the customer:
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
United States
$
48,640

 
$
37,751

 
$
126,573

 
$
109,961

Canada
9,084

 
10,620

 
30,039

 
31,685

Other Americas
1,391

 
1,358

 
6,630

 
6,573

Total Americas
59,115

 
49,729

 
163,242

 
148,219

United Kingdom
7,662

 
5,035

 
28,316

 
17,114

Other EMEA
9,624

 
6,894

 
25,649

 
19,839

Total EMEA
17,286

 
11,929

 
53,965

 
36,953

Total APAC
5,634

 
6,592

 
14,832

 
18,567

Total revenues
$
82,035

 
$
68,250

 
$
232,039

 
$
203,739

No country, other than those presented above, accounted for more than 10% of revenues during the three and nine months ended April 30, 2014 and 2013.
The following table sets forth the Company’s long-lived assets, including intangibles and goodwill, net by geographic region:
 
 
April 30, 2014
 
July 31, 2013
 
 (in thousands)
North America
$
26,183

 
$
27,280

Europe
1,038

 
1,276

Asia Pacific
242

 
285

Total
$
27,463

 
$
28,841


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ITEM 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this document and the Risk Factors included in Item 1A of Part II of this Quarterly Report on Form 10-Q. All information presented herein is based on our fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to our fiscal years ended in July and the associated quarters of those fiscal years. We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.
Overview
We are a leading provider of core system software to the global property and casualty ("P&C") insurance and reinsurance industry. Our solutions serve as the transactional systems-of-record for, and enable the key functions of, a P&C insurance carrier’s business: underwriting and policy administration, claims management and billing. Since our inception, our mission has been to empower P&C insurance carriers to transform and improve their businesses by replacing their legacy core systems with our software platform.
We derive our revenues from licensing our software applications, providing maintenance support and providing professional services to the extent requested by our customers. Our license revenues are primarily generated through annual license fees that recur during the term of our multi-year contracts. These multi-year contracts have an average term of approximately five years and are renewed on an annual or multi-year basis. In certain cases, when required by a customer, we license our software on a perpetual license basis. In addition, certain of our multi-year term licenses provide the customer with the option to purchase a perpetual license at the end of the initial contract term. We generally price our licenses based on the amount of direct written premiums (“DWP”) that will be managed by our solutions. We typically invoice our customers annually in advance and quarterly in certain cases, for both term license and maintenance fees, and we invoice our perpetual license customers either in full at contract signing or on an installment basis and invoice related maintenance fees annually, in advance.
To extend our technology leadership position in our market, we intend to continue to focus on product innovation through research and development and aggressively pursue new customers and up-sell additional products within our existing customer base. This will require us to make continued investment in our research and development and sales and marketing functions to capitalize on opportunities for growth. We expect research and development, sales and marketing and general and administrative expenses to continue to increase in absolute dollars for the foreseeable future to support this strategy. Research and development and sales and marketing expenses are also expected to increase as a percentage of revenues in future periods as we focus on expanding our technological leadership.
We face a number of risks in the execution of our strategy, including reliance on sales to a relatively small number of large customers, variances in the mix amongst our components of revenues, which could result in lower gross margin from services revenues as compared to license and maintenance revenues, and the overall impact of weakening economic conditions on the insurance industry. We believe that our focus on continued product innovation and customer wins and renewals will support the expansion of our license sales and reduce the impact from weakened economic conditions.
We sell our core system software primarily through our direct sales force. Our sales cycle for new customers is typically 12 to 24 months. Product implementations, the primary driver of our services revenues, typically last 6 to 24 months and may take longer.
Opportunities, Challenges, & Risks
Since August 2010, our license revenues from new orders and subsequent annual and, in some cases, quarterly payments have generally been recognized when payment is due from our customers. Historically, and to a lesser extent during fiscal years 2013, 2012 and 2011, our license revenues from existing orders have been recognized under three methods: under the residual method when payment is due and payable from our customers, under the percentage-of-completion method as we complete customer implementations of our software, or under the zero-gross-margin method as we complete customer implementations of our software. During the three months ended April 30, 2014 and 2013, our license revenues accounted for 39% and 34% of our total revenues, respectively, and our recurring term license revenues accounted for 88% and 78% of our total license revenues, respectively. During the nine months ended April 30, 2014 and 2013, our license revenues accounted for 37% and 36% of our total revenues, respectively, and our recurring term license revenues accounted for 94% and 91% of our total license revenues, respectively.

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Our maintenance revenues are generally recognized annually over the committed maintenance term. Our maintenance fees are typically priced as a fixed percentage of the associated license fees and generate lower gross margins than our license revenues. Our maintenance revenues accounted for 13% and 13% of our total revenues during the three months ended April 30, 2014 and 2013, respectively, and 13% and 14% of our total revenues during the nine months ended April 30, 2014 and 2013, respectively.
We generally charge services fees on a time and materials basis and revenues are typically recognized upon delivery of our services. In certain offerings sold as fixed fee arrangements, we recognize services revenues on a proportional performance basis as performance obligations are completed by using the ratio of labor hours to date as an input measure compared to total estimated labor hours for the consulting services. We derive our services revenues primarily from implementation services performed for our customers, revenues related to reimbursable travel expenses and training fees. Our services revenues generate lower gross margins than our license and maintenance revenues and accounted for 48% and 53% of our total revenues during the three months ended April 30, 2014 and 2013, respectively. Our services revenues accounted for 50% and 50% of our total revenues during the nine months ended April 30, 2014 and 2013, respectively.
We enter into multi-year renewable contracts to license our software. Regardless of contract length, we typically invoice our customers for annual or quarterly amounts at the beginning of the corresponding period. Our deferred revenues consist only of amounts that have been invoiced, but not yet recognized as revenues. As a result, deferred revenues and change in deferred revenues are incomplete measures of the strength of our business and are not necessarily indicative of our future performance. Further, we expect to recognize our current deferred services revenue into income but do not expect significant deferrals of services revenue in future periods. Deferred license and service revenues related to projects under contract accounting as of April 30, 2014 were $1.3 million and $1.9 million, respectively, while deferred license and service revenues related to projects under contract accounting as of July 31, 2013 were $2.2 million and $2.0 million, respectively. Such deferral is in accordance with our Revenue Recognition policy as described in Note 1 to the condensed consolidated financial statements.
We have historically experienced seasonal variations in our revenues as a result of increased customer orders in our second and fourth fiscal quarters and subsequent annual fees. We generally see increased orders in our second fiscal quarter, which is the quarter ended January 31, due to customer buying patterns. We also see increased orders in our fourth fiscal quarter due to efforts by our sales team to achieve annual incentives. As a result, a significantly higher percentage of our annual license fees are invoiced and recognized as revenues during those quarters at contract inception or in the subsequent quarter when the annual license payment is due and in subsequent years upon the anniversary of the contract date. We generally expect these seasonal trends to continue in the future, which may cause quarterly fluctuations in our results of operations and certain financial metrics.
Our quarterly growth in license revenues may not match up to new orders we receive in a given quarter. This mismatch is primarily due to the following reasons:
for the initial year of a multi-year term license, we generally recognize revenues when payment is due and payment may not be due until a subsequent fiscal quarter;
we may enter into license agreements with specified terms for product upgrades or functionality, which may require us to delay revenue recognition until the period in which the upgrade or functionality is delivered; and
we may enter into license agreements with other contractual terms that may affect the timing of revenue recognition.
Our revenue seasonality may fluctuate versus comparable prior periods or prior quarters within the same fiscal year based upon when new orders are executed in the quarter and the payment terms of each order. Additionally, our revenue may fluctuate if our customers make an early payment or change payment terms during or after the end of the contract term for up-sell of additional products or renewals. Our ability to renew existing contracts for multiple year terms versus annual automatic renewals may impact revenue recognition.
We generally charge annual software license fees for our multi-year term licenses and price our licenses based on the amount of direct written premiums (“DWP”) that will be managed by our solutions. However, in rare circumstances, our customers desire the ability to purchase our products on a perpetual license basis, resulting in an acceleration of license revenue recognition. Milestone payments in a perpetual license order also cause seasonal variations. Our perpetual license revenues are not consistent from period to period. In addition, a few of our multi-year term licenses provide the customer with the option to purchase a perpetual license at the end of the initial contract term, which we refer to as a perpetual buyout right. The mix of our contract terms for our licenses and the exercise of perpetual buyout rights at the end of the initial contract term by our customers may lead to variability in our results of operations. Increases in perpetual license sales and exercises of perpetual buyout rights by our customers may affect our ability to show consistent growth in license revenues in subsequent periods. Reductions in perpetual licenses in future periods could cause adverse period-to-period comparisons of our financial results.

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In addition, because we price our products based on the amount of DWP that will be managed by our solutions, license revenues from each customer may fluctuate up or down based upon insurance policies sold by the customer in the preceding year. If we enter into a new territory, our revenue recognition pattern may change depending on the contractual terms and local laws and regulations.
We generated revenues of $82.0 million and $68.3 million in the three months ended April 30, 2014 and 2013, respectively and revenues of $232.0 million and $203.7 million in the nine months ended April 30, 2014 and 2013, respectively. We generate the majority of our revenues in the United States and Canada. Our revenues from outside the United States and Canada as a percentage of total revenues were 30% and 29% in the three months ended April 30, 2014 and 2013, respectively, and 33% and 30% in the nine months ended April 30, 2014 and 2013, respectively. We generated a net loss of $1.4 million and $2.7 million in the three months ended April 30, 2014 and 2013, respectively, and a net loss of $12.9 million and net income of $3.3 million in the nine months ended April 30, 2014 and 2013, respectively. No customer accounted for 10% or more of our revenues for the three and nine months ended April 30, 2014 or 2013. Our ten largest customers accounted for 38% and 39% of our total revenues for the three months ended April 30, 2014 and 2013, respectively, and 37% and 34% of our total revenues for the nine month periods ended April 30, 2014 and 2013, respectively. We count as customers distinct buying entities, which may include multiple national or regional subsidiaries of large, global P&C insurance carriers.
Key Business Metrics
We use certain key metrics to evaluate and manage our business, including rolling four-quarter recurring revenues from term licenses and maintenance. In addition, we present select GAAP and non-GAAP financial metrics that we use internally to manage the business and that we believe are useful for investors. These metrics include operating cash flow and non-GAAP measures such as Adjusted EBITDA.
Four-Quarter Recurring Revenues
We measure four-quarter recurring revenues by adding the total term license revenues and maintenance revenues recognized in the preceding four quarters ended in the stated period and excluding perpetual license revenues, revenues from perpetual buyout rights and services revenues. This metric allows us to better understand the trends in our recurring revenues because it typically reduces the variations in any particular quarter caused by seasonality, the effects of the annual invoicing of our term licenses, the effects of differences in timing of payments, and certain effects of contractual provisions that may accelerate or delay revenue recognition in some cases. Our four-quarter recurring revenues for each of the eight periods presented were:

 
Four quarters ended
 
4/30/2014
 
1/31/2014
 
10/31/2013
 
7/31/2013
 
4/30/2013
 
1/31/2013
 
10/31/2012
 
7/31/2012
 
(in thousands)
Term license revenues
$
125,485

 
$
115,144

 
$
110,640

 
$
112,863

 
$
95,303

 
$
92,792

 
$
83,114

 
$
74,869

Maintenance revenues
39,836

 
38,510

 
37,830

 
37,561

 
35,548

 
34,207

 
31,802

 
29,538

Total four-quarter recurring revenues
$
165,321

 
$
153,654

 
$
148,470

 
$
150,424

 
$
130,851

 
$
126,999

 
$
114,916

 
$
104,407


Adjusted EBITDA
We believe Adjusted EBITDA, a non-GAAP measure, is useful, in addition to other financial measures presented in accordance with GAAP, in evaluating our operating performance compared to that of other companies in our industry, as this metric generally eliminates the effects of certain items that may vary for different companies for reasons unrelated to overall operating performance. We believe that:
Adjusted EBITDA provides investors and other users of our financial information consistency and comparability with our past financial performance, facilitates period-to-period comparisons of operations and facilitates comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results; and
it is useful to exclude non-cash charges, such as depreciation and amortization, stock-based compensation and one-time cash or non-cash charges because the amount of such expenses in any specific period may not directly correlate to the underlying performance of our business operations and these expenses can vary significantly between periods.

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Table of Contents

We use Adjusted EBITDA in conjunction with traditional GAAP measures as part of our overall assessment of our performance, including the preparation of our annual operating budget and quarterly forecasts, to evaluate the effectiveness of our business strategies and to communicate with our board of directors regarding our financial performance.
Adjusted EBITDA should not be considered as a substitute for other measures of financial performance reported in accordance with GAAP. There are limitations to using non-GAAP financial measures, including that other companies may calculate these measures differently than we do. We compensate for the inherent limitations associated with using Adjusted EBITDA through disclosure of these limitations, presentation of our financial statements in accordance with GAAP and reconciliation of Adjusted EBITDA to the most directly comparable GAAP measure, net income.
The following table provides a reconciliation of net income (loss) to Adjusted EBITDA:
 
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
 
 
 
 
Reconciliation of Adjusted EBITDA:
 
 
 
 
 
 
 
Net income (loss)
$
(1,358
)
 
$
(2,670
)
 
$
(12,865
)
 
$
3,278

Non-GAAP adjustments:
 
 
 
 
 
 
 
Benefit from income taxes
(1,435
)
 
(1,823
)
 
(9,670
)
 
(2,366
)
Other expense (income), net
(190
)
 
268

 
(372
)
 
104

Interest income, net
(415
)
 
(137
)
 
(919
)
 
(359
)
Depreciation and amortization
1,770

 
1,137

 
4,978

 
3,182

Total stock-based compensation
13,913

 
8,272

 
47,520

 
28,430

Adjusted EBITDA
$
12,285

 
$
5,047

 
$
28,672

 
$
32,269

Operating Cash Flows
We monitor our cash flows from operating activities, or operating cash flows, as a key measure of our overall business performance, which enables us to analyze our financial performance without the effects of certain non-cash items such as depreciation and amortization and stock-based compensation expenses. Additionally, operating cash flows takes into account the impact of changes in deferred revenues, which reflects the receipt of cash payment for products before they are recognized as revenues. Our operating cash flows are significantly impacted by changes in deferred revenues, timing of bonus payments and collections of accounts receivable. As a result, our operating cash flows fluctuate significantly on a quarterly basis. Cash provided by operations was $26.1 million and $8.1 million for the nine months ended April 30, 2014 and 2013, respectively. For a further discussion of our operating cash flows, see “Liquidity and Capital Resources—Cash Flows from Operating Activities.”
Results of Operations
The following tables set forth our results of operations for the periods presented (in thousands, except per share data, and as a percentage of our total revenues) for those periods. The data have been derived from the unaudited Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods presented. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K filed with the SEC on September 27, 2013.
 

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Table of Contents

 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
(in thousands)
License
$
31,927

 
$
22,918

 
$
86,012

 
$
74,482

Maintenance
10,440

 
9,110

 
29,969

 
27,690

Services
39,668

 
36,222

 
116,058

 
101,567

Total revenues
82,035

 
68,250

 
232,039

 
203,739

Cost of revenues:
 
 
 
 
 
 
 
License
845

 
139

 
3,394

 
436

Maintenance
2,238

 
2,079

 
6,192

 
5,430

Services
34,259

 
33,774

 
106,397

 
89,071

Total cost of revenues
37,342

 
35,992

 
115,983

 
94,937

Gross profit:
 
 
 
 
 
 
 
License
31,082

 
22,779

 
82,618

 
74,046

Maintenance
8,202

 
7,031

 
23,777

 
22,260

Services
5,409

 
2,448

 
9,661

 
12,496

Total gross profit
44,693

 
32,258

 
116,056

 
108,802

Operating expenses:
 
 
 
 
 
 
 
Research and development
20,634

 
16,854

 
58,444

 
47,503

Sales and marketing
17,968

 
11,915

 
53,871

 
36,680

General and administrative
9,489

 
7,851

 
27,567

 
23,962

Total operating expenses
48,091

 
36,620

 
139,882

 
108,145

Income (loss) from operations
(3,398
)
 
(4,362
)
 
(23,826
)
 
657

Interest income, net
415

 
137

 
919

 
359

Other income (expense), net
190

 
(268
)
 
372

 
(104
)
Income (loss) before benefit from income taxes
(2,793
)
 
(4,493
)
 
(22,535
)
 
912

Benefit from income taxes
(1,435
)
 
(1,823
)
 
(9,670
)
 
(2,366
)
Net income (loss)
$
(1,358
)
 
$
(2,670
)
 
$
(12,865
)
 
$
3,278

 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
License
39
 %
 
34
 %
 
37
 %
 
36
 %
Maintenance
13
 %
 
13
 %
 
13
 %
 
14
 %
Services
48
 %
 
53
 %
 
50
 %
 
50
 %
Total revenues
100
 %
 
100
 %
 
100
 %
 
100
 %
Total cost of revenues
46
 %
 
52
 %
 
50
 %
 
47
 %
Total gross profit
54
 %
 
48
 %
 
50
 %
 
53
 %
Operating expenses:
 
 
 
 
 
 
 
Research and development
25
 %
 
25
 %
 
25
 %
 
23
 %
Sales and marketing
22
 %
 
17
 %
 
23
 %
 
18
 %
General and administrative
12
 %
 
12
 %
 
12
 %
 
12
 %
Total operating expenses
59
 %
 
54
 %
 
60
 %
 
53
 %
Income (loss) from operations
(5
)%
 
(6
)%
 
(10
)%
 
 %
Interest income, net
1
 %
 
 %
 
 %
 
1
 %
Other income (expense), net
 %
 
(1
)%
 
 %
 
 %
Income (loss) before benefit from income taxes
(4
)%
 
(7
)%
 
(10
)%
 
1
 %
Benefit from income taxes
(2
)%
 
(3
)%
 
(4
)%
 
(1
)%
Net income (loss)
(2
)%
 
(4
)%
 
(6
)%
 
2
 %


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Table of Contents

Comparison of the Three and Nine Months Ended April 30, 2014 and 2013
Revenues
Please refer to Note 1 of Notes to Condensed Consolidated Financial Statements for a description of our accounting policy related to revenue recognition.
 
 
Three Months Ended April 30,
 
 
 
 
 
2014
 
2013
 
 
 
 
 
 
 
% of total
 
 
 
% of total
 
Change
 
Amount
 
revenues
 
Amount
 
revenues
 
($)
 
(%)
 
(in thousands, except percentages)
 Revenues:
 
 
 
 
 
 
 
 
 
 
 
 License
$
31,927

 
39
%
 
$
22,918

 
34
%
 
$
9,009

 
39
%
 Maintenance
10,440

 
13
%
 
9,110

 
13
%
 
1,330

 
15