Guidewire Software, Inc. — Fiscal 2017 Second-Quarter Form 10-Q
Reporting period: Three and six months ended January 31, 2017. The filing was submitted March 2, 2017. Guidewire provides software for property and casualty insurers, including core transaction processing, data management and analytics, and digital engagement.
Financial Performance and Position
| Metric | Three months ended Jan. 31, 2017 | Three months ended Jan. 31, 2016 | Six months ended Jan. 31, 2017 | Six months ended Jan. 31, 2016 |
|---|---|---|---|---|
| Total revenue | $115.6 million | $102.1 million | $209.7 million | $184.4 million |
| License and other revenue | $64.1 million | $53.4 million | $102.8 million | $85.7 million |
| Maintenance revenue | $16.6 million | $14.3 million | $33.1 million | $28.3 million |
| Services revenue | $35.0 million | $34.5 million | $73.8 million | $70.4 million |
| Gross profit | $74.8 million | $67.2 million | $126.9 million | $114.3 million |
| Gross margin | 64.7% | 65.8% | 60.5% | 62.0% |
| Income (loss) from operations | $8.2 million | $7.7 million | $(10.1) million | $(1.3) million |
| Net income (loss) | $4.0 million | $0.9 million | $(3.9) million | $(0.7) million |
| Diluted EPS | $0.05 | $0.01 | $(0.05) | $(0.01) |
| Adjusted EBITDA | $30.1 million | $26.0 million | $32.8 million | $34.0 million |
- Quarterly revenue increased 13%; six-month revenue increased 14%. Quarterly license and other revenue increased 20%, maintenance increased 16%, and services increased 1%.
- Quarterly operating margin was approximately 7%; six-month operating margin was approximately negative 5%. Operating expenses increased 12% in the quarter and 19% for the six-month period, led by research and development and personnel investment.
- Operating cash flow for the six months was $29.6 million, compared with $27.0 million in the prior-year period. Cash and cash equivalents increased to $225.4 million from $223.6 million at July 31, 2016.
- Cash, cash equivalents and investments totaled $728.9 million at January 31, 2017, compared with $735.8 million at July 31, 2016. Working capital was $542.7 million.
- The filing reports no commercial debt arrangements, credit-line borrowings, or material non-cancellable purchase commitments. Total liabilities were $134.2 million, including $89.3 million of deferred revenue.
- Stock-based compensation charged to income was $36.5 million for the six months, up from $31.7 million. Unrecognized stock-based compensation was $140.5 million at January 31, 2017.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven primarily by continued product sales, new term-license orders, higher maintenance revenue from the larger customer base, and a $5.0 million increase in perpetual-license revenue for the six-month period.
- Gross margin declined because of higher services personnel and acquisition-related costs, as well as revenue and direct-cost deferrals on a large cloud-delivered implementation. Services gross margin was approximately zero in the quarter and 4% for the six months, versus 11% and 12%, respectively, in the prior-year periods.
- Research and development expense increased 18% in the quarter and 19% for the six months; sales and marketing expense increased 4% and 17%; general and administrative expense increased 14% and 21%.
- Four-quarter recurring revenue increased to $285.3 million from $238.3 million for the comparable four-quarter period, consisting of $220.5 million of term-license and other revenue and $64.8 million of maintenance revenue.
- Deferred revenue rose 28% to $89.3 million from $70.0 million at July 31, 2016, including a significant increase in deferred services revenue related to one large national insurer engagement.
- Guidewire acquired FirstBest Systems on August 31, 2016 for approximately $37.8 million. The preliminary allocation included $15.5 million of goodwill and $15.4 million of identifiable intangible assets; acquired operations were not material to consolidated results.
- After quarter-end, on February 16, 2017, Guidewire acquired ISCS for approximately $160 million in cash. The acquisition was not included in the January 31 balance sheet and purchase accounting remained incomplete at filing.
Outlook, Commentary, Risks, and Unusual Items
- Management expects research and development, sales and marketing, and general and administrative expenses to continue increasing as it invests in product development, international expansion, sales capacity, and infrastructure.
- Management expects services margins to remain pressured during fiscal 2017 by the deferred cloud implementation and increased staffing. It expects deferred revenue and related costs to begin recognition on a ratable basis by the fourth fiscal quarter, subject to satisfaction of revenue-recognition criteria.
- The company expects the ISCS acquisition to materially increase expenses during the remainder of fiscal 2017 because of hiring and training requirements, with an adverse impact on profitability.
- Guidewire expects seasonal increases in customer orders during the second and fourth fiscal quarters. Revenue can also fluctuate based on invoice timing, payment terms, perpetual-license transactions, acceptance criteria, and customer implementation timing.
- Guidewire intends to adopt the new revenue-recognition standard on August 1, 2018 using the modified retrospective method. Management expects the standard to change the timing and pattern of software-license revenue recognition and is revising contract terms accordingly.
- The filing identifies risks from lengthy sales and implementation cycles, services-margin pressure, acquisition integration, intense competition, cloud-transition execution, customer concentration, foreign currency volatility, data security and privacy requirements, intellectual-property claims, and changes in revenue-recognition or tax rules.
- Management believes existing cash, cash equivalents, investments, and operating cash flows will be sufficient to fund operations for at least the next 12 months, although future acquisitions or expansion could require substantial cash or incremental financing.
- There were no material pending legal proceedings or accrued legal losses reported. Two letters of credit totaling approximately $2.9 million supported contractual commitments, with no amounts drawn.
Most Important Facts for Investors to Verify
- Whether ISCS integration, approximately $160 million of cash consideration, and related hiring costs materially affect fiscal 2017 margins, cash, goodwill, and intangible assets.
- The timing and amount of revenue and direct-cost recognition for the large cloud implementation expected to begin in the fourth fiscal quarter.
- Whether services-margin pressure persists as cloud offerings and acquired products expand.
- The impact of the August 2018 adoption of Topic 606 on reported revenue, deferred revenue, earnings, commissions, and comparability.
- The sustainability of recurring-revenue growth and the effect of seasonal ordering, perpetual-license transactions, payment timing, and customer renewals.
- The magnitude of ongoing stock-based compensation and its effect on GAAP profitability and cash-flow interpretation.