Guidewire Software, Inc. — FY2013 Form 10-K Summary
Business context and reporting period
Guidewire provides software for property and casualty insurers, including PolicyCenter, ClaimCenter and BillingCenter, with related maintenance and implementation services. The filing covers the fiscal year ended July 31, 2013. The fourth quarter ended July 31, 2013 is also presented in the quarterly results.
As of July 31, 2013, Guidewire had 158 customers in 17 countries and 1,149 employees. Contracts generally average approximately five years, with recurring term-license and maintenance fees billed annually or quarterly in advance.
Financial performance and liquidity
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Total revenue | $300.6 million | $232.1 million | +30% |
| License revenue | $123.6 million | $97.1 million | +27% |
| Maintenance revenue | $37.6 million | $29.5 million | +27% |
| Services revenue | $139.5 million | $105.4 million | +32% |
| Gross profit | $168.9 million | $140.7 million | +20% |
| Gross margin | 56% | 61% | Down 5 points |
| Income from operations | $16.8 million | $23.6 million | -29% |
| Operating margin | 6% | 11% | Down 5 points |
| Net income | $15.4 million | $15.2 million | +1% |
| Diluted EPS | $0.25 | $0.25 | Flat |
| Adjusted EBITDA | $60.1 million | $44.8 million | +34% |
| Operating cash flow | $32.5 million | $17.1 million | +90% |
Services represented 46% of revenue and generated a 12% gross margin, compared with 99% for license revenue and 80% for maintenance. The greater mix of lower-margin services, higher personnel costs and increased stock-based compensation reduced consolidated profitability.
Fiscal 2013 stock-based compensation was $38.4 million, more than double the $18.3 million recorded in fiscal 2012. The income tax provision declined to $1.8 million from $8.0 million, producing a 10.6% effective tax rate versus 34.4% in the prior year.
Cash and cash equivalents were $79.8 million at July 31, 2013, compared with $205.7 million a year earlier. The company also held $128.0 million of short- and long-term investments, resulting in cash, cash equivalents and investments of approximately $207.7 million. Working capital was $135.3 million. The balance sheet does not present borrowings or debt; the filing text does not provide a separate debt metric.
Investing cash outflows were $148.9 million, primarily reflecting $128.5 million of net purchases of available-for-sale securities, the $14.7 million Millbrook acquisition and $9.2 million of capital expenditures. Management stated that existing liquidity and expected operating cash flow should fund operations for at least the next 12 months.
Fourth-quarter results
| Metric | Q4 FY2013 | Q4 FY2012 |
|---|---|---|
| Revenue | $96.9 million | $67.6 million |
| Gross margin | 62% | 60% |
| Income from operations | $16.2 million | $5.3 million |
| Net income | $12.1 million | $3.5 million |
Quarterly results were affected by the company’s normal seasonality: license orders and revenue recognition are generally higher in the second and fourth fiscal quarters. Q4 FY2013 included $49.1 million of license revenue, $9.9 million of maintenance revenue and $38.0 million of services revenue.
Material changes versus the prior comparable period
- Term-license revenue increased 51% to $112.9 million, while perpetual-license revenue declined 52% to $10.7 million as customers increasingly selected term licenses.
- Four-quarter recurring revenue increased to $150.4 million from $104.4 million, consisting of term-license and maintenance revenue.
- Gross margin fell primarily because services grew faster than higher-margin license revenue and services margin declined to 12% from 19%.
- Research and development expense rose 31% to $66.3 million, sales and marketing expense rose 39% to $53.3 million, and general and administrative expense rose 14% to $32.4 million.
- Deferred revenue declined 26% to $41.2 million, including a 44% decline in deferred license revenue to $14.4 million. Deferred revenue is not a complete measure of future contract value because customers are generally invoiced annually or quarterly.
- International revenue declined to 28% of total revenue from 30%, although total revenue increased substantially.
- Headcount increased by 312 employees during fiscal 2013, primarily to support services delivery, research and development and sales and marketing.
Guidance, outlook, commentary and unusual items
Management did not provide specific quantitative revenue or earnings guidance in the supplied filing. It expects revenue and operating expenses to continue increasing, with continued investment in research and development, sales and marketing, international expansion, infrastructure and services capacity. Management also expects positive annual operating cash flow, although quarterly cash flow may fluctuate materially.
- Millbrook acquisition: Acquired May 10, 2013 for $14.7 million net of cash, with $9.0 million of preliminary goodwill and $7.2 million of acquired technology. The acquisition was intended to enhance reporting capabilities; its fiscal 2013 operating contribution was not material.
- Accenture litigation: Guidewire paid $10.0 million under a 2011 settlement. On September 5, 2013, the Federal Circuit affirmed that Accenture’s patent was invalid. A further $20.0 million payment could become due if Accenture obtains further review and ultimately prevails; otherwise no additional settlement payment is due.
- Contractual commitments: Total disclosed commitments were $30.3 million, including $28.8 million of operating leases, $0.9 million of royalties and $0.5 million of purchase commitments.
- Tax contingencies: Unrecognized tax benefits were $6.7 million, including $3.3 million that would affect the effective tax rate if recognized. The company also had $6.7 million of unrecognized tax benefits associated with federal and California research and development credits.
- Revenue recognition: Revenue timing can vary materially based on payment terms, customer implementation progress, perpetual-license elections, specified functionality, vendor-specific objective evidence and other contract provisions.
Principal risks
- Significant seasonality and volatility in license orders, revenue recognition and cash flow.
- Customer concentration: the ten largest customers generated 33% of FY2013 revenue, although no individual customer exceeded 10%.
- Long sales cycles of approximately 12 to 24 months and implementation cycles of six to 24 months or longer.
- Services delivery risks, including staffing, utilization, implementation delays and continued pressure on services margins.
- Intense competition from internally developed systems, technology consulting firms, specialized insurance-software vendors and horizontal software providers.
- Dependence on customer renewals, expansions, system-integrator partners and acceptance of the core product suite.
- Potential cybersecurity, product liability, intellectual-property, warranty and indemnification claims.
- International exposure, including foreign exchange, regulatory, tax, anti-corruption and collections risks.
- Potential dilution and substantial non-cash expense from stock-based compensation; unrecognized equity compensation expense was $43.8 million at July 31, 2013.
Important facts for investors to verify
- Whether recurring term-license and maintenance growth continues to offset declines or volatility in perpetual-license revenue.
- Whether services utilization and staffing improvements can restore services and consolidated gross margins.
- The level and economic impact of stock-based compensation and related share dilution.
- The ultimate resolution of the remaining Accenture appeal risk and potential $20.0 million payment.
- Millbrook’s contribution, purchase-price allocation and integration results in subsequent filings.
- Customer renewal rates, expansion activity and concentration among the largest insurance carriers.
- Cash conversion after investment purchases, acquisitions, capital expenditures, bonuses and equity-award tax withholding.
- Future tax liabilities, utilization of tax attributes and changes in unrecognized tax benefits.