Guidewire Software, Inc. — Fiscal 2020 First Quarter Form 10-Q
Reporting period: Three months ended October 31, 2019; comparative period ended October 31, 2018. The filing was dated December 5, 2019. Guidewire provides software, cloud subscriptions, maintenance, and professional services primarily to property and casualty insurers.
Key Financial Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Total revenue | $157.0 million | $180.3 million | Down 13% |
| License and subscription revenue | $82.4 million | $94.7 million | Down 13% |
| Maintenance revenue | $21.0 million | $21.0 million | Approximately flat |
| Services revenue | $53.6 million | $64.6 million | Down 17% |
| Gross profit | $76.2 million | $98.6 million | Down 23% |
| Gross margin | 49% | 55% | Down 6 percentage points |
| Operating income (loss) | $(24.6) million | $2.5 million | Declined $27.1 million |
| Net income (loss) | $(15.0) million | $6.3 million | Declined $21.3 million |
| GAAP diluted EPS | $(0.18) | $0.08 | Declined $0.26 |
| Non-GAAP diluted EPS | $0.13 | $0.38 | Down $0.25 |
| Free cash flow | $(29.1) million | $(30.7) million | Use improved $1.5 million |
Revenue mix: Term-license revenue was $54.2 million, down 32%, while subscription revenue was $28.2 million, up 84%. Subscription revenue included $12.6 million from new Guidewire Cloud InsuranceSuite orders since the comparable prior-year period. Perpetual-license revenue was $49,000.
Operating expenses: Research and development increased 2% to $46.5 million; sales and marketing increased 2% to $33.0 million; general and administrative increased 16% to $21.2 million. Total operating expenses rose 5% to $100.8 million.
Stock-based compensation: Expense was $24.6 million, compared with $23.3 million in the prior-year quarter. Unrecognized stock-based compensation totaled $250.7 million at October 31, 2019.
Cash, Liquidity, Debt, and Balance Sheet
- Cash, cash equivalents, and investments totaled $1.312 billion at October 31, 2019, compared with $1.338 billion at July 31, 2019.
- Cash and cash equivalents were $179.1 million; short-term investments were $832.1 million; long-term investments were $300.8 million.
- Working capital was $1.025 billion, down from $1.103 billion at July 31, 2019.
- Operating cash flow was negative $18.1 million, compared with negative $27.2 million in the prior-year quarter. The company noted that first-quarter cash usage is typically affected by annual bonus payments and seasonally higher commissions.
- Investing cash flow was negative $57.5 million, including $46.5 million of net purchases of available-for-sale securities, $9.6 million of property and equipment purchases, and $1.3 million of capitalized software costs.
- The company had $400.0 million principal amount of 1.25% convertible senior notes due March 2025, with a net carrying amount of $320.5 million and estimated fair value of $476.0 million.
- Operating lease liabilities totaled $112.0 million after adoption of ASC 842. Future operating lease payments totaled $142.1 million before $30.1 million of imputed interest.
- Management stated that existing liquidity and cash sources were sufficient to fund operations for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because the prior-year quarter included two large term-license transactions totaling $23.6 million, including a $14.5 million ten-year license recognized upfront. The current quarter was described as more representative of normal seasonal patterns.
- The business continued shifting toward cloud subscriptions, which are recognized ratably over three to five years and therefore delay revenue recognition relative to term licenses.
- Gross margin fell from 55% to 49%, primarily because of fewer high-margin term-license transactions and increased investment in cloud operations. License and subscription gross margin fell from 86% to 71%.
- Services revenue and cost of services both declined 17%, reflecting completion of certain large cloud implementations, lower professional-services headcount, and greater use of system integrator partners.
- Cost of license and subscription revenue increased 79%, driven primarily by higher cloud-operations personnel costs, cloud infrastructure costs, and professional-services costs supporting subscriptions.
- Annual Recurring Revenue was $463 million at October 31, 2019, up from $460 million at July 31, 2019.
- On August 1, 2019, the company adopted ASC 842 for leases, recognizing approximately $93.0 million of operating lease assets and $111.7 million of lease liabilities at adoption without an opening retained-earnings impact.
Guidance, Outlook, Risks, and Unusual Items
The filing does not provide a clear quarterly or annual revenue or earnings guidance range. Management expects subscriptions to become a larger portion of sales, while acknowledging that ratable recognition will pressure near-term reported revenue growth and margins during the transition.
- Management expects continued investment in cloud operations, research and development, sales and marketing, infrastructure, security, and general administration.
- Management expects research and development and sales and marketing expenses to increase in absolute dollars and expects higher license-and-subscription costs as cloud customers increase.
- Key risks include lengthy and seasonal sales cycles, concentration among large property and casualty insurers, customer renewals, competition, implementation delays, reliance on system integrators, cloud-service costs and service-level obligations, cybersecurity and privacy, foreign currency volatility, and macroeconomic conditions.
- The company reported no material legal proceedings or accrued litigation losses as of October 31, 2019. Customer software agreements include potentially broad intellectual-property indemnification provisions for which future payments cannot be estimated.
- The company had $6.6 million of unrecognized tax benefits. IRS BEAT regulations issued after quarter-end could materially affect the tax provision and cash taxes in the quarter ending January 31, 2020.
- The filing discusses prior restatements of fiscal 2017 and 2018 financial statements and a previously identified revenue-related material weakness in internal control. Management stated that the weakness had been remediated in fiscal 2019; current disclosure controls were considered effective, with no material changes other than controls related to ASC 842 adoption.
- The $400.0 million convertible notes could require cash settlement upon conversion or repurchase following a fundamental change. Conversion-related dilution and liquidity exposure remain important contingencies, although the notes were not dilutive in the quarter because the average share price was below the $113.75 conversion price.
Investor Verification Checklist
- Verify the pace of migration from term licenses to subscriptions and whether ARR growth is translating into future recognized revenue.
- Track cloud gross-margin performance, infrastructure costs, and the timing of operating leverage.
- Assess whether services revenue and margins continue to decline as system integrators lead more implementations.
- Reconcile GAAP losses with non-GAAP results, particularly the effects of $24.6 million of stock-based compensation and $7.2 million of intangible amortization.
- Review cash usage, investment maturities, lease commitments, and the company’s ability to fund potential cash settlement of the convertible notes.
- Monitor the effect of BEAT and other tax guidance on the effective tax rate, cash taxes, and deferred tax assets.
- Evaluate remediation of prior revenue-control weaknesses and the continuing risks associated with complex revenue recognition under ASC 606.