Guidewire Software, Inc. — Fiscal 2018 Second-Quarter Form 10-Q
Reporting period: Three and six months ended January 31, 2018; filed March 6, 2018. Guidewire provides software, subscriptions, maintenance, and implementation services to property and casualty insurers. The company operates as one segment.
Key Financial Metrics
| Metric | Three months ended Jan. 31, 2018 | Prior year | Six months ended Jan. 31, 2018 | Prior year |
|---|---|---|---|---|
| Total revenue | $163.8 million | $115.6 million | $272.0 million | $209.7 million |
| Revenue growth | 42% | 30% | ||
| Gross profit | $96.0 million | $74.8 million | $141.3 million | $126.9 million |
| Gross margin | 59% | 65% | 52% | 60% |
| Operating income (loss) | $(0.7) million | $8.2 million | $(33.4) million | $(10.1) million |
| Net income (loss) | $(45.6) million | $4.0 million | $(54.5) million | $(3.9) million |
| Diluted EPS | $(0.59) | $0.05 | $(0.72) | $(0.05) |
| Operating cash flow | Not separately provided | $16.4 million | $29.6 million |
- Quarterly revenue growth was led by license and other revenue of $84.2 million, up 31%; maintenance revenue of $19.1 million, up 15%; and services revenue of $60.5 million, up 73%.
- Services represented 37% of quarterly revenue and 44% of six-month revenue. Services gross margin was 9% for the quarter and 10% for the six-month period.
- Operating expenses increased 45% year over year in the quarter to $96.7 million, including research and development of $43.7 million, sales and marketing of $32.0 million, and general and administrative expense of $21.1 million.
- Six-month stock-based compensation expense was $44.7 million, compared with $36.5 million in the prior year.
- Cash, cash equivalents, and investments totaled $569.5 million at January 31, 2018, including $205.3 million of cash and cash equivalents, $299.9 million of short-term investments, and $64.3 million of long-term investments.
- Total current assets were $638.9 million versus current liabilities of $172.7 million, producing working capital of approximately $466.2 million.
- The filing identifies no commercial debt arrangements or material lines of credit. Management stated that existing liquidity should fund operations for at least the next 12 months.
- Total deferred revenue increased 18% from July 31, 2017 to $130.9 million. Four-quarter recurring revenue increased to $345.9 million from $285.3 million a year earlier.
Material Changes Versus the Prior Comparable Period
- Revenue increased substantially, but gross margin declined because of a greater mix of lower-margin services, higher cloud-operations costs, and increased amortization of acquired intangible assets.
- Operating results deteriorated despite revenue growth as operating expenses expanded faster than gross profit. The company moved from quarterly operating income of $8.2 million to a loss of $0.7 million and from quarterly net income of $4.0 million to a loss of $45.6 million.
- The net loss was heavily affected by a $48.1 million quarterly income-tax provision. This included a provisional $34.0 million charge to remeasure deferred tax assets and liabilities under the Tax Cuts and Jobs Act, partially offset by a $5.4 million valuation-allowance release. The resulting quarterly effective tax rate was approximately 1,880%.
- On November 1, 2017, Guidewire acquired Cyence for approximately $260.3 million, consisting of approximately $146.6 million in cash and approximately $113.7 million in equity consideration. Cyence contributed approximately $2.1 million of revenue and $9.7 million of net loss during the quarter and six-month period since acquisition.
- Cyence added approximately $201.1 million of goodwill and increased amortizable intangible assets. Acquisition-related costs were $3.8 million in the quarter and $5.2 million for the six-month period.
- Cash used in investing activities was $76.3 million for the six-month period, including approximately $130.1 million of cash used for the Cyence acquisition. Cash and cash equivalents declined by $57.9 million from July 31, 2017.
- Accounts receivable increased to $100.0 million from $79.4 million, while accrued employee compensation declined to $33.7 million from $48.9 million.
Guidance, Outlook, Risks, and Unusual Items
- No specific quantitative revenue or earnings guidance is provided in the filing.
- Management expects positive operating cash flow on an annual basis, although quarterly cash flow may fluctuate significantly. Management also expects existing liquidity to be sufficient for at least the next 12 months.
- Management expects fiscal 2018 gross margins to decline from fiscal 2017 because of the higher proportion of services revenue, continued investment in cloud operations and Guidewire Production Services, and increased amortization of acquired intangibles.
- The company expects research and development, sales and marketing, and general and administrative expenses to continue increasing as it hires personnel, expands globally, invests in infrastructure, and integrates acquisitions.
- Guidewire will adopt the new revenue standard, ASC 606, on August 1, 2018 using the modified retrospective method. Management expects the standard to change the timing of revenue recognition for term licenses, subscriptions, and certain cloud offerings, and continues to evaluate effects on systems, controls, commissions, and acquired revenue models.
- The company is transitioning to a greater mix of cloud-based subscriptions. This may delay revenue recognition, increase deferred revenue, raise delivery and implementation costs, reduce margins, and increase exposure to service-level penalties and implementation risks.
- Key operating risks include lengthy and seasonal sales cycles, dependence on large P&C insurance customers, intense competition, acquisition integration, cybersecurity and privacy requirements, foreign-currency volatility, implementation delays, reliance on systems-integrator partners, employee retention, and the effectiveness of new ERP and revenue-reporting systems.
- In December 2017, the company entered into a prospective headquarters lease expected to commence December 1, 2018, with total committed payments of $132.1 million and a $1.8 million standby letter of credit for the security deposit.
- No material legal proceedings, material off-balance-sheet arrangements, or material contractual-obligation changes other than those disclosed were reported. Disclosure controls were deemed effective, while ERP-related internal-control processes continue to be modified and monitored.
Important Facts for Investors to Verify
- Whether the Cyence acquisition generates expected revenue growth and strategic synergies while controlling integration costs, amortization, and operating losses.
- The effect of ASC 606 adoption on reported revenue, deferred revenue, remaining performance obligations, commissions, and comparability with prior periods.
- Whether services growth and cloud investment improve over time or continue to pressure gross and operating margins.
- The final accounting for the Tax Cuts and Jobs Act, including deferred-tax remeasurement, valuation allowances, global intangible low-taxed income, and the company’s effective tax rate.
- Trends in recurring revenue, subscription bookings, customer renewals, accounts receivable collections, and deferred revenue conversion.
- Progress and control effectiveness during completion of the ERP, revenue-reporting, and related accounting-system implementations.
- Liquidity after acquisition spending, the new headquarters lease commitment, ongoing hiring, and any additional acquisitions or financing.