Business Context and Reporting Period
Guidewire Software, Inc. provides software and subscriptions supporting property and casualty insurers, including core transaction processing, data management and analytics, and digital engagement. This unaudited Form 10-Q covers the three and nine months ended April 30, 2018, Guidewire’s fiscal third quarter and first nine months of fiscal 2018. The company operates as one reportable segment.
Key Financial Metrics
| Metric | Three Months Ended April 30, 2018 | Prior Period | Nine Months Ended April 30, 2018 | Prior Period |
|---|---|---|---|---|
| Total revenue | $140.5 million | $123.4 million | $412.4 million | $333.2 million |
| License and other revenue | $50.4 million | $59.0 million | $164.7 million | $161.8 million |
| Maintenance revenue | $18.7 million | $16.9 million | $56.8 million | $50.0 million |
| Services revenue | $71.4 million | $47.6 million | $191.0 million | $121.4 million |
| Gross profit | $66.1 million | $72.0 million | $207.4 million | $198.9 million |
| Gross margin | 47% | 58% | 50% | 60% |
| Loss from operations | $(29.2) million | $(4.3) million | $(62.6) million | $(14.4) million |
| Net loss | $(48.6) million | $(1.8) million | $(103.1) million | $(5.7) million |
| diluted loss per share | $(0.62) | $(0.02) | $(1.32) | $(0.08) |
Operating expenses were $95.3 million in the quarter and $270.0 million for the nine-month period, representing 68% and 65% of revenue, respectively. Nine-month expenses included research and development of $126.2 million, sales and marketing of $85.9 million, and general and administrative expense of $57.9 million.
Cash provided by operating activities was $36.6 million for the nine months, down from $51.5 million in the prior-year period. Investing cash outflow was $395.2 million, including $130.1 million for acquisitions and substantial purchases of marketable securities. Financing cash inflow was $572.0 million, primarily from common stock and convertible-note offerings.
At April 30, 2018, cash and cash equivalents were $476.1 million, short-term investments were $518.2 million, and long-term investments were $164.2 million. Total cash, cash equivalents and investments were approximately $1.16 billion. Working capital was $937.9 million. The balance sheet included $400.0 million principal amount of convertible senior notes, presented at a net carrying amount of $302.2 million.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue increased 14%, while nine-month revenue increased 24%. Services revenue was the principal growth driver, increasing 50% in the quarter and 57% for the nine-month period.
- Quarterly license and other revenue declined 15%, primarily because of the timing of term-license revenue recognition, annual license payments and a large prior-year customer transaction. Nine-month license and other revenue increased 2%.
- Services represented 51% of quarterly revenue and 46% of nine-month revenue, compared with 38% and 36%, respectively, in the prior-year periods.
- Gross margin declined to 47% from 58% in the quarter and to 50% from 60% for the nine months, reflecting the greater mix of lower-margin services, higher cloud-operation costs, and increased amortization of acquired intangible assets.
- Research and development expense increased 37% in the quarter and 33% for the nine months, consistent with continued product and cloud investment. General and administrative expense increased 35% and 42%, respectively.
- Cyence, acquired on November 1, 2017, contributed approximately $2.9 million of revenue and $8.5 million of net loss in the quarter, and $5.0 million of revenue and $18.2 million of net loss for the nine months. The preliminary acquisition consideration was approximately $260.3 million, including $200.5 million of goodwill.
- The company raised approximately $220.9 million net from issuing common stock and $387.2 million net from issuing 1.250% convertible senior notes due 2025. It paid $37.2 million for related capped calls.
- Deferred revenue increased 21% from July 31, 2017, to $134.6 million, including a 98% increase in deferred license and other revenue to $47.1 million.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2018 gross margins to decline from fiscal 2017 levels because of higher services revenue, continued investment in cloud operations and increased amortization of acquired intangible assets.
- Research and development, sales and marketing, and general and administrative expenses are expected to increase in absolute dollars as the company expands its products, cloud infrastructure, personnel and corporate systems.
- Guidewire expects to adopt the new revenue recognition standard, ASC 606, on August 1, 2018, using the modified retrospective method. Management expects the standard to materially change the timing of revenue recognition for term licenses, subscriptions and certain cloud arrangements.
- The Tax Cuts and Jobs Act generated a provisional net tax charge of approximately $34.0 million for deferred-tax-asset remeasurement, partially offset by a $5.4 million valuation-allowance release. The company recorded income tax expense of $46.6 million for the nine months despite its pretax loss.
- The company believes existing cash, investments and liquidity sources are sufficient to fund operations for at least the next 12 months. Future needs may increase with acquisitions, product development, cloud investment and international expansion.
- Key risks include lengthy and seasonal sales cycles, dependence on a relatively small number of large insurance customers, migration toward lower-margin cloud and subscription offerings, implementation and service-delivery risks, competition, cybersecurity and privacy exposure, foreign-currency fluctuations, acquisition integration, and execution of new ERP and revenue-recognition systems.
- The company entered into a 10.5-year lease for a potential future headquarters facility, with total committed payments of approximately $132.1 million, and issued a $1.8 million standby letter of credit for the security deposit.
- No material legal proceedings or material unrecorded litigation liabilities were reported. Management concluded that disclosure controls were effective as of April 30, 2018.
Important Facts for Investors to Verify
- Whether services growth and the resulting lower gross margin are temporary implementation effects or a lasting change in revenue mix.
- The actual fiscal 2018 revenue and margin impact of ASC 606, including effects on deferred revenue and term-license recognition.
- Cyence integration progress, future operating losses, goodwill valuation and realization of expected strategic benefits.
- Cash-generation trends, particularly given nine-month operating cash flow declined while capital requirements and acquisition activity increased.
- Terms, potential cash-settlement obligations and dilution risk associated with the $400.0 million convertible notes due 2025.
- The finalization of provisional Tax Act accounting and the potential effect of future tax provisions, including global intangible low-taxed income and base-erosion taxes.
- Implementation of remaining ERP and revenue-recognition modules and whether the system transition affects billing, collections, controls or financial reporting.