Guidewire Software, Inc. — Fiscal 2020 Form 10-K Summary
Business Context and Reporting Period
Guidewire provides core administration, digital engagement, analytics, and artificial intelligence software for property and casualty insurers. Offerings are delivered through cloud subscriptions or self-managed licenses, supplemented by implementation and other professional services.
The filing covers the fiscal year ended July 31, 2020. The fourth-quarter results are for the three months ended July 31, 2020. Guidewire operated as one reportable segment and served more than 340 customers representing over 400 insurance brands in 35 countries.
Financial Performance and Key Metrics
| Metric | FY2020 | FY2019 | Change |
|---|---|---|---|
| Total revenue | $742.3 million | $719.5 million | +3% |
| Subscription and support revenue | $203.5 million | $150.5 million | +35% |
| License revenue | $331.6 million | $320.3 million | +4% |
| Services revenue | $207.3 million | $248.8 million | -17% |
| Gross profit | $404.3 million | $395.2 million | +2% |
| Gross margin | 54% | 55% | Down approximately 1 point |
| Operating income (loss) | $(23.9) million | $1.5 million | Declined |
| Net income (loss) | $(27.2) million | $20.7 million | Declined |
| GAAP diluted EPS | $(0.33) | $0.25 | Declined |
| Non-GAAP net income | $105.8 million | $119.9 million | Declined |
| Non-GAAP diluted EPS | $1.26 | $1.45 | Declined |
Subscription revenue increased to $119.7 million from $65.1 million, reflecting the growing Guidewire Cloud customer base and prior-period bookings. Subscription and support represented 27% of total revenue, compared with 21% in FY2019. Services revenue fell primarily because large implementations were completed, system integrator partners assumed more implementation work, and COVID-19 restricted travel and customer-site activity.
Subscription and support gross margin declined to 42% from 51% as Guidewire expanded cloud operations, personnel, infrastructure, and technical support. License gross margin was 97%, while services gross margin was negative 1% versus 2% in the prior year.
Operating expenses increased 9% to $428.2 million, including research and development of $200.6 million, sales and marketing of $142.4 million, and general and administrative expense of $85.2 million. Stock-based compensation was $101.8 million, compared with $91.5 million in FY2019.
FY2020 included a $10.7 million impairment or fair-value reduction related to a strategic investment and a $11.4 million BEAT-related tax liability, including interest and penalties. Interest expense was $17.9 million, of which approximately $12.9 million was non-cash amortization of the convertible debt discount and issuance costs.
Fourth-Quarter Performance
| Metric | Q4 FY2020 | Q4 FY2019 |
|---|---|---|
| Revenue | $243.7 million | $207.9 million |
| Gross profit | $155.9 million | $125.1 million |
| Operating income | $44.3 million | $21.1 million |
| Net income | $38.8 million | $23.0 million |
| Diluted EPS | $0.46 | $0.28 |
The fourth quarter benefited from the company’s normal seasonal concentration of orders and upfront recognition of certain term licenses. Quarterly results remain difficult to compare because subscription revenue is recognized ratably while term license revenue is generally recognized when delivered.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Operating cash flow was $113.1 million, compared with $116.1 million in FY2019.
- Free cash flow was $87.4 million, compared with $67.3 million in FY2019. FY2020 free cash flow included a $9.9 million early partial bonus payment and $11.1 million of headquarters-related spending.
- Cash, cash equivalents, and investments totaled $1.434 billion at July 31, 2020, up from $1.338 billion. Working capital was $1.118 billion.
- Cash and cash equivalents were $367.0 million; short-term investments were $766.5 million; and long-term investments were $300.8 million.
- The company had $400.0 million principal amount of 1.25% convertible senior notes due March 2025. The net carrying amount was $330.2 million, and total contractual debt payments, including interest, were $425.0 million.
- Lease liabilities totaled $130.3 million, with total future operating lease payments of $160.5 million.
- Management stated that existing cash and liquidity sources should fund operations for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- The business continued shifting from self-managed licenses toward cloud subscriptions. ARR increased to $514 million from $460 million, approximately 12% growth.
- Subscription revenue grew sharply, but the transition reduced near-term reported revenue growth because subscription revenue is recognized over three to five years.
- Cloud investment increased substantially, including higher cloud infrastructure and personnel costs, reducing subscription gross margin.
- Services revenue and services margin weakened as major implementations ended, system integrators performed more work, and COVID-19 disrupted travel and implementations.
- Operating expenses rose faster than revenue, resulting in a GAAP operating loss and net loss for FY2020.
- Interest income declined because of lower investment yields, while other expense increased primarily because of the strategic investment fair-value reduction.
- Guidewire adopted ASC 842 lease accounting in FY2020, recording operating lease assets of approximately $103.8 million and lease liabilities of $130.3 million at year-end.
Outlook, Management Commentary, Risks, and Unusual Items
Management expects subscriptions to represent a majority of new sales and anticipates continued investment in cloud operations, research and development, security, and international expansion. The filing does not provide a clear formal numerical FY2021 revenue or earnings guidance.
COVID-19 delayed sales activities, lengthened implementation cycles, reduced services revenue and utilization, and affected ARR growth. Management believed many delayed sales were postponed rather than canceled, but expected adverse effects to continue at least through the first half of fiscal 2021 and potentially longer. The company also identified risks relating to customer payment capacity, increased credit reserves, asset impairments, and lower customer direct written premiums.
- Revenue recognition depends on complex contract terms, particularly arrangements involving term-license extensions, migrations to subscriptions, variable consideration, and multiple performance obligations. Remaining performance obligations were $587.9 million at July 31, 2020.
- The ten largest customers represented 31% of revenue in each of FY2020, FY2019, and FY2018; the ten largest customers represented 29% of FY2020 ARR.
- Cloud delivery creates risks related to security, privacy, service levels, AWS and other third-party dependencies, implementation costs, and lower margins.
- The company reported a July 2020 putative securities class action alleging Exchange Act and Rule 10b-5 violations. Guidewire disputes the claims and intends to defend the case; potential damages were unspecified.
- Guidewire previously restated FY2018 and FY2017 financial statements and disclosed a prior material weakness related to revenue controls. Management and KPMG concluded that internal control over financial reporting was effective as of July 31, 2020.
- The company was under examination by the California Franchise Tax Board for FY2018 and FY2017 tax returns. Unrecognized tax benefits totaled $23.7 million, of which $18.0 million could affect the effective tax rate.
- Convertible note holders may require cash settlement upon conversion or a fundamental change, creating liquidity and potential dilution risk. A future accounting change is expected to increase the use of the if-converted method for diluted EPS.
Most Important Facts for Investors to Verify
- Whether ARR growth and new cloud bookings translate into sustained recognized revenue and improved subscription gross margins.
- The pace and economics of migration from term licenses to subscriptions, including the resulting effects on revenue timing, deferred revenue, cash flow, and margins.
- Whether COVID-19-related implementation delays, customer budget pressure, and services underutilization persist beyond the first half of FY2021.
- The company’s ability to generate sufficient cash to fund cloud investments and meet or refinance the $400 million convertible notes due in 2025.
- The status and potential cost of the securities class action, California tax examination, and any remaining tax or accounting contingencies.
- The effect of high stock-based compensation, convertible-note accounting, and future diluted-share requirements on per-share economics.