Guidewire Software, Inc. — Fiscal 2016 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended April 30, 2016; comparative periods ended April 30, 2015. Guidewire provides software for property and casualty insurers, including core transaction processing, data management and analytics, and digital engagement. The company operates as one segment.
Financial highlights
| Metric | Three months ended April 30, 2016 | Three months ended April 30, 2015 | Nine months ended April 30, 2016 | Nine months ended April 30, 2015 |
|---|---|---|---|---|
| Total revenue | $98.9 million | $85.4 million | $283.3 million | $254.6 million |
| Gross profit | $59.9 million | $47.5 million | $174.2 million | $146.9 million |
| Gross margin | 61% | 56% | 61% | 58% |
| Operating loss | $(5.8) million | $(6.7) million | $(7.0) million | $(7.0) million |
| Net loss | $(0.4) million | $(3.0) million | $(1.1) million | $(2.0) million |
| Adjusted EBITDA | $12.7 million | $7.6 million | $46.7 million | $36.4 million |
| Operating cash flow | Not separately provided | Not separately provided | $50.6 million | $30.7 million |
- Revenue mix: Third-quarter license revenue was $45.8 million, maintenance revenue was $14.7 million, and services revenue was $38.4 million. Nine-month amounts were $131.5 million, $42.9 million, and $108.8 million, respectively.
- Revenue growth: Total revenue increased 16% in the quarter and 11% year to date. License revenue increased 38% in the quarter and 24% year to date; maintenance revenue increased 20% and 16%, respectively. Services revenue declined 4% in the quarter and 3% year to date.
- Profitability: Gross-margin expansion reflected a greater mix of higher-margin license and maintenance revenue. Operating expenses increased 21% in the quarter and 18% year to date, led by research and development, sales and marketing, and general and administrative spending.
- Stock-based compensation: Expense was $16.2 million in the quarter and $47.9 million year to date, compared with $12.4 million and $37.9 million in the comparable periods.
- Liquidity: Cash, cash equivalents, and investments totaled approximately $680.8 million at April 30, 2016, including $204.6 million of cash and cash equivalents, $374.1 million of short-term investments, and $102.2 million of long-term investments. Working capital was $546.3 million.
- Debt: The filing does not report outstanding debt or credit-line borrowings. The company states that it has no material commercial commitments under lines of credit or similar debt arrangements.
- Deferred revenue: Deferred revenue increased 30% from July 31, 2015 to $68.3 million, primarily due to higher deferred license billings.
- Recurring revenue: Four-quarter recurring revenue reached $250.6 million at April 30, 2016, up from $208.9 million at April 30, 2015.
Material changes versus the prior comparable period
- License growth and a higher proportion of license and maintenance revenue increased gross margin from 56% to 61% for the quarter and from 58% to 61% year to date.
- Services revenue and services gross profit declined as several large implementation projects neared completion and the company continued using system-integrator partners.
- Research and development expense increased 19% in the quarter and 20% year to date; research and development headcount increased to 448 from 383 at April 30, 2015.
- Cash provided by operations increased $20.0 million year to date, primarily from improved profitability excluding noncash items, collections, and deferred-revenue changes.
- Investing cash flow shifted to a $63.0 million use from a $3.8 million source, largely because of the EagleEye acquisition and increased net purchases of marketable securities.
- On March 31, 2016, Guidewire acquired EagleEye Analytics for total consideration of $40.2 million, including $39.5 million of cash used net of cash acquired. The preliminary allocation included $20.4 million of goodwill and $12.5 million of acquired intangible assets. EagleEye’s reported operating results were not material to the quarter.
- Deferred tax assets were reclassified to noncurrent under the prospective adoption of ASU 2015-17.
Outlook, management commentary, risks, and unusual items
- Management expects positive annual operating cash flow and believes existing cash and liquidity will fund operations for at least the next 12 months.
- Management expects research and development, sales and marketing, and general and administrative expenses to continue increasing in absolute dollars as the business expands.
- Services revenue is expected to decline as a percentage of total revenue as more implementation work is performed by third-party system integrators. Services revenue has materially lower margins than license revenue.
- The company expects continued seasonal volatility, with customer orders generally higher in the second and fourth fiscal quarters. License revenue may also fluctuate based on billing timing, payment terms, perpetual licenses, and perpetual buyout rights.
- Interest income included approximately $1.0 million of income related to the conversion of a strategic convertible investment into preferred equity. A $1.5 million acquisition-related cost was recorded in general and administrative expense for the quarter.
- The effective tax rates were unusually high at 85.4% for the quarter and 68.3% year to date, reflecting permanent differences, credits, foreign tax-rate differences, and discrete items.
- Key risks include lengthy and unpredictable sales and implementation cycles, customer concentration and renewal risk, intense competition, reliance on system-integrator partners, acquisition integration risk, foreign-currency volatility, data-security and privacy obligations, intellectual-property claims, and changes in revenue-recognition rules.
- ASU 2014-09 and related guidance on revenue from contracts with customers will be effective for Guidewire beginning August 1, 2018. The company had not selected a transition method and was evaluating potential effects.
- No material legal proceeding was identified as likely to have a material adverse effect. No material change in contractual obligations was reported, and no material off-balance-sheet arrangements were disclosed.
- Management concluded that disclosure controls and procedures were effective as of April 30, 2016, with no material changes in internal control over financial reporting during the quarter.
Investor verification priorities
- Verify whether license and recurring-revenue growth continues to offset declining services revenue and rising operating expenses.
- Assess the sustainability of the 61% gross margin as revenue mix, implementation activity, and system-integrator usage change.
- Track EagleEye’s integration, customer adoption, acquired intangible amortization, goodwill valuation, and any future measurement-period adjustments.
- Reconcile reported net losses with Adjusted EBITDA and operating cash flow, particularly given substantial stock-based compensation.
- Monitor deferred revenue, billing timing, perpetual-license activity, renewal rates, and customer concentration as indicators of future revenue visibility.
- Evaluate the potential impact of the upcoming revenue-recognition standard, including the eventual transition method and changes to contract terms.
- Review tax exposures, including $3.9 million of unrecognized tax benefits and approximately $9.5 million of potential deferred tax liability associated with undistributed foreign earnings.