Guidewire Software, Inc. quarterly report, Q2 FY2023

Guidewire Software, Inc. — Fiscal 2023 Second-Quarter Form 10-Q Summary

Reporting period: Three and six months ended January 31, 2023. The filing was dated March 6, 2023. Guidewire provides software and cloud services for property and casualty insurers, including core policy, billing, claims, digital engagement, analytics, and artificial intelligence applications.

Financial Highlights

Metric	Three Months Ended Jan. 31, 2023	Year-over-Year Change	Six Months Ended Jan. 31, 2023	Year-over-Year Change
Total revenue	$232.6 million	14%	$427.9 million	15%
Subscription and support revenue	$105.8 million	25%	$204.8 million	25%
License revenue	$73.1 million	5%	$114.1 million	4%
Services revenue	$53.7 million	6%	$109.0 million	12%
Gross profit	$123.5 million	21%	$195.6 million	15%
Gross margin	53%	Up from 50%	46%	Down from 47%
Operating loss	$(23.2) million	Improved from $(39.5) million	$(97.8) million	Improved from $(104.8) million
Net loss	$(9.2) million	Improved from $(40.7) million	$(78.5) million	Improved from $(92.0) million
Basic and diluted loss per share	$(0.11)	Improved from $(0.49)	$(0.95)	Improved from $(1.10)

Margins and Operating Expenses

Second-quarter subscription and support gross margin was 54%, compared with 43% in the prior-year period; license gross margin remained 97%, while services gross margin declined to negative 9% from negative 3%.
Six-month subscription and support gross margin was 49%, compared with 41%; license gross margin was 97%, compared with 96%; services gross margin was negative 14%, compared with negative 2%.
Six-month operating expenses increased 7% to $293.4 million. Research and development increased 8% to $119.9 million, sales and marketing increased 2% to $91.2 million, and general and administrative expense increased 10% to $82.3 million.
Stock-based compensation expense was $36.2 million in the quarter and $71.3 million for the six-month period.

Cash Flow, Liquidity, and Debt

Net cash used in operating activities was $86.2 million for the six months, improving from $110.1 million used in the prior-year period.
Free cash flow was negative $94.3 million, compared with negative $123.2 million in the prior-year period.
At January 31, 2023, cash, cash equivalents, and investments totaled $870.0 million, down from $1.164 billion at July 31, 2022. Working capital was $731.1 million.
The company had $400.0 million principal amount of 1.25% convertible senior notes due 2025, carried at $396.3 million net. The notes had a reported fair value of $387.0 million.
During the six months, Guidewire used $200.0 million for an accelerated share repurchase and had approximately $200.0 million remaining under its authorized repurchase program as of January 31, 2023.
Management stated that existing cash, cash equivalents, and liquidity sources are expected to fund operations for at least the next 12 months.

Material Changes Versus the Prior Comparable Period

Revenue growth was led by subscription revenue, which increased 37% in both the quarter and six-month period. Subscription revenue represented 37% of quarterly revenue and 39% of six-month revenue, compared with 31% and 32%, respectively, in the prior-year periods.
Support revenue declined 8% in both periods as customers migrated from self-managed term licenses to subscription services.
Services revenue increased, but services profitability deteriorated substantially because of investments in cloud migrations and implementations, increased subcontractor costs, lower billing rates, and fixed-fee or capped arrangements.
Subscription and support gross profit improved due to revenue growth and cloud operations efficiencies. The company expects cloud infrastructure costs to rise in absolute dollars but to grow more slowly than subscription and support revenue over time.
Operating losses narrowed despite higher research and development and general and administrative spending. Sales and marketing expense declined in the quarter partly because the timing of the annual customer conference shifted between periods.
Interest income increased materially because of higher interest rates, while interest expense declined after adoption of ASU 2020-06 eliminated amortization of the convertible notes’ debt discount.
Guidewire adopted ASU 2020-06 on August 1, 2022, recording the convertible notes as a single liability and making other balance-sheet and retained-earnings adjustments.

Guidance, Outlook, and Management Commentary

ARR was $707 million at January 31, 2023, compared with $664 million at July 31, 2022.
Remaining performance obligations were approximately $1.2 billion at January 31, 2023, with subscription obligations generally satisfied over three to five years.
Management expects subscriptions to comprise a majority of new arrangements, including migrations from term licenses. Because subscription revenue is recognized ratably, growth in orders may precede reported revenue growth.
Management expects subscription and support gross margins to improve over the next several years through cloud operating efficiencies and scale. Services margins are expected to improve as reliance on subcontractors and fixed-fee arrangements declines.
Research and development, sales and marketing, and general and administrative expenses are expected to increase in absolute dollars but decline as a percentage of revenue as hiring and investments moderate.
The company expects to generate positive operating cash flow annually in the future, although quarterly cash flow may fluctuate significantly.
Guidewire entered into a new cloud infrastructure services agreement requiring total payments of $600 million over five years.
In February 2023, the company assigned its existing San Mateo headquarters lease, with approximately $90 million of remaining payments through December 2029, and entered into a four-year sublease with approximately $22 million of payments. The accounting treatment was still under evaluation.

Key Risks and Unusual Items

The transition to cloud subscriptions may delay revenue recognition, increase cloud infrastructure and implementation costs, and pressure near-term margins and operating cash flow.
Services gross losses are a material concern, particularly if migration projects run over budget or require additional personnel without corresponding customer payments.
Sales and implementation cycles are lengthy and variable, and the business is seasonal, with increased orders historically occurring in the fourth fiscal quarter.
Macroeconomic conditions, inflation, foreign exchange volatility, the Russia-Ukraine conflict, supply-chain disruptions, and ongoing effects of COVID-19 may delay customer decisions and implementations.
Guidewire relies on third-party cloud infrastructure, primarily AWS, creating availability, security, service-level, and cost risks. Data breaches or privacy-law violations could result in liabilities, regulatory penalties, and customer losses.
The company remains exposed to the renewal and expansion decisions of large P&C insurance customers, although no individual customer represented at least 10% of revenue or accounts receivable in the periods presented.
A hypothetical 10% foreign-exchange movement could produce an estimated transaction gain or loss of approximately $32.3 million.
No material legal proceedings or litigation accruals were reported. The company has broad customer indemnification obligations for certain intellectual-property claims, but cannot estimate potential future payments.
The convertible notes could require cash settlement upon conversion or a fundamental change and could dilute shareholders if settled in shares.

Investor Verification Checklist

Reconcile ARR growth with recognized subscription revenue, deferred revenue, remaining performance obligations, and actual new bookings.
Assess whether services gross losses are improving and whether cloud migration investments are producing sustainable customer and margin benefits.
Review the $600 million, five-year cloud infrastructure commitment relative to expected subscription growth and liquidity.
Monitor cash burn, free cash flow, share repurchases, and the company’s ability to fund the $400 million convertible notes due 2025.
Evaluate the effect of subscription mix, term-license migrations, seasonality, and revenue-allocation judgments on reported growth.
Review the accounting impact of the February 2023 headquarters lease assignment and sublease.
Track foreign-exchange exposure, cybersecurity and privacy compliance, third-party cloud dependence, customer concentration, and renewal trends.
Distinguish GAAP losses from non-GAAP measures, particularly given $71.3 million of six-month stock-based compensation and other excluded costs.