Guidewire Software, Inc. — Fiscal 2018 Form 10-K Summary
Business context and reporting period
Guidewire provides software, cloud subscriptions, implementation services, data and analytics, and digital engagement applications for the global property and casualty insurance industry. The filing covers the fiscal year ended July 31, 2018; the fourth fiscal quarter ended July 31, 2018 is also presented in the quarterly results table.
As of July 31, 2018, Guidewire served approximately 380 customers in 39 countries and had 2,292 employees. The company operates as one reportable segment.
Financial performance and key metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Total revenue | $661.1 million | $514.3 million | Up 29% |
| License and other revenue | $315.8 million | $271.5 million | Up 16% |
| Maintenance revenue | $77.3 million | $68.6 million | Up 13% |
| Services revenue | $268.0 million | $174.2 million | Up 54% |
| Gross profit | $364.4 million | $322.7 million | Up 13% |
| Gross margin | 55% | 63% | Down 8 percentage points |
| Operating income (loss) | $(7.3) million | $26.6 million | Declined |
| Net income (loss) | $(19.7) million | $21.2 million | Declined |
| Operating cash flow | $140.5 million | $137.2 million | Up $3.3 million |
Services represented 41% of revenue versus 34% in the prior year and carried an 8% gross margin. License and other revenue carried an 89% gross margin, down from 94%, primarily because of higher cloud infrastructure costs, acquired intangible amortization, and related headcount. Operating expenses increased 26% to $371.7 million, led by research and development spending of $171.7 million.
Fourth-quarter revenue was $248.6 million, with operating income of $55.2 million and net income of $83.4 million. Quarterly results were highly seasonal and included significant fluctuations across the year.
Liquidity, cash flow, debt, and balance sheet
- Cash, cash equivalents, and investments totaled $1.258 billion at July 31, 2018, compared with $687.8 million a year earlier.
- Working capital was $997.3 million, compared with $515.6 million in fiscal 2017.
- Operating cash flow was $140.5 million; capital expenditures were $12.0 million.
- Investing cash outflow was $537.6 million, including $130.1 million for the Cyence acquisition and increased purchases of marketable securities.
- Financing cash inflow was $573.0 million, primarily from $220.9 million of net common-stock offering proceeds and $387.2 million of net convertible-note proceeds, partly offset by a $37.2 million capped-call purchase.
- The company issued $400.0 million of 1.25% unsecured convertible senior notes due March 2025. The notes had a net carrying value of $305.1 million at year-end and a $113.75 initial conversion price.
- Total assets were $2.0 billion, including $340.9 million of goodwill and $95.7 million of intangible assets. Stockholders’ equity was $1.424 billion.
Material changes versus the prior comparable period
- Revenue growth accelerated to 29%, driven particularly by services revenue, recently acquired products, and increased adoption of cloud, data, analytics, and digital offerings.
- Gross margin declined from 63% to 55% as the revenue mix shifted toward lower-margin services and as cloud delivery costs and amortization increased.
- Guidewire moved from $26.6 million of operating income and $21.2 million of net income to a $7.3 million operating loss and $19.7 million net loss.
- The fiscal 2018 tax provision was $19.7 million despite pretax income of only $18,000. The provision primarily reflected a $35.0 million remeasurement charge for U.S. deferred tax assets under the Tax Cuts and Jobs Act, partially offset by other tax benefits.
- Cyence was acquired on November 1, 2017 for approximately $260.3 million, including $146.6 million in cash and equity consideration. Cyence contributed $11.0 million of revenue and a $20.3 million net loss after acquisition.
- Deferred revenue increased 24% to $137.9 million, reflecting growth in term-license renewals and subscription contracts.
- Four-quarter recurring revenue increased to $381.3 million from $327.0 million, although management stated that the measure would become less indicative after the transition to subscription contracts and ASC 606.
- Stock-based compensation increased to $89.6 million from $71.8 million.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide a clear quantitative fiscal 2019 revenue or earnings forecast. Management expects continued investment in research and development, sales and marketing, cloud operations, services capacity, and corporate infrastructure. Services revenue was expected to remain at approximately its fiscal 2018 percentage of total revenue in fiscal 2019, with potentially greater variability.
ASC 606 became effective August 1, 2018 under the modified retrospective method. The standard is expected to accelerate recognition of many term-license arrangements upon software delivery, while subscription revenue will generally remain ratable. Management estimated an adoption-date reduction primarily to deferred revenue and increase to unbilled contract revenue of approximately $29 million to $39 million, plus capitalization of approximately $11 million to $17 million of deferred sales commissions.
- Key operating risks include lengthy and unpredictable sales and implementation cycles, customer concentration, competition, pricing pressure, and dependence on renewals.
- The transition toward cloud delivery may increase infrastructure, implementation, support, security, privacy, and service-level obligations and may pressure margins before scale benefits develop.
- Large customers have substantial negotiating leverage, and the ten largest customers represented 31% of fiscal 2018 revenue.
- International operations expose the company to foreign-exchange, regulatory, tax, political, trade, and data-privacy risks. International revenue was $244.1 million, or approximately 37% of total revenue.
- The company has significant commitments, including $435.0 million of scheduled convertible-note principal and interest payments, $147.0 million of operating lease obligations, and $70.1 million of purchase commitments. It also entered into a future headquarters lease with total committed payments of $126.7 million.
- Legal proceedings arise in the ordinary course; management reported no pending matter expected to have a material adverse effect. Indemnification obligations, particularly intellectual-property claims, cannot be reliably estimated.
- The company reported effective disclosure controls and internal control over financial reporting, and KPMG issued an unqualified audit opinion.
Most important facts for investors to verify
- Whether ASC 606 materially changes reported revenue, deferred revenue, contract assets, sales-commission amortization, margins, and quarterly volatility.
- Whether cloud and subscription growth improves long-term recurring revenue without causing sustained services-margin and operating-margin pressure.
- The scale and profitability contribution of Cyence and other acquired products, including integration costs and potential goodwill or intangible impairment.
- Cash conversion relative to net income, especially the effects of invoicing seasonality, deferred revenue, accounts receivable, bonuses, and acquisitions.
- Future liquidity requirements and potential cash or share settlement of the 2025 convertible notes, including dilution above the $113.75 conversion price.
- Customer renewal, expansion, and concentration trends, particularly among large insurance carriers.
- Execution of the new ERP and revenue-reporting systems and the company’s ability to maintain effective controls during the ASC 606 transition.