Guidewire Software, Inc. — Q3 FY2020 Form 10-Q Summary
Business context and reporting period
Guidewire provides software, cloud subscriptions, implementation and support services to property and casualty insurers. The filing covers the three and nine months ended April 30, 2020, Guidewire’s fiscal third quarter, with comparative periods ended April 30, 2019. The company operates as one segment and had 83.2 million shares outstanding at April 30, 2020.
Financial performance and key metrics
| Metric | Q3 FY2020 | Q3 FY2019 | Change |
|---|---|---|---|
| Total revenue | $168.2 million | $162.9 million | Up 3% |
| License and subscription revenue | $93.2 million | $76.2 million | Up 22% |
| Maintenance revenue | $20.7 million | $21.3 million | Down 3% |
| Services revenue | $54.3 million | $65.3 million | Down 17% |
| Gross profit | $82.4 million | $82.6 million | Down slightly |
| Gross margin | 49% | 50% | Down 1 percentage point |
| Operating loss | $25.6 million | $15.8 million | Loss increased |
| Net loss | $31.0 million | $8.6 million | Loss increased |
| GAAP diluted loss per share | $0.37 | $0.11 | Higher loss |
| Non-GAAP net income | $7.7 million | $15.2 million | Down 49% |
For the nine months ended April 30, 2020, revenue was $498.6 million versus $511.7 million, gross profit was $248.4 million versus $270.1 million, and gross margin was 50% versus 54%. The operating loss was $68.2 million versus $19.6 million, and the net loss was $66.0 million versus $2.3 million. Non-GAAP net income was $36.2 million versus $73.6 million.
Q3 subscription revenue rose 105% to $30.1 million, while term-license revenue increased 4% to $62.7 million. For the nine-month period, subscription revenue increased 94% to $86.9 million, while term-license revenue decreased 10% to $191.1 million. The mix shift toward subscriptions is increasing recurring revenue but delaying revenue recognition and pressuring near-term reported growth and margins.
Operating expenses increased 10% in Q3 to $108.0 million and 9% for the nine-month period to $316.7 million. Q3 research and development, sales and marketing, and general and administrative expenses were $51.9 million, $35.2 million, and $20.9 million, respectively. Stock-based compensation was $24.8 million in Q3 and $76.1 million for the nine-month period.
Cash flow, liquidity and capital structure
- Cash, cash equivalents and investments totaled $1.326 billion at April 30, 2020, compared with $1.338 billion at July 31, 2019.
- Working capital was $1.048 billion, compared with $1.103 billion at July 31, 2019.
- Nine-month operating cash flow was $5.9 million, compared with $13.3 million in the prior-year period.
- Nine-month free cash flow was negative $16.3 million, compared with negative $17.8 million. Capital expenditures and capitalized software costs totaled $22.2 million.
- The company had $400.0 million principal amount of 1.25% convertible senior notes due March 2025, carried at $326.9 million net. The notes had a fair value of approximately $414.0 million at April 30, 2020.
- Operating lease liabilities totaled $109.0 million. New Dublin and Mississauga facility leases added approximately $36.8 million of obligations over 12 years and had not commenced as of April 30, 2020.
- Management stated that existing cash, cash equivalents and investments should fund operations for at least the next 12 months.
Material changes versus the prior comparable period
- Revenue growth was driven by subscription expansion, partially offset by a substantial decline in services revenue.
- Services gross profit declined to $1.6 million in Q3 from $4.7 million and was negative $3.2 million for the nine-month period, versus positive $4.5 million in the prior year.
- License and subscription gross margin declined to 69% in Q3 from 79% and to 72% for the nine-month period from 83%, reflecting higher cloud infrastructure and personnel costs.
- Operating losses widened as the company continued investing in cloud operations, product development, sales and marketing, information security and its new headquarters.
- Annual recurring revenue was $483 million at April 30, 2020, up from $460 million at July 31, 2019.
- The company adopted ASC 842 lease accounting on August 1, 2019, recognizing operating lease assets of $93.0 million and lease liabilities of $111.7 million at adoption.
Guidance, outlook, commentary and unusual items
The filing does not provide clear numerical revenue or earnings guidance. Management expects subscription sales to comprise a majority of annual new sales, with continued investment in cloud operations and research and development. Management expects services revenue and margins to remain under pressure in the fourth fiscal quarter and potentially longer.
COVID-19 materially affected operations. Most employees were working remotely, and customer, partner and vendor travel restrictions delayed sales activity and implementations. Management expected Q4 ARR and revenue, particularly services revenue, to be adversely affected, although it believed many delayed sales were postponed rather than canceled. Customers may also request extended payment terms or fail to pay, increasing credit and reserve risks.
Notable Q3 and year-to-date items included a $10.7 million impairment or fair-value reduction on a strategic investment, primarily due to liquidity constraints; a $9.9 million early partial bonus payment to employees; and a $1.0 million reduction in BEAT tax liability under the CARES Act. The company also recognized $11.3 million of BEAT liability for the nine-month period, including $5.9 million relating to the prior fiscal year.
Key risks include COVID-19 and macroeconomic conditions, the transition from term licenses to cloud subscriptions, elevated cloud delivery costs, low or volatile services margins, lengthy sales and implementation cycles, customer concentration, competition, cybersecurity and privacy obligations, foreign-currency exposure, tax matters, and potential cash requirements associated with the convertible notes.
Important facts for investors to verify
- Whether COVID-19 delays in sales and implementations convert into cancellations, lower ARR growth or weaker collections.
- Subscription growth, provisioning timing and the effect of ratable recognition on revenue, deferred revenue and cash flow.
- The path toward improvement in license and subscription gross margins as cloud scale increases.
- The sustainability of services margins, including the impact of SI partners and customer implementation investments.
- Liquidity requirements related to the $400 million convertible notes, potential cash settlement or repurchase obligations, and capped-call protection.
- Potential further impairment of strategic investments, lease assets, goodwill or other long-lived assets.
- The outcome of the California Franchise Tax Board review and the effect of BEAT and other tax regulations.
- Management’s assertion that disclosure controls were effective and that no material changes occurred in internal control over financial reporting, while also considering prior-year revenue-control remediation and restatement-related risks.