Guidewire Software, Inc. 10-Q Summary
Business Context and Reporting Period
Guidewire provides software, cloud services, data and analytics, and digital engagement products primarily to property and casualty insurers. The filing covers the three and six months ended January 31, 2019, the second quarter and first six months of fiscal 2019. The financial statements are unaudited.
Key Financial Metrics
| Metric | Three Months Ended January 31, 2019 | Prior Year | Six Months Ended January 31, 2019 | Prior Year |
|---|---|---|---|---|
| Total revenue | $169.3 million | $163.8 million | $348.9 million | $272.0 million |
| Gross profit | $89.6 million | $96.0 million | $186.9 million | $141.3 million |
| Gross margin | 52% | 59% | 54% | 52% |
| Operating income (loss) | $(5.5) million | $(0.7) million | $(4.5) million | $(33.4) million |
| Net income (loss) | $0.8 million | $(45.6) million | $6.2 million | $(54.5) million |
| Diluted EPS | $0.01 | $(0.59) | $0.08 | $(0.72) |
| Operating cash flow | Not separately provided | Not separately provided | $(13.0) million | $16.4 million |
| Free cash flow | Not separately provided | Not separately provided | $(25.1) million | $11.1 million |
- Second-quarter revenue increased 3%; six-month revenue increased 28%.
- Six-month license and subscription revenue rose 59% to $181.4 million, including $150.9 million of term-license revenue and $30.1 million of subscription revenue. Subscription revenue increased 145% year over year for the six-month period.
- Second-quarter services gross profit was $(0.1) million, compared with $5.3 million in the prior-year quarter. Six-month services gross profit was $(0.9) million, compared with $11.8 million previously.
- Six-month operating expenses increased 10% to $191.3 million, driven principally by higher research and development and sales and marketing spending.
- Non-GAAP operating income was $26.1 million for the quarter and $57.8 million for the six-month period. Non-GAAP net income was $27.9 million and $57.8 million, respectively.
Liquidity, Capital Structure and Balance Sheet
- Cash, cash equivalents and investments totaled $1.238 billion at January 31, 2019, compared with $1.258 billion at July 31, 2018.
- Working capital was $1.094 billion, compared with $997.3 million at July 31, 2018.
- The company had $400.0 million principal amount of 1.25% convertible senior notes due March 2025, carried at a net liability value of $311.1 million. The notes had a fair value of approximately $408.0 million.
- The notes generated $8.5 million of interest expense during the six-month period, including $6.0 million of non-cash debt discount and issuance-cost amortization.
- The company expects existing liquidity to fund operations for at least the next 12 months. It also has a 10.5-year headquarters lease with total committed payments of $126.4 million and an $1.8 million standby letter of credit for the security deposit.
Material Changes Versus the Prior Comparable Period
- Guidewire adopted ASC 606 on August 1, 2018 using the modified retrospective method, increasing opening retained earnings by $35.6 million.
- ASC 606 accelerated recognition of term-license revenue upon delivery. For the six months, reported revenue was $348.9 million under ASC 606 versus $244.4 million on an as-if ASC 605 basis; reported net income was $6.2 million versus an as-if loss of $76.1 million.
- A ten-year term-license agreement contributed $13.0 million of revenue in the six-month period that would have been recognized in years two through ten under the former guidance.
- The second-quarter revenue benefit from ASC 606 was less pronounced than in the first quarter. Term-license revenue declined 2% year over year in the quarter, while subscription revenue increased 93%.
- Reported gross margin declined seven percentage points in the quarter because of higher cloud operations costs, infrastructure spending, acquired-intangible amortization, and weaker services margins. Six-month gross margin increased two percentage points because of the larger mix of license and subscription revenue.
- Operating cash flow declined from $16.4 million provided in the prior-year six-month period to $13.0 million used, and free cash flow declined from $11.1 million to $(25.1) million.
- The prior-year period included a significant one-time tax charge associated with the Tax Cuts and Jobs Act; the current period included tax benefits of $1.9 million for the quarter and $5.2 million year to date.
Outlook, Management Commentary, Risks and Unusual Items
- Management expects subscription sales to increase as a percentage of new sales, but ratable subscription recognition may reduce near-term reported revenue growth and increase deferred revenue.
- Management expects greater volatility in quarterly and annual results because of ASC 606, the timing of term-license deliveries and renewals, seasonality, large transactions, and the mix between term licenses and subscriptions.
- The company expects to continue investing in cloud operations, research and development, sales and marketing, and implementation capacity. These investments may pressure cloud and services margins.
- Professional services implementations are lengthy and may require more company involvement for cloud offerings and InsuranceNow. Fixed-fee projects, customer acceptance criteria, service-level commitments and implementation delays could result in additional costs, penalties, credits or delayed revenue.
- Key risks include competitive pressure, lengthy sales cycles, customer concentration, dependence on renewals, cybersecurity and privacy obligations, foreign-exchange volatility, acquisition integration, intellectual-property claims, and the ability to manage the transition to cloud delivery.
- The company reported no material legal proceedings requiring accrual and no material indemnification claims. No goodwill impairment was recorded.
- The company identified no material changes in internal control over financial reporting and concluded that disclosure controls were effective as of January 31, 2019.
Important Facts Investors Should Verify
- Assess the sustainability of revenue growth after adjusting for ASC 606 acceleration, the ten-year license deal and other contract-remediation effects.
- Monitor the shift toward subscriptions, deferred revenue, unbilled accounts receivable and remaining performance obligations of $169.1 million.
- Evaluate whether cloud investments and implementation costs improve long-term economics or continue to depress services and overall margins.
- Reconcile GAAP results with non-GAAP results, particularly the effects of $47.7 million of stock-based compensation and $14.6 million of intangible amortization during the six-month period.
- Review cash conversion, working-capital movements and the effects of annual bonus payments, billing timing and unbilled revenue on quarterly cash flow.
- Consider the $400.0 million convertible-note obligation, potential cash settlement or dilution, the capped-call protection, and the $126.4 million headquarters lease commitment.
- Follow potential tax impacts from BEAT regulations, unrecognized tax benefits of $5.8 million, and future accounting changes, including lease accounting.