Guidewire Software, Inc. — Fiscal 2019 Form 10-K
Reporting period: Fiscal year ended July 31, 2019. The filing includes fourth-quarter results for the quarter ended July 31, 2019, but is an annual report rather than a quarterly filing. Guidewire provides software, cloud subscriptions, data and analytics, digital engagement, and implementation services to global property and casualty insurers. It reported approximately 380 customers in 34 countries and 2,355 employees at year-end.
Financial performance and liquidity
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Total revenue | $719.5 million | $652.8 million | Up 10% |
| License and subscription revenue | $385.3 million | $309.0 million | Up 25% |
| Maintenance revenue | $85.4 million | $77.3 million | Up 10% |
| Services revenue | $248.8 million | $266.5 million | Down 7% |
| Gross profit | $395.2 million | $356.1 million | Up 11% |
| Gross margin | 55% | 55% | Flat |
| Operating income | $1.5 million | $(15.6) million | Improved |
| Net income | $20.7 million | $(26.7) million | Returned to profit |
| Diluted EPS | $0.25 | $(0.34) | Improved |
| Operating cash flow | $116.1 million | $140.5 million | Down 17% |
| Free cash flow | $67.3 million | $128.4 million | Down 48% |
License and subscription revenue consisted of $318.1 million of term licenses, $65.1 million of subscriptions, and $2.1 million of perpetual licenses. Subscription revenue nearly doubled year over year and represented 9% of total revenue. Annual recurring revenue was $460 million at July 31, 2019, compared with $412 million in the prior year.
License and subscription gross margin declined to 83% from 89%, primarily because of higher cloud infrastructure and subscription-related costs. Services gross margin declined to 2% from 7%, reflecting lower services revenue and costs associated with a lower-margin fixed-fee contract. Total gross margin remained 55% because of the greater mix of license and subscription revenue.
Research and development expense increased 10% to $188.5 million, sales and marketing expense increased 5% to $130.8 million, and general and administrative expense decreased 2% to $74.4 million. Stock-based compensation was $91.5 million, compared with $89.6 million in FY2018.
Cash, cash equivalents, and investments totaled $1.34 billion at year-end, including $254.1 million of cash and cash equivalents, $870.1 million of short-term investments, and $213.5 million of long-term investments. Working capital was $1.10 billion. Management stated that existing liquidity was sufficient to fund operations for at least the next 12 months.
Debt and obligations
Guidewire had $400.0 million principal amount of unsecured 1.25% convertible senior notes due March 2025. The net carrying value was $317.3 million, and the estimated fair value was $454.1 million at July 31, 2019. The notes have an initial conversion price of approximately $113.75 per share. Contractual obligations totaled $613.8 million, including $430.0 million of debt-related payments, $141.8 million of lease obligations, $37.8 million of purchase commitments, and $4.2 million of royalty obligations.
Material changes versus FY2018
- Revenue increased 10%, driven primarily by higher term license and subscription revenue. A single ten-year term license contributed $13.0 million of FY2019 revenue that would have been recognized over years two through ten under the prior accounting guidance.
- Subscription revenue increased 95%, reflecting new and existing customer orders, additional hosting revenue classified as subscription revenue under the new standard, and the Cyence acquisition.
- Services revenue decreased 7%, partly because hosting revenue was reclassified to subscription revenue and because of lower revenue from a fixed-fee contract.
- Guidewire adopted ASC 606 on August 1, 2018 using the modified retrospective method, increasing opening retained earnings by $44.3 million. The new standard generally accelerates recognition of term license revenue and defers subscription revenue ratably over the contract term.
- Cash flow weakened despite higher net income, primarily due to working-capital use and a $36.8 million increase in capital expenditures. FY2019 capital expenditures included $23.6 million for the new San Mateo headquarters.
- In FY2018, Guidewire completed a $220.9 million net common-stock offering and received $387.2 million net proceeds from convertible notes; no comparable financing occurred in FY2019.
Fourth-quarter context
For the quarter ended July 31, 2019, revenue was $207.9 million, gross profit was $125.1 million, operating income was $21.1 million, and net income was $23.0 million, or $0.28 diluted EPS. The company reported significant quarterly seasonality, with historically higher orders in the second and fourth fiscal quarters.
Outlook, commentary, and risks
The filing does not provide a clear formal FY2020 revenue or earnings guidance figure. Management expects subscriptions to increase as a proportion of new sales and revenue, while continuing to invest in cloud operations, research and development, sales and marketing, international expansion, and customer implementation capabilities. Management also expects services revenue to modestly decline as a percentage of total revenue as system integrator partners assume a greater role in implementations.
- The transition from term licenses to cloud subscriptions may reduce near-term reported revenue growth because subscription revenue is recognized ratably, while cloud delivery costs are incurred as services are provided.
- Revenue and cash flows may fluctuate significantly because of seasonality, lengthy and unpredictable sales cycles, customer concentration, contract modifications, renewals, and the timing of revenue recognition under ASC 606.
- The ten largest customers represented 31% of FY2019 revenue, creating exposure to customer delays, cancellations, non-renewals, or pricing pressure.
- Cloud operations expose Guidewire to higher infrastructure and personnel costs, service-level penalties, implementation risks, cybersecurity incidents, data privacy regulation, and potential customer liability.
- Guidewire restated its FY2018 and FY2017 financial statements in June 2019 for errors primarily involving revenue recognition under prior ASC 605 guidance. Management identified a material weakness related to revenue controls as of July 31, 2018 and stated that it was remediated during FY2019. Management and KPMG concluded that internal control over financial reporting was effective as of July 31, 2019.
- Other risks include intense competition, reliance on system integrators, international operations and foreign exchange, acquisitions, intellectual-property claims, tax uncertainty, and the ability to repay or settle the convertible notes.
Important facts for investors to verify
- Reconcile FY2019 growth under ASC 606 with comparable results under prior ASC 605 guidance; the filing presents FY2019 revenue on an “as if” ASC 605 basis of $556.8 million.
- Assess the durability and quality of the $460 million ARR, including the mix of term licenses, subscriptions, maintenance, renewals, and customer concentration.
- Monitor subscription growth against cloud infrastructure costs and the resulting license and subscription gross-margin trend.
- Review operating cash flow, free cash flow, unbilled accounts receivable, deferred revenue, and capitalized contract costs for effects of accelerated license recognition.
- Confirm sustained effectiveness of the remediated revenue controls following the FY2018 and FY2017 restatement.
- Evaluate liquidity and potential dilution or cash settlement requirements associated with the $400 million convertible notes due in 2025.
- Review the impact of the CEO transition from Marcus Ryu to Mike Rosenbaum, effective August 2019, on execution and customer relationships.