Guidewire Software, Inc. — Fiscal 2014 Third-Quarter Form 10-Q
Business context and reporting period
Guidewire provides software platforms for property and casualty insurance operations, including underwriting and policy administration, claims management and billing through PolicyCenter, ClaimCenter and BillingCenter. The unaudited report covers the three and nine months ended April 30, 2014, compared with the corresponding 2013 periods. The company operates as one reportable segment.
Key financial metrics
| Metric | Three months ended April 30, 2014 | Three months ended April 30, 2013 | Nine months ended April 30, 2014 | Nine months ended April 30, 2013 |
|---|---|---|---|---|
| Revenue | $82.0 million | $68.3 million | $232.0 million | $203.7 million |
| Gross profit | $44.7 million | $32.3 million | $116.1 million | $108.8 million |
| Gross margin | 55% | 48% | 50% | 53% |
| Operating income (loss) | $(3.4) million | $(4.4) million | $(23.8) million | $0.7 million |
| Net income (loss) | $(1.4) million | $(2.7) million | $(12.9) million | $3.3 million |
| Adjusted EBITDA | $12.3 million | $5.0 million | $28.7 million | $32.3 million |
| Operating cash flow | Not separately provided | Not separately provided | $26.1 million | $8.1 million |
- Quarterly revenue increased 20%, led by license revenue growth of 39%, maintenance growth of 15% and services growth of 10%. Nine-month revenue increased 14%.
- Quarterly license revenue was $31.9 million, including $28.2 million of term licenses and $3.7 million of perpetual licenses. Nine-month license revenue was $86.0 million, including $80.6 million of term licenses.
- Services represented 48% of quarterly revenue and 50% of nine-month revenue. Services gross margin was 14% for the quarter and 8% for the nine-month period, substantially below license and maintenance margins.
- Operating expenses increased 31% in the quarter and 29% for the nine-month period. Nine-month research and development, sales and marketing, and general and administrative expenses were $58.4 million, $53.9 million and $27.6 million, respectively.
- Stock-based compensation was $13.9 million for the quarter and $47.5 million for the nine-month period, compared with $8.3 million and $28.4 million, respectively, in the prior-year periods.
- As of April 30, 2014, cash, cash equivalents and investments totaled approximately $600.1 million, comprising $159.3 million of cash and cash equivalents, $271.0 million of short-term investments and $169.8 million of long-term investments. Working capital was $414.7 million.
- The filing reports no debt arrangements or material non-cancellable purchase commitments. Total liabilities were $98.7 million, including $58.3 million of deferred revenue.
- Capital expenditures were $3.7 million for the nine-month period. Cash paid for employee withholding taxes on vested RSUs was $25.7 million.
Material changes versus the prior comparable periods
- Quarterly gross margin improved to 55% from 48%, primarily because of better services and maintenance margins and a more favorable revenue mix. Nine-month gross margin declined to 50% from 53%, mainly because services, which carry lower margins, remained a larger portion of revenue and services and license margins declined.
- Quarterly operating loss narrowed from $4.4 million to $3.4 million, while the nine-month period moved from operating income of $0.7 million to an operating loss of $23.8 million as operating expenses grew faster than gross profit.
- Quarterly net loss narrowed to $1.4 million from $2.7 million, but nine-month results declined from net income of $3.3 million to a net loss of $12.9 million.
- Four-quarter recurring revenue increased to $165.3 million at April 30, 2014, from $130.9 million at April 30, 2013. Term-license recurring revenue was $125.5 million and maintenance recurring revenue was $39.8 million.
- Deferred revenue increased 42% from July 31, 2013, to $58.3 million, including increases in deferred license and services revenue. The balance includes $4.0 million related to one customer and subject to refund if specified implementation milestones are not achieved.
- On October 28, 2013, Guidewire completed a follow-on offering of 8.3 million shares at $48.75 per share, generating approximately $389.9 million of net proceeds before offering costs. The proceeds were invested primarily in available-for-sale securities.
Guidance, outlook, commentary and risks
- Management expects research and development, sales and marketing, general and administrative expenses and operating costs to increase in absolute dollars as the company invests in product innovation, international expansion, infrastructure and growth.
- Management expects positive annual operating cash flow, but quarterly cash flow may fluctuate significantly because of seasonality, bonus payments, collections, deferred revenue and billing timing. Management believes existing liquidity will fund operations for at least the next 12 months.
- Sales cycles generally last 12 to 24 months, and implementations generally last 6 to 24 months or longer. Revenue recognition may vary based on payment timing, contract terms, perpetual-license activity, customer acceptance and specified future functionality.
- Key risks include customer concentration, intense competition, lower-margin professional services, implementation delays, dependence on renewals and expansions, international operations and foreign exchange, cybersecurity and cloud-service disruptions, intellectual-property claims, product defects, employee retention, rapid growth and adverse economic conditions affecting insurance-industry technology spending.
- The Accenture litigation remains a contingent exposure. The Federal Circuit affirmed the invalidity of Accenture’s patent, but Accenture sought U.S. Supreme Court review. If further appeal is allowed and Accenture ultimately prevails, Guidewire may owe an additional $20.0 million; otherwise, no further settlement payment is due.
- The company recognized income-tax benefits of $1.4 million for the quarter and $9.7 million for the nine-month period. Unrecognized tax benefits were $4.1 million at April 30, 2014, and the company had approximately $14.8 million of undistributed foreign earnings for which an estimated $1.5 million deferred tax liability was not recognized.
- Management concluded that disclosure controls and procedures were effective as of April 30, 2014, and reported no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the strong recurring-revenue growth continues and converts into recognized license and maintenance revenue.
- Whether services utilization and project execution improve the nine-month services gross margin of 8%.
- Whether expense growth, particularly sales and marketing, research and development and stock-based compensation, is supported by sustainable revenue growth.
- The timing and terms of customer renewals, expansions, perpetual-license buyout rights and large customer implementations.
- The outcome of Accenture’s requested Supreme Court review and the potential $20.0 million settlement payment.
- The collectability and refund exposure associated with the $4.0 million deferred-revenue balance tied to implementation milestones.
- The company’s revenue-recognition judgments, including deferred revenue, contract accounting and arrangements involving specified future functionality.
- Liquidity composition, investment-credit exposure and the effect of future acquisitions, international expansion or additional financing needs.