Guidewire Software, Inc. — Fiscal Q1 2013 Form 10-Q Summary
Reporting period: Three months ended October 31, 2012, compared with the three months ended October 31, 2011. The filing is unaudited and presented under U.S. GAAP. Guidewire provides core software platforms for property and casualty insurance operations, including PolicyCenter, ClaimCenter and BillingCenter, together with maintenance and professional services.
Financial Highlights
| Metric | Q1 FY2013 | Q1 FY2012 | Change |
|---|---|---|---|
| Total revenue | $63.3 million | $52.4 million | Up 21% |
| License revenue | $20.8 million | $20.8 million | Approximately flat |
| Maintenance revenue | $9.4 million | $7.1 million | Up 32% |
| Services revenue | $33.1 million | $24.5 million | Up 35% |
| Gross profit | $35.7 million | $32.9 million | Up 9% |
| Gross margin | 56% | 63% | Down 7 percentage points |
| Operating income (loss) | $(0.1) million | $8.1 million | Declined |
| Net income | $0.4 million | $4.8 million | Declined |
| Adjusted EBITDA | $10.8 million | $12.1 million | Down 11% |
| Operating cash flow | $(16.3) million | $(27.1) million | Improved by $10.8 million |
Revenue and Margins
- Term license revenue increased 67% to $20.6 million, while perpetual license revenue fell 98% to $0.2 million, reflecting increased adoption of recurring term licenses.
- Services represented 52% of revenue versus 46% in the prior-year quarter. Services gross margin declined to 22% from 27%, primarily because of increased implementation headcount.
- License gross margin was 99% and maintenance gross margin was 83%. The higher mix of lower-margin services reduced total gross margin to 56%.
- Research and development expense increased 35% to $14.8 million, sales and marketing increased 68% to $12.4 million, and general and administrative expense increased 35% to $8.7 million.
- Stock-based compensation increased to $9.8 million from $3.3 million and represented a significant portion of operating costs.
- The income tax benefit was $0.3 million versus a $3.0 million tax provision in the prior-year quarter. The effective tax rate was negative 164.5%, principally because of incentive stock option tax deductions and lower projected worldwide pretax income.
Cash, Liquidity and Debt
- Cash and cash equivalents were $185.5 million at October 31, 2012, down from $205.7 million at July 31, 2012. Cash and restricted cash totaled approximately $187.6 million.
- Working capital was $179.7 million at October 31, 2012, compared with $169.3 million at July 31, 2012.
- Net cash used in investing activities was $3.2 million, including $4.8 million of capital expenditures. Financing activities used $0.9 million, including $4.2 million of employee tax withholding payments on vested RSUs, partly offset by option exercise proceeds.
- The company reported no outstanding debt or short-term borrowings and no material non-cancelable purchase commitments. Liquidity consisted primarily of cash, money market funds and certificates of deposit.
- Management stated that existing cash and expected operating cash flows should fund operations for at least the next 12 months, although quarterly cash flows are expected to fluctuate substantially.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by maintenance and services, while total license revenue was flat because the increase in term licenses offset the decline in perpetual licenses.
- Total operating expenses rose 45%, outpacing revenue growth and resulting in a loss from operations compared with operating income of $8.1 million in the prior-year quarter.
- Deferred revenue declined 21% to $43.6 million from $55.5 million at July 31, 2012, primarily as previously billed license, maintenance and services amounts were recognized.
- Four-quarter recurring revenue increased to $114.9 million from $88.0 million for the comparable four-quarter period, including term license revenue of $83.1 million and maintenance revenue of $31.8 million.
- Revenue included non-recurring recognition of $3.2 million of license revenue and $1.7 million of services revenue after reliable project estimates were obtained. These items related to prior orders and should be considered when assessing underlying growth.
- Cash use improved versus the prior year partly because the prior-year quarter included a $10.0 million Accenture litigation settlement payment.
- The company completed an IPO in January 2012 and a follow-on offering in April 2012, receiving approximately $123.0 million and $20.4 million, respectively, before certain offering costs. These transactions materially strengthened liquidity and increased the public-company cost structure.
Outlook, Commentary and Risks
- Management expects continued investment in research and development, sales and marketing, services delivery and international expansion. Operating expenses and cost of revenues are expected to increase in absolute dollars.
- Management expects recurring term-license adoption to continue and perpetual license revenue to remain significantly lower than historical levels.
- Results are seasonal: customer orders generally increase in the second and fourth fiscal quarters. Revenue recognition may lag bookings because of payment timing, implementation milestones, specified functionality and other contract terms.
- New-customer sales cycles typically last 12 to 24 months, and implementations generally last 6 to 24 months or longer, creating volatility in revenue, margins and cash flows.
- Key risks include customer concentration, competition, adverse economic conditions affecting insurance-industry technology spending, implementation delays, lower services margins, foreign-exchange exposure, cybersecurity and product liability, intellectual-property claims, employee retention and rapid-growth execution.
- The Accenture patent appeal remained pending. Guidewire had paid $10.0 million under the settlement and could owe an additional $20.0 million if Accenture succeeds, or could elect to pay $15.0 million before an initial appellate determination to discharge the potential obligation.
- Approximately $15.3 million of cash was domiciled in foreign tax jurisdictions and could incur additional U.S. tax if repatriated.
- Management reported effective disclosure controls and procedures and no material changes to internal control over financial reporting during the quarter.
Investor Verification Items
- Verify the sustainability of term-license and recurring-revenue growth after excluding the $3.2 million license and $1.7 million services recognition adjustments.
- Monitor services mix, implementation headcount and services gross margin, which declined to 22%.
- Assess whether operating-expense growth and stock-based compensation can be supported by recurring revenue growth.
- Track cash conversion, deferred revenue trends, seasonal bonus and commission payments, and capital expenditures.
- Confirm the status and potential cash impact of the Accenture appeal and settlement obligation.
- Evaluate customer concentration, renewal and expansion rates, long implementation cycles and the effect of perpetual-license migration on future reported revenue.