Guidewire Software, Inc. — Fiscal 2018 First-Quarter Form 10-Q
Reporting period: Three months ended October 31, 2017, compared with the three months ended October 31, 2016. Guidewire provides software and subscription services for property and casualty insurers, including core transaction processing, data management and analytics, and digital engagement.
Financial performance and liquidity
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Total revenue | $108.2 million | $94.1 million | 15% |
| License and other revenue | $30.1 million | $38.7 million | (22%) |
| Maintenance revenue | $18.9 million | $16.5 million | 15% |
| Services revenue | $59.1 million | $38.9 million | 52% |
| Gross profit | $45.3 million | $52.1 million | (13%) |
| Gross margin | 42% | 55% | (13 percentage points) |
| Loss from operations | $(32.7) million | $(18.3) million | Loss increased |
| Net loss | $(8.9) million | $(7.9) million | Loss increased |
| Diluted loss per share | $(0.12) | $(0.11) | — |
| Cash used in operating activities | $(31.2) million | $(12.9) million | Use increased |
- Cash, cash equivalents and investments totaled $653.5 million at October 31, 2017, including $255.4 million of cash and cash equivalents, $305.7 million of short-term investments and $92.4 million of long-term investments.
- Working capital was $532.2 million. Management stated that existing liquidity and sources of liquidity should fund operations for at least the next 12 months.
- The filing reports no commercial commitments under lines of credit or other debt arrangements and no material non-cancellable purchase commitments. It does not present material debt outstanding.
- Net cash provided by investing activities was $23.8 million, primarily reflecting net sales of marketable securities. Capital expenditures were $1.9 million, and capitalized software development costs were $0.5 million.
- Stock-based compensation was $19.6 million, or approximately 18% of revenue, compared with $17.9 million in the prior-year quarter.
- Four-quarter recurring revenue was $324.8 million at October 31, 2017, compared with $272.7 million at October 31, 2016.
Material changes versus the prior comparable period
- Revenue growth was driven by a 52% increase in services revenue and a 15% increase in maintenance revenue, more than offsetting a 22% decline in license and other revenue.
- License and other revenue was affected by approximately $4.8 million of unfavorable timing from early payments in the prior period, fewer perpetual license orders, and a greater prevalence of subscription arrangements.
- Gross margin declined to 42% from 55%, primarily because of the lower mix of high-margin license revenue, higher amortization of acquired intangible assets, and increased staffing for cloud operations and Guidewire Production Services.
- Services gross margin improved to 11% from 7%, but remained substantially below license and maintenance margins. Services revenue represented 54% of total revenue versus 41% in the prior-year quarter.
- Research and development expense increased 16% to $35.7 million, while general and administrative expense increased 32% to $18.7 million. Sales and marketing expense declined 7% to $23.6 million, largely because the Connections user conference occurred in the second quarter rather than the first quarter.
- Operating cash use increased partly because the first quarter typically includes annual bonus payments and seasonally higher commissions, as well as the effect of early customer payments received in the prior fiscal quarter.
- Guidewire adopted ASU 2016-09 for stock-based compensation on August 1, 2017. The adoption added $85.1 million net to opening retained earnings through previously unrecognized excess tax benefits and reduced opening retained earnings by $1.0 million for forfeiture accounting.
Guidance, outlook, commentary and unusual items
- Management expects subscription sales to increase as a percentage of annual sales. Because subscription revenue is generally recognized ratably, growth in subscription bookings may not translate into comparable near-term reported revenue growth.
- Management expects full-year fiscal 2018 gross margins to decline from fiscal 2017 levels as lower-margin services revenue grows faster than license revenue and as cloud operating costs and acquired-intangible amortization increase.
- Management expects continued increases in research and development, sales and marketing, and general and administrative spending to support product development, growth, international expansion, systems implementation and acquisitions.
- Guidewire completed the Cyence acquisition on November 1, 2017 for approximately $275 million, consisting of approximately $130 million in cash and approximately 1.7 million newly issued shares and options. The acquisition was not included in the October 31 financial statements and purchase accounting was incomplete at filing.
- The February 2017 ISCS acquisition contributed InsuranceNow, a cloud-based policy, billing and claims platform. Guidewire expects to retain greater responsibility for InsuranceNow and InsuranceSuite Cloud implementations while it develops partner capacity, which may increase services revenue and related costs.
- Guidewire plans to adopt the new revenue recognition standard, Topic 606, on August 1, 2018 using the modified retrospective method. Management expects the standard to change the timing of revenue recognition for term licenses and continues to evaluate impacts on commissions, subscriptions, systems and controls.
- The company was implementing a new ERP and related accounting and revenue systems. It completed implementation of the new ERP system in November 2017 and expected the remaining applications to be completed by the third quarter of fiscal 2018.
- One customer represented 10% of quarterly revenue, and one customer represented 11% of accounts receivable at October 31, 2017, creating customer concentration exposure.
- Unrealized losses on available-for-sale investments totaled $0.5 million. Management did not consider the losses other-than-temporary or credit-related.
- No material legal proceedings requiring accrual were reported. The company has standard customer intellectual-property indemnification obligations for which potential future payments cannot be estimated.
Key risks
- Quarterly results are highly sensitive to seasonality, large transactions, early customer payments, contract terms, perpetual license activity and the timing of subscription provisioning.
- The shift toward cloud and subscription offerings may delay revenue recognition, increase implementation and infrastructure costs, reduce margins and introduce service-level penalty exposure.
- Services growth and implementation requirements may pressure consolidated margins, particularly while Guidewire expands its services workforce and trains system-integrator partners.
- Long sales and implementation cycles, customer concentration, renewal risk, competitive pressure and large customers’ negotiating leverage could affect revenue and profitability.
- Acquisition integration, retention of key personnel, expected synergies, purchase-accounting adjustments and potential dilution or cash usage require monitoring, particularly following the Cyence acquisition.
- Cybersecurity, data privacy, intellectual-property claims, foreign-exchange movements, international operations, economic conditions affecting insurers and natural catastrophes could adversely affect results.
- ERP and revenue-system implementation issues could impair invoicing, collections, internal controls or timely and accurate financial reporting.
Investor verification checklist
- Verify the post-quarter financial impact, purchase accounting and integration progress of the Cyence acquisition.
- Track recurring revenue, subscription bookings, deferred license revenue and the timing effects of Topic 606 adoption.
- Monitor services revenue growth, utilization, implementation delays and services gross margin as cloud deployments expand.
- Reconcile reported operating cash flow with bonus payments, commission timing, receivables, deferred revenue and other working-capital movements.
- Assess the sustainability of the unusually large tax benefit, including the effects of stock-based compensation and deferred tax assets.
- Review customer concentration, renewal rates, contract terms and the effect of early payments or perpetual buyout rights on reported revenue.
- Confirm progress and control implications from the ERP, revenue-reporting and other accounting-system implementations.