Guidewire Software, Inc. — Fiscal 2014 First-Quarter 10-Q Summary
Reporting period: Three months ended October 31, 2013; comparative period was the three months ended October 31, 2012. The financial statements are unaudited. Guidewire provides core software platforms for property and casualty insurance operations, including PolicyCenter, ClaimCenter and BillingCenter, together with maintenance and professional services.
Key Financial Metrics
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Total revenue | $66.5 million | $63.3 million | 5% |
| License revenue | $18.9 million | $20.8 million | (9%) |
| Maintenance revenue | $9.6 million | $9.4 million | 3% |
| Services revenue | $38.0 million | $33.1 million | 15% |
| Gross profit | $26.6 million | $35.7 million | (26%) |
| Gross margin | 40% | 56% | Down 16 percentage points |
| Operating loss | $18.1 million | $0.1 million | Material deterioration |
| Net income (loss) | $(10.6) million | $0.4 million | Material deterioration |
| Diluted EPS | $(0.18) | $0.01 | Declined |
| Adjusted EBITDA | $(1.8) million | $10.8 million | Declined |
| Operating cash flow | $(14.6) million | $(16.3) million | Improved by $1.7 million |
Revenue, Profitability and Margins
- Services represented 57% of revenue versus 52% in the prior-year quarter, while license revenue declined to 28% from 33%. The shift toward lower-margin services was the principal driver of the gross-margin decline.
- Services gross margin fell to 2% from 22%, primarily because of higher personnel costs, third-party consultants, administrative and non-billable travel costs, and increased stock-based compensation. The company added approximately 92 to 93 employees supporting implementation services during the prior twelve months.
- License gross margin was 95% versus 99%; maintenance gross margin was 80% versus 83%.
- Operating expenses increased 25% to $44.7 million. Research and development rose 27% to $18.8 million, sales and marketing rose 38% to $17.1 million, and general and administrative expense rose 2% to $8.9 million.
- Total stock-based compensation increased to $14.7 million from $9.8 million and represented a significant cost in both cost of revenues and operating expenses. Approximately $78.9 million of unrecognized stock-based compensation remained at October 31, 2013.
- The company recognized a $7.2 million income-tax benefit, producing an effective tax rate of 40.3%, primarily because of the pretax loss and tax effects related to stock compensation, incentive stock options, state and foreign taxes, and tax credits.
Cash Flow, Liquidity and Capital Structure
- Cash, cash equivalents and investments totaled $576.9 million at October 31, 2013, compared with $207.7 million at July 31, 2013. Cash and cash equivalents alone were $437.1 million.
- Working capital increased to $520.2 million from $135.3 million.
- Cash flow from operations was negative $14.6 million. The first quarter typically uses cash because of employee bonus payments and seasonally higher sales commissions.
- Investing cash outflow was $13.4 million, including $12.1 million of net purchases of available-for-sale securities, $1.2 million of capital expenditures and $0.1 million for an acquisition.
- Financing cash inflow was $384.7 million, primarily reflecting $389.9 million of net proceeds from the October 28, 2013 follow-on offering of 8.3 million shares at $48.75 per share.
- The filing reports no debt arrangements, material non-cancellable purchase commitments or off-balance-sheet arrangements. Primary contractual obligations consist of operating leases and letters of credit.
- Management believes existing cash and cash equivalents and other liquidity sources are sufficient to fund operations for at least the next 12 months, although future financing could be required for expansion, acquisitions or other strategic activities.
Material Changes Versus the Prior Comparable Period
- Revenue increased 5%, but gross profit declined 26% because of the unfavorable revenue mix and substantially lower services profitability.
- License revenue decreased $1.9 million, principally because the prior-year period included $3.2 million of non-recurring revenue recognized when revenue-recognition criteria were met. Current-period license revenue included a $0.3 million increase in perpetual license revenue from a customer exercising a perpetual buyout option.
- Services revenue increased $4.9 million, primarily from implementation work, while related costs increased $11.3 million.
- Deferred revenue increased 6% to $43.5 million from July 31, 2013. Deferred license revenue increased 23% to $17.8 million and deferred services revenue increased 42% to $6.7 million, partly offset by a 14% decline in deferred maintenance revenue.
- Four-quarter recurring revenue increased to $148.5 million from $114.9 million for the comparable four-quarter period a year earlier, with term license revenue of $110.6 million and maintenance revenue of $37.8 million.
- The company moved from near break-even operating results and modest net income in the prior-year quarter to a significant operating and net loss, reflecting increased hiring, growth investments, services costs and stock-based compensation.
Guidance, Outlook, Commentary and Risks
- Management expects research and development, sales and marketing and general and administrative expenses to continue increasing in absolute dollars; research and development and sales and marketing may also rise as percentages of revenue.
- Management expects annual operating cash flow to be positive, but quarterly cash flow may fluctuate materially because of seasonality, collections, deferred revenue, bonuses and commissions.
- New-customer sales cycles generally last 12 to 24 months, and implementations generally last 6 to 24 months or longer. Revenue recognition can therefore differ materially from order timing.
- Seasonality is concentrated in the second and fourth fiscal quarters, when customer orders and annual incentive activity typically increase. Quarterly license revenue may also vary with payment terms, perpetual licenses, perpetual buyout rights and contract-specific revenue-recognition requirements.
- The company identified services-margin pressure, customer concentration, competition, lengthy sales and implementation cycles, international operations, foreign-exchange movements, economic conditions affecting insurance-industry technology spending, cybersecurity and product-performance risks as important uncertainties.
- Accenture requested rehearing of the Federal Circuit’s September 2013 decision affirming invalidity of Accenture’s patent. If further appeal is permitted and Accenture ultimately prevails, Guidewire may owe an additional $20.0 million; otherwise, no further settlement payment is due.
- Deferred revenue included $2.2 million related to one customer that could be refundable if specified implementation milestones are not achieved.
- Disclosure controls and procedures were determined to be effective as of October 31, 2013, and no material change in internal control over financial reporting was reported.
Most Important Facts for Investors to Verify
- Whether services revenue growth can translate into sustainable positive services margins after the significant expansion of implementation personnel.
- Whether recurring revenue growth and deferred license and services revenue convert into recognized revenue and operating cash flow.
- The timing and outcome of any further Accenture appeal and the potential $20.0 million payment.
- The effect of $14.7 million of quarterly stock-based compensation and approximately $78.9 million of remaining unrecognized compensation cost on future profitability and dilution.
- Whether the substantial proceeds from the follow-on offering are deployed productively without materially increasing operating losses or shareholder dilution.
- Customer renewal, expansion and concentration trends, including the fact that the ten largest customers represented 40% of quarterly revenue.
- Future effects of seasonality, perpetual-license activity, payment timing and revenue-recognition judgments on quarterly results.