Guidewire Software, Inc. — Q3 FY2013 Form 10-Q Summary
Business context and reporting period
Guidewire provides software platforms for property and casualty insurance operations, including PolicyCenter, ClaimCenter and BillingCenter, together with maintenance and professional services. The filing covers the three and nine months ended April 30, 2013, with comparisons to April 30, 2012. The company operates as one segment and sells primarily through a direct sales force.
Financial highlights
| Metric | Three months ended Apr. 30, 2013 | Three months ended Apr. 30, 2012 | Nine months ended Apr. 30, 2013 | Nine months ended Apr. 30, 2012 |
|---|---|---|---|---|
| Revenue | $68.3 million | $57.0 million | $203.7 million | $164.5 million |
| License revenue | $22.9 million | $21.7 million | $74.5 million | $68.2 million |
| Maintenance revenue | $9.1 million | $7.8 million | $27.7 million | $21.7 million |
| Services revenue | $36.2 million | $27.6 million | $101.6 million | $74.6 million |
| Gross profit | $32.3 million | $33.0 million | $108.8 million | $100.3 million |
| Gross margin | 48% | 58% | 53% | 61% |
| Operating income (loss) | $(4.4) million | $4.8 million | $0.7 million | $18.3 million |
| Net income (loss) | $(2.7) million | $3.1 million | $3.3 million | $11.7 million |
| Adjusted EBITDA | $5.0 million | $9.9 million | $32.3 million | $34.4 million |
| Operating cash flow | Not separately provided for the quarter | $8.1 million | $(2.0) million |
License gross margin was approximately 99% in both periods. Services gross margin declined to 7% from 18% for the quarter and to 12% from 20% for the nine-month period. The company reported basic and diluted earnings per share of $(0.05) for the quarter and $0.05 for the nine-month period.
Balance sheet, liquidity and debt
- Cash and cash equivalents were $90.5 million at April 30, 2013, compared with $205.7 million at July 31, 2012.
- Cash, cash equivalents and investments totaled approximately $203.6 million at April 30, 2013, including $63.6 million of short-term investments and $49.5 million of long-term investments.
- Working capital was $146.3 million, compared with $169.3 million at July 31, 2012.
- Total liabilities were $89.7 million, including $51.5 million of deferred revenue. The filing reports no borrowings or commercial debt arrangements.
- Nine-month investing cash outflow was $116.8 million, primarily from purchases of available-for-sale securities of $170.5 million and capital expenditures of $7.1 million.
- Nine-month financing cash outflow was $6.4 million, including $14.7 million of employee tax withholding payments on vested RSUs, partly offset by $8.0 million from option exercises.
Material changes versus the prior comparable period
- Total revenue increased 20% for the quarter and 24% for the nine months. Services revenue was the principal growth driver, increasing 31% and 36%, respectively.
- Term-license revenue increased 16% for the quarter and 43% for the nine months, while perpetual-license revenue declined 20% and 69%, respectively, reflecting the company’s shift toward recurring term licenses.
- Gross profit increased for the nine-month period but declined slightly for the quarter as services, which carry lower margins, represented a larger share of revenue.
- Operating expenses increased 30% for the quarter and 32% for the nine months, driven by increased headcount, sales and marketing investment, research and development, public-company costs and stock-based compensation.
- Stock-based compensation increased to $8.3 million for the quarter and $28.4 million for the nine months, compared with $4.3 million and $13.9 million, respectively.
- Four-quarter recurring revenue reached $130.9 million at April 30, 2013, compared with $97.7 million at April 30, 2012.
- Deferred revenue declined 7% from July 31, 2012, to $51.5 million, primarily because deferred services revenue decreased $3.9 million.
Guidance, outlook, risks and unusual items
Management did not provide specific numerical revenue or earnings guidance in the filing. It expects research and development, sales and marketing, general and administrative expenses and cost of revenues to increase in absolute dollars as it invests in product innovation, international expansion, sales capacity and implementation services. Management expects annual operating cash flow to remain positive, but quarterly cash flow may fluctuate significantly, and believes available liquidity is sufficient for at least the next 12 months.
- Revenue is seasonal, with stronger order activity generally in the second and fourth fiscal quarters. Revenue recognition can also be affected by payment timing, implementation milestones, acceptance criteria, perpetual buyout rights and contractual functionality requirements.
- Services represented 53% of quarterly revenue and 50% of nine-month revenue, creating pressure on consolidated margins because services are substantially less profitable than licenses.
- The business relies on a relatively small number of large insurance customers; the ten largest customers represented 39% of quarterly revenue and 34% of nine-month revenue.
- The Accenture patent settlement remains contingent. Guidewire previously paid $10.0 million and could owe an additional $20.0 million if Accenture prevails on appeal, or may elect to pay $15.0 million before an initial appellate determination. The appeal remained pending at the filing date.
- On May 10, 2013, after the reporting period, Guidewire acquired Millbrook, Inc. for $18.5 million, consisting of approximately $14.8 million in cash and $3.7 million in RSUs. Millbrook’s results were expected to be included beginning in the fourth quarter of fiscal 2013.
- Other key risks include lengthy sales and implementation cycles, competition, customer budget reductions, foreign-exchange exposure, intellectual-property claims, cybersecurity and product liability, employee retention, international operations and acquisition integration.
- Disclosure controls and procedures were considered effective, and management reported no material changes to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether services growth and implementation staffing translate into improved services utilization and recovery of the significant margin decline.
- The sustainability of recurring term-license growth and customer renewal, expansion and perpetual-buyout trends.
- The timing and financial impact of any additional Accenture settlement payment.
- The final purchase-price allocation, integration costs and operating contribution from the Millbrook acquisition.
- The effect of substantial stock-based compensation, RSU tax-withholding cash payments and potential equity dilution.
- Whether cash generation remains positive after capital expenditures, acquisitions and other working-capital fluctuations.
- Customer concentration, deferred revenue trends and revenue-recognition judgments related to implementation milestones and acceptance criteria.