Guidewire Software, Inc. FY2017 Form 10-K Summary
Business context and reporting period
Guidewire provides software products, cloud subscriptions, maintenance and implementation services to global property and casualty insurers. Its platform covers core insurance operations, data management and analytics, and digital engagement. The filing covers the fiscal year ended July 31, 2017; the fourth quarter ended July 31, 2017 is included in the annual results.
At July 31, 2017, Guidewire had 328 customers in 37 countries and 1,893 employees. The company operates as one segment and sells through a direct sales force supported by systems-integrator partners.
Key financial metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Total revenue | $514.3 million | $424.4 million | +21% |
| License and other revenue | $271.5 million | $219.8 million | +24% |
| Maintenance revenue | $68.6 million | $59.9 million | +15% |
| Services revenue | $174.2 million | $144.8 million | +20% |
| Gross profit | $322.7 million | $272.6 million | +18% |
| Gross margin | 63% | 64% | Down 1 point |
| Operating income | $26.6 million | $16.4 million | +62% |
| Operating margin | 5% | 4% | Improved |
| Net income | $21.2 million | $15.0 million | +42% |
| Diluted EPS | $0.28 | $0.20 | +40% |
| Operating cash flow | $137.2 million | $99.9 million | +37% |
| Capital expenditures | $6.7 million | $7.1 million | Down $0.4 million |
Four-quarter recurring revenue reached $327.0 million at July 31, 2017, up from $268.4 million at July 31, 2016. Services represented 34% of revenue and generated a 7% gross margin, compared with a 94% gross margin for license and other revenue. Stock-based compensation expense was $71.8 million, or approximately 14% of revenue.
Cash, cash equivalents and investments totaled $687.8 million at July 31, 2017, compared with $735.8 million a year earlier. Working capital was $515.6 million. No debt or borrowing balance is presented on the consolidated balance sheet. Total liabilities were $185.6 million and stockholders’ equity was $893.3 million.
Fourth-quarter revenue was $181.1 million, compared with $141.2 million in the prior-year quarter. Fourth-quarter operating income was $41.0 million and net income was $26.9 million, compared with $23.5 million and $16.1 million, respectively, in the prior-year quarter.
Material changes versus the prior comparable period
- Revenue growth was driven by increased adoption of InsurancePlatform products, including InsuranceSuite, data and analytics, digital engagement and acquired offerings.
- Services revenue increased substantially, including $17.8 million of billings associated with recently acquired products and services. Services headcount increased to 730 from 573.
- Gross margin declined because of higher cloud-related costs and revenue and cost deferrals associated with the MetLife InsuranceSuite Cloud implementation.
- Research and development expense increased 16% to $130.3 million, while sales and marketing expense increased 18% to $109.2 million.
- ISCS was acquired in February 2017 for approximately $154.9 million in cash consideration. FirstBest was acquired in August 2016 for approximately $37.8 million. These acquisitions increased goodwill and intangible assets and were initially dilutive to earnings.
- Goodwill increased to $141.9 million from $30.1 million, and net intangible assets increased to $71.3 million from $14.2 million, primarily because of the acquisitions.
- Deferred revenue increased 59% to $111.1 million, including $39.7 million of deferred services revenue. The increase included deferred amounts related to MetLife and acquired ISCS implementations.
- International revenue outside the United States and Canada increased to $162.1 million from $148.8 million, but remained exposed to foreign-currency and regional operating risks.
Guidance, outlook, management commentary and risks
Management expects subscription and cloud-delivered revenue to increase as a percentage of total revenue. Because subscription revenue is generally recognized ratably after provisioning, subscription sales growth may initially outpace reported revenue growth. Management expects services revenue to grow significantly in fiscal 2018 and anticipates that overall gross and operating margins will decline as lower-margin services expand and cloud investments continue.
The company expects positive annual operating cash flow and believes existing liquidity is sufficient to fund operations for at least the next 12 months. Future cash needs may include product development, international expansion and additional acquisitions.
Guidewire planned to adopt the new revenue standard, ASC 606, on August 1, 2018 using the modified retrospective method. The standard was expected to change the timing and pattern of license revenue recognition. The company also planned major ERP, revenue-reporting and accounting-system implementations during fiscal 2018, creating execution and reporting risks.
- Results are subject to significant seasonality, lengthy and variable sales and implementation cycles, early customer payments and the timing of large contracts.
- The transition from term licenses to cloud subscriptions may delay revenue recognition, increase delivery costs and pressure margins.
- Services margins are materially lower than license margins and may be affected by difficult implementations, staffing requirements and customer acceptance conditions.
- The company relies on a relatively small number of large customers; its ten largest customers represented 27% of FY2017 revenue.
- Competition is intense, including from insurance software vendors, systems integrators, internally developed systems and horizontal software providers.
- Acquisition integration, goodwill and intangible-asset valuation, and realization of expected synergies create financial and operating risks.
- Cloud operations expose the company to service-level penalties, data-security breaches, privacy regulation and dependence on third-party infrastructure.
- Other risks include foreign exchange, economic weakness in the insurance sector, natural catastrophes, intellectual-property claims, tax examinations and changes in accounting standards.
The company disclosed no material pending legal proceeding and reported that management and KPMG concluded internal control over financial reporting was effective as of July 31, 2017.
Important facts investors should verify
- Whether the expected shift toward subscriptions and cloud delivery produces sustainable growth without greater-than-expected margin compression.
- The recurring-revenue trajectory, renewal rates, customer expansion and concentration among major insurance carriers.
- The financial performance and integration progress of ISCS, FirstBest and EagleEye, including goodwill impairment indicators.
- The timing and financial impact of MetLife and InsuranceNow implementation deferrals and customer-acceptance requirements.
- The effect of ASC 606 adoption and the ERP and revenue-system implementation on reported revenue, deferred revenue and internal controls.
- The level and use of stock-based compensation, which was $71.8 million in FY2017, and its effect on non-GAAP versus GAAP profitability.
- Future services mix, cloud infrastructure costs, implementation staffing and the resulting gross-margin outlook.
- Contractual commitments of $39.0 million, unrecognized tax benefits of $9.3 million and potential tax liabilities associated with undistributed foreign earnings.