Guidewire Software, Inc. — Fiscal 2019 First-Quarter 10-Q Summary
Reporting period: Three months ended October 31, 2018; comparative period ended October 31, 2017. Guidewire provides software, cloud subscriptions, data and analytics, digital engagement, maintenance, and implementation services primarily to property and casualty insurers.
Financial performance and liquidity
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Total revenue | $179.7 million | $108.2 million | 66% |
| License and subscription revenue | $94.3 million | $30.1 million | 214% |
| Maintenance revenue | $21.0 million | $18.9 million | 11% |
| Services revenue | $64.4 million | $59.1 million | 9% |
| Gross profit | $97.2 million | $45.3 million | 115% |
| Gross margin | 54% | 42% | Up 12 points |
| Operating income (loss) | $1.1 million | $(32.7) million | Improved |
| Net income (loss) | $5.5 million | $(8.9) million | Improved |
| Diluted earnings (loss) per share | $0.07 | $(0.12) | Improved |
| Cash used in operating activities | $(27.2) million | $(31.2) million | Improved by $4.0 million |
License and subscription revenue included $79.0 million of term-license revenue and $15.3 million of subscription revenue. Services generated a gross loss of $0.9 million versus $6.4 million of gross profit in the prior-year quarter, reflecting higher personnel, contractor, and cloud-implementation costs. Research and development expense increased 27% to $45.5 million, and sales and marketing expense increased 37% to $32.3 million. Stock-based compensation expense was $23.3 million, compared with $19.6 million in the prior-year period.
As of October 31, 2018, cash, cash equivalents, and investments totaled $1.229 billion, including $391.3 million of cash and cash equivalents, $693.3 million of short-term investments, and $144.4 million of long-term investments. Working capital was $1.103 billion. The company stated that existing liquidity should fund operations for at least the next 12 months.
Debt and commitments
Guidewire had $400.0 million principal amount of 1.25% convertible senior notes due March 2025, with a net carrying amount of $308.1 million. Interest expense was $4.2 million, including $3.0 million of non-cash amortization of debt discount and issuance costs. The notes have an initial conversion price of approximately $113.75 per share. Guidewire also paid $37.2 million for capped calls intended to reduce potential dilution or cash obligations upon conversion.
The company entered into a future headquarters lease with total committed payments of $126.7 million and provided a $1.8 million irrevocable standby letter of credit for the security deposit. Management reported no material change in contractual obligations other than in the ordinary course of business.
Material changes versus the prior comparable period
- Guidewire adopted ASC 606 on August 1, 2018 using the modified retrospective method, increasing opening retained earnings by $35.6 million.
- ASC 606 caused term-license revenue to be recognized upon delivery for the committed license term rather than over time under the prior guidance. On an as-if ASC 605 basis, Q1 FY2019 revenue would have been $109.1 million, gross profit $26.7 million, operating loss $(69.8) million, and net loss $(48.4) million.
- The reported quarter benefited from a $13.0 million ten-year term-license arrangement, $9.1 million from a customer contract consolidation, remediation of contracts before adoption, and earlier recognition of renewals. Management expects the ASC 606 impact to be less significant on an annual basis after the first quarter.
- ASC 606 created $65.1 million of unbilled accounts receivable, $13.6 million of capitalized contract costs, and $107.4 million of deferred revenue at October 31, 2018. Remaining performance obligations were $173.4 million.
- Subscription revenue increased 379%, partly due to the Cyence acquisition, new and expanded customer orders, and the reclassification of $3.0 million of hosting revenue from services to subscription revenue.
- Cyence, acquired November 1, 2017 for approximately $260.3 million, contributed to increased subscription revenue, research and development expense, sales and marketing expense, and amortization.
- Cash used in investing activities was $18.5 million, compared with $23.8 million of cash provided in the prior-year quarter, primarily reflecting net purchases of marketable securities and higher capital expenditures.
Outlook, management commentary, and risks
- Management expects subscription sales to become a larger portion of new sales. Because subscription revenue is recognized ratably over generally three- to five-year terms, increased subscription mix may reduce near-term reported revenue growth and increase deferred revenue.
- Management expects continued investment in cloud operations, research and development, sales and marketing, and implementation capacity. These investments may pressure license and subscription margins and operating expenses.
- Services revenue may modestly decline as a percentage of total revenue and may become more variable as Guidewire shifts implementation work toward system integrators. Cloud implementations currently require greater Guidewire involvement and have pressured services margins.
- Sales are seasonal, with stronger ordering historically in the second and fourth fiscal quarters. Management stated that the unusually high first-quarter term-license recognition, including the ten-year deal, may mask the normal second-quarter seasonal effect.
- Key risks include ASC 606 estimation and comparability issues, lengthy sales and implementation cycles, cloud migration costs and service-level penalties, customer concentration, competition, cybersecurity and privacy exposure, foreign-currency volatility, acquisition integration, and the ability to service or cash-settle convertible notes.
- Foreign-currency losses were $1.5 million in the quarter. Management identified the Argentine peso, Australian dollar, Brazilian real, British pound, Canadian dollar, euro, Japanese yen, Malaysian ringgit, and Polish zloty as significant exposures.
- No material legal proceedings were identified, and management concluded that disclosure controls were effective as of October 31, 2018.
Investor verification checklist
- Reconcile reported ASC 606 results with the as-if ASC 605 presentation and distinguish accounting acceleration from underlying bookings and cash economics.
- Verify the sustainability of the $78.95 million term-license contribution, particularly the $13.0 million ten-year deal, $9.1 million contract consolidation, and renewal timing effects.
- Track subscription billings, remaining performance obligations, deferred revenue, unbilled receivables, and provisioning delays.
- Monitor services gross margin, cloud implementation costs, contractor usage, and the pace of shifting work to system integrators.
- Assess operating cash flow after seasonal bonus and commission payments and compare cash generation with reported net income.
- Review the $400 million convertible notes, potential cash settlement or dilution, capped-call coverage, and liquidity available for future obligations.
- Evaluate Cyence integration, acquisition-related amortization, and whether acquired products generate expected subscription growth.