Guidewire Software, Inc. 2017 Q3 Form 10-Q Summary
Business Context and Reporting Period
Guidewire provides software for property and casualty insurers, including core transaction processing, data management and analytics, and digital engagement. The report covers the three and nine months ended April 30, 2017, within the fiscal year ending July 31, 2017. Financial statements are unaudited and presented under U.S. GAAP.
Guidewire completed the $154.9 million ISCS acquisition in February 2017, adding the cloud-based InsuranceNow platform, and completed the $37.8 million FirstBest acquisition in August 2016.
Financial Performance and Key Metrics
| Metric | Three Months Ended April 30 | Nine Months Ended April 30 |
|---|---|---|
| Total revenue | $123.4 million, up 25% | $333.2 million, up 18% |
| License and other revenue | $59.0 million, up 29% | $161.8 million, up 23% |
| Maintenance revenue | $16.9 million, up 15% | $50.0 million, up 16% |
| Services revenue | $47.6 million, up 24% | $121.4 million, up 12% |
| Gross profit | $72.0 million | $198.9 million |
| Gross margin | 58%, versus 61% | 60%, versus 61% |
| Operating loss | $(4.3) million | $(14.4) million |
| Net loss | $(1.8) million, or $(0.02) per share | $(5.7) million, or $(0.08) per share |
| Adjusted EBITDA | $18.7 million | $51.4 million |
| Operating cash flow | Not separately provided | $51.5 million, versus $50.6 million |
License revenue growth was primarily driven by new term-license orders, including a large order from an existing Tier 1 customer. Perpetual license revenue declined 82% in the quarter to $0.9 million and represented a small portion of license revenue.
Gross margin declined because of higher compensation and headcount costs, acquisition-related costs, increased services activity, amortization of acquired intangible assets, and deferred revenue and costs associated with a large cloud-delivery implementation. Stock-based compensation charged to expense was $17.2 million in the quarter and $53.7 million for the nine-month period.
At April 30, 2017, cash and cash equivalents were $180.2 million, short-term investments were $297.3 million, and long-term investments were $113.9 million. Total cash, cash equivalents and investments were $591.4 million, compared with $735.8 million at July 31, 2016. Working capital was $439.1 million. The company reported no debt arrangements or material non-cancellable purchase commitments.
Material Changes Versus the Prior Comparable Period
- Revenue increased 25% in the quarter and 18% year to date, with term-license growth the primary driver.
- Operating expenses increased 16% in the quarter and 18% year to date, led by research and development and sales and marketing investments.
- Net loss widened to $1.8 million in the quarter and $5.7 million year to date, despite higher revenue and operating cash flow.
- Gross margin declined three percentage points in both comparable periods, primarily due to services mix, acquisition-related personnel, and deferred cloud implementation revenue and costs.
- Deferred revenue increased 53% from July 31, 2016 to $107.2 million, including $19.8 million of deferred services revenue related to one large national insurer.
- Goodwill increased from $30.1 million to $142.0 million and net intangible assets increased from $14.2 million to $76.1 million, primarily due to the FirstBest and ISCS acquisitions.
- Cash declined by $43.4 million during the first nine months, principally because of acquisitions and other investing activity. Investing cash outflows totaled $96.8 million.
- Four-quarter recurring revenue reached $304.9 million as of April 30, 2017, compared with $250.6 million a year earlier.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management expects positive annual operating cash flow and believes existing cash, cash equivalents and investments will fund operations for at least the next 12 months. No specific revenue or earnings guidance is provided in the filing text.
Management expects research and development, sales and marketing, and general and administrative expenses to increase in absolute dollars. ISCS added approximately 193 employees and is expected to be dilutive to earnings through fiscal 2018. The company also expects services margins and overall gross margins to vary with revenue mix; recognition of deferred cloud-implementation amounts is expected to improve services margins in fiscal 2018.
Services and related direct costs for a large cloud-delivered InsurancePlatform engagement were deferred. The services were completed and accepted in May 2017, after the reporting date, and the deferred amounts are being recognized ratably over two years from acceptance.
Guidewire intends to adopt the new revenue recognition standard on August 1, 2018 using the modified retrospective method. Management expects the standard to change the timing and pattern of software-license revenue recognition, potentially creating earnings volatility. The company is also preparing for the August 1, 2017 adoption of share-based-payment accounting changes, which could materially affect future tax-related earnings volatility.
Key risks include lengthy and seasonal sales and implementation cycles, dependence on a relatively small number of large insurance customers, competitive pressure, services-margin volatility, acquisition integration and impairment risk, migration toward cloud and ratable subscription models, cybersecurity and privacy exposure, foreign currency fluctuations, international regulatory and tax risks, and reliance on highly skilled personnel and system-integrator partners.
One customer represented at least 10% of quarterly revenue and one customer represented at least 10% of accounts receivable at April 30, 2017. No material adverse legal proceeding was identified, no litigation accrual was recorded, and outstanding letters of credit had no amounts drawn.
Important Facts for Investors to Verify
- Confirm the size, duration, renewal terms, and collectability of the large Tier 1 customer order contributing to license growth.
- Assess the timing and margin impact of recognizing the $19.8 million of deferred services revenue and related costs from the large cloud-delivery engagement.
- Evaluate whether the ISCS and FirstBest acquisitions achieve expected customer, product, and synergy benefits while controlling integration costs and earnings dilution.
- Monitor gross-margin recovery, particularly services utilization, acquisition-related staffing, and acquired-intangible amortization.
- Model the effect of Topic 606 adoption on license revenue timing, deferred revenue, reported growth, and comparability.
- Review customer concentration, renewal rates, perpetual buyout rights, and the effect of seasonal order timing on quarterly results.
- Reconcile non-GAAP Adjusted EBITDA with GAAP operating loss and track the substantial stock-based compensation expense.
- Verify liquidity after acquisitions, the composition and maturity of the $591.4 million investment portfolio, and the absence of debt financing.