Guidewire Software, Inc. — Fiscal 2012 Third-Quarter Form 10-Q
Business context and reporting period
Guidewire provides software platforms for property and casualty insurance operations, including underwriting and policy administration, claims management, billing, maintenance and professional services. The filing covers the three and nine months ended April 30, 2012, compared with the corresponding 2011 periods. The fiscal year ends July 31.
Financial performance and liquidity
| Metric | Three months ended April 30, 2012 | Three months ended April 30, 2011 | Nine months ended April 30, 2012 | Nine months ended April 30, 2011 |
|---|---|---|---|---|
| Total revenue | $57.0 million | $44.5 million | $164.5 million | $121.5 million |
| Gross profit | $33.0 million | $26.6 million | $100.3 million | $72.0 million |
| Gross margin | 58% | 60% | 61% | 59% |
| Income from operations | $4.8 million | $4.7 million | $18.3 million | $11.9 million |
| Net income | $3.1 million | $29.4 million | $11.7 million | $36.7 million |
| Diluted earnings per share | $0.05 | $0.66 | $0.19 | $0.82 |
| Adjusted EBITDA | $9.9 million | $6.9 million | $34.4 million | $17.2 million |
| Operating cash flow | Not separately provided | Not separately provided | $(2.0) million | $7.9 million |
Revenue increased 28% year over year in the quarter and 35% year to date. Nine-month revenue consisted of $68.2 million of license revenue, $21.7 million of maintenance revenue and $74.6 million of services revenue. Services represented 49% of quarterly revenue and 45% of year-to-date revenue, versus 47% and 48%, respectively, in the prior comparable periods.
Calculated net margins were approximately 5.5% for the quarter and 7.1% year to date. Operating margins were approximately 8.5% and 11.1%, respectively. The quarterly net income comparison was distorted by a $23.7 million tax benefit in the prior-year quarter, primarily from releasing a significant portion of the tax valuation allowance. The 2012 nine-month tax provision was $6.4 million, representing a 35.6% effective tax rate.
Cash and cash equivalents were $201.9 million at April 30, 2012, compared with $59.6 million at July 31, 2011. Including restricted cash, total cash and equivalents were approximately $205.6 million. Working capital was $166.1 million. The company reported no outstanding debt or short-term investments and stated that existing liquidity should fund operations for at least the next 12 months.
Total liabilities were $89.0 million, including $61.2 million of deferred revenue. Deferred revenue declined from $73.8 million at July 31, 2011, primarily because previously deferred license revenue was recognized. Capital expenditures were $2.1 million for the nine months.
Material changes versus the prior comparable period
- Quarterly license revenue increased 22% to $21.7 million, maintenance revenue increased 39% to $7.8 million, and services revenue increased 31% to $27.6 million.
- Nine-month license revenue increased 42%, maintenance revenue increased 41%, and services revenue increased 28%. License growth reflected adoption of ClaimCenter, PolicyCenter and InsuranceSuite, as well as stronger sales and marketing activity.
- Perpetual license revenue increased substantially, to $6.3 million from $1.7 million in the quarter and to $20.7 million from $10.0 million year to date. Management cautioned that perpetual license revenue is inconsistent from quarter to quarter.
- Quarterly gross margin declined to 58% from 60% because of the higher proportion of lower-margin services revenue. Year-to-date gross margin improved to 61% from 59% because license revenue represented a larger share of revenue.
- Operating expenses increased 29% in the quarter and 36% year to date, led by research and development, personnel additions, professional services, marketing programs and stock-based compensation.
- Stock-based compensation increased to $4.3 million in the quarter and $13.9 million year to date, compared with $1.8 million and $4.3 million, respectively, in the prior periods.
- Cash from financing activities was $144.5 million year to date, primarily from the January 2012 IPO and April 2012 follow-on offering, compared with $0.6 million in the prior-year period.
- The company completed its IPO on January 30, 2012, raising approximately $123.0 million before offering costs, and completed a follow-on offering on April 24, 2012. The follow-on offering included company and selling-stockholder shares; Guidewire received approximately $20.4 million before offering costs, while selling stockholders received no proceeds from their shares.
Guidance, outlook, commentary and risks
Management did not provide specific revenue or earnings guidance in the supplied filing text. It expects research and development, sales and marketing, general and administrative expenses and services delivery costs to increase in absolute dollars as the company invests in growth. Management expects positive annual operating cash flow, although quarterly cash flow may fluctuate significantly.
Revenue recognition is sensitive to customer payment timing, contract terms, specified functionality, implementation progress and the availability of vendor-specific objective evidence. Sales cycles typically last 12 to 24 months, and implementations generally last 6 to 24 months or longer. Seasonal buying patterns typically produce stronger order activity in the second and fourth fiscal quarters.
The company’s principal contingent obligation is the Accenture litigation settlement. Guidewire paid $10.0 million and may owe an additional $20.0 million if Accenture prevails in its appeal, or may elect to pay $15.0 million before an initial appellate determination to discharge the obligation. No further payment would be due if Accenture is unsuccessful.
Other significant risks include customer concentration, competition, dependence on ClaimCenter, PolicyCenter and BillingCenter, lower services margins, implementation delays, intellectual-property claims, foreign-currency movements, economic weakness in the insurance industry, data-security incidents, employee retention and rapid growth. The company also entered into a seven-year lease for a new Foster City headquarters beginning August 1, 2012, with total future operating lease payments of approximately $31.9 million, partially offset by $0.3 million of contracted sublease income.
Management concluded that disclosure controls and procedures were effective as of April 30, 2012, and reported no material changes in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the high level of perpetual license revenue is sustainable or creates quarter-to-quarter volatility.
- The mix of services revenue and its effect on consolidated gross margins and profitability.
- The effect of continued hiring and elevated stock-based compensation on operating leverage and dilution.
- Operating cash flow conversion, particularly after the litigation payment, seasonal compensation payments and changes in deferred revenue and accounts receivable.
- The status and potential ultimate cost of the Accenture appeal and settlement obligation.
- Customer renewal, expansion and concentration trends, including the ten largest customers’ 37% share of nine-month revenue.
- Execution of the new headquarters transition and the company’s ability to scale implementation capacity while maintaining services margins.
- The filing’s reported offering proceeds and use of cash, including the distinction between proceeds received by Guidewire and proceeds from shares sold by selling stockholders.