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GWRE > SEC Filings for GWRE > Form 10-Q on 3-Jun-2013All Recent SEC Filings

Show all filings for GUIDEWIRE SOFTWARE, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for GUIDEWIRE SOFTWARE, INC.


3-Jun-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this document and the Risk Factors included in Item 1A of Part II of this Quarterly Report on Form 10-Q. All information presented herein is based on our fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to our fiscal years ended in July and the associated quarters of those fiscal years. We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.
Overview
We are a leading provider of core system software to the global property and casualty ("P&C") insurance and reinsurance industry. Our solutions serve as the transactional systems-of-record for, and enable the key functions of, a P&C insurance carrier's business: underwriting and policy administration, claims management and billing. Since our inception, our mission has been to empower P&C insurance carriers to transform and improve their businesses by replacing their legacy core systems with our software platform.

We derive our revenues from licensing our software applications, providing maintenance support and providing professional services to the extent requested by our customers. Our license revenues are primarily generated through annual license fees that recur during the term of our multi-year contracts. These multi-year contracts have an average term of approximately five years and are renewed on an annual or multi-year basis. In certain cases, when required by a customer, we license our software on a perpetual basis. In addition, certain of our multi-year term licenses provide the customer with the option to purchase a perpetual license at the end of the initial contract term. We generally price our licenses based on the amount of direct written premiums ("DWP") that will be managed by our solutions. We typically invoice our customers annually in advance or, in certain cases, quarterly for both recurring term license and maintenance fees, and we invoice our perpetual license customers either in full at contract signing or on an installment basis and invoice related maintenance fees annually, in advance. Our focus is to encourage recurring term license arrangements instead of perpetual license arrangements, and we have historically experienced seasonal variations in our revenues as a result of increased customer orders in our second and fourth fiscal quarters and subsequent annual fees.

To extend our technology leadership position in our market, we intend to continue to focus on product innovation through research and development and aggressively pursue new customers and up-sell additional products within our existing customer base. This will require us to make continued investment in our research and development and sales and marketing functions to capitalize on opportunities for growth. We expect research and development, sales and marketing and general and administrative expenses to continue to increase in absolute dollars for the foreseeable future to support this strategy. Research and development and sales and marketing expenses are also expected to increase as a percentage of revenues in future periods as we focus on expanding our technological leadership.
We face a number of risks in the execution of our strategy, including reliance on sales to a relatively small number of large customers, variances in the mix amongst our components of revenues, possibly resulting in lower gross margin from services revenues as compared to license and maintenance revenues, and the overall impact of weakening economic conditions on the insurance industry. We believe that our focus on continued product innovation and customer wins and renewals will support the expansion of our license sales and reduce the impact from weakened economic conditions. We sell our core system software primarily through our direct sales force. Our sales cycle for new customers is typically 12 to 24 months and may take longer.
Opportunities, Challenges, & Risks
Since August 2010, our license revenues from new orders and subsequent annual payments have generally been recognized when payment is due from our customers. Historically, and to a lesser extent during fiscal years 2013, 2012 and 2011, our license revenues from existing orders have been recognized under three methods: under the residual method upon the earlier of payment being due and payable or cash being received from our customers, under the percentage-of-completion method as we complete customer implementations of our software, or under the zero gross margin method as we complete customer implementations of our software. During the three months ended April 30, 2013 and 2012, our license revenues accounted for 34% and 38% of our total revenues, respectively, and our recurring term license revenues accounted for 78% and 71% of our total license revenues, respectively. During the nine months ended April 30, 2013 and 2012, our license revenues accounted for 36% and 42% of our total revenues, respectively, and our recurring term license revenues accounted for 91% and 70% of our total license revenues, respectively.


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Our maintenance revenues are generally recognized over the committed maintenance term. Our maintenance fees are invoiced annually, typically priced as a fixed percentage of the associated license fees and generate lower gross margins than our license revenues. Our maintenance revenues accounted for 13% of our total revenues during the three months ended April 30, 2013 and 2012, respectively, and 14% and 13% of our total revenues during the nine months ended April 30, 2013 and 2012, respectively.
We generally charge services fees on a time and materials basis and revenues are typically recognized upon delivery of our services. We derive our services revenues primarily from implementation services performed for our customers, revenues related to reimbursable travel expenses and training fees. Our services revenues generate lower gross margins than our license and maintenance revenues and accounted for 53% and 49% of our total revenues during the three months ended April 30, 2013 and 2012, respectively. Our services revenues accounted for 50% and 45% of our total revenues during the nine months ended April 30, 2013 and 2012, respectively.
We enter into multi-year renewable contracts to license our software and provide technical support and unspecified upgrades to our software as they become available. Regardless of contract length, we typically invoice our customers for annual and, in certain cases, quarterly amounts at the contract signing and at each anniversary date. Our deferred revenues consist only of amounts that have been invoiced, but not yet recognized as revenues. As a result, deferred revenues and change in deferred revenues are incomplete measures of the strength of our business and are not necessarily indicative of our future performance. Further, we expect to recognize our current deferred services revenue into income but do not expect significant deferrals of services revenue in future periods. Deferred license and service revenues related to projects under contract accounting as of April 30, 2013 were $2.2 million and $1.8 million, respectively, while deferred license and service revenues as of July 31, 2012 were $10.2 million and $5.6 million, respectively. Such deferral is in accordance with our Revenue Recognition policy as described in Note 1 to the consolidated financial statements.
In October 2012, we announced the introduction of Guidewire LiveTM, a network connecting Guidewire customers to one another, curated external content, and expert tools. Guidewire Live delivers relevant context to P & C insurance professionals based on who they are and the problems they are trying to solve. Guidewire Live is deployed as a cloud-based, instant-on solution that can be used by Guidewire customers within days, without the need for an implementation project. Guidewire Live enables insurers to compare their operational performance versus their peers. While we have incurred expenses to develop and market Guidewire Live, initial revenue expectations for fiscal 2013 are modest. We have historically experienced seasonal variations in our revenues as a result of increased customer orders in our second and fourth fiscal quarters and subsequent annual fees. We generally see increased orders in our second fiscal quarter, which is the quarter-ended January 31, due to customer buying patterns. We also see increased orders in our fourth fiscal quarter due to efforts by our sales team to achieve annual incentives. As a result, a significantly higher percentage of our annual license fees are invoiced and recognized as revenues during those quarters at contract inception or in the subsequent quarter when the annual license payment is due and in subsequent years upon the anniversary of the contract date. We generally expect these seasonal trends to continue in the future, which may cause quarterly fluctuations in our results of operations and certain financial metrics. Our perpetual license revenues are not consistent from quarter to quarter. We expect that perpetual license revenues recognized in fiscal 2013 will be significantly lower than those recognized in prior periods, due to continued adoption of recurring term licenses, and our continued emphasis away from perpetual licenses.
Our quarterly growth in revenues may not match up to new orders we receive in a given quarter. This mismatch is primarily due to the following reasons:
for the initial year of a multi-year term license, we generally recognize revenues when payment is due and payment may not be due until a subsequent fiscal quarter;

          we may enter into license agreements with specified terms for product
           upgrades or functionality, which may require us to delay revenue
           recognition until the period in which the upgrade or functionality is
           delivered;


          we may separately negotiate renewals of contracts which may have
           differing terms and conditions from the original contract; and


          we may enter into license agreements with other contractual terms that
           may affect the timing of revenue recognition.

For example, we received new orders for both term and perpetual licenses in the fourth quarter of fiscal year 2011 that committed future product functionality that was delivered in the first quarter of fiscal year 2012. As a result, our license revenues in the first quarter of fiscal year 2012 were $7.2 million higher than they would have been had the functionality been delivered in the fourth fiscal quarter of fiscal year 2011.


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In addition, our revenue may fluctuate if our customers make an early payment of their annual fees. For example, during the three months ended January 31, 2012, we recognized $2.5 million of revenue upon early payment of annual fees from one customer, which would have been otherwise recognized during the three months ended April 30, 2012.
Product implementations, the primary driver of our services revenues, typically last 6 to 24 months and may take longer. No customer accounted for 10% or more of our revenues for the three and nine months ended April 30, 2013 or 2012. Our ten largest customers accounted for 39% and 40% of our total revenues for the three months ended April 30, 2013 and 2012, respectively, and 34% and 37% of our total revenues for the nine months ended April 30, 2013 and 2012, respectively. We count as customers distinct buying entities, which may include multiple national or regional subsidiaries of large, global P&C insurance carriers. We generated revenues of $68.3 million and $57.0 million in the three months ended April 30, 2013 and 2012, respectively, and revenues of $203.7 million and $164.5 million in the nine months ended April 30, 2013 and 2012, respectively. We generate the majority of our revenues in the United States and Canada. Our revenues from outside the United States and Canada as a percentage of total revenues were 29% and 26% in the three months ended April 30, 2013 and 2012, respectively, and 30% and 28% in the nine months ended April 30, 2013 and 2012, respectively. We generated net loss of $2.7 million and net income of $3.1 million in the three months ended April 30, 2013 and 2012, respectively, and net income of $3.3 million and $11.7 million in the nine months ended April 30, 2013 and 2012, respectively.
Key Business Metrics
We use certain key metrics to evaluate and manage our business, including rolling four-quarter recurring revenues from term licenses and total maintenance. In addition, we present select GAAP and non-GAAP financial metrics that we use internally to manage the business and that we believe are useful for investors. These metrics include Adjusted EBITDA and operating cash flow. Four-Quarter Recurring Revenues
We measure four-quarter recurring revenues by adding the total term license revenues and total maintenance revenues recognized in the preceding four quarters ended in the stated period and excluding perpetual license revenues, revenues from perpetual buyout rights and services revenues. This metric allows us to better understand the trends in our recurring revenues because it typically reduces the variations in any particular quarter caused by seasonality, the effects of the annual invoicing of our term licenses and certain effects of contractual provisions that may accelerate or delay revenue recognition in some cases. Our four-quarter recurring revenues for each of the eight periods presented were:

                                                                           Four quarters ended
                        4/30/2013      1/31/2013       10/31/2012      7/31/2012       4/30/2012       1/31/2012       10/31/2011       7/31/2011
                                                                              (in thousands)
Term license revenues  $   95,303     $   92,792     $     83,114     $   74,869     $    70,165     $    70,871     $     64,174     $    60,541
Total maintenance
revenues                   35,548         34,207           31,802         29,538          27,581          25,412           23,818          21,321
Total four-quarter
recurring revenues     $  130,851     $  126,999     $    114,916     $  104,407     $    97,746     $    96,283     $     87,992     $    81,862

Adjusted EBITDA
We define Adjusted EBITDA as net income (loss) plus provision for (benefit from) income taxes, other (income) expense, net, interest income, net, depreciation and amortization and stock-based compensation. We believe Adjusted EBITDA provides investors and other users of our financial information consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations. Adjusted EBITDA was $5.0 million and $9.9 million for the three months ended April 30, 2013 and 2012, respectively, and $32.3 million and $34.4 million for the nine months ended April 30, 2013 and 2012, respectively.
We believe Adjusted EBITDA, a non-GAAP measure, is useful, in addition to other financial measures presented in accordance with GAAP, in evaluating our operating performance compared to that of other companies in our industry, as this metric generally eliminates the effects of certain items that may vary for different companies for reasons unrelated to overall operating performance. We believe that:

         Adjusted EBITDA provides investors and other users of our financial
          information consistency and comparability with our past financial
          performance, facilitates period-to-period comparisons of operations and
          facilitates


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comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results; and

         it is useful to exclude non-cash charges, such as depreciation and
          amortization, stock-based compensation and one-time charges because the
          amount of such expenses in any specific period may not directly
          correlate to the underlying performance of our business operations and
          these expenses can vary significantly between periods.

We use Adjusted EBITDA in conjunction with traditional GAAP measures as part of our overall assessment of our performance, including the preparation of our annual operating budget and quarterly forecasts, to evaluate the effectiveness of our business strategies and to communicate with our board of directors regarding our financial performance.
Adjusted EBITDA should not be considered as a substitute for other measures of financial performance reported in accordance with GAAP. There are limitations to using non-GAAP financial measures, including that other companies may calculate these measures differently than we do. We compensate for the inherent limitations associated with using Adjusted EBITDA through disclosure of these limitations, presentation of our financial statements in accordance with GAAP and reconciliation of Adjusted EBITDA to the most directly comparable GAAP measure, net income.
The following table provides a reconciliation of net income (loss) to Adjusted
EBITDA:

                                    Three Months Ended April 30,           Nine Months Ended April 30,
                                       2013                2012              2013               2012
                                                              (in thousands)
Reconciliation of Adjusted
EBITDA:
Net income (loss)                $       (2,670 )     $      3,149     $       3,278       $      11,652
Non-GAAP adjustments:
Provision for (benefit from)
income taxes                             (1,823 )            1,964            (2,366 )             6,428
Other (income) expense, net                 268               (164 )             104                 471
Interest income, net                       (137 )             (107 )            (359 )              (220 )
Depreciation and amortization             1,137                784             3,182               2,147
Total stock-based compensation            8,272              4,274            28,430              13,878
Adjusted EBITDA                  $        5,047       $      9,900     $      32,269       $      34,356

Operating Cash Flows
We monitor our cash flows from operating activities, or operating cash flows, as a key measure of our overall business performance, enabling us to analyze our financial performance without the effects of certain non-cash items such as depreciation and amortization and stock-based compensation expenses. Additionally, operating cash flows takes into account the impact of changes in deferred revenues, which reflects the receipt of cash payment for products before they are recognized as revenues. Our operating cash flows are significantly impacted by changes in deferred revenues, timing of bonus payments and collections of accounts receivable. They were also impacted by the payment of a litigation settlement during the three months ended October 31, 2011. As a result, our operating cash flows fluctuate significantly on a quarterly basis. Operating cash flows were inflows of $8.1 million and outflows of $2.0 million for the nine months ended April 30, 2013 and 2012, respectively. For a further discussion of our operating cash flows, see "Liquidity and Capital Resources-Cash Flows from Operating Activities." Results of Operations
The following tables set forth our results of operations for the periods presented (in thousands, except per share data, and as a percentage of our total revenues) for those periods. The data have been derived from the unaudited Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods presented. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K filed with the SEC on September 25, 2012.


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                                       Three Months Ended April 30,            Nine Months Ended April 30,
                                         2013                 2012               2013               2012
Revenues:                                                        (in thousands)
License                            $       22,918       $       21,662     $      74,482       $      68,206
Maintenance                                 9,110                7,769            27,690              21,680
Services                                   36,222               27,564           101,567              74,586
Total revenues                             68,250               56,995           203,739             164,472
Cost of revenues:
License                                       139                  150               436                 683
Maintenance                                 2,079                1,310             5,430               3,773
Services                                   33,774               22,513            89,071              59,748
Total cost of revenues                     35,992               23,973            94,937              64,204
Gross profit:
License                                    22,779               21,512            74,046              67,523
Maintenance                                 7,031                6,459            22,260              17,907
Services                                    2,448                5,051            12,496              14,838
Total gross profit                         32,258               33,022           108,802             100,268
Operating expenses:
Research and development                   16,854               12,986            47,503              36,107
Sales and marketing                        11,915                8,409            36,680              24,968
General and administrative                  7,851                6,785            23,962              20,862
Total operating expenses                   36,620               28,180           108,145              81,937
Income (loss) from operations              (4,362 )              4,842               657              18,331
Interest income, net                          137                  107               359                 220
Other income (expense), net                  (268 )                164              (104 )              (471 )
Income (loss) before provision for
(benefit from) income taxes                (4,493 )              5,113               912              18,080
Provision for (benefit from)
income taxes                               (1,823 )              1,964            (2,366 )             6,428
Net income (loss)                  $       (2,670 )     $        3,149     $       3,278       $      11,652


                                      Three Months Ended April 30,        Nine Months Ended April 30,
                                         2013                2012             2013              2012
Revenues:
License                                    34  %                 38 %          36  %                42 %
Maintenance                                13  %                 13 %          14  %                13 %
Services                                   53  %                 49 %          50  %                45 %
Total revenues                            100  %                100 %         100  %               100 %
Total cost of revenues                     52  %                 42 %          47  %                39 %
Total gross profit                         48  %                 58 %          53  %                61 %
Operating expenses:
Research and development                   25  %                 23 %          23  %                22 %
Sales and marketing                        17  %                 15 %          18  %                15 %
General and administrative                 12  %                 12 %          12  %                13 %
Total operating expenses                   54  %                 50 %          53  %                50 %
Income (loss) from operations              (6 )%                  8 %           -  %                11 %
Interest income, net                        -  %                  - %           1  %                 - %
Other income (expense), net                (1 )%                  - %           -  %                 - %
Income (loss) before provision for
(benefit from) income taxes                (7 )%                  8 %           1  %                11 %
Provision for (benefit from)
income taxes                               (3 )%                  3 %          (1 )%                 4 %
Net income (loss)                          (4 )%                  5 %           2  %                 7 %


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Comparison of the Three and Nine Months Ended April 30, 2013 and 2012
Revenues
Please refer to Note 1 of Notes to Condensed Consolidated Financial Statements
for a description of our accounting policy related to revenue recognition.

                               Three Months Ended April 30,
                             2013                          2012
                                   % of total                 % of total         Change
                    Amount          revenues      Amount       revenues        ($)      (%)
                                     (in thousands, except percentages)
 Revenues:
 License        $   22,918              34 %     $ 21,662          38 %     $  1,256     6 %
 Maintenance         9,110              13 %        7,769          13 %        1,341    17 %
 Services           36,222              53 %       27,564          49 %        8,658    31 %
 Total revenues $   68,250             100 %     $ 56,995         100 %     $ 11,255    20 %


                             Nine Months Ended April 30,
                          2013                        2012
                              % of total                  % of total         Change
                  Amount       revenues       Amount       revenues        ($)      (%)
                                   (in thousands, except percentages)
 Revenues:
 License        $  74,482          36 %     $  68,206          42 %     $  6,276     9 %
 Maintenance       27,690          14 %        21,680          13 %        6,010    28 %
 Services         101,567          50 %        74,586          45 %       26,981    36 %
 Total revenues $ 203,739         100 %     $ 164,472         100 %     $ 39,267    24 %

License Revenues
The $1.3 million increase in license revenues during the three months ended April 30, 2013 was primarily driven by increasing term licensing of PolicyCenter in the current period, and increased sales and marketing efforts in North America, partially offset by a decrease in perpetual license revenues in the current period.
The $6.3 million increase in license revenues during the nine months ended . . .

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