Guidewire Software: Slower Growth And Earnings Pressure Creates Risks

Sep. 3.14 | About: Guidewire Software, (GWRE)

Summary

Guidewire posted solid fourth quarter results but issued a very soft outlook.

This triggered a sell-off as investors are rightfully disappointed.

Long-term revenue growth slowdown and earnings pressure limits the appeal in my eyes amidst a premium valuation.

Investors in Guidewire Software (GWRE) were undoubtedly pleased with the company's solid fourth quarter earnings report. Still the very soft guidance for the upcoming quarter and year pushed shares lower.

The bad news cocktail of slowing revenue growth and pressure on GAAP earnings makes shares quite unattractive in my eyes amidst a still premium valuation. In the light of these trends, I continue to deem an investment in the company as being rather unattractive from a risk-reward stance.

Solid End To The Year

Guidewire posted fourth quarter sales of $118.2 million, a 22.0% increase compared to the same period the year before. Topline sales comfortably beat consensus estimates at $112.7 million.

The company showed excellent operating leverage on reported sales growth as it posted net earnings of $19.8 million, a 42.7% improvement versus last year. Due to some dilution over the past year, the improvement in earnings on a per share basis was limited to six cents. Reported earnings advanced to $0.28 per share on a GAAP basis.

Non-GAAP earnings rose by ten cents to $0.37 per share, coming in comfortably above consensus estimates at $0.28 per share.

Solid Growth, Strong Operating Leverage

Driving the reported revenue growth was the increase in license sales, which rose by more than 34% to $65.9 million. This growth is very important given that this particular segment posts gross margins of over 98%.

Growth in the maintenance segment came in a little below 21% to $11.9 million, while growth at the low-margin service segment came in at just little above 6% with revenues advancing to $40.4 million.

Thanks to the favorable shift in growth in the high margin businesses, the gross profits of the company improved to 67.3% of sales, nearly a four percent point increase compared to the year before. Operating expenses totaled 45.0% of sales, which is a modest 1.3% increase compared to last year on a relative basis.

All in all earnings benefited notably from sales growth and margin expansion although dilution has been rather high over the past year as the total outstanding diluted share base increased by some 15% on an annual basis.

Disappointing Outlook

For the first quarter, Guidewire sees revenues of $71.5 to $78.5 million, which at the midpoint of the guidance represents a roughly 13% growth in revenues on an annual basis.

Non-GAAP earnings are seen between $0.01 and $0.05 per share while analysts expected Guidewire to guide for a break-even result.

For the full year, Guidewire sees sales between $364 and $382 million, which at the midpoint of $373 million implies 6-7% annual growth in revenues. Analysts expected sales for the upcoming year to come in as high as $383 million.

The company anticipates full year non-GAAP earnings of $0.35 to $0.45 per share. This falls short compared to consensus estimates at $0.55 per share and this year's reported earnings of $0.63 per share.

Strong Balance Sheet, Premium Valuation

At the end of the quarter, Guidewire held some $648 million in cash, equivalents and short-term investments. This is as the company has no debt outstanding, resulting in a rock-solid balance sheet.

With 71 million shares outstanding at the end of the quarter, which currently trade at around $43 per share in after-hours trading, equity is valued at a little over $3.0 billion. This values operating assets much closer to $2.4 billion.

For the year, Guidewire posted sales of $350 million as annual earnings came in at just $15 million. This values operating assets at nearly 7 times annual sales and a non-meaningful earnings multiple.

Long-Term Strategy

It was October of last year when the company last held an analyst day. In the presentation, the company outlined its ambitions to benefit from the technology transition in the $2 trillion global property-casualty industry. Within this industry, legacy systems will need a big wave of upgrades to remain competitive in the future. The biggest insurers in the world are among the company's customers including the likes of AIG (AIG), Zurich, AXA and Allianz.

Guidewire's high margin software business, including products like PolicyCenter and InsuranceSuite, are driving this growth, aiding customers in the process in achieving their goals. Notably the licensing business is very important given the very high margins versus the low margins service business, which the company offers as well to offer a broad package of services to its customers.

Implications For Investors

Guidewire has seen very aggressive and profitable growth in recent years, yet trends are not improving. Growth is slowing down in topline sales and despite a shift toward sales in the high margin license segment, earnings on a GAAP basis have been trending down.

In this light, the acceleration of revenue growth to 22% on an annual basis for the fourth quarter looks favorable to the 17% reported growth rate for the full year. In that light the current momentum is clearly not sustainable given the disappointing outlook for the first quarter and upcoming year.

Back in September of last year, I last had a look at the outlook for the company's shares. At the time, I was quite cautious or even bearish amidst the relatively slow pace of guided sales growth and high stock-based compensation expenses, which hurt GAAP profitability amidst a high valuation. Ever since shares have hardly moved since that moment.

Despite being nearly a year further by now, I don't see compelling reasons to change my stance. Revenue growth for the upcoming year is not very upbeat, while the earnings outlook continues to disappoint. I remain cautious, staying on the sidelines with perhaps even a modest negative stance.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.