Guidewire: Market Goes Haywire Following Earnings Conference Call

| About: Guidewire Software, (GWRE)
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Shares of Guidewire Software (GWRE) have seen their fair share of volatility in after hours trading. After shares spiked upwards in after-hours trading on the back of the headline numbers, they sold off after the earnings conference call revealed very cautious guidance for 2014.

Based on the guided revenue slowdown, after strong momentum in the fourth quarter, and large guided losses, I remain very cautious and remain on the sidelines.

Fourth Quarter Results

Guidewire Software generated fourth quarter revenues of $96.9 million, up 43% compared to last year. Revenues came in ahead of the company's own guidance of revenues of $91 to $94 million.

GAAP net income more than tripled to $12.1 million as GAAP earnings rose from $0.06 per share last year to $0.19 per share in the past quarter.

Non-GAAP earnings per share rose from ten cents to $0.25 per share over the past quarter. GAAP earnings comfortably beat the company's guidance of earnings of $0.13 to $0.14 per share.

Results easily beat consensus estimates from analysts and estimates were in line with the company's previously issued guidance.

Looking Into The Results..

The spectacular revenue growth rates of 46% are driven by license revenues which rose by 70% to $49.1 million, now making up more than 50% of total sales.

Maintenance revenues were up by 26% to $9.9 million, while service revenues advanced by 23% to $38.0 million.

As license margins carry gross margins of over 99%, the strong growth in the area boosts the overall margin of the business. Gross margins increased by a cool 230 basis points to 62.0% of total revenues.

Despite additional hiring, Guidewire saw positive operating sales leverage in selling, general and administrative expenses which fell by 670 basis points to just 45.3% of total revenues.

The combination of increased gross margins, general revenue growth and positive operating leverage all contributed heavily to the bottom line.

..And The Outlook For 2014

Guidewire sees full year revenues for the coming fiscal 2014 between $328.5 and $340.5 million, up 11% at the midpoint of the guided range. License and maintenance revenues are expected to outpace service revenue growth, which should bode well for margins.

Increased sales and marketing hires in the second half of 2013 will impact margins going forward, while Guidewire is conservative and does not factor in large sales transactions.

Non-GAAP operating income is seen between $18.2 and $22.2 million, representing non-GAAP operating margins of just 6%. Yet Guidewire sees better margins beyond 2014 on the back of strong license growth and operating leverage.

Non-GAAP net income is seen between $12.6 million and $15.3 million, but a $64.2 million expected stock based compensation will result in large $43-$47 million GAAP losses.


Guidewire ended the fiscal year of 2013 with $207.7 million in cash, equivalents and marketable securities. The company operates without the assumption of debt for a solid net cash position.

Full year revenues for the fiscal year of 2013 came in at $300.6 million, up 30% on the year before. GAAP earnings came in at $15.4 million, or $0.25 per share, unchanged from the year before.

Factoring in losses of 5% in after-hours trading, with shares exchanging hands at $45 per share, the market values the business at $2.55 billion. Excluding the net cash position, operating assets are valued at $2.25 billion, or 7.5 times last year's annual revenues and roughly 150 times GAAP earnings.

Guidewire Software does not pay a dividend at the moment.

Some Historical Perspective

Shares of Guidewire Software made their debut in January of 2012. Shares were sold to the general public at $13 per share, above the preliminary guided range of $10-$12 per share.

Shares immediately rose to $17 and traded around the $30 mark for most of the remainder of 2012, marking a hugely successful offering. So far in 2013, shares have continued their march upwards, currently trading around all time highs of $50 per share.

Between fiscal year of 2009 and 2013, Guidewire has increased its annual revenues from $85 million to some $300 million. The company turned a $11 million loss in to a $15 million profit last year.

Investment Thesis

Besides announcing a stellar set of results, Guidewire announced the formation of a strategic alliance to codevelop integration between Guidewire's claim management systems and Mitchell's adjusting and workflow solutions in North America.

Yet the news of the rapid slowdown in annual revenue growth, although the guidance is extremely conservative, coupled with the large expected GAAP losses made investors run toward the exit.

After the original press release was released shares traded with gains of 10% or more to levels in their fifties, only to see the stock fall in after hours to levels around $44 per share. Note that the outlook for the fiscal year of 2014 was only announced in the earnings call.

Obviously Guidewire is cautious in its revenue outlook by excluding the impact of potential large contracts. Yet the guided annual revenue growth rate of 11% is quite low compared to the annual growth rate of 30% for 2013 and the 43% growth rate reported for the final quarter of that year.

The GAAP net loss guidance for next year is a true shocker as the company plans to hand out $64 million in stock-based compensation in a firm with just over a 1,000 employees.

Even when excluding the stock-based compensation, non-GAAP earnings are extremely disappointing as well, despite all the new initiatives and recent customers wins. While Guidewire operates in a nice niche market, providing updated software for a general outdated IT infrastructure at insurers, it has already captured 20% of the global market, as measured by premiums being underwritten.

As should be clear by now I'm negatively surprised by both the base case revenue guidance and impact of stock-based payments on GAAP earnings. Therefore I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.