Guidewire Software, Inc. (GWRE) Earnings Call Transcript & Summary

Excellent. Good morning and thanks for joining. I'm delighted to welcome Guidewire to the conference. I always look forward to our conversation with Guidewire. We're lucky to have the recently named CFO, Jeff Cooper, on. Thank you, Jeff, for joining us.

Yes. Thanks for having me.

Absolutely. And congratulations on your promotion. And yes, the format of the session, as you guys are familiar, well, I've got some questions that I'll go through with Jeff. And then if you have any questions you'd like to post from the audience, you have the chat box in front of you. And you can do that through that, and I'll save some time at the end for any questions that you may have from the audience. So again, Jeff, thanks again. Congratulations on your promotion.

And why don't we start, since you reported yesterday your Q3 results, what were kind of the salient points you want to kind of call out from the earnings call and key takeaways?

Yes. Yes. So first and foremost, we've been very impressed with how our global employee base has adapted to 100% working from home. So just before our last earnings call, we conducted a 100% work-from-home test to see how we can handle that type of environment. And then almost immediately after we completed that test, we moved the company to a mandatory work-from-home posture. So just been super impressed with how everybody has adapted to that. It's become clear that this has created some significant challenges for employees who are often juggling being parents and teachers and employees, among other things, and so a bit of a challenging environment. And so with that backdrop, I was just really pleased with the results we were able to post, pleased with the momentum that we've seen in our engineering team able to get Aspen over the finish line and get that released, so just a lot of really, really, really good activity we saw in the quarter. Sales activity was a bit lighter than what we would see in a typical Q3 and a bit lighter than we all would like, but wasn't surprised by that given the overall environment, and even just really impressed with our sales team in Europe to get the Aviva Italy deal over the finish line, which was a big project in very difficult circumstances in that part of the world. So that was really exciting. And in general, this quarter in particular just demonstrated the resiliency of our business. We're a recurring revenue business selling mission-critical core systems of record to a very well capitalized and resilient end vertical, being P&C insurance. So we consider ourselves lucky to be well capitalized, have a really strong recurring revenue model and servicing great customers, and consider ourselves lucky especially in times like this.

Thanks, Jeff. That's a good overview. I appreciate that. And with regard to the sales activity being lighter that you mentioned, can you describe what that might be? How that came about with COVID, all the work-from-home disruption? These are, in many cases, bigger expansion deals. There are cloud transition deals that you're signing, so a little bit more involved, large-type deals. Is it simply customers just aren't on-site, it's more difficult to sell those kinds of deals, prove the data security and compliance model, more transformative moving to the cloud. I guess what would you attribute the lighter sales activity to? Is that COVID?

Yes. It's really a lot of things. There was a theme that we talked about quite vocally on our Q2 call was, as we have transitioned, and it is our view that this industry will go to the cloud and that we can best service our customers and the industry in general through the cloud modality, and that's a big shift for this industry. And so part of what we're seeing is absent COVID and just the industry coming to terms about what this means for them. People are at various stages of readiness to go to the cloud, and insurers who were thinking about a large core modernization project on premise may now be second guessing the decision to do that on premise and maybe stepping back and saying, well, Guidewire is telling the industry and me that they can service me best in the cloud. Maybe it'd be crazy for me to kind of kick off an 18-month implementation on premise. So we are seeing a little bit of that backdrop that was a part of -- just a continuation of some trends we've seen recently. Longer term, we think that's really positive. We want to take the industry to the cloud. And so it's not that people are not thinking about core modernization projects. Those dialogues are active and ongoing, it's just which modality. And then as we moved into Q3, COVID-19 became a much bigger part of the conversation. There's a variety of challenges that it presented. The teams have been able to work through that. Just it's been pretty surprising how efficiently the teams have been able -- our internal teams and the teams we work with on the customer side have been able to transition to a virtual work environment. That being said, I just think that there was a lot of distraction in the overall customer base. All of our customers and prospects were having to deal with their own situations about how to migrate their employee base to work from home. And so it just created a pretty distracting environment. In addition, getting final approval on multimillion-dollar, multiyear projects was just a little bit more difficult in this environment. And we found that certain things that could have been approved at the local level now required Board approval and just a couple more steps to go through in order to get things to transact.

Got it. And you did report some upside to at least our estimates on term license this quarter, and I think some of that was timing-related. Was that the case or was there just some surprise demand from existing customers? You didn't raise the term license number for the year, so I think it probably was more timing-related. But anything you can do to kind of provide color on what's happening in the term business?

Yes. It was more timing-based. And in addition, we mentioned that there were some multiyear renewals that deviated from our standard annual renewal cycle. And under ASC 606, that will pull forward some revenue, so that had an impact. In addition, for us, it's always hard to call exactly when those term deals that are working through our pipeline will close. And so we did see, I think there was one deal in particular that we knew would close in the back half of the year and weren't sure if it would land in Q3 or Q4, so it was not embedded in our outlook. And we got that over the finish line in Q3. So little things like that. It's mostly timing, but pleased to see the ability to get some of these deals to transact.

Got it. And there's the debate within the industry as to which companies and industries are net beneficiaries of COVID in the short term or which are companies that are kind of beneficiaries as we exit the COVID pandemic as a potential longer-term catalyst for digital transformation. How do you think Guidewire and insurance core systems category falls in that spectrum?

Yes. It's a really good question. I do think that over the longer term, this will shine a light on the need for agile, modern core systems to be able to kind of meet the needs of a business that needs to continue to be more agile, right? So I think longer term those themes will help us. The insurance industry overall is just very resilient. We were talking internally with our team, and I heard a stat that I didn't really know, which was interesting that somewhere up of 75% of insurance is kind of nondiscretionary. You need auto insurance to drive a car. You need home insurance to get a mortgage. So that's a really resilient end market that we operate in. And so we think longer term this will help encourage modernization activities, which is really the foundation of our business, kind of this move to modernizing mainframe systems and then now this kind of move to taking on-premise systems to the cloud. So we think it's a long-term positive, but obviously creating some kind of shorter-term challenges and complexities that we have to work through.

Got it. And it sounded like you made some progress closing some Cyence deals this quarter. I know the cyber risk business hasn't trended perhaps as to how you thought when you made the acquisition of Cyence. Are things turning around in that business? Should we read the results that way?

Yes. It was a good quarter for Cyence. We were really pleased to see that momentum. There are some interesting themes that are COVID-related with respect to Cyence. Obviously, when corporations move their entire employee base to a work-from-home posture, that increases some of the risks around cyberattacks. It's too early to say whether that is really going to drive kind of some exciting bookings activity out of Cyence. But we did see some positive momentum in Cyence in the quarter, and we were excited to see that, and hopefully it's the beginning of a trend.

Got it. Great. Why don't we start with the cloud transition? Just at a high level, the cloud is different for the insurance industry. It's obviously been -- I think you've stated a couple of years ago, this is a 10-year cycle, which is remarkably long because it's different. The industry moves more slowly. How are the requirements different? How are you guys satisfying those requirements? What do you think the trajectory of adoption is going to look like in the near and longer term?

Yes. One of the big challenges with servicing the industry that we service is the complexity of the overall IT environment that our products integrate into. And there's also some of the complexity of what have historically been relatively bespoke workflows and processes at individual insurers. And so I think there's a real opportunity here as we simplify and try to standardize our approach to bring some of those best practices into the industry and help insurers realize that differentiation does not necessarily need to be embedded into their core system framework, but differentiation in terms of the flexibility of their core systems to allow for different digital engagement models is really important. So it's a unique industry. We think a lot about how the opportunity in front of us is very exciting. And there is a inevitability viewpoint that exists in the industry that this industry will go to the cloud. It's just a risk-averse industry, and how quickly it will move is the big question. We obviously had some really exciting early adopters transact and buy our cloud product, whether it's USAA or American Family and some really exciting large insurers that will be really positive proof points for us, but these cycles are long. The sales cycles are long and then the implementation cycles are even longer. So before we can really demonstrate some of those proof points, it can take a while, and we'll see. My sense is that it's not going to be a straight line, but we will hit a point where the industry in general feels very comfortable with the cloud products that we're providing. And that's when we'll see a pretty significant shift. It just takes time to get there, and there's just a lot of blocking and tackling you have to work through.

Sure. Sure. And the Aspen release that you mentioned, I think, is a big step forward in your kind of road map for cloud. Can you describe what's in that release? What makes this more cloud-ready? I think it's out now, I think. Is it in beta or is this the GA today?

Yes. So technically, we released it. The public launch, I think it's June 16. But later this month is when we will do our public launch. Yes, so we're really excited about this release. I mean you heard Mike talk about it as the most important release that Guidewire has ever done. And this is really setting the foundation for future innovation and how we think about architecting our product. The release will enforce a consistent architecture grounded in what we call our Guidewire Cloud platform. The common architecture will enable us to better take advantage of the benefits of the cloud. The really exciting thing is the ability to upgrade customers in a more seamless fashion as we deliver new innovation. So this is putting us on a twice-a-year release cadence, and this is the first step to getting to that twice-a-year release cadence. And then not only releasing software, but being technically able to allow our customers to take those releases in a relatively seamless fashion and benefit from that innovation is a huge step for us. And that's kind of what is the foundational elements of this release, so really excited to get this out. And new cloud customers that we sell to will go straight on to this new release, which will be very exciting.

That's great. That's great. So I think at the Analyst Day, you talked about architecting cloud services behind your cloud applications. Is that what this is about? Now you've got that kind of services capability where you had developed a set of new features, you can push those out to the cloud version instantaneously to all those that are on these single-tenant hosted instances, kind of like single tenant, but multi-tenant capabilities in the sense that you can more seamlessly deploy new features?

Yes. That's right. I mean there will be elements of our platform and our solution that will remain single tenant. And certain of those elements are very important to our customers, whether it's the database or other critical components. But we're going to architect it in a way that is more modular and can call on what would be multi-tenant cloud services, right? And so we will build in components and elements of multi-tenancy, and there will also be element of single-tenant architecture. And as we become more standardized in this approach, it should begin to -- and now as a finance person, I feel like I have much cleaner line of sight into the steps that need to be taken and kind of the initiatives that we're working on as an organization that will impact our margins, right? So we feel much more comfortable in kind of the steps we're taking to really drive those longer-term margins that we've talked about historically.

Sure. And is multi-tenancy something that the company sees in the future? Is the industry interested in going there? Is it in the road map? Anything on kind of that step?

Yes. I mean it's more components of our solution will be multi-tenant, and there will be components that will be single tenant. I don't expect us to ever move to a full multi tenanted platform, but we will kind of identify areas where multi tenancy makes a ton of sense and build that in as a cloud service. And then certain parts of the technology stack will remain single tenant. And we can do that in a much more way today than you could 5, 6, 7 years ago when some of the tools and technology around public cloud infrastructure and other things weren't as accessible.

Got it. Got it. And you talked about a long-term gross margin target for your cloud business in the 60% to 50%. Where is it now? What are the sources of leverage? Maybe you can just break down a little bit what the economics look like today in some of these cloud deals and how can you generate scale, given the architecture you described over time?

Yes. I think the big challenges to our margin today is, it's still a very small number of customers that we have, especially kind of the ones that are live and fully running the platform. And so we're still learning along with our customers. From a support perspective, we have to overstaff it a bit just to make sure that these early consequential customers are getting a high-quality experience. And then over time, we can figure out how to scale those investments across a large number of customers. But we are building that infrastructure now, and a lot of that right now is kind of headcount. It's the people layer to be in a position to support the run time operations of our cloud platform to do those customer support, answer all those questions, resolve all those issues because the surface area of what we're covering is much broader than when we were just a software vendor, right? So those are the big investments that we're making. You can, as an investor, you can back into our subscription margins by kind of looking at our subscription revenue. And our term license revenue tends to be very high margin. So kind of breaking out those components, you can back into a margin that's a blended margin of subscription that's kind of in that 30%, 40%. And I would say that early IS Cloud customers are a drag even on that margin just because we're not at scale yet. But we see the path to -- as we kind of see more and more customers migrate over to our cloud product, we see that path to scaling those margins to a much more appropriate place over the next year, couple of years.

And what is the source of that, the cost of sales today? Are these hardware costs, people costs, headcount to kind of manage these single-tenant? Any just color on just what they look like.

So the first, the biggest cost right now is just people cost and the people who are managing our cloud operations and managing these environments for our customers, which are pretty complex, right? And then we also focus on AWS. AWS is the cloud provider we're using to build our platform on top of. So we manage and monitor AWS costs. Those are much lower. It's really the people costs right now are the most significant costs. And then there are other kind of some third-party software costs. We have to do a lot of investment in security to make sure these environments are secure, whether that's penetration testing or other things. So there's a variety of things that go into the cost of goods sold in the cloud. But right now the biggest one is really the people cost, and that is something that I know we can solve over time with technology and make more efficient. So that's a positive thing that I think while we're not at efficiency yet, we know how we can drive those down.

Got you. And you've talked about the ramp cloud in years 4 or 5 of a 5-year deal getting to 3x what customers are paying annually in term. What drives that? Is it just they're starting small departmentally and expanding over time? Or is there other usage of other technology that they're expanding with as well?

It's a variety of things that drives the ramp. Obviously, we provision the software pretty quickly once we transact with the customer. And they will use that, kind of those environments through the implementation process. So they do start using the software, but they're not running their DWP, they're not managing their business through those environments until they've integrated it and implemented it and gone live. So there is a process there that plays into the negotiation around a ramp schedule. The ramp schedule really becomes a negotiation. There are certain things that I really care about. And one of them is getting to what we call that fully ramped value that will set up the basis for the ongoing renewals for the next 10, 15, 20 years. And so as we go through a sales negotiation, a willingness to be a little bit flexible on year 1, year 2 as long as my sales team is holding the line on year 5, that fully ramped number is something that I care a lot about. And so it plays into just the overall negotiation of how we structure the deal.

Got it. And you guys had been very consistent at your Analyst Day of kind of presenting the penetration of direct written premium, still relatively low in the Tier 1s and Tier 2s, which speaks to the long-term opportunity for modernization just generally in the installed base. How has the cloud transition impacted that expansion? If you're a term customer, you've signed on term license deal over the last 5 years or so. Are these customers, do they want to expand with more term? Are you accommodating that? I guess just generally, what impact is this cloud cycle having on just the rate of expansion from a DWP standpoint in the installed base?

Yes. So I think there are a couple of different things that are going on. With the cloud, there has been a thesis internally that some of our existing customers who know Guidewire, who trust Guidewire, who had very positive experiences working with Guidewire, may be some of the early adopters of our cloud product. And we have seen that in many instances. And so that is a meaningful expansion opportunity that comes with no incremental DWP, right, because we already have that DWP. We're already managing that DWP in our system. So you won't see DWP growth in that context, but you should see kind of what I think about as a take rate on that DWP, kind of how much ARR are we getting for the DWP that we're managing. And so that is something that we could see develop here where DWP maybe isn't growing as fast as this migration opportunity with the existing customers creates that first wave of people that adopt to cloud. That being said, we've also seen some interesting activity of folks like USAA is a good example of this, where it's an organization that wants to -- has not modernized yet and kind of managing systems that have been in place for some period of time and decided to just go directly to the cloud and do that without going on-premise in a modern system. And so we are seeing some of that as well, so. And if we see that, then we should see kind of that DWP expansion again start to grow. So those are the 2 levers in the model, right? How much DWP can we add and how many systems can we modernize? And then as we move into the cloud, the ASPs are higher. And so what's our take rate on that DWP?

Got you. And on the new opportunity, new business opportunity, I think at the Analyst Day you disclosed 34 of 50 Tier 1 customers, 99 of the 250 Tier 2. The question is, what are the other, the customers that aren't running Guidewire, what are they running today? Is there still an opportunity to win that business or is this more about really expansion in the installed base?

Yes. No, it's a great question. And we maintain a massive spreadsheet internally that our sales organization maintains that looks at kind of every insurer that we know or have called on and try to kind of make sense of what their IT system framework is and what systems exist out there. And when you look through that sheet, a lot of the names, a lot of the systems that you see on that sheet are names that I personally don't recognize. They're older, bespoke systems, been in place for a number of years, mainframe-based systems or just completely custom-built systems. So that's the opportunity. I mean these systems are heavily -- they are entrenched and they are difficult to modernize. And that's been the bread and butter of our success is going in there and doing that difficult work. And right now there's a lot of pressure for insurers to be able to engage with their customer base in a more digital way. And it's our view that starting with a modern core system framework will really help you do that. But we may see insurers take that digital imperative as the foremost imperative right now and put wrappers around their legacy systems. And that may work for a while. We think over time that starts to fray and break down. And so we are encouraging folks to think about modernizing their core in conjunction with digital initiatives. And in fact, the market for kind of digital applications should be a big driver of core modernization over the longer term. So those are some of the things that we're seeing. But when you look at the overall systems that are out there, it's a lot of bespoke kind of one-off systems still out in the industry.

Got you. Got you. And over the last couple of years to really 3 years ago when you started embarking on the move towards the cloud, you took on more services. And so the services mix expanded. I think it's been flattening out. And my apologies, I don't have that model in front of me, but it's been kind of more pacing in line with the business. Is this a function now of partner readiness, the global SIs are more capable of delivering these cloud deployments now? What efforts have you done there to kind of get the channel ready for the cloud offerings? And should we expect services mix to kind of stabilize here?

Yes. It's a great question. So we have done a lot of work to bring our partners along on this journey. And there has been a lot of effort to certify and educate our partners. Mike had a good stat in the script. I'm trying to pull it up to get it right. I think we certified something like 400 and -- I don't have the exact number, 490-some consultants, which was a very significant upgrade quarter-over-quarter. And it's a reflection of how our SI partners are engaging and digging in and learning the cloud product. And it also, I think, is a really interesting leading indicator because people are investing their time, they're investing their money to get certified on our cloud products. And I think that's an interesting leading indicator of a wave of migration activity to be done. We need this partner community to take a lot of that work. If we start seeing a significant shift where customers start migrating to the cloud in meaningful numbers, we don't have the capacity to do all that work, so we're very lucky to have strong partners who can help with that. And the more that we can push in their direction, we will do that.

Got it. Got it. And why don't we shift. We just have a few more minutes here. Why don't we shift to digital and data. Any commentary on how that business, the focus has been so much on the cloud transition that I think we forget that you have this innovative suite of applications on the analytics side. Can you just talk a little bit about the uptake there? I know there have been some kind of organizational changes you've made in that business over the last couple of years. But kind of where is it today? What does penetration look like? And where is the opportunity for digital and data from here?

Yes. I think the one thing I would comment on with respect to digital and data is as we think about moving into the cloud, there are interesting opportunities where we infuse data much more natively into our core application. And so historically we've talked a lot about attach rates. In the future, some of these will just be kind of in -- the digital and data capabilities will just be infused right into the product. And so it will be a little bit less of a bespoke sale, but kind of a part of the overall way we engage with the customer and the core system optimization. So that's one thing that we're spending a lot of time thinking about in terms of how we best service our customers and deliver the most feature-rich core products. Obviously, Cyence had a good quarter, so we were excited to see that. In the cloud, we migrate kind of what we used to call DataHub becomes cloud data platform. And that should be more integrated into the cloud product and more native to cloud product. So there's a lot of really exciting things going on. Predictive capabilities in terms of what we historically have called our Smart Core, but really building that into our cloud product is a big part. And that's kind of coming from our PA, our predictive analytics products. So a lot -- there's a lot going on, a lot going on there. I do think that we may shift how we think about it from bespoke sales and attach rates to just being a critical part of the solution that we sell.

Got it. Are there any common use cases you've seen here that customers are kind of running the suite for? Is the SI channel picking up on that? Are they building some accelerators or solutions around that?

Yes. There are a lot of different use cases in our overall data applications, so I'm not sure I'd call out one specifically. But just building more data right into the core solution and then over time kind of enabling more straight-through processing and other things as a result of kind of data that's used into the application is something that people are really interested in.

Got it. Great. Well, Jeff, that's all the time we have. Thank you so much for joining us. I know it's a busy time given that you just reported earnings. Really appreciate you being here. Congratulations again on your promotion.

Great. Yes. Thanks so much for having me. It was a pleasure.

Absolutely. Thanks again, and thanks to those in the audience for listening in.

All right. Thank you.

Have a good day. You too. Bye-bye.