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

This is Tom Roderick, applications software analyst here at Stifel, and we're very lucky to be joined today by Guidewire. The presentation slide you see, we have some nice updates to offer you. So Jeff Cooper is indeed here with us. The interim tag has been removed. Jeff recently, as many of you noticed, got promoted to full-time CFO just on the company's earnings call last week, and we're also joined by Priscilla Hung, who has been Chief Operating Officer since 2017 and recently added the title of President to her role as well. So Jeff and Priscilla, thank you so much for being here, for joining us. I'm going to take the opportunity to hand the ball over to you both, and perhaps you could take just 5 minutes to briefly discuss what does Guidewire do, who are your customers and how do you think about the size of your total addressable market.

Sure. So Guidewire is a vertically focused enterprise software company. Since our founding in 2001, we have exclusively served one industry, and that would be the global property and casualty insurance market. And that's a roughly $2 trillion industry that sells a wide variety of products that are indispensable for indemnifying people and businesses against all sorts of different risks. So a pretty big, overall global market opportunity. We sell a suite of core systems of record that manage an insurer's policies, claims process, underwriting process, billings as well as, what I call, systems of engagement and systems of intelligence, which we refer to as our digital and data products. We've always monetized our software in a recurring term license model and now are in the early stages of migrating our customers and this industry in general to the cloud and selling subscriptions to our cloud-delivered products. We service approximately 380 customers in over 30 countries. And our customers include some of the largest insurers in the world, and we have obviously a very global customer base. So I think that's a quick overview that will hopefully give people a little bit of background on Guidewire.

Fantastic. Perfect overview. Priscilla, why don't I bring you in here just for the first question, and Jeff talked about the shift in the cloud. Given your role as Chief Operating Officer over the last several years, this is a -- this has been a hot topic across the whole industry, across your product portfolio. Tell us a little bit more about how you think customers are embracing the cloud now as opposed to, say, 2017 when we really started to shift to the cloud at Guidewire. Is that accelerating? Or do you expect it to accelerate with the impact of COVID and customers thinking more digitally? Let's just talk high level about the shift to the cloud and how fast that's going.

Yes. Good question, Tom. So I would say that the insurance industry that we wholeheartedly serve since the beginning of the forming of the company 19 years ago, as you can imagine, they are in the business of risk assessment. So they are a very conservative list of customers or sector of customers that have the really sort of noble [ cause ] of a mission to make their claimants or the policyholders [ whole ]. May it be this interruption, that is a hot topic today, and then only to be a -- perils, like a hurricane or flood. Now the whole cloud -- the notion of cloud, we started spotting it actually back in 2015. Now however, because of the conservative nature of our target audience and the fact that they go through many different check marks, right, so this cloud transformation project is really -- it's like having a heart transplant. So none of us really want to do heart surgery. So it goes through many, many different check marks in order for them to execute a core transformation. Now it used to be on-prem since the beginning of times, but I would say that back in 2015, we started to see some innovators of this very conservative industry to -- starting to ask question and explore what it means by running the operation in the cloud. But I would say that between 2015, 2017, only a very, very few handful of carriers are -- I would say, have that sort of the pioneer kind of spirit to really explore that in -- I would say, with a phase 0 of the cloud transformation because public cloud, like AWS, was quite immature. And also Azure and Google Cloud and Oracle Cloud, so to speak, they are really catching up and almost even nonexistent back in 2015. So I would say that accelerate to 2017, I think one of the main difference is -- really is the maturation of public cloud infrastructure and accessibility of AWS and also the confidence that data residing on the cloud can be secured, and they don't always have to be under the control of these very conservative cloud customers behind 4 walls. So therefore, I would say that the acceleration of the cloud adoption between '15 and '17, I would say that, that's a lot to do with the maturity of AWS and other public infrastructure. And also, it allows a software company like ourselves to have options to have a much more cost-efficient way to build out a cloud infrastructure as opposed to the traditional way like you have to procure hardware and you have to procure real estate to build your own data center, which is very cost prohibitive. Now -- so the cloud journey really started for us about 2, 2.5 years ago, and there was an initial wave of cloud customers and adoptions or to take advantage of our ability to offer our cloud offering in a relatively cost-efficient manner and also acceptance of this conservative client base to adopt the cloud and trust the cloud and trust data in the cloud. Now in terms of COVID, so there are many reasons why customer want to go to a cloud is -- from the business perspective is -- are there a better way for them to explore the -- using an allocation of the resources like IT, right? So they can choose to run on-prem and would find a large number of IT resources to continue to implement and also responsible for ongoing support of -- on Guidewire or they could have Guidewire be -- do this in the cloud and there are many technology benefits of it, which I'm sure that we'll touch on later on in this presentation. In addition to that, I mean, they can -- in addition to technology innovation enabled by the cloud, they also can have the opportunity to pivot their IT resources to focus on something that really drives top line growth for their own business as opposed to managing and upgrading Guidewire core system. It also allow them to not having to worry about procuring hardware and capital expenses and to also divert the sort of -- use the capitalization and how they allocate resources much more wisely that is beneficial to the insurance business. Now the one thing interesting about COVID is that it really accelerate the thinking in terms of taking advantage of the cloud. And also because of the conservative nature of the insurers, and they don't always act very quickly, but COVID really accelerate the learning in so many different ways. We all experienced today that work from home actually turned out to be much more efficient and -- than we would have ever imagined. And one of the reasons is because it's not only 1 or 2 constituents doing it, the entire world had to do it so that really we all come together, and we have to make it work. Now from the insurance perspective, if you are not able to use digital to really help to drive the insurance process, you really end up buying, right? So if you look at what insurance company needs to do is -- say, if you have some sort of a peril and that your roof needs to be -- is insured and your roof need to be repaired and you file a claim. Now the most traditional way is the customer would send a few adjuster to your house and take a look at the roof. But the thing is that in the COVID days when nobody can go out, there's no means for you to really process this roof repair and also to send out the reimbursement to your claimants if you can't take advantage of digital pictures or drone pictures or -- you won't be able to -- if you only -- the only ability for you to process the claims is to send someone to write a check, and you have the printer checked out and so and so forth and not using any sort of automated online platform, you really can't run your business, right? And digitization is not quite possible, if you don't take a look at the underlying core platform. So COVID really accelerate the thinking and really put some initiative of transformation and digitalization of the core process up at the top. I hope that's helpful. It's a long answer that you probably hoped, Tom, but that's the story.

No. It's a perfect answer. And it's a great framework for sort of laying out the challenges carriers are going through right now versus the opportunities they're thinking about on the back end. So I want to come back to digital in just a second because I think digital and data are kind of critical towards sort of the growth drivers and the cloud element of the story. While we're on the topic of COVID, perhaps you could put a little bit of a finer point on it and, Jeff, if you don't mind jumping in with some numbers. I think the whole world saw a pause back in March and then probably the first half of April. When you're talking about multimillion-dollar decisions from big national, multinational insurance companies, tell us how this sort of rippled through the impact to your third quarter results and what you're seeing kind of in real time with respect to sales efforts and reengaging customers on some of the cloud deals and the overall pipeline.

Yes. It's a good question. I like to think about kind of COVID in certain phases. And I think in Phase 1, we really saw insurers migrate into what I would call fire-drill mode. Yes, I think businesses all over the world are thinking about what I need to do right now to keep things working in this environment. Can we support work-from-home posture? Is our environment secure in this environment? And all of these type of questions kind of pushed to the forefront, a real here-and-now type of mentality, whereas the decision to modernize a core system is a very strategic decision, and it kicks off a lengthy implementation cycle that can take 10, 12 to 18 months. And so not surprising to have seen a little bit of a slowdown in [indiscernible] we're addressing the here and now. I do think as we [indiscernible] this here-and-now thinking and start to kind of think longer term, again, the current environment has -- will shine a light on the need for modern and flexible core systems. And I'm sure there are lots of insurers out there that were thankful that they did a core modernization project a couple of years ago, and I'm sure there are others that were kicking themselves a bit and wishing they had kind of finished that project but kicked the can down the road. So it's been -- it has had an impact. We've seen a little bit of a shift in some of the buying patterns that we would typically see. For example, there was a deal that -- in Q3 that we felt pretty confident that would have transacted under normal circumstances. But it was a kind of local entity of a global insurer in the current environment, what typically would have been authorized for approval at the local level required parent-level approval. And we are seeing those types of activities happen in the kind of here-and-now environment that we're seeing with respect to COVID-19. We expect that to continue to impact Q4. And Q4 is a very consequential quarter for us given the seasonality of our business. And so we're working through that. But in general, we've been very positively -- I'm excited about just how stable and resilient our recurring revenue model is, and this has also shined the light on that. So lots of moving parts in the model right now kind of pre-COVID, and then COVID just adds another layer of complexity.

Yes. I'm glad you -- oh, go ahead, Priscilla.

Sorry, this is just quickly around what Jeff's explanation is. I think it's -- we believe, even more so now, that not only that our business model is resilient. And we really zoom out to look at the insurance industry. Unlike many very unfortunate sectors out there that is really suffering about having to close a business or furlough or get rid of their employees, insurance is really not a discretionary industry. When you have commerce, you need insurance, right? And core system is also not discretionary for insurance sector that we serve because you need to have a heart to pump your business. So you can't turn it off neither. So I think that [ they're both combined, mated in a ] while. These core system decisions, it's very consequential, and they're conservative. And I think the COVID impact is not that the opportunity goes away entirely, it's just that while they are conservatively really assessing the impact to the business because people are driving less or they're buying houses less and so on and so forth, impact to the business is to basically add a couple more checks before they write multimillion-dollar check as opposed to the opportunity this goes away completely.

Yes. And so -- and I think what you both said there brings back an important point. And Jeff, you mentioned the criticality of the fourth quarter. It's coming up at the end of July. I guess there's kind of a history of software of, "Hey, if you don't get that big deal done in the fourth quarter, you might have to wait a while. It might be 2, 3 quarters until it comes back." This is a unique situation obviously where the pause button we've talked about, it got pressed, but they can foreseeably come back a lot quicker than a typical sort of deal delay. Maybe you could kind of go to real-time conversations that you're both having with executives or how you think about what that delay might do. Is it as simple as, as soon as the carriers feel more comfortable and they kind of clear through those extra checks and balances that might simply be a 30-, 45-, 90-day delay? Or do you kind of expect that it could just take a little while for some of those bigger deals to sort of come back after they hit the pause button?

Yes. I'll start, Priscilla, and then you can jump in if you have any added comments. I think it's -- we are in somewhat uncharted waters here. And so not sure there is a perfect historical corollary that we can rely upon. We have been heartened by people's just desire to keep things moving, right, keep the trains running on time, keep making progress on strategic initiatives. I think what we were able to accomplish with Aviva Italy was a really great example of that. Just there was a very challenging circumstance on the ground in Italy during our third quarter. And the desire of that team just to kind of demonstrate that we can continue to make progress in this environment. And we're part of a global economic system that needs to continue to move forward -- was good to see. Our hope is that if we do see delays in Q4 that, that will kind of allow us to just have a lot of confidence in our pipeline, and the maturity of our pipeline going into next year will just be that much stronger.

Yes. Fantastic. I'm going to take some questions from the audience as they come in. If you're out there on the audience and you'd like to submit a question, don't hesitate to do so in the Wall Street Webcasting format. I can read them as you submit them. One of the questions that's come in here, Jeff and Priscilla, is a question about competition. Can you talk about how your solution differs from Duck Creek software? Both are installed by Accenture and Capgemini. Talk a little bit of just about that competitive landscape and how you work within the scope of your partners as you go to market on the cloud.

Yes. We try to comment on our competitive landscape in a regular cadence. Duck Creek is a very real competitor that we see throughout North America and to some extent, internationally, primarily in the English-speaking geographies. Our success has been more concentrated at the upper end of the market, where there's a little bit more complexity in the sales motions and the product requirements. And we have been working on and developing products that meet the needs of smaller insurers with relatively more simplistic requirements. Duck Creek -- specifically, we haven't seen any sort of big shift in the competitive posture with respect to Duck Creek. I think the part of the market that they service was a little bit on the lower end. And as a result, kind of a little bit less complex and more willingness to go to the cloud. And so we did see them kind of put a bit more emphasis on the cloud a bit earlier than we did. We feel very good about our timing with respect to the parts of the market that we service. And as we move into this next phase of delivering in the cloud, we're really excited about some of the product momentum that we're seeing. Mike talked about Aspen. He mentioned it as the most important release that Guidewire has ever done. And we think that [indiscernible] demonstrating to the industry kind of what the future looks like with Guidewire in the cloud and how we can help customers move beyond kind of taking our releases every 4 to 6 years, which is what we see in the on-premise world to kind of getting access to that innovation maybe twice a year. So we're excited about the future. We think we have the right product set to meet the needs of a very complex market. And there's always competitors that will push us to be stronger.

Yes. Jeff, I'm glad you brought up Aspen. And I kind of wanted to throw that question back over to you, Priscilla, just in terms of what customers can expect in terms of a feature addition versus platform complexity on Aspen itself. And from your own perspective, how does this sort of inform the way you think about the cost structure and potentially the margin benefits of bringing cloud customers to market?

Excellent question, Tom. So the first -- I would say that the first phase of our delivering a cost platform, that is the last 2 years. I think we emphasized a lot of time taking over the customer's IT operation. We're responsible for post-production support, SLA and so forth and the data security, so that will free up our customers to really focus their IT resources and what matter to them even more, right, which is like driving new products and customer acquisition, customer engagement. So Aspen really is a significant addition to that story, above and beyond, just talk about operation being implementation and running and upgrading forever the Guidewire solution. So Aspen is very pivotal in so many different directions. So first of all, it is our first cloud-optimized solution that runs on AWS. Optimized in a sense that it's the first time we launched what we call a Guidewire Cloud platform, which is a multi-tenant platform that enable efficiencies in operation, and I'll come back to that in terms of margin expansion that you asked, and also agile deployment, right? And what that actually also means is that what does it mean to the customers, right? So the Guidewire Cloud platform, this multi-tenant platform, is a necessary infrastructure to allow us to offer what we call fast cadence upgrade, which is what Jeff alluded earlier. When we're on-prem, we have major releases probably every 18 to 24 months for the entire history of the company. So the customer consumption of new product capability, of innovation is 18 to 24 months if they upgrade to the latest release. And oftentimes, they don't, right? So with this Guidewire Cloud platform -- enable us to have new releases, new innovation, new capabilities every 6 months and for consumption of the customer if they would like to take the fast cadence release every single time when we have something that come out. So it is there, the customer will be able to consume this sort of new product capability and make the business even stronger and so forth by consuming and/or migrating, depending on whether [ you install base for a ] new customer the Guidewire Cloud platform. So we're very excited about this. Now -- and also, as part of the cloud transformation, Aspen release is the first release that we deliver and made available to our customers and truly cloud-native rating engine and truly cloud-native rules engine. We also have made some significant enhancement in digital and also the PolicyCenter that we're integrating the whole digital experience in a seamless way with PolicyCenter and also allow the insurers to really launch new business in the cloud much more quicker and easier than in the past. Now in the past, if you're on-prem, you want to launch a new product, you need to implement probably 9, 12, 18 months before you can launch a new product. But when you're launching in the cloud, you're able to probably launch -- it depends on the complexity you desire. You can potentially launch a product in like 3 -- 2, 3 months, right, if you don't have a lot of complex integration and so forth, and also fully taking advantage of our cloud stack. So this is a really significant release for us. Now to go back to your point about cost efficiency is -- as you can imagine, even though our customers did not come out and say, "I want you to build me a multi-tenant solution," because it means different things to different people, for us, if we are able to build a one-to-many infrastructure, which is what Aspen -- the Guidewire platform is, it's when we are able to reduce the incremental cost of adding more and more cloud customers to our platform over time. So that is where I think that is pretty significant and the technology aspect of driving cost down over time.

And this is a follow-up question from the audience, but I think it kind of plays right into your answer, Priscilla. So the question here, just in terms of -- maybe I'll throw it back to Jeff. But the question is what are the limiting factors from driving your gross margin higher over time? If we look out 5 to 10 years, is there any reason or are there structural reasons why Guidewire can't achieve gross margins analogous to some of the more well-known vertical SaaS companies like Veeva, for example?

Yes. And we think about this a lot, kind of what our -- where we think we can take our long-term gross margins. We've talked about getting to 65% in the kind of mid to near term and getting beyond that over the longer term. I do think that there are some complexity elements in the industry we serve. The nature of the IT stacks in which we integrate into creates some complexity that could be challenges, but we're investing a lot in our integration layers in order to make those more and more efficient over time. So over the long, long term, there's nothing structural that would inhibit us from kind of capturing those types of margins. I do think in the near term, there's a lot of complexity in the IT stack that we integrate into that we'll have some challenges to getting to kind of 80% plus gross margin. But kind of 65% plus is the target that we feel comfortable with.

Yes. I agree with Jeff. I would say so, yes. One minor thing to add is that the complexity of IT stack is because we have over 300 customers over the last 19 years that they have done a lot of configuration and customization because we have a very flexible on-prem platform, right? And to be able to move them to a common one-to-many platform, we will require the willingness of these customers to conform to a certain standard. So that is something that we're moving along. And as time goes by, when we have much more sort of apple-to-apple sort of delivery of the cloud-native nature of Aspen and the future releases of that and give confidence to the customer that they will not lose their sort of competitive differentiator if they go to a one-to-many platform is when we will see much more conformance to standard that allow margin expansion.

Yes. That -- I mean I'm glad you brought that up, Priscilla, because as we think about that history of customers making very complex implementations, a lot of customization historically, it's tricky, of course, to move those customers to the cloud on a forklift-and-shift type of basis. Can you kind of give us an update on how many cloud customers you've landed to date? And then how many of those have been kind of core system, forklift-and-shift type of moves as opposed to a digital-first type of approach that might be more greenfield on the architectural front?

Yes. So it's about just under 20 cloud customers to date. And most of those are -- to the extent that they were migrations, so existing customers, we're utilizing a more lift-and-shift style approach. As we move forward with new cloud customers, we expect to put them on the Guidewire Cloud platform that Priscilla mentioned that is part of Aspen. And there will be some remediation work that needs to be done with these customers in order to make some adjustments to how they would have implemented the software historically in order to get them to our Guidewire Cloud platform. But that's the process that we're going to be going through with that cohort of customers going forward. And we believe the upside of going through that upfront work is one that sets up a framework by which they can take those releases in a rapid cadence going forward. But to date, most of the existing customers that were migration customers have been more in that lift-and-shift mode.

Great. There's been a lot...

And over time -- and each one of those customers, Tom, just additional thought, sorry, was the -- we would have to put a process in place and a path in place to kind of figure out how we take them eventually to the Guidewire Cloud platform, which will be the basis for all of our customers at some point in time.

Great. Okay, good. Probably just time for 1 or 2 more questions, and then we'll get everyone off to the next sessions. But I did want to touch on one of the questions that came in from the audience just in terms of the M&A strategy. And the question in particular here was just can you comment on the Cyence acquisition you made for $300 million back in 2017. Cyence focused, of course, on assessing cyber risk at companies. Talk a little bit more about the percentage of revenue that comes from cyber risk-related insurance transactions and how Cyence has added to the portfolio adoption for Guidewire.

Yes. So Cyence was a data listening platform whose initial use case was focused on helping people better underwrite cyber insurance. And we've talked a little bit about some of the market adoption of cyber insurance and how there's been some complexity and some challenges with the overall market adoption of underwriting cyber insurance. It's interesting outcome of what we're experiencing with COVID-19 as companies moved to work-from-home postures en masse and the different exposures that, that can potentially create from a cyber perspective. We'll see if that has an impact on cyber insurance market going forward. But that -- the cyber is -- and Cyence, in general, right now is still a relatively small part of our overall ARR. One of the main theses we had when we acquired the company was that we could broaden this data listening platform beyond just the cyber use case. And some of the exciting things we're working on with respect to Cyence is kind of taking that data listening platform and applying it to small commercial use cases, and we think there are other use cases that we can focus the data listening platform on as well. So the long-term thesis of this acquisition was always kind of more than just the cyber opportunity.

Yes. Fantastic. I guess, Jeff, I'll let you wrap it up here with the sort of classic question. As you go through your model transition, how does the company think and how do you think about the balance between aggressive investment, accelerating the model transition to cloud and holding those margins steady? They've come down over the years as expected as you go through the transition. When should investors think about those margins sort of bottoming out as part of the transition and starting to go higher? And then what are the levers that make that happen?

Yes. We view ourselves at the early stages of a major platform shift for the industry, and it's presenting a really exciting opportunity for us to accelerate ARR growth as we capture that opportunity and as we migrate our customer base to the cloud. So it is our focus to continue to build on our market leadership position. And the investments we're making today in the cloud will be critical as we monetize this platform for the next 20 years. So we're not slowing down investments in 2 critical areas. I think the cloud operations team and the investments we're making to make sure that we're ready to support our initial customers, that they get a high-quality experience and they become the references for the industry as we move forward. So you're going to continue to see pretty significant investments in cloud operations that will continue to have a margin impact. We're also continuing to invest in R&D and other areas that are critical to building this platform. That being said, I do think we have a very large R&D team. And so that's probably more just kind of how we focus our investments and how we optimize our efforts in R&D rather than material kind of new -- adding new -- a lot of new headcount. And then in other parts of the organization, I think we can be much more disciplined with respect to how we're thinking about spend. With respect to sales and marketing, we have a broad team that covers the landscape well. So there's not major investments currently being contemplated there. And then obviously, kind of more back-office functions, we think we can tighten the belt a little bit as we're moving through the current macroeconomic environment. So that's how we're thinking about it. We'll update people on the long-term model, and we're -- obviously, we'll give outlook for our next fiscal year on the Q4 call that will provide additional insights.

Outstanding. I think we'll wrap it up there. So Jeff and Priscilla, thank you so much. Fantastic conversation. Really appreciate it. And thank you all in the audience for joining us today. Appreciate it.

All right. Thanks so much.

Thanks so much, guys. Buh-bye. Thank you.