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

Good afternoon. Thank you all for being here. Usually at this point in the conference, I usually say this is the last meeting between you and cocktails. It may still be the last meeting, but you can have a cocktail. I won't be able to see you, so we won't judge. I will hold my cocktails until post this. My name's Bhavan Suri. I'm the analyst at William Blair that covers Guidewire Software. And you can find all the appropriate disclosures on our website at www.williamblair.com. It's a great pleasure to have Jeff Cooper with us. He is the CFO of Guidewire. The company has done an amazing job building itself into a behemoth and sort of is transforming how insurance systems are done. Jeff was the interim CFO, but we're excited to have him onboard, and he's thrilled to be part of a bigger company. Jeff, thank you for all the support Guidewire's given William Blair over the years. Thanks for being here. We appreciate that. We've got about 30 minutes. It's going to be very sort of high level. We're going to do a fireside chat here. But many investors here are likely familiar with Guidewire. But for those that aren't, just a little background of the company, a little overview of where you started and kind of what core pain points your technology solves for insurance companies.

Sure. Yes. So Guidewire is a vertically focused enterprise software company. Since our founding in 2001, we have served exclusively one industry, and that would be the global property and casualty insurance industry, which is a roughly $2 trillion industry that sells a wide variety of products that are indispensable and indemnifying people and businesses against all sorts of risks. But we sell a core suite of software applications to help insurers manage their policies, manage the claims process, manage the underwriting and billings process. And we also sell systems of engagement and systems of intelligence, which we refer to as our digital and data products that sit around our core. We've always monetized our software in a recurring term license model. And we are now in the early stages of migrating our customers and this industry to the cloud and selling subscriptions to our cloud-delivered products. We have approximately 380 customers that are in over 30 countries, so a global business. And yes, that's -- I mean I think that's a quick overview. It's a really interesting time to be in the industry. There's a lot going on and a lot that we can help our customers with.

Yes. No, that's a great start off. This historically has been a slow moving kind of risk-averse industry, runs in very large but generally very antiquated systems. I'd love to understand the conversations you and your sales teams, Mike, are having or providing these customers. And while it's not an immediate accelerant, the potential importance of innovation and change, digital transformation, given the current environment and stresses, is that driving a new set of conversations? Is that driving a potential for acceleration of the business decide -- your end customers deciding to transform in the next 12, 18, 24 months because these are not short-cycle deals?

Yes. So it is a conservative industry and has a reputation of being a relatively slow-moving industry. I would say this industry moves at its own pace. And this whole campaign -- and from my background perspective, I actually was one of the bankers who worked on the IPO as an underwriter. So I do remember the thesis that was discussed a lot during the IPO, and it was these legacy systems, these mainframe-based systems, in some instances, are literally on fire. They're difficult to maintain and support. They are not allowing insurers to have the flexibility to bring new products to market in a rapid fashion. In addition, it's just difficult to find and attract and retain talent to support some of these systems, whether it's just being able to find people that understand COBOL or other things. And so there's a lot of imperatives that are driving the need to modernize. And those have changed over time. I mean, in the current world, whether it's concerns around someone like Amazon entering the insurance market or just overall disruption in the market through more digital modalities, being able to touch your customer very directly, make it as seamless and as easy a process as possible, those are big initiatives that insurers are considering. And in many instances, their legacy core systems are a hindrance to their ability to engage with customers in a modern way. So those are some of the more recent mandates and drivers of core system modernization that we've seen. And then where we are today is a very interesting and challenging environment. I am sure there are insurers out there who are very happy that they modernize their core systems so that they are able to be flexible and agile in the current environment, whether that's enabling your employees to work from home or whatever it is, just to kind of minimize the disruption that people are experiencing as a result of COVID-19. I think COVID-19 is having a bit of a here-and-now impact on the industry where insurers are trying to deal with kind of the fires that are being -- occurring all over their IT infrastructure to support kind of working from home and other things. And so it's put a little bit of a delay and it's made the selling environment a little bit more challenging in the here and now. But longer term, it will just shine a light on a theme that is well understood that, if you have legacy core systems, they're going to hold you back in your ability to kind of react quickly to the market. So we think coming out of this, hopefully, that mandate is even more clear.

Yes. Yes. No, helpful. Let's touch on the overall market opportunity. You've talked about sort of the trillions underwritten. The amount of dollars spent by these companies in IT, a lot of that just supporting legacy stuff with professional services or offshore and whatever. You've got 130-plus Tier 1, Tier 2 carriers, 20% of global DWP. And so if someone looked at that and said, "Okay, you've got 20% of the market, how fast could you potentially grow?" The thesis, obviously, is you've got that going through maybe a claims system or one of the core systems. Help us understand how you define the market and, more importantly, your penetration because this question comes up with investors a lot, it seems like they're pretty well penetrated.

Yes. So there's a couple of ways we think about this. There's obviously -- we think about a $2.4 trillion global DWP market, of which we have a little over $500 billion. So still -- a meaningful market share but still a long ways to go with respect to just further penetrating the DWP opportunity. And then we also look at how we penetrated the revenue opportunity. So there's the DWP opportunity, which we may have one core system at an insurer, and so we have exposure to that DWP but it's only one product of our portfolio of products. And so if we're 20% penetrated on DWP, if you look at the math, we're very likely penetrated on the total revenue opportunity. And that's even before -- and we've talked about what this new opportunity, which is the cloud opportunity, which changes our relationship with our customers from being a software vendor to owning the post-production environment and delivering their core systems as a service, which materially changes the surface area of what we do for our customers and, as a result, changes the price point we're able to charge. So...

And maybe to talk about the 2 to 3x, I think it's worth walking us through about how that cloud customer revenue shift -- forget the DWP contraction and the revenue is a lot less, but then the shift to cloud drive, so I'd love for investors to understand.

Yes. Yes. So our relationship with the customer changes pretty significantly. And when you think about Guidewire and your core systems, there's a pie of overall spend that -- and I'm sure it takes on -- as a result of modernizing a core system, there's the professional services work they need to do to implement those -- that project. There's the IT support staff that they need to put in place in order to manage that core system day in, day out. There's all the hardware and other kind of compute components that they need to build out in order to support the system. So there's a whole significant spend that occurs around the Guidewire system. And as a software vendor, we capture a relatively small sliver of that. And as we move into the cloud, we take on much more of that responsibility. And as a result, we've talked to the investor community about we think this is kind of a 2 to 3x pricing uplift vis-à-vis our ARR in an on-premise modality. And our early data points have been positive with respect to kind of our thinking we've had with respect to that 2 to 3x benchmark that we put out there so that we still kind of feel that that's the right benchmark for us. And as we evaluate the opportunity, that's how we think about the uplift associated with moving to the cloud. Oh, I can't hear you, Bhavan, I think you're on mute.

Sorry, I just muted in case there's some trouble next door. There was some construction yesterday and so it was loud. And so I automatically muted. Let's talk about the noncore products, the 2 of them. I'd love to just add attach rates there. And it feels like initial deals are now starting to include that. Just why is that happening? Is it -- and it might be because of COVID, but I think it's been happening pre-COVID even. Sort of what's the driver to start accruing these initial deals? And then how do you feel that sort of trends over time in terms of penetration into the base?

Yes. And so it's kind of an interesting thing that we're going through internally right now. So while you're used to hear us talk quite regularly about attach rates of our data and digital products, as we migrate -- in Aspen, we have a new release of our software that is our most cloud-native release, and it's called Aspen, and the public release is going to be next week, so June 16. So I just want to put that plug out there. We welcome people to tune in for that. But as we move more and more into the cloud and build out what will become a 6-month release cadence for us, there's a deviation from what is our history of doing a major release every 2 years and a customer may take that upgrade every 4 to 6 years, the new world is going to be much rapid -- much more rapid releases and the ability of a customer to take that release in a seamless, nondisruptive way, right? And so that's a big part of the vision. And the other -- another part of the vision as we migrate more and more to the cloud is a lot of the digital and data components will be much more native to the core application. So we've talked about this a bit in the past in how we've thought about SmartCore and bringing predictive capabilities right into your workflow. You're going to start to see us talk about that less as a product attach and more just built into how we think about the world in a cloud modality. And that's the same for digital as well. Digital is such a critical component of kind of what's instigating the move to the cloud. And so having digital capabilities native in our cloud application is going to be just kind of built right into the product. And so you'll probably end up hearing us talk a little bit less and less over time about attach rates just because it's just kind of in there and part of the product.

Let's touch on 2 other areas before I get into some of the partners and the implementation cycles. But one, the data asset, which you and I have talked about in person about as you go to the cloud, there's a tremendous amount of data, and you alluded to it just now, that can drive all sorts of predictability. It can drive benchmarking. It can drive all sorts of comparisons for insurers, but for actuarials or for the guys writing policy, how do you view that data asset today, and maybe this is too far in the future, but the monetization of it? And the second question is on cyber. But let's touch on that one first, and I'll jump into cyber right after.

Yes. Obviously, our customers treat their internal data as a crown jewel, and that is something that is very important to them. Our view is that there are some interesting things that we can bring to bear in the industry to help benefit the industry over time as we can start to aggregate some of those data sets and deliver insights to the industry. I think that's more of a future state. We earn that right with the customers once we get to certain levels of market share. And once we're at certain levels of market share, those data sets become much more valuable. And once those data sets become much more valuable, I think customers are more willing to contribute to benefit from those data sets. And so we think that, that could be a very interesting opportunity that opens up to us as we are very successful in winning in the core environment in the cloud context where we are managing those assets on our clients' behalf. So we do think that there's some -- there are interesting things there that we're thinking about but more future state is how we're currently thinking about it.

Got you. Got you. And let's touch on cyber. Obviously, an acquisition you made took a while because one of the coolest things about that acquisition, again, something you and I have talked about, is the idea that no one has the actuarial, the policy part of that, right? Like, it's just -- you didn't have the numbers coming in the data to say, okay, this is how we price a cyber or insure a cyberattack. But you just had some wins. I guess help us, kind of what's driving those wins because it doesn't feel like -- I mean the world's been cyber-afraid or cyber-concerned for quite a while. And sort of are you starting to see the value of the idea of having sort of the cyber actuarial type of pricing, type of policy model built in as you offer that to customers? Because typically, they have their own models built in, right, for P&C or whatever but love to get some sense on what you're seeing there and what's driving that growth.

Yes. I think there's a couple of things to highlight. Our acquisition of Cyence was predicated on a couple of different theses that were important, right? So one of them was the cyber market is a newer part of the overall insurance market, an area where we do expect to see growth. And if you ask the leaders of Guidewire, they're more worried about a cyberattack than a fire or flood in our building, right, so obviously, a big area of risk that is going underinsured right now and an area that we think we can really help the industry. So we are excited about it. It has been a little bit slower to develop than we had originally thought. And so we have seen that play out a bit. The other thesis that was embedded into our acquisition of Cyence was that they had this really interesting data listening platform and this really unique way of kind of handling that, and that we could broaden that beyond cyber, right? So the acquisition was never just a cyber acquisition. It was a data listening acquisition. And so we've also started to see some success in our ability to broaden that data listening platform to small commercial use cases and some other use cases. So -- and some of the wins have been in that context. The final thing I would point out is the current environment that we're in where, all of a sudden, enterprises across the world are having their entire workforce work from home, creates a whole new set of cyber risks that could instigate some demand for cyber insurance as we go forward. So we're watching that pretty closely.

That is interesting. Given end point concerns, you start getting a ransomware attack at someone's home and the equipment -- and you can use GPS as a way to get around that, that certainly presents an interesting risk. Yes, interesting.

Yes.

Let's touch on the move down market. You started to do that a little while ago. The sales force has some challenges figuring that out. I'd love to get to understand, update on where you are with that move down market and then just competition because there's only kind of one competitor operating in the market for newer cloud just -- for newer core systems. But how has that changed as you move down market? So I'd love to understand how is the move down market going? How is the sales force shift going? And then how is the competition down there?

Yes. So we acquired ISCS a while back now, and that's our -- created the basis of what we call our InsuranceNow product. And our InsuranceNow product is targeted at smaller insurers. It's an all-in-one suite of applications. So you don't buy it in a piecemeal fashion, it's kind of all or nothing. And I think we've been pretty transparent about -- had a little bit of reorg there and instituted a new leader about 1.5 years ago, and he's really done a great job driving focus on that product internally. And then we put in place this year a dedicated sales team. I think the initial thesis was we would allow our sales reps to kind of differentiate between whether this particular opportunity should be an InsuranceNow opportunity or an InsuranceSuite opportunity. And what we found is most of our sellers are just much more comfortable selling InsuranceSuite. So putting in place a dedicated sales team to sell InsuranceNow has had a meaningful impact this year. So we started to see the pipeline build, the momentum build and actually starting to close some deals, so it's been positive there. We love this product. I think it gives us a really interesting product in that part of the market. And I like it because that protects a flank, right? The last thing you want is there's some kind of upstart getting traction at that part of the market and then marching upstream. And so it's a really strong product to protect that plank. And we'll see. We have a lot of excitement about the potential there. The other thing we're doing, as we now are releasing more cloud-native versions of our InsuranceSuite software, we're exploring kind of slim down packages that would allow us to optimize the cost structure and allow us to maybe simplify some of the complexity associated with our InsuranceSuite product. And that's more for maybe smaller greenfield use cases that could then grow into much larger use cases and potentially for some smaller insurers internationally where we're not selling InsuranceNow. And so that's another avenue that we're starting to put some muscle behind. And I think you'll see us lean into more of that next year.

That's great, Jeff. Just maybe on the competitive environment, if I look at the Tier 1, Tier 2s, if you think about sort of guys who are trying to modernize core systems, it's you guys and Duck. But who do you face down market? And is there anyone else of substantial size? How does it differ in that Tier 3, Tier 4 space?

Yes. I mean I think that as we inspect the competitive landscape, Duck Creek continues to be a competitor that we see most often. I tend to think that they tend to be stronger at the Tier 3 and kind of the lower level than the Tier 2, Tier 1, although they, obviously, are present there as well. There are a host of other competitors that we see. If you look at the U.S., there are some kind of some smaller cloud-native competitors that are newer. It's been hard for them, I think, to really get meaningful traction beyond kind of test and learn and greenfield use cases. So we haven't seen anybody kind of make meaningful jumps into large portions of the DWP for insurers of scale but something that we watch very closely. And then as we think internationally, one of the things that we see is each country has its own regulatory environment. And so there tends to be a competitor that has a lot of in-market intelligence or in market know-how. Those tend to be more kind of services companies rather than software companies and building more bespoke systems rather than packaged software systems. But each -- when you go into Europe, kind of almost each country has a somewhat entrenched competitor that we compete against.

Got you. Got you. So now let's touch on some of the financial parts. So you've seen the shift away from on-premise license to more sort of interest in cloud subscription delivery. Maybe quickly, as you -- more quickly than you actually anticipated led to adjusting the Q2 guidance, for example, for the impact of revenue. With subscription now expected to make about 15%, a little over 15% for revenue for the year, just help us get a sense of where you view yourselves in the time line as it relates to that subscription model transition and maybe some of the moving parts that are going on there.

Yes. And so most of the investors know who follow us.

A lot of moving parts.

A lot of moving parts, appreciate the question. Yes, so I think there's a couple of things we've highlighted. And on the Q2 call, we noted that this is a big shift for the industry to go to the cloud. And I think the industry is coming to terms and trying to understand what it means for them and our customers, our prospects. And we saw, in Q2, the theme that we highlighted that, actually, when we go back and scratch beneath the surface, has been around for maybe -- it started to manifest itself last year, although there was a lot of cloud activity that happened at the last -- the back end of the year that kind of masked this trend. But we've seen a little bit of a slowdown in core modernization activity. And core modernization activity has been very consistent. When you go back and look at the data, there is a certain slate of core systems that come up for bid to be modernized every single year. And we've seen a slowdown in that activity. And when we go out and stress test the reasons why, it's really a reaction to our focus on the cloud that is causing some insurers who were thinking about modernizing on-prem to step back and say, well, wait a second, Guidewire is focused on the cloud, would I be crazy to go and do an on-prem implementation that's going to take me 18 months to get up and running, and I'm going to invest a lot of money on this project. And then 18 months from now, I'm going to go live and be kicking myself wishing I had gone to the cloud directly. And so we're seeing those conversations play out. And a lot of those insurers are choosing to kind of take a step back, see how the cloud develops before they make that decision to transact. So there are a couple of things that we're focused on. One, this Aspen release is a really important step as I think it will give the industry a lot more clarity on what the steps look like to go to the cloud. And the more clarity we can provide, the more we'll be able to instigate demand. And then there's this first cohort of customers that are going on to the Guidewire cloud platform that we'll be able to point to as referenceability in order to help instigate that demand to transact. The opportunity is there. Very focused on it. It's very exciting. It's just kind of -- one of these cohort of customers transact and, as a conservative industry, it may take a little while. And then we expect, at some point in time, we'll see the herd mentality kick in once we've answered all the questions around cloud maturity and where we are on the journey. So all of that goes into how we think about the model and how we model subscription revenue. And what we've noted is that this year -- and we're starting to think about next year. We haven't guided to next year. But as we think about this journey, we understand that there's a near-term ARR impact as customers aren't quite at the point where we've seen this wave of people transacting in a very consistent way. But we know that's out there, and so we are -- my expectation -- and we've talked about kind of longer term getting ARR growth rates back into the mid- to high teens. And even getting back up in the 20% range is in the cards, depending on how this demand moves. If they all move at once, I think 20% is back in the realm of possibility. And if it's a slower wave, then kind of a longer-term duration of mid- to high-teens ARR growth is what we're planning to get back to.

Great. No, that was helpful. I want to touch on one more thing. We might have time for 2 more questions. And I'll start with, one, the shift to cloud, obviously -- let's assume tomorrow, everyone is in the cloud. That's an impact on gross margin for you guys because today is a software business, incredibly high gross margins, if the partners implement cloud, it's kind of still a term license and so on and so forth. Help us understand what the longer-term margin profile business could look like, assuming that this cloud thing happens. And let's not worry about 3 to 5 years, but let's say, like, 10 years where growth may be 10% to 12% or somewhere in that range. How do we think about sort of what the margins might look like for the business?

Yes. And we've talked about some of this, in how we've talked about the long-range plan in our Analyst Days, we plan to update that on a regular cadence. And so we are constantly reevaluating what the time line looks like to achieving certain margin thresholds. But the -- there hasn't been much change in how we think about some of the end states, right? And so we've talked about getting to 65%-plus gross margin in the cloud. We think the potential is there to bring that over 70% over the longer term. And with some of these enhancements and releases we're doing on the product development side, I feel like I have more line of sight into the real steps that we're going to be taking in order to drive that margin profile. We've also talked about getting free cash flow margins in the 30%-plus range. And I think we can get back up to the high 30%-plus. Those are some of the numbers we've talked about historically that -- our view hasn't necessarily changed on the end state, and we are constantly evaluating kind of the timing horizon in order to capture those types of numbers.

Yes. Yes. At 65%, 70%, I mean we can easily see north of 20%-plus at the operating margin line, again, longer term, as opposed to rent growth has slowed and you can sort of take R&D to a more normalized level, sales and marketing, certainly. Cool. I want to touch on one last thing quickly. Last week, you sort of announced the plan to reduce the number of metrics that you're providing, increase the number of lines of revenue that provide disclosure and color. Just what was the thought process behind this? We actually think that the disclosures on revenue will be well received. But just how do you guys think about that? And what area should investors focus on to sort of gauge the business momentum as we continue this model transition? Because you have it sort of fully ramped now. You had a bunch of things. And investors work and sort of like what's the thing to focus on to truly understand what this business should grow at?

Yes. So the short answer is ARR is the right way to think about the business. We're making the change on the income statement side. As subscription revenue has now grown to more than 10% of total revenue, we had to kind of revisit our presentation to comply with SEC guidelines. And so we're making some small changes there but still providing all the details that investors have had historically. So they should be able -- everyone should be able to do comparisons. The real challenge is the move to ASC 606, combined with the shift to cloud, is going to create some dynamics that will happen over the short term in our term license revenue line that's going to make that line a little bit bumpy and will create some difficult compares. Duration becomes a very important factor in the revenue. And so ARR helps normalize through all the different revenue patterns that we have. And so we just think fundamentally that that's the right way to think about the business. So we will be leaning into ARR. You'll continue to see us lean into that as a metric. Subscription revenue is also an important one to track as an investor. And then it wouldn't surprise me, we're still working through this to see us deemphasize all the different kind of components of revenue that we've guided to in the past, like maintenance and service. We may kind of give some people some broader pictures around that rather than having them focus on all those different components on a quarter-to-quarter basis.

Got it. That was super helpful. We are out of time. I'll let these guys get to -- the good people get to the cocktails. Jeff, thank you so much again. Thanks for the support. Thanks for being here today. Thanks for taking the time to meet with investors, appreciate it.

Thanks so much. It was great to be here.