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

All right. I think we're ready to get going. Thanks, everyone, for joining. My name is Tyler Radke. I do software research here at Citi, covering the data and analytics and vertical software space. Our next presentation is with Guidewire, and we're happy to have Jeff Cooper, who is the official CFO after taking on the official title earlier this year. So Jeff, thank you very much for joining us.

Happy to be here. Thanks for having me.

Yes. And so, Jeff, I thought we would just start off. I think we have been getting some questions around some of the nuances with respect to the results you reported last week. But I thought maybe we could just start off at a high level, particularly maybe for investors that are new or just kind of want to get a catch-up on the story. So obviously, Guidewire has been a company that's been around for some time. Most folks understand that they serve the property and casualty insurance market, and I think it's largely been considered a pretty stable business, with nice growth, great kind of competitive moat. But over the past couple of years, we have seen some changes. We've seen new CEO leadership changes. Also recently, you've taken on the CFO role. And there's been a lot more focus, I think, at the company in terms of transitioning to the cloud. Meanwhile, you've seen some changes in the competitive landscape with one of your competitors also going public. Maybe you could just -- I mean obviously, you've been at Guidewire for a while. Just kind of level set for investors how the Guidewire story has evolved and maybe recap some of the leadership changes with the CEO and kind of where the company's headed.

Sure. Sure, sure. Yes. So Guidewire is a vertically focused enterprise software company. Since our founding in 2001, we've served exclusively one industry, that's the property and casualty insurance industry, which is a roughly $2 trillion industry that sells a wide variety of products that are indispensable for indemnifying people and businesses against all sorts of risks, right? We sell a suite of core systems of record that manage and insures policies, claims process, underwriting process and billings. And then we also sell systems, what I call, systems of engagement, systems of intelligence, that sit around the core. And we refer to those as our digital and data products. It's important to note that we've always focused our go-to-market motion on a term license model, so always monetized our software using a recurring term license model. And we're now starting to migrate our customers in this industry in general to the cloud by selling subscriptions to our cloud-delivered products. The cloud has been a big emphasis for us as we start this transition. I like to refer to this as a kind of once-in-a-generation replatforming as this industry starts to embrace the cloud. And we are making organizational changes to make sure that we're set up effectively to address that need, and one of them, you referenced, was the hiring of Mike Rosenbaum, who is a veteran out of salesforce.com and spent a lot of his time on product, so I think the right person to help us navigate this shift. We're early into the shift. So as of Q4, we talked about having 24 customers that have bought our InsuranceSuite product in the cloud, which is our flagship product, and we have 62 customers that have bought one of our core software products in the cloud. We also have a product called InsuranceNow that services the needs of smaller insurers in the U.S. So kind of early days in this transition to the cloud, but very excited about the opportunity and what it means for tailwinds for growth as we look forward to the future.

Great. Maybe we could dive in a little bit. I know last week was a busy week of earnings across the software sector, especially on Wednesday. Maybe if you could just share kind of some of the puts and takes from the results. I think, on the surface, it seemed like a very strong Q4. You talked about signing 10 of these ISC deals, InsuranceSuite Cloud deals. You had nice upside to revenue and profitability for the quarter. But you issued guidance for the next fiscal year that was at least below where a lot of the sell side had modeled. Maybe just help us understand what drove that strength and also what's driving the relatively weaker guidance.

Sure. Yes, we had a very strong quarter in Q4. So this has been an interesting year. Q3, we found to be very heavily disrupted by COVID-19. It was just a challenging quarter. We saw a lot of our customers shift their focus from longer-term strategic IT initiatives to near-term initiatives, emergencies that exist in their IT stack. And so we were very pleased to see the demand profile take shape and customers start to transact in a meaningful way in Q4, and that was highlighted by 10 InsuranceSuite Cloud deals in the quarter. We saw a lot of activity with existing customers, which we think will continue to be a bit of a trend. These are the customers who know us well and have invested a lot of time and effort with us in the past and trust our abilities to make them successful, either on-premise or in the cloud. And so we saw some heavy activity from existing customers. And that included migrating their on-premise instance, just kicking off a process to migrate their on-premise instance to the Guidewire Cloud. And it also included areas of expansion, so expanding into new lines within existing customers for our cloud products. So I felt that was an exciting development and just good to see that success in Q4. It's still a very -- we're still very early days in this cloud transition, right? And as we work through this year, there were a couple of things that happened that we were reflecting on as we thought about the guidance. And then obviously, the overall macroeconomic environment also is weighing on kind of how we approached guidance. But we are seeing a slowdown in insurers buying on-premise modern systems. So the key driver of Guidewire's growth up into this point has been our ability to modernize legacy, mostly mainframe-based systems with our modern software in an on-premise modality as we are now focusing much more heavily on updating our platform to the cloud. What we've seen is a bit of a step-back from the customer base and prospect base to better understand what that means. And we are kind of working through that with some of these early customers. We have some really exciting wins that we think will be really important reference points for the industry as we make the shift. We serve a conservative industry that is measured in their approaches to these sorts of shifts. And the core systems of record are what they rely upon day in and day out to run their business. So we do think, over time, this industry will shift to the cloud, and that is just an inevitability that will happen over time, but they will be measured in how they approach this shift. And we're seeing that a bit in our customer base right now and you're seeing that a bit in kind of our guidance and how we think about the opportunity in front of us. And you're on mute, Tyler, sorry.

There we go. Wouldn't be a Zoom meeting without having to say that, right? That was super clear. And I just wanted to remind investors, if you do have a question, feel free to e-mail me. It's tyler.radke@citi.com. And we actually have had a couple of questions kind of come in as a follow-up on that. There are also a couple of other points that I wanted to bring up. But just as we think about ARR, which I think is a key metric for Guidewire, I think, in the past, you had kind of talked about a reported ARR number and then a ramped ARR number and with the idea being these -- some of these deals, you don't see that ARR impact immediately. It's kind of longer-term as the customer takes time to implement the system. But just in terms of thinking about your ARR growth in 2021, is there a way to help us understand how much of that is going to be driven by kind of older deals that are ramping versus stuff that is being signed in the current year?

Yes. Yes. So we talked a bit about that on the call. We said that in Q4, we had a little bit more than half of the new -- the gross new ARR added came from new deals, not necessarily new customers, but new deals, new sales activity. And we had a little less than half that came from ramp activity from deals sold prior to fiscal '20. So that is something that we do monitor and track. As we look forward to FY '21, our current expectations are that we will have a little bit more coming from ramped activity versus coming from new deals. One of the drivers of that is as we inspect our pipeline for fiscal '21, and this could change as we move through the year, but right now, our expectation is that there will be a significant amount of new deal activity that comes from migrating our core customers that are existing on-premise customers. And one of the dynamics we've talked about quite a bit with The Street is when we go through a migration, that you have a customer that is already paying us ARR in a term license modality, and they make a commitment with us to migrate to the cloud. So if we just take a simple example and assume we have a customer that's paying us $2 million a year, and as we shift them to the cloud over the next 5 years, that $2 million will ramp to $5 million. In the first year, after they have executed on this cloud deal with us, there are -- they already kind of are paying $2 million to use that on-premise term license, and they're not going to go live in the cloud for a period of time. So there's a bit of a hesitancy to pay. We always get more incremental -- a little bit incremental ARR in year 1, but that ARR -- that year 1 impact to ARR can be quite muted for migration deals. And so that's also factored into our guidance and how we think about it. Over time, that should build up a little bit more of what we think of as the concept of ARR backlog that becomes a tailwind to our ARR numbers in the future.

I see. Okay. That's helpful. And in terms of the other question that's come in, just kind of some of the near-term dynamics on the subscription revenue guidance. So it looked like subscription revenue is actually supposed to decline sequentially from Q4 to Q1. And then as we just think about year-over-year growth rates, the math kind of implies that the growth rate picks back up in the second half of this year. So maybe just help us understand the factors driving both...

Yes. So subscription revenue isn't slated to decline, but the ARR is slated to decline sequentially. And there are a couple of factors that we called out on the call that are driving that, that were unique in Q1. One of them was a very significant contract where we had a customer that had over 12 active licenses to different products, also had licensed our products for a new greenfield insurance line that did not evolve the way they had thought it would and had contracted for. And so as part of that process, we kind of cleaned up that relationship and put in place more of an enterprise license arrangement with this customer. And that did -- it did have all sorts of -- kind of doing those sorts of things can create some complexity in the revenue recognition from an ASC 606 perspective. So a lot of term license in those licenses. So there was some revenue pull-forwards that have impacted both Q4 and are embedded in our guidance and part of the kind of $14 million of duration that we called out, duration impacts for Q1. But it also had an ARR decline as they had some products that they weren't using that we sunsetted and then also this particular line that they decided that they were moving away from. So those had some ARR impacts in Q1. And then the other thing that we highlighted on the call is we still had a number of ISCS, which was an acquisition we made that formed the basis for our InsuranceNow product. But when we acquired that company, there was a number of perpetual license customers that we were still supporting through maintenance. And we made the decision, I think it was about 18 months ago, that we were going to migrate those customers to our cloud or -- and sunset support for those because it just wasn't -- it was a distraction to our focus going forward. And so that hit also in Q1. So those are the 2 kind of unique events that are impacting the sequential decline. And then Q1 is always a light new business quarter for us. And I think we did a really good job closing out Q4. So there wasn't many deals that slipped into Q1. So our expectations for kind of new business to be added in Q1 are relatively modest.

Right. And then just on the subscription revenue, kind of implied reacceleration in the back half of next year, is that simply just more of these ramp deals coming? Or is it based on your expectation of having it be more of a second half bookings seasonality dynamic? Or what's driving that?

Yes. Most of it's coming from what we call our base. So it is kind of -- there is new business that's embedded into our guide, but it takes a little while once we sell a deal. And then -- and once we provision the software, it takes a little while. So most of what you see in our subscription revenue is coming from the base.

Got it. Okay. That's super helpful. So one thing, Jeff, you talked about with respect to the cloud is you are seeing some of these insurance companies, you're seeing the appetite maybe for on-prem deals maybe not be as strong as it has been in the past. And maybe if we could just think about that dynamic as it relates to the bigger picture. I mean Guidewire in the past has always talked about kind of modernizing some of these very homegrown legacy brittle systems. As we think about your market share, like how far do you think the industry is in terms of modernizing those systems? I think in terms of direct written premium, your ballpark, around 30% of direct premium underwritten, but is that full 70% up for grabs? Maybe just help frame how you see that -- kind of that broader market opportunity in the context of modernizing the homegrown systems.

Yes. It's something we spend a lot of time on. And our sales team manages a massive spreadsheet that -- where we try to assess kind of all the systems that exist out there and how many of them are legacy and how many of them are -- have been modernized in some capacity. We tend to have pretty healthy win rates, especially when measured by DWP. So when we think about occupying 25% to 30% of the global DWP opportunity, our sense is that 50% of some component of that, call it, and maybe another 25% has modernized in some capacity. And a lot of it out there still has yet to be modernized. It's hard for us to kind of really assess what that exact number is. And then some of these legacy systems that have now been in place for a period of time have been shored up and improved in order to make them continue to work in today's environment. So these systems can tend to be -- they work, right? They can constrain your ability to be agile. They can constrain your ability to react. And so I think coming out of the current environment that we're in, there is recognition that having a modern system to be able to adapt to the current environment rate is a very positive thing. But our sense is close to 50% of the market is still kind of yet to be modernized.

And do you think that in terms of the slowdown that -- it seemed like over the past 2 quarters that, that slowdown kind of, in the on-prem side, happened relatively quickly. Do you think for the -- it sounds like there's still a decent chunk of the market that hasn't fully modernized. Do you think that now that those customers are simply maybe looking at going from legacy to cloud and that's kind of what's driving the slowdown, or is this a reflection of just insurance carriers are risk-averse and not wanting to like change the engines on the 747, so to speak, like while we're in the middle of a pandemic? Like what do you think is driving that? Is it simply just the cloud? Or is it a reflection of the current environment?

Yes. I think the current environment has caused people to slow down buying a bit. But we saw a return to what felt like a return to normalcy in Q4, right? It's hard to say what FY '21 will look like. Will people be a little bit measured as a result of the economic environment? That's very possible. But the cloud is the big shift. I think as this industry is conservative and these core system upgrades or modernizations come with a fair amount of risk, right? There's business disruption. There's a whole bunch of stuff that goes on. And then taking that to the cloud is still very new for the industry, and it's new for Guidewire, right? So it's not surprising to see customers want to be measured with respect to how they approach this, which is part of the reason why we think that existing customers may be the first ones to go because we have a long history and there's a really strong relationship of trust that we've built up over the years. And then as we start to see these customers go live, as we start to see kind of real interesting reference points, we think that people will start to move in a more meaningful way because they can feel confident. This shift has been -- we're sympathetic to our customers and how they're thinking through this because we know that it's incumbent on us to make it as visible as possible and as clear as possible what this is going to look like and tactically, what are the steps that each insurer needs to go through. And so we're doing that work with our customers right now, with cloud readiness assessment programs and all sorts of different initiatives that we have to help our customers understand what this journey looks like for them. So there's just a lot of blocking and tackling needed to do to get people comfortable. And we feel like we're making really good strides and really, really good progress, but it's also something that takes time. And you can hurry it along as much as you want, but you just kind of got to work through it. And we have a really strong commitment to our on-premise customers. We know that these customers have made very significant investments in Guidewire. We intend to bring everybody to the cloud eventually, but we will do so at their own pace. And we think that, over time, people will start to recognize the differentiation and the value that the cloud delivers. But it will take each customer to come to that decision at the right point in time for them.

Got it. And maybe we can talk a little bit about the new product release. I think you have called it Aspen. It's kind of this first-optimized true cloud release of your InsuranceSuite product. Maybe just help us understand the -- your expectations on adoption rates and the timing of that. It seems like, from the company's messaging, this has been a pretty significant release, something you guys are really excited about. Just help us understand how you would encourage investors to think about this release as potentially being a catalyst or a significant milestone in terms of your goal of migrating customers to the cloud.

Yes. And I will defer to Mike on kind of getting too -- in terms of getting too deep into the technology. But what I -- what gets me very excited about Aspen is one of the key value drivers going to the cloud is the ability for us to deliver upgrades in what we would call a rapid cadence posture, right? And so that's -- right now, our customers, we -- in an on-premise world, we would do a major release every 2 years, and it was not uncommon for customers to skip 1 or 2 releases. So customers would take a new release every 4 to 6 years. And when you do that, the upgrade process, because they skipped an upgrade and because they had configured a number of custom one-of-a-kind integrations, those were challenging endeavors. They weren't -- it wasn't an 18-month project, but it was a multi-month project that caused expensing complexity. And so Aspen creates a framework by which we will have all of our cloud customers on a common architecture layer. And it starts to build the pieces to allow for much more sophisticated APIs that will deliver on the vision of enabling us to upgrade customers every 6 months with no business disruption in a rapid fashion. So that's a huge value driver, in my opinion. And it's also one of those things that I think customers really like that vision and wanted to get on a platform. We call it it's future-proofing your platform because we will kind of deliver the upgrades behind the scenes. And there's a lot of belief in that's the right approach. But I think there was a little bit of ambiguity up until Aspen in what tactically Guidewire was doing to make that a reality. And so Aspen is what really starts to put the pieces together so customers can see how that will work for them. So that's what gets me excited about it. The intent is that new cloud customers will go on to Aspen right off the bat. There may be some -- if you have -- if we have a customer that has a relatively complex on-premise installation, there may be some customers that migrate to a version 10 host that will be managed by Guidewire. And then over time, we will shift them to Aspen behind the scenes. But we should start seeing customers go on Aspen here relatively quickly. We're going to have Banff right behind Aspen as part of the 6-month release cadence. So not many customers will actually go live on Aspen because by the time we take them live, it will be Banff, but that's how we're thinking about it.

I'm sensing like a winter or ski theme with these releases. So...