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

Good afternoon, everyone. Thank you for joining us. My name is Bhavan Suri. I'm the analyst at William Blair that covers Guidewire. And it's a great pleasure today to have Mike Rosenbaum, CEO; and Jeff Cooper, CFO, excuse me, with us. You can find the appropriate disclosures on our website at www.williamblair.com. Mike, Jeff, thank you for being here. Thanks for the support over the years. I really do appreciate you guys taking the time. For the investors, we're going to do this as a fireside chat. I have a host of questions. But if you'd like to ask a question, please feel free to just type in the chat, and I'll curate those.

Gentlemen, we'll start at a high level just for investors, while most are likely familiar with Guidewire, those that aren't just a little background of the company. Kind of some of the more recent transition points that we're seeing and sort of the problem that Guidewire is solving for carriers in the property casualty space.

Yes, sure. Thanks for the question, and thanks very much for the opportunity to speak. It's been 2 years now for me as the CEO here at Guidewire. Guidewire is a 20-year-old company. I'd say, founded on the thesis that we could do a better job serving the property casualty insurance market with core system software. It's a very large industry, and I think understanding Guidewire is really important to understand the property casualty insurance space overall. About $2.5 trillion every year in direct written premium, written by just a few thousand companies with very, very specific technology needs, right? And so when you think about the unique problem that Guidewire solves is we do core systems technology. So the core claims automation system, the core policy administration, the core billing systems, that the largest and almost -- maybe not the smallest, but pretty much the -- kind of the smaller insurance companies rely on Guidewire with their core systems needs. And I'd say, key transition points in the company, I'd say a couple of years ago, Guidewire and the rest of the industry realized that there was an opportunity to move these core systems to the cloud and turn them into cloud systems. And we are very proud of the progress that we've made on the transformation of Guidewire to becoming a cloud service, a sort of continually upgrading and evolving service that these companies can rely on to be updated every 6 months and continue to deliver the core system requirements that they have for operating their companies.

Yes, super. And I think obviously, you reported last night, and even as we discussed last night, you saw a really nice traction in the cloud. Maybe just for the folks on the line, in case they weren't there last night, just give them a quick update of what you're seeing in terms of the adoption of cloud, especially for new logos and where it is vis-à-vis your expectations, Mike, when you joined the company a couple of years, even, say, 6 months into it, where you thought you'd be today versus where -- what's actually happening.

Yes, sure. Thanks for the question. So yes, we just had a very, very good quarter, right in line with our expectations. It's actually a little ahead of our expectations and right in line with the long-term plan that we've set out for the company. I think what's really interesting to understand about the cloud transformation at Guidewire and overall in the industry is that we are very, very focused on bringing our installed base of customers with us to the cloud. That is very much the orientation of our approach to our cloud. Our cloud product strategy, our cloud technology strategy is to be customer first. And I think we've always had an attitude here of sort of this idea that we are serving our customers, all right. It's a real opportunity that I think we -- a unique opportunity that we have to sort of provide this service as the overall industry mix, the leap to cloud that if we don't really leave anybody behind, that we preserve the investment that they've made in Guidewire and we bring them forward to our cloud platform. And like I said, Q3 was a good example of us being sort of right on plan in terms of how we're executing. We continue to see a mix both of our existing customers, making the decision to migrate to our cloud and net new customers and net new core system implementations making the decision to go directly to our cloud offering. Q3 was a good example of that with a number of key wins really across the world, both America, but especially actually uniquely this quarter in Asia Pacific. So things are going really, really well. We've got our Q4 ahead of us and a lot of work to do.

A really big quarter for you.

Yes. It's traditionally a big quarter, but things are going according to plan.

That's great to hear. That is great to hear. I guess as we talk about this transition, there's quite a few moving parts in that this has challenged investors. And I suspect that sometimes it challenged you in terms of visibility, what's on-premise, what's not on-premise, things like that, where customers change their minds. If I was to look out sort of 3 to 5 years, it'd be great to understand how you think the business looks from a percentage of subscription that's cloud subscription versus everything else, whether that's services or on-premise or term, how we think through -- again, it could be 10 years. I think to your time frame, what that might look like in sort of a strategic road map that makes sense to you that -- again, I'm sure you'll always have some customers don't want to be on premise. You're not having the hardware, but would love to think through what that long-term mix might look like?

Well, I think there's 2 things that you need to keep in mind. One is, what's the ratio of net new business that we are doing. And then what is the ratio of the overall business that we are supporting, okay? We talked about in the quarter, the last quarter, we had over 90% of the business was cloud. And that does jump around a little bit quarter-to-quarter. We do very -- we tend to do big deals. And so some of the discrete transactions might be self-managed and might skew that in the quarter. But 90%, I think, is pretty high, when you think about where is the activity for the net new business that's going on in the overall industry and specifically at Guidewire. And so that -- I don't -- I hesitate to call it a trend when you're already at 90, but that will continue, right? So 3, 5 years out, this is going to be majority, vast, vast majority of this is going to be cloud. But separate from that is this question about how does that relate to our installed base and how much of our installed base has moved to the cloud. We work really hard every day to make sure that we're creating the right incentives, the right value, the right -- creating the right trust and confidence in our customers that it makes sense for them to make that migration. It would be ideal. It would be wonderful if everybody moved in that 3- to 5-year time line. But the reality is we don't have complete control over that. Our customers -- these systems that they've run critical to their operation. And there's a variety of factors that play into their readiness to make that decision and readiness to make that move. So that's kind of why we've sort of used this mechanism of projecting. Here's what we think it will look like in the medium term, and here's what we will look like in the long term. It's hard to say exactly how many years it's going to take for that to play out. I will say this, as you can imagine and I've had hundreds and hundreds of conversations with customers around this, the attitude is almost universally when, not if, okay? Like I have literally had only one single customer conversation in my entire time here at Guidewire, where the response has been, we just don't ever see us moving to cloud, right? Exactly one. And I remember it very specifically, and I'm not going to rest until we change that person's mind. But that -- just to give you a sense, this is eventually going to happen, and I think the whole industry recognizes that.

Got you. Got you. Maybe we'll turn it over to Jeff to make sure he's fully engaged here. Jeff, one of the biggest conversations we've had with investors is this concept of gross margin. And the transition along as well as some of the challenges with the double counting of revenue or splitting of revenue between an existing customer in the cloud. Can you just walk us through sort of gross margin trajectory, maybe, again, at a high level without specific numbers for the next, say, 12, 24 months for the subscription business?

Sure. Yes. And we pride ourselves of being on the cutting-edge of cloud transition accounting, which is great. And as you kind of hinted at, those relationships can be complex, and it plays into the model and how much of the revenue will flow through the term license line and the subscription line. And it does have a bit of an impact on how we think about subscription margins as we enter into -- and a lot of our business as we're looking into the early phases of the cloud adoption curve. It's an expectation that our existing customers will be some of the early adopters of Guidewire cloud and will really help us build referenceability in the industry. When we migrate a customer to the cloud, we will typically enter into a multiyear relationship and some of -- and there's a recognition that, that customer will continue to use their on-premise software for a transition period. And so we look at the total contract value of that relationship. We allocate part of it to term license and we allocate part of it to subscription revenue, which is then recognized ratably. What that does is it does depress some of the initial subscription revenue vis-a-vis if it was a brand-new cloud win. And then that kind of flows through to some effect to the margins. I don't want to overstate that, but that is a phenomenon that we're seeing in the overall gross margins of the subscription line. The big driver of margin for us is the investments we've been making on our cloud operations function to build out that function to support our future cloud customers. There's been a big push for us to make sure that we have that in place ready to go as this early part of the adoption curve is really critical because referenceability is very critical in our industry. So over the last 2 years, we've been making meaningful investments in cloud operations. As we exit this year, we feel like we're in a place where we can start to temper those investments in addition to benefiting from some of the product investments we've made to make the platform more scalable and able to run more efficiently. And so those investments are starting to pay off. As we look into next year, we do expect to see margin expansion on the subscription line, which we talked about on the earnings call.

Yes. Yes. Great. There actually is an investor question coming in, Mike, just about the customer you were talking about, the one customer within cloud, I guess, the question is, just getting your broad thoughts, will that cloud intransient customer be disadvantaged in the markets as all others move to cloud? And if so, in what ways?

Sorry, I was talking on mute. I certainly think so, rookie move. Here's what I think is happening in the industry and why companies that do not adopt cloud systems that deliver more IT agility will be disadvantaged. First of all, I think there is this overarching initiative to make insurance interactions more convenient for consumers and for companies and for agents and brokers. And the whole value chain needs to become more and more efficient and more and more convenient. I was talking to a customer the other day about a cloud opportunity and we talked about the necessity to deliver an API that would enable them to connect into an agency management system that would enable them to do more business, to open up a new line of business and open up a sort of category, and it was convenience of the digital interaction that he was looking for because that's what the agents wanted. And so that story in one way or another is playing out at every single insurance company in the world, regardless of the lines of business that they serve. There is this drive to be more convenient and to be more digital and to be more flexible. And I think that's delivered more effectively by cloud systems like Guidewire, and that agility necessary to sort of stay current. I think the other part of it is around making better decisions every single day with how you're running your insurance operation. And that comes from analytics and that comes from data. And those things are going to be more effectively delivered by cloud platforms that are continually evolving. I think this is an area where the industry is really picking up pace in terms of how connected the insurance companies and carriers are to the actual risks that they're underwriting. And this is a really, really interesting sort of view into -- with the future of insurance. We launched in our Cortina release recently, something we're calling Guidewire usage-based insurance, which is a collection of solutions and packages from our solution marketplace that makes it very easy for a carrier, an auto carrier to be able to launch a usage-based insurance line. I think that's going to become more common, that sort of pattern of being connected to the actual risk you're underwriting over time. And I think that companies that don't have to worry so much about the infrastructure associated with their core, but instead can benefit from the innovation that Guidewire is producing each cycle, that's going to give them an advantage.

Got you. Got you. There's a couple of quick questions we can take from investors that I think will be easy to hit on. I'll toss them out here. A question, do you have a Tier 1 reference cloud customer yet? And I believe the answer is yes. But yes, I think it's announced, too.

Yes. Probably the Tier 1 that we're most focused on and proud of is our relationship with USAA. And the first phase of that project went live. They were able to launch a small business insurance line on top of the Guidewire platform, and that's available now and referenceable. And I'd refer people over to the replays of our first virtual connections event where we were able to have a bunch of really great conversations with USAA about that project.

Yes. And there's a couple of questions I'll dive into the investor front, but something you and I touched on last night a little bit. Some of the investments you've made, especially around commercial content and this API, this connection you've built with some data pipeline, say, from various -- I forget who else you added to that list. But I'd love to dig into a little bit sort of how do you peel back the investments you've made, it may not be obvious to us or investors, that allow for a much more robust technical, repeatable outcome for the insurance carrier by bringing data in as opposed to a let's throw hundreds of people at it, and that's a problem that you have to all -- every time the data changes, which it also takes longer to do. Maybe talk a little bit about that investment approach and some of the things we may not see under the covers.