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

Hey, good afternoon, everybody. My name is Tyler Radke. I co-head the software sector here at Citi. And for our 3:30 Eastern presentation, we have Guidewire, joined by Jeff Cooper, the CFO. Jeff, thanks again for joining our conference.

Happy to be here.

So Jeff, I thought we could start -- we were just talking before we started. Jeff has been in the CFO role, I think, about 1.5 years now, maybe a little bit longer, certainly been with the company longer than that. But just a brief overview of where Guidewire is in the cloud transition. I mean -- I think this has been something that's been topical for a number of years, given that your customer base is -- can be slow to move at times and a little bit unpredictable. Just help us understand where we are in the transition and kind of what some of the key points you'd like to highlight for investors.

Sure. Sure. Happy to do that. And maybe I'll even take a little bit of a step back and explain Guidewire because I think the transition to the cloud is really just part of our ongoing evolution to service our industry. So Guidewire is a vertically focused enterprise software company. Since our founding in 2001, we served as exclusively one industry, the global P&C insurance industry, which is an over $2 trillion industry that sells a wide variety of products that are indispensable for indemnifying people and businesses against all sorts of risks. We sell a suite of core systems that manage insurers' policies, claims process, underwriting process and billings. And we also sell systems of engagement and systems of intelligence, which we refer to as our digital and data products. We have all -- we've historically monetized our software in a recurring term license model and now are in the process migrating our customers in this industry to the cloud by selling subscriptions to our cloud-delivered products. Last year, over 80% of our new sales came from our cloud products, and our cloud products now represent about 40% of our total annual recurring revenue, so becoming more and more meaningful every day. We've always been a leader in our market, and touched approximately $540 billion in direct written premiums for our customers with at least one of our core modules. And the shift to the cloud is a consequential one for the industry. It's one thing to entrust a vendor to sell you the software that powers your business, and it's another thing to rely on that vendor to run that system as a service. And especially when you consider how critical these systems are for our customers. So not surprising that this industry takes a measured approach to how they think about cloud and how they think about modernizing their overall core system framework. But over the longer term, we believe that, that will benefit Guidewire as a clear market leader and one of significant breadth and investment in how we tackle this potential opportunity. We see the benefits of the cloud, both the Guidewire from a business model shift, but also to just how we service our customers and help them innovate. So it's a little bit of an overview.

Yes, yes. Great. So maybe we can just kind of talk about the overall macro environment for the P&C insurance space. Because I think -- in some ways, I think you could argue this is some of the more favorable times in recent years, just kind of where interest rates are and some of the dynamics around the pandemic reducing the number of claims, stock prices for a lot of your customers are at all-time highs. What are you seeing just from a macro perspective, whether it's digital transformation? Do you see any kind of high-level catalysts that might be new relative to a year ago?

So none of the themes that we're seeing are new, per se, I think the sense of urgency is continuing to increase. Digital disruption has been with us for a very long period of time. Insurers have been thinking through kind of what is the right way to ensure that they can engage with their end customers in a digital way. There are certainly newer models that have gone public and built businesses around a much more modern approach to how you engage with your insureds. And so there's -- that has been around for a while. I would say that COVID has probably increased the urgency as we all shifted to new ways of working. It clearly was imperative that you need to be able to touch your end users in a much more digitally native manner. Over the long term, there are ways that your core systems can inhibit your ability to do that. It can make it more complicated to do that. That being said, the overall shift from -- maybe it's a legacy mainframe-based core system framework you're running today, to a modern cloud-based core system delivered by Guidewire, that's a big decision and those are longer-term projects. And as we transition to COVID, I think we saw a heightened focus on what I like to call here and now initiatives. Maybe there's some -- everybody's working from home. We have to increase our security protocols or we have to increase how we engage with our customers digitally. There's -- there were very urgent imperatives that were going on. And taking a step in dealing with the foundation, which is the core system framework is something that the timing was such that it was hard for insurers to do that. At the same time, insurers were adjusting to what it means for cloud to be the new norm in core systems. We're still just scratching the surface in the overall market for cloud-delivered core systems. And so I think that created an environment where it was a little bit difficult to -- for new core system modernization projects to be kicked off. And our Q4 was exciting for that reason because we announced 5 new customers, some existing customers expanding and modernizing new systems that they hadn't previously modernized. So it's positive to start to see that move in a material way. And as we exit fiscal '21 and into fiscal '22, it does feel like people are starting to reevaluate some of those longer-term strategic IT initiatives, which is -- would be a very positive thing for Guidewire.

Yes, yes. And I thought one interesting -- there were a number of interesting things from Q4, but the record net adds of 17 cloud deals really stood out to me, kind of a good mix of new and as well as expansions. I guess what were -- what do you think was behind that strength in the quarter? Do you think this was just a market awareness dynamic? Maybe -- you talked about some of the pandemic-related trends around moving the cloud, more urgency? Or was this a -- do you think this was kind of more company-specific around the maturation of the Guidewire Cloud products?

Yes, yes. I -- there is a lot that enabled us to have a quarter like that. And I think Mike said it well in the earnings call that this is really the result of years of hard work and execution on Guidewire to have -- to find ourselves in this position. I mean -- I think if you think back to 2 years ago, when we were just starting this journey and the amount of effort required to bring an incremental customer to the Guidewire Cloud was substantial as we were learning and learning how to make the platform more scalable. The thought of doing 17 deals in a single quarter would have struck fear in the eyes of many of the cloud operations engineers at Guidewire. And so to be at a place where we can do that kind of business and then feel like we can continue to grow on that is exciting for us. A lot of the hurdles in the early days, when customers were thinking about what this transition to the cloud meant for them, was providing a clarity of where they are today and where the end state is, where we're trying to take them and why is that better. And some of the things that really underpinned what they were looking for was the ability to gain access to the innovation that Guidewire delivers at a much more rapid cadence. So in an on-prem world, we did a major release every 2 years. Customers would typically skip a major release, and so take our innovation every 4 to 6 years. In a cloud world, the vision is that you will upgrade to our cloud and we can deliver upgrades behind the scenes in a much more seamless fashion and do so every 6 months. But in the early days, it was not perfectly clear from our customers' perspective what that world really looked like. And so over the last 2 years, building out Guidewire Cloud Platform, defining the ski slope releases that sit on top of that, that we release on a 6-month cadence, showing the marketplace what that looks like, also being much more prescriptive and definitive on the steps that you need to take to get from point A to point B., that's a lot of the blocking and tackling that the industry needed in order to feel comfortable to start moving. And then there's also just the overall how you sequence these types of investments into your IT initiatives. That is much more typical that -- those are the typical conversations we have with customers around thinking through a core modernization. But we're moving beyond some of these more existential, strategic conversations that we've been having over the last 2 years. So I think that's a really positive thing. So there's a lot of things in the quarter that got me excited. Some of the new systems that we modernized, just the overall scale and what that means for how much work we had to do over the last 2 years to enable something like that.

Right. Right. I think that -- certainly, the 17 deals was a really impressive number. But I think some -- maybe the pushback to that would be that there weren't any Tier 1 customers involved there. So I guess 2 questions, I mean, are -- should we read into this as maybe the cloud is having more success down market? And how are you thinking about that? And then 2 would be just how have your customer conversations evolved with the Tier 1 customers?

So it's -- this is a natural evolution. I do -- we have had some early successes with meaningful Tier 1 customers, USAA, American Family, MACIF. There's been some of these kind of big wins for us in the early days of transitioning to the cloud. That being said, I do think the early days in the cloud has been more weighted if you look at deal volume, right. Maybe not deal size, but deal volume, been more weighted towards smaller lines, greenfield lines of insurance going to the cloud, test and learn, innovative use cases, which is very positive. People are -- larger insurers are using that in some capacity to kick the tires on some of these cloud platforms. At the same time, that's also a more competitive part of the market. Once you get into migrating over meaningful books of business and taking that to the cloud, that's the part of the market that we, at Guidewire, are very excited to see start moving because that's what we're investing for. And where we are in that -- we're still early days in the overall cloud demand. We've talked a bit in prior earnings calls about the level of engagement and conversations we're having with some of our Tier 1 customers. We've moved beyond kind of the high-level conversation into the more nitty-gritty. Let's go through the road map. Let's understand kind of key features and functionality. Let's look at your studies of scalability. Let's really understand kind of how this can handle our workloads. And then let's also start talking in a meaningful way about the economics. So those conversations are happening, which is positive, but it's a part of the market that will move at its own pace. And these are big, complex projects. So we feel really good about the momentum of these conversations and these activities that are happening at some of the larger insurers, but we also recognize it's going to take time.

Yes, yes. Okay. Okay. Makes sense. So I think as we are -- what, like a few weeks out from the Analyst Day, I think one of the slides that we typically get is just kind of Guidewire's overall penetration of the direct written premium from kind of the Tier 1 and Tier 2 insurers. I guess the question is, as we look at your opportunity there -- I believe the most recent update was you have slightly more than 25% penetration of Tier 1 DWP. Like of that remaining 75%, I mean, what's kind of the latest on -- yes, we -- like I think the 2 questions we often get is like how much of that is in-house versus how much of is at a competitor. And how do you think about the migration of that going forward? And how much of it will stay on-premise versus move to the cloud?

Yes. So we feel very good about how we've executed with large insurers. It's interesting. If you look at the overall DWP managed with the Tier 1 universe, it is quite high. It tends to be more modular and other things. Tier 2, it's a little bit lower, but actually, the ARR from Tier 2s is our most meaningful [ slog ] of the overall ARR. So both of those parts of the market are very critical to Guidewire. We think that all of that business -- so if you think about what -- I guess -- so stepping back, if you think about what's been modernized and what hasn't been modernized, we have some views into this. Our sales team certainly has deep conversations with every insurer that we would be able to sell to that is a Tier 1 insurer. There may be some geographies that we're not currently active in. But - and we have a good sense of -- and we have what we call our white space analysis that looks at all the different systems that are out there. A lot of it is still -- would not be classified as modern systems from our perspective. There are some that have modernized in a much more bespoke fashion. So chosen to kind of do a custom build and, we think over the longer term, as this industry eventually evolves to the cloud, that, that's going to be a difficult and potentially unsustainable strategies. So that part of the market, while depending on how you look at it, depending on the situation and a particular customer, may not be available to us today, we do think it will be available to us in the not-too-distant future. And then what's been modernized by competitors -- we published our competitive win loss rates. And we do quite well in this part of the market. So it -- that's a smaller overall [ slog ]. So when you kind of do all of that math and look at all of that data, you come to the conclusion that there's still a lot of white space out there to be modernized and that these systems are foundational to how an insurer runs their business, so a lot of work to be done. We have seen a bit of a slowdown in insurers taking on that work as I think they're trying to get comfortable with what the shift to the cloud means. Obviously, a win like USAA, which has traditionally been an internal build shop, to come to Guidewire is a really exciting proof point for us. And we think that there will be more like that in the future as we continue to execute.

Yes. And as we think about the mix globally, I think the Americas today is still about 80% of total revenue. I feel like at least from a qualitative perspective, you have had some pretty nice wins internationally, particularly in EMEA. So how are you just thinking about the relative growth going forward of EMEA? And how are you investing in EMEA?

We're excited about the international opportunity in front of us. We've seen some good traction in EMEA, U.K., France, Germany and a variety of opportunities in the Nordic region. So there's good traction that we're seeing in EMEA. And we're starting to see EMEA adopt cloud. So I think that it's something we're obviously monitoring quite closely. And I would say sales cycles tend to be a little bit longer for cloud in EMEA, but it does feel like there is an openness to adopting cloud in EMEA. So that's really positive. We make -- we are making investments. Any time we enter into a new country, they're -- you may hear us talk about what we call country layer content, which is country-specific content to handle the regulatory environment. And so we do make investments. Oftentimes, we'll make investments in conjunction with landing a new customer that we can leverage to further penetrate that market. So those are some of the investments that we're making. We also have made some investments in sales and marketing to better flesh out our position in both EMEA and in Asia Pac. Australia is a very mature market for insurance as is Japan. We've had historically good traction in Japan. A little bit slower move to cloud there, and -- but we're watching that market closely and staying very closely to it -- staying very close to it.

Yes, yes. Makes sense. One question that's come in through the chat here is just if you think about your ARR guidance for fiscal year '22, is there a way to kind of unpack how much of that is coming from ramped deals versus kind of new logos versus expansions?

So we haven't broken that out in detail. Some of the commentary we provided in the past is for fiscal '21. We were expecting approximately 50% of our gross new ARR to come from ramped arrangements, meaning the remainder would come from new sales activities that could include expansions or new customer wins. As we look ahead to fiscal '22, as we continue to layer on more and more cloud cohorts that have ramped arrangements, I would expect that to skew a little bit more than 50%. And as we thought about -- it's kind of interesting. The way I always orient myself is less about new logos and more about new systems that we're modernizing versus kind of new ARR coming from migrations.

Right.

And we have a bunch of internal estimates on that. In fiscal '21, we ended up doing a little bit more on the new system side versus straight migration side than I had expected, which is actually a positive thing because the migration work, we're working hard on it, and we know over time, we should win the totality of that work. So it was nice to see some new systems coming up for bid.

Got you. Got you. So just to clarify, you said slightly more than 50% from ramp next year?

Yes. I mean last year it was around 50-50, and I expect that to -- that number to keep going up. I wouldn't -- I'm not going to get into the details, but [ I would expect it to keep going up ].

Okay. Okay. Got you. I guess talking about migrations, so I guess is it fair to say that -- it sounds like the new business was kind of a -- or maybe not new business but like new, incremental DWP, new lines of business was kind of the area of positive surprise. Is it fair to say that migrations were a little bit below expectations relative to where -- your initial expectations at the beginning of the year?

It -- they -- we expected the year to be a bit more heavily weighted towards migrations. And so -- and that -- so it was a little bit lower than what I expected that can be attributed to. We had a couple of deals that pushed out into Q1 or Q2, which is not atypical, but overall, we were very pleased with how we finished the year.

Right. Right. And I guess for the deals that you did close and the ones that you're expecting to close, like what are you seeing in terms of the uplift? I think you historically talked about 2 to 3x uplift when you go from on-prem to cloud. Where are you kind of seeing it fall in that range?

Yes, we still feel good about that general range. And that -- and just for clarity, that range is when we compare to the annual term license fee and maintenance that attaches to a term license fee in an on-prem context, and move that customer to our subscription cloud-delivered software, we expect to get a 2 to 3x uplift on that total annual invoicing activity. It will often take us a while to ramp to those full values, especially in a straight migration context, but we still feel good about kind of how we've outlined that opportunity in the past.

Yes. So I wanted to go back to the ski slope release cadence. And as a fellow skier, I am a big fan of the marketing language there. But specifically on Cortina, which I think is the third iteration of the Guidewire Cloud Platform, how is just overall adoption trending as it relates to your initial expectations? And kind of curious, what are some of the initial customer feedback on kind of this more rapid release cadence?

So I think customers view this as a critical part of the reason why they're going to cloud. So understanding how this more rapid cadence will develop, how they can consume these updates and how we can deliver them in a seamless, nondisruptive manner? So that's a -- it's a big part of the overall vision of our cloud. The process has gone well. We are still early days. So we've now -- with all the deal activity that we signed in Q4, we brought our total InsuranceSuite Cloud customers to over 50. Those that are up and running and live and actually hitting the system is still on the upper teens. And so all the activity that we sold this year is still being worked on to getting that up and running and live. So -- and of those, there are still -- some of those aren't on the ski slope releases yet. So there's still -- it's still early days. There are some exciting early proof points. I think we had one customer move from Aspen to Banff, and they did that shift in a matter of 3 or 4 days versus the disruption that would have taken place in an on-prem world. This is wildly different than that. And there are some other kind of interesting proof points as we start to implement this shift into our base. But it's pretty early, but it is a key part of the overall vision for the cloud.

Yes. And maybe we could talk about the Guidewire Cloud Platform a lot because -- in a little bit more detail because I do get a lot of questions. I think there's kind of some confusion on -- between kind of the traditional customers who might have moved to the cloud prior to the release of Aspen. Just I guess where are we at? Like I think you talked about 50 customers on cloud. How many of those have kind of migrated to these ski slope releases? And then secondly, like when they do get there, is this kind of an auto update? Or do -- like how much kind of initiative and -- does the customer have to put into those upgrades?

Yes, yes, yes. So the -- so first of all, the vast majority of the cloud customers are going on to the ski slope releases. So there is a relatively small cohort that were either very far along in their implementation process or already live before we announced Guidewire Cloud Platform, the ski slope releases. And so those customers are, for the most part, all working with us to figure out an appropriate migration plan to eventually port over. And that will take some time to work through that. But that's constrained to a relatively small cohort at this time. And so the vast majority are working towards going to the ski slope releases in Aspen or the kind of Guidewire Cloud Platform. So -- and then within that cohort, how seamless are the upgrades. I mean this is a -- it's a pretty conservative customer base. So any time you push an upgrade to an insurer that's going to impact their core system, they're going to be measured about how they take that. There's going to be testing and other things that occur as a result of that. And I think over time, as we demonstrate an ability to deliver these upgrades in a much more efficient way, it will get more and more seamless as a process. But today, it's not like this gets delivered overnight and they wake up and they have the upgrade. We're not at that point yet. Will we eventually get to that point as we're continuing to invest in the platform? That is certainly the aspiration that it would be that seamless. My sense is that there's always going to be some testing and some other things that is required in order to make sure that nothing breaks. A big part of the overall complexity of these systems is all the different integration points. Some of our more complex customers have hundreds of integration points to different systems that sit within their IT landscape. And some of those systems may be one-of-a-kind bespoke systems. So we're making big investments in our API surface area to make that process of maintaining and updating all of those integration points much more efficient, but we're not at 100% yet. So that's a -- that is also an area that may slow down a bit, kind of the seamlessness of taking an upgrade. But it is the intention to get that down to, as we mentioned with one of our customers, 4 days or eventually even kind of shorter than that.

Yes, yes, yes. Okay. That makes sense. So shifting to kind of the products beyond kind of the core, right? I think you've had a number of different ways to monetize customers, I think, with analytics as well as kind of some customer-facing use cases as well. I guess starting on analytics, can you just kind of run through where you see the opportunity for Guidewire? Is this kind of an embedded feature in the product? Or are you kind of monetizing this through a new SKU?

Yes. So the -- we have a multipronged approach to how we think about analytics in our products. So almost foundational is core reporting capabilities, right? So you need to be able to report on the data that's running through. And that's very much just embedded into how or at least kind of bundled into how we sell our products. And then additionally, there are things -- predictive analytics capabilities that we have that can be unattached and you can utilize that to build more intelligence into how you manage your workflows, how you arrive at certain outcomes. And we certainly think that over time, core systems should be smart, right, should be able to -- whether that's enabling things like straight-through processing of claims or how you manage the sequence of how you attack a portfolio of decisions to be underwritten. There's a variety of ways that you can build intelligence directly into the workflow, and that is also a core part of our vision. And then there's certain data products that can help you better underwrite certain risks, right? So Cyence has a data listening platform that can help insurers be thoughtful in terms of how they underwrite cyber risk. We recently announced an acquisition of a company called HazardHub, which is pulling in both publicly available third-party data along with proprietary data to help understand property risk. And so there's a variety of things that we can bring to bear on the data side over time that will help our customers make better decisions. And so it's really a multipronged approach with respect to analytics. But a huge opportunity out there, especially as we start to aggregate more and more of our customer base on our common cloud architecture, where it will be much easier to tap into some of these capabilities.

Got you. Got you. Okay. And I wanted to touch on the competitive environment. Just any noticeable changes that you're seeing? Maybe kind of compare and contrast some of the more modern insurtech vendors that you see maybe around the edges and then the traditional competitors, the Duck Creeks of the world?

Yes. So it's -- we operate in a competitive environment. Most of the competitors that we compete against today have been around for some period of time. So largely known entities. There has been a fair amount of investment in new companies to -- but all -- most of that insurtech investment has been targeted on better ways of underwriting and selling insurance rather than better ways of modernizing our core system framework. In general, the shift to the cloud is interesting. I think what we've seen a bit in the early days of the shift to the cloud is smaller workloads, more simplistic lines of business going cloud. And by nature, those are also kind of areas where there are more competitors who can be credible, who can actually kind of do that work. And so the competition has always been higher at the smaller end of the overall spectrum. And so we see that with our InsuranceNow product. And we've also seen that kind of as greenfield lines and smaller lines that have moved to the cloud. What we are very excited about is as the cloud starts to realize the vision and as we can demonstrate success with our customers, moving big parts of the overall industry to the cloud is something that Guidewire is really excited about. And we expect to continue to do it in a meaningful way.

Yes. And one question that we've gotten, the company, CCC Intelligent Solutions, who recently went through SPAC [ in connection ], how would you view them? Is it kind of a partner or more of a coopetition? Just curious how you would...

Very much a partner. They occupy a critical part of the overall real estate. It's not competitive. They are obviously providing critical elements into how we manage a claim flow, but very much more on the partner side of the spectrum rather than the core competitor side.

Okay. Okay. Got you. So shifting back to the numbers a little bit. I think as we looked at initial guidance for FY '22, it came in a little bit below, at least where consensus was expecting. Part of that, I think, was just on the gross margin side, where you are seeing certainly a lot of activity in the cloud from a signing perspective. So could you just help us -- I guess, 2 elements, just overall, kind of what the moving pieces in profitability outlook and then what you're seeing on the cloud gross margin front?

Yes, yes, yes. So I think top line came in a bit ahead of consensus and then overall operating income came in likely a little bit below consensus. It was not -- it was very much in line with our expectation as we took a multiyear approach to modeling our business over the last year. And as we talked about the opportunity in front of us at Analyst Day, there is some disruption in the overall revenue line. And as I inspected some of the Street models and looked at kind of how they modeled costs, I thought maybe there was a little bit of modeling based off of a percentage of revenue because some of the growth in the overall OpEx was even below inflation. So a little bit surprising for me. I think that we are investing. Clearly, we think that this is a generational shift to cloud-based core systems. We've been lucky enough to be the winner as the industry initially modernized to on-premise systems. We fully expect to be the long-term winner as well and are investing to capture that opportunity. And the investments we've made are very much in line with how we established the opportunity at Analyst Day last year. As we exit this year, one of the things that we talked about in fiscal '22, you'll start to see subscription margins moving up in the right directions. We believe that our overall subscription revenue growth is quite durable, and we've made a lot of the investments required to support our early cloud cohorts and leverage those investments materially. So that should be a driver for us. And then as we look ahead, there -- part of the margin story is really the revenue story. And if you look at ARR growth and you compare that to overall software revenue growth, the complexity of the accounting is playing into that. ARR growth has been running ahead of overall software growth. And some of that is related to the impact of moving into ASC 606, creating multiyear revenue recognition upfront that's not recurrent. So overall, as the model normalizes, we feel very good about the long-term margin targets we outlined at Analyst Day. And we'll expect to give people a bit more incremental detail on that at Analyst Day at the end of this month.

Okay. Okay. Got you. I wanted to just kind of ask you about the R&D -- your R&D initiatives. And I think we've heard from Diego in the past just around how -- I think this was several years ago where you shifted a lot of the kind of resources from on-premise to the cloud. And I guess from a -- remind us, I guess, first, where we are today in terms of how much of R&D is focused on the cloud. And are we at the point now where you're kind of releasing the new features in the cloud version and then kind of pushing those back on-premise at a point later in time?

Yes. That's the approach we've taken. It's a cloud-first approach. We are -- our innovation efforts have been focused on the cloud product. We will certainly drop down capabilities that we can to the on-premise products and do that in a more managed, packaged way. We have -- still, the vast majority of our customers today are on-prem, and we recognize that our customers have made very significant investments in the Guidewire Platform. And we intend to be there for them and continue to invest to make sure that they're getting the most out of that implementation and help them work through the right time to eventually switch to the cloud. But the efforts in our [ P&V ] organization are focused on the cloud moving forward with the recognition that we still have a number of customers that are on-prem on still a handful of different versions, and that does create a little bit of an R&D burden in the near term as we help customers affect this change to the cloud.

Right. Okay. Well, Jeff, I know we've got about a minute left, but I would love for you to just leave us with some thoughts heading into Analyst Day and anything you wanted to cover that we didn't touch on.

No, thanks, Tyler. I mean -- I think we touched on a lot. So we covered a lot of ground. We were -- we're very pleased with how Q4 played out, and we feel confident that it sets us up well to hit some of the -- hit the targets that we talked about last Analyst Day. And we'll certainly look forward to the opportunity to going through that in more detail at the end of this month. So thank you.

All right. Thanks, Jeff, for the time, and thanks, everyone, for joining.

All right. Thanks.