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

Thank you, everybody, for taking the time. My name is Dylan Becker. I am the research analyst here at William Blair that covers vertical software, cover Guidewire. And we do have to mention that all the necessary disclosures can be found on our website at williamblair.com. But fortunate enough here today to have Guidewire's CFO, Jeff Cooper, with us in attendance. And I think the planned format is this, Jeff will kind of give a high-level overview. He's got a handful of slides relative to the backdrop of the business, and then we will transition over into more of the fireside Q&A type of dynamic. So Jeff, thanks for taking the time today.

Perfect. Yes. No, thanks so much for having me, and thank you all for sticking it out. I think this is maybe the last session. So it's great to see you all. I have a couple of slides that I'll walk through, give a little bit of background on Guidewire and then we'll move into Q&A. I'll skip over that. So Guidewire for those that don't know Guidewire, Guidewire is an enterprise software company exclusively focused on 1 vertical, and that's the P&C insurance industry. It is our mission to be the cloud platform that the industry trust to engage, innovate and grow efficiently. So what does that mean? We sell core systems of record to this industry to help this industry modernize. And we've been doing that since 2001. The company was founded in 2001, started out selling on-prem systems, are now transitioning our customers to the cloud and selling subscriptions. And it's all been in a recurring revenue model, really, since day 1. And the insurance industry obviously plays a very critical role in our world and our economy. And so we are delighted to help make insurers more efficient to make this whole process and experience better. We also are delighted to service an industry that is very resilient and just a critical part of the overall economy. It's a big market that we operate in, and this is a view into how we think about the world. There are almost 2,000 insurers in the world. So that allows us to be pretty focused in terms of how we think about go-to-market. We tend to categorize that in tiers. So if you hear our quarterly earnings calls, you may hear us talk about Tier 1 and Tier 2 insurers that -- that equates to how much direct written premium, a particular insurer may have and we price our software on basis points of direct written premium. So that's how we think about pricing as well. And it's a broad global market. The majority of our current revenue still resides in North America, but we have a meaningful business, both in EMEA and in APAC. And we sell kind of the core systems of record that an insurer relies upon to run their business. So policy administration systems, claims management systems, billing systems, those kind of core transactional and foundational systems that sit at the core of what they do. We surround those systems with, what I call, systems of intelligence, or data and analytics applications and systems of engagement and digital applications to help insurers interact with their customers in a more digital footprint. So it's really kind of at the core of what insurers do. And as a result, these programs that we work on tend to be pretty in-depth and can be quite complicated. Lots of times, we're replacing 30- or 40-year-old systems that have been in place for a long period of time. And we've been pleased to be a leader in doing that over the last 20-odd years as we've helped this industry modernize. We get broad recognition from a lot of the research firms out there about our leadership position. And then you just look at our overall scale and how we've been able to grow ARR, we are pleased to continue to be a leader in this industry and excited to take this industry into the 21st century, replatforming this industry in the cloud. We have transitioned pretty recently. You can -- this slide shows the percentage of our new bookings activity that comes from cloud sales and the percentage that comes from self-managed or on-premise sales. So if you go back to FY '16, it was really all on-premise. That was though our primary go-to-market motion prior to fiscal '17. And it's been a pretty material shift in new sales activity. So this year, around 90% of our new sales, year-to-date, has come from our cloud products. And that's a trend we just expect to continue into the foreseeable future. We still have a lot of our overall ARR coming from our term license customers that bought in a self-managed modality. We always sold in a recurring manner through a term license model. But clearly, the new sales is being driven by our cloud products. And we're in a bit of a transition as we're transitioning the industry to the cloud. That's impacting our overall business model to help investors understand some of the machinations we've leaned into ARR as the primary metric to understand our organic growth and momentum with the transition from a subscription -- a term license model to a subscription model in conjunction with the adoption of ASC 606, that has inserted some complexity into the different revenue patterns on the income statement. But we think ARR normalizes that. We're starting to see kind of a real meaningful subscription revenue growth inflection. So growing 52% based on our most recent guide this year, and we expect that growth to be durable into the future. So we're really excited to see that starting to play out as this cloud journey is taking root. And then finally, there's -- we have a lot of material on our Analyst Day website -- our analyst IR website from our Analyst Day around how we think this model will play out and transition, but we're starting to see the leverage that we were expecting and continue to have good confidence into our long-term targets. So with that, all that I have.

Very helpful overview. And maybe you kind of hinted at it at the very end there as well. But you guys did just report Q3 numbers earlier this week and we're continuing to see the visibility in that, that steady, consistent momentum tick up. But can you give us a broader sense and perspective for maybe those that didn't get a chance to listen to the call, relative to the performance and the key kind of takeaways from your perspective?

Yes. So we're seeing this transition to the cloud really build and start to take root. We did 8 cloud deals in the quarter. That tends to be one of the key metrics that people focus on is that momentum. We've seen a pretty significant acceleration year-over-year on our bookings activity. We've seen better linearity this year than prior years as the demand for cloud is more broad-based and a bit more robust. So all of that points to a very healthy backdrop for the business. We talk about this opportunity as a steady growth engine and just building those layers and cohorts of cloud customers and more of a kind of a steady growth pattern rather than -- we often get the question as, will there be a big inflection point. These are large consequential projects for insurers. A lot of time and effort goes into thinking about when to start a program like this. And so we're happy to see that just continue to build over time.

And going into, I think you had a slide here, over the last several years, but seeing that cadence around the cloud and your level of investment really tick up over the last few years. You just, I think, for at least your fifth iteration at GWCP, I guess, how are you thinking about the messaging? What's resonating with customers? What's really getting them to that point of where they're saying, "Okay, I need to modernize. I need to move to the cloud and the time is now."

Yes. So we're in a handful of years into this journey. I think one of the things that we've done very effectively over the last couple of years is the consistency of the message and helping insurers understand the road map, the path to getting from point A to point B. And these projects are very complicated and consequential. And so having that clarity is super important. We're now on our fifth release of our cloud solution on what we call Guidewire Cloud Platform. And we have what we call our ski slope releases that sit on top of that. Those are released every 6 months. So that steady progression of executing against that release cadence is providing a lot more comfort to the industry and to our customers about kind of what this journey will look like. The application layer that sits on top of the Guidewire Cloud Platform is not too different from the current application layer that sits on a self-managed stack. And so there's a lot of familiarity with the application layer and what that will look like in the cloud. But the ability to drive much more rapid upgrades is a big part of the value proposition. In an on-prem world, we would do a major release every other year. And a lot of our customers just because of not wanting to take on disruption would not take a major release every time. So they would typically do a major upgrade every 4 to 6 years. And in the cloud domain, we will be able to, behind the scenes in a much more seamless way, deliver these upgrades to customers on a 6-month cadence. And that's a big part of the value driver. There's a lot of complexity in maintaining and supporting these environments. And unburdening our customers of that complexity to allow them to focus on things that will touch their customers, digital initiatives, other initiatives, is a big part of the value prop as well. So yes, I think most of our customers have invested a lot in their Guidewire implementations. And they view the cloud as the next step. They want to stay current with Guidewire. They want to be on our long-term release train path. And so they're all kind of evaluating what makes the most sense for them from a timing perspective. I don't think there's any key features or functionalities that, outside of some of the larger customers where we're engaged very, very deeply on some of their unique requirements and when our release cadence will line up with what they think they need, outside of those handful of customers that are unique, I think it's just more a timing perspective.

And that probably speaks to the extent of the durability that you talked about and the opportunity here. I think one of your slides called out the premium penetration that you have in the mix today, a lot of that is still probably from an on-premise solution. How do you think about the mix of the business that has started that cloud path today? What can that opportunity look like over time? And then again, what does that upsell look like as you think about progressing over there and then the adopting curve as well, too, is it a modular approach? Is it typically a line of business? A solution? What does that transformation look like?

Yes. So we will sell our software, and we have 3 primary modules: ClaimCenter, BillingCenter and PolicyCenter. Customers in an on-prem modality would very often buy in a modular approach, although every once in a while would buy in a full suite approach. It kind of depends on the program that they're trying to instantiate. But as we've seen people start to adopt cloud, we have seen a bit of a trend towards more full suite, and that's an exciting trend for us. I think folks are just generally looking to simplify their IT stack and rely on someone like Guidewire to take some of that complexity off of their hand. So we would certainly love to see that continue to play out. But as this opportunity plays out, it is a fundamental shift in the division of labor between what we do in an on-prem world and what we do in the cloud world, where we just take on more. We are essentially delivering a core system as a service and managing the postproduction environments on behalf of our customers. And so there is a pretty significant pricing uplift associated with that transition. Most of our customers can benefit from Guidewire's scale. And them managing this in a bespoke fashion in their own environment turns out to be generally usually more expensive over the long term. And so we engage very deeply and build business cases with our customers to help them justify the investment. But there's certainly a TAM expansion associated with them moving to cloud. And then what I think is really exciting is we have an opportunity to modernize an industry here and bring a meaningful portion of the global DWP in the world to our common cloud architecture and then build out the integration layers and the API frameworks to allow third parties to tap into that and build on top of that, which creates a really compelling opportunity to have a pretty nice ecosystem in the industry, which we're really excited about.

And obviously, a nice value case and proposition for those end customers as well. And I think you touched on the metrics across the model, but there's added -- some puts and takes, too, right, relative to the revenue recognition and how you're able to allocate across those line items. Can you help us get a sense of where we are in the model transition today? You've set out some longer-term targets. And maybe how the visibility of kind of some of these ramped deals helped give you the -- I think there was one of the slides, the increased confidence in that long-term vision, right?

Yes. So when we engage with our customers, they typically take a very long-term approach to that relationship. We're usually replacing a system that's been in place for decades, and these are the types of investments that they think about on a decade time frame. And so we will build out -- in a negotiation, a relatively long-term fee structure that considers how they think about a rollout, how they think about implementing the product. And we will embed a fee table into that, that has a ramp associated with it. If you've listened to our earnings calls, you've heard some of the commentary around these contracts and how they ramp. And so that's -- it's a nice pattern for me because it creates some visibility into the forward financials. And there's a lot of selling activity that happens upfront. It may not manifest itself in ARR in year 1, but it creates a meaningful and very stable growth within an existing customer base. So that's one element of how these contracts are written. We tend to write 5-year contracts on the subscription side. There can be, even in the cloud context, an 18- to 24-month implementation process. Once you get through that and are live, we tend to be about as sticky as it gets in terms of software. I remember -- so I spent a lot of my career as an investment banker, and I actually got the opportunity to work on the Guidewire IPO as one of the underwriters. And when Guidewire went public, they were able to say that they had never lost a customer at the time of the IPO, which is just an amazing thing to be able to say. And if you look at our overall attrition rate today, we talked a little bit about this on the last earnings call. Our ARR gross attrition over the last 12 months is less than 3%, and that includes kind of $3 million of Russian ARR that we lost as a result of exiting that market. So it just -- once these programs take root and are instantiated and are being used, it's about as sticky as it get, which also helps us. We think about building this modeling and constructing this model. Now we've been transitioning from a term license model. And when ASC 606 was adopted, that forced us to recognize a lot of that revenue in a more -- in an upfront revenue pattern. And we have a pattern of long-term relationships with our customers. So that did create some lumpiness on the revenue line. We're not selling a lot of new term license arrangements. And as those term license arrangements that were sold previously, they will translate into annual renewals as they get to that -- kind of into that initial term. And so those should have a much more consistent pattern going forward as well. So I think as we look ahead to fiscal '23, I do believe that some of that accounting complexity on the top line will fade into the background. One of the things we've seen is that if you look at total software revenue growth and you compare that to ARR growth, there's been a gap there that's largely driven by some of these accounting machinations. And that's going to start to fade into the background, which I think will be a helpful pattern just for people to understand the overall momentum of revenue is much more aligned with ARR going forward. And that's going to help with some of the model complexity as well. But there's -- if you look at the overall build of how we think that this model is going to play out, we have been investing very heavily for what I view as a once-in-a-generation replatforming of an industry. And the investments we're making in our platform today are going to set us up to be the long-term winner of the space, and that's kind of how we think about it. So we've been investing quite aggressively to make sure that we're ready to take these early cohorts to the cloud, and we think that will set up -- set us up for success over the long term. But -- and as we look at overall margins, it is this fiscal year 2022 where we expect margins to bottom out and start demonstrating some margin expansion as we look ahead.

Right. And I think that, that will continue to work itself out and show and highlight the underlying fundamental strength that you guys are seeing. As we switch out, thinking about the resiliency of the industry, right, death, taxes, insurance, it's -- how should you think about the broader macro backdrop here? These are mission-critical transformational projects. There's been a lot of behind the scenes work to get a deal kind of to that point of execution. How do you think about, in a macro environment, potential recessionary period, have the resiliency of the model and the industry can look like?

It tends to be really resilient. These are long term -- they're very thought-through decisions. Some of these deals are -- we had a deal flow through our pipeline that we've been talking to for 10 years and just kind of finding that right time to pull a lever and start the project. So what's happening in the macro, certainly, has the potential to have an impact. We haven't seen any slowdown in buying behavior as a result of some of the most recent macro dynamics. It's hard for me to entangle a couple of different things. One is just the overall comfort of cloud maturity and the platforms to support and ensure going to the cloud. So we did see, as we started the transition to the cloud, a slowdown in buying behavior as an insurer at that point in time that was thinking about modernizing their core system, wasn't going to buy on-prem because the thrust of our R&D efforts are going towards our cloud product. And so they would get -- they slowed down buying of on-prem, but they weren't quite ready with the amount of maturity and how many customers were up and running on the cloud platform yet. And so we saw a period of time where overall modernization activity slowed down pretty significantly. We're starting to come out of that as insurers are getting more and more confident in the maturity of the platform. So there are certain micro dynamics that are happening in our industry that are quite positive. And it's possible that, that's masking some macro sensitivity, but we haven't seen any kind of -- any big change in the overall buying patterns.

Okay. And as you think about that value driver too, how much of it comes into that data aspect? Thinking of a carrier as a large data aggregator, but typically siloed if they've got a 20- or 30-year-old custom-built system. How much of it is -- is that visibility unlocking the operational efficiency and then being able to introduce new lines or expand their books of business as maybe a core system driver, at least sparking the level of conversation?

I think that's a big part of it. I mean, a big part of it is unlocking agility and visibility that your legacy systems are restraining you. And data can show up in a variety of different ways. How you utilize data make yourself more operationally efficient, how you utilize data for -- our underwriting decisions. So there's a variety of ways that data can get locked up in a core system and modernizing that can help you unlock that, certainly. And then there's other products that we sell that sit around the core that are predictive analytics, allowing us to start to automate certain decision-making that were very manual previously by unlocking those data assets. So I think about data as unlocking agility, and that's a big part of what our platform helps an insurer do.

Right. Maybe if we switch to the competitive landscape as well, right? So I think that there's been a broader push across the industry of the cloud transition and cloud modernization. How do you guys think about your positioning and the pace of investments that you guys have had to accelerate your own cloud vision, right?

Yes. Yes. It's -- we're still in the very early, early innings of this industry adopting cloud. And it's going to be a long journey ahead as we replatform this industry. And for a company like Guidewire, a public company that's done really well in the on-prem world, it was a very -- we had to be very considered as we thought about when we were going to make this push. As soon as we signal to the industry that we're going all in on cloud, that is certainly going to put a chill into any on-prem demand that's out there. And I feel very good about how we time that and how we work through that as an organization. I think we are now very clearly developing cloud first. Our customers understand that path, understand where we are on that journey. It has been our view that we will continue to win at similar win rates in the cloud domain as we did in the on-prem domain. I think that there's a case that we do even better. It is a really consequential decision to choose a core vendor provider, but it's an even more consequential decision to choose a vendor that's going to run that system on your behalf. So I think market leadership in the cloud domain matters even more than it does in the self-managed domain. And that's part of the reason why we've been investing so aggressively to make sure that we continue that market leadership position. So I think we're starting to see that play out. We feel really good about the win rates we're demonstrating right now. Excited to see some interesting Tier 1 insurers, such as Cincinnati Financial in this most recent quarter, choose to modernize their claims system with Guidewire. So it's -- yes, the momentum is good.

How much of that confidence as well comes from, again, the leadership positioning that you talked about in the on-prem world? The installed base that you have to go and sell into, there's still a lot of legacy to go out in this place. But as you think about the migration opportunity alone, I think you've talked about sub 25% of your existing customers. But having that level of visibility of moving those guys over time as well and driving that reference building.

That on-prem success matters and that was hard thought, and we worked hard to build that leadership position. And one of the things that has always differentiated Guidewire is the commitment we have to customer success. And these projects are hard. They're hard in on-prem. They're hard in the cloud. But we've done a really good job of getting customers over the finish line live and successful. There's a lot of failed projects in this industry. And this industry talks. And so that's been a big part of our overall leadership position and -- so that matters. And as people have made large investments in their Guidewire implementations and we can take that to the cloud, there are some adjustments that they have to make and how they operate with us in the cloud domain versus self-managed. But there's a lot of parallels and similarities. It's not like a reimplementation completely.

Right. Right. And you've done a lot as well on that front, going back to your point of the 4- to 6-year implementation cycles of now of a more direct -- cloud-direct program. Having that road map as you do more of these implementations to where you can standardize some of those processes to accelerate that migration gains as you want to.

Yes. Yes. Yes, exactly.

Okay. Maybe on the international side, there's the broader perception that, that had been a little slower to adopt the core, but you've had a number of key international wins as well. How do you think about the cloud willingness there and the potential for a lot of these larger globalized carriers to drive the success that guys are seeing on the international side as well? I think a lot of the cloud adoptions with North America today, but positioning on the international front?

Yes. We've had some very important anchor wins internationally. We're excited about that progress. My sense is that Europe has been a little bit slower to go cloud than North America, a little bit more measured. Things like -- you don't really see the decision of building a bespoke system still exists in the marketplace in North America. In Europe, we see that every now and again, and we have to compete against that. And the market is a little bit more complex just because every country has its own regulatory environment that you need to adjust to. But we've had some really good momentum there, both in Italy and in France and in Germany, some really interesting wins for us. And starting to see the momentum build a little bit on cloud. My sense is it's still going to be a bit behind North America. And then on the multinationals, there are a number of kind of large multinational insurers that we're engaging with. Some of them have bought or in a more bespoke -- or in a more kind of modular fashion with some of their smaller lines. And over time, we hope to move those to more enterprise-grade or enterprise-wide arrangements. But all that's progressing kind of in line with how we were expecting as we thought about the model and build this out.

Yes. Right. How much of that expectation that you're talking about too, you touched on it a little bit earlier around the ramped contract structure. Giving you the sense of visibility as we think about the model progression back in because now -- seeing more of that consistent execution throughout the business and that fundamental strength we've talked about, how much of that visibility comes from that ramp's dynamic that continues to flow through?

Yes. I mean, it's a nice element of our -- how we're structuring this because it does provide a bit more visibility. But there's a ton of sales activity that goes into putting that in place. And so it's a little bit of delayed gratification on ARR, but it is nice because it creates a little back pocket for us as we think about forecasting and think about how we build our model. And it's just more how this -- we think the opportunity will build out. So the ramp structure has been effective for us, and it's an important lever for us as we negotiate these arrangements because we know it takes a while for these systems to get up and running and instantiate it.

Right. Maybe lastly, and I know we've got a little bit of time here, but -- as we think about -- and I know you don't like to reference it as that inflection point. But as we think about the pathway to those steady-state margin profile of the business, I think you said 2022 could be a potential trough from a margin perspective. Thinking about the scale and linearity of the targets, you have a midterm set out, there are longer term set. What would -- how should we think about Guidewire as a normalized steady-state business?

Yes. So we have some longer-term targets out there. As you think about our movement towards those targets. At this point in time, I expect it to be more linear in nature. Last year, fiscal '21, was really the low point from a subscription margin perspective, and we're seeing a nice step-up on subscription margins this year. And then when you look at subscription and support, because of the mix of maintenance included in there, we're seeing a smaller step-up on subscription and support this year. We'd expect a more meaningful expansion there next year. And I think the model will be more linear moving forward. And you could start to see it build off of the low point. A lot of what's driving that is we had a very significant headcount investment in building out the cloud operations team to support these early cloud customers. We feel like that team is in place and that we can leverage and scale. That team will benefit from the investments we made in the product in a very significant way. And we're seeing that play out. So that will help us provide more -- that will give us more visibility into the model as it goes forward. But it will be more linear as we march towards those longer-term targets. We set a baseline of $1 billion of ARR and then $1.5 billion of ARR. And as you kind of look at how that plays out, we expect this business to look much more similar to some of our vertical software peers once we get to those levels.

Right. I think that will do it for time here. I know -- I appreciate you taking the time to be here with us today. Thank you for everybody in the audience. And I think as this is the last presentation, we will be staying in this room for the breakout session. So we will kind of transition that. We'll take a second if you'd like, but transition it more to an investor-led Q&A here as well too.