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

Awesome. Thank you, everybody, for joining today. My name is Dylan Becker. I am the research analyst here at William Blair that covers Guidewire. For all the necessary disclosures, you can find those on williamblair.com. We have Guidewire CFO, Jeff Cooper here today with us. He's got a presentation that he's prepared. We'll run through a handful of slides, and then we'll break it out into Q&A. But Jeff, thank you for joining us.

Thank you. Thanks for joining. I'll go quickly through slides, and then we'll move into Q&A pretty fast. First, the safe harbor. And then I'll start with our mission. So Guidewire, if you're unfamiliar with Guidewire, Guidewire is a software company, 100% focused on P&C insurance industry. We sell core systems of record to support that industry. And our mission is to power the agility with a platform that P&C insurers trust to engage, innovate and grow efficiently. So we treat this very seriously in terms of how we think about our mission. And part of our power has been our focus and our focus on this industry specifically. This is how we think about our market opportunity. Most of these slides, you can find in our Analyst Day presentation that we did back in the September time frame. But this is a visualization of how we think about our TAM. We currently -- or as of the end of our last fiscal year, had about $900 million of what we call fully ramped ARR. So that is ARR that's embedded into our customer contracts once they are all fully ramped within that -- the way we think about selling our software is based on basis points of direct written premium, and that's the outlying pricing -- the fundamental pricing metric that we rely upon. So there's really 2 ways that we can think about expansion within our customer set. One is we can penetrate further into their portfolio of direct written premium. The other is we can further penetrate into the core modules that we sell into our accounts. We sell a policy administration system for our customers called PolicyCenter, our claims management system for our customers called ClaimCenter and a billing system to support the core functions of an insurance company. So there's meaningful opportunity. We estimate around $3 billion of ARR opportunity just selling into the customer base that we touch in some capacity today. Then there's obviously a lot of new work to do out there. It is our mission to modernize this industry. There's still a lot of legacy, a lot of mainframe that exists within the industry today. So we intend to modernize all of that over time and bring the industry into the 21st century and get it ready for Gen AI, right? That's -- and then we sell a suite of data and analytics capabilities that sit on top of that core platform. We have a very broad global presence and think about ourselves as the market leader, over 540 different insurance brands in 40 countries. We have a very broad network of SI partners that we work with. That's been a key part of our strategy. We touch over $600 billion of direct written premium, and that -- we kind of think about our TAM for total direct written premium that we could touch in the $2 trillion to $2.4 trillion. So that's a meaningful market share that we hope to grow over time. And then we have a growing suite of solutions partners that make up a marketplace that can integrate directly into our platform. This is a view of the application suite that we sell and kind of how we think about our product portfolio. A lot of the work we've been doing over the last 3 to 4 years is driving the cloud infrastructure and the core services to support our business applications to be delivered in a cloud context. So there's been a big lift on the platform side of this slide. We have very strong market-leading business applications and a growing portfolio of analytics applications to support insurance use cases. This is -- we have been -- if you know Guidewire, we primarily had sold our software on-premise and had started a cloud transition now about 4 or 5, maybe started thinking about it 6 years ago. And as we thought about the transition to the cloud, there were really 3 in some ways, existential risks that we had to work through as an organization. We were the market leader on-prem. But to make the transition to the cloud, the first thing we had to do is work hard to establish our cloud infrastructure and establish a scalable cloud architecture. The team has been working very hard to do that. That was risk -- primary risk one. We've made a lot of progress in that regard and feel like we have derisked that part of the story. The second was to continue to drive sales and modernization activities in the industry. We are quite thrilled with the sales momentum we're experiencing right now and the competitive differentiation is showing up in our win rates. And so we're very pleased with the progress we're making on our ability to continue to drive sales and adoption of our cloud product. And then the third part of the story is can we drive to a long-term software margin? Can we deliver the efficiency required to see our subscription and support gross margins inflect and demonstrate a software gross margin. We felt strongly that if we architect things appropriately, we could unlock that, and we're starting to see that play out. This slide is a good visualization of our non-GAAP operating margin. But if you take those 3 risks that we are working through as a company, first, investing a lot to establish a cloud architecture to further extend our market leadership position. Second, kind of driving sales and adoption. And then third, driving that margin efficiency. We're now at that part of this journey where that's been a primary focus for the company, and we're really seeing that play out in the numbers. And this chart is -- I remember we had our Head of Sales join about 2 years ago. And when I was walking through the long-term model and helping him understand the opportunity we were trying to unlock, he was very skeptical of V-shaped charts, and I know a lot of people are or can be skeptical of V-shaped charts, but we're thrilled that the progress we've seen in FY '23 and FY '24, this is playing out as we had modeled it. So very excited about the progress we're making here. This is just a view of our ARR, and this breaks it out into our on-prem and cloud ARR. Our cloud ARR is the key driver of our growth today. On the earnings call, I got a question about some perpetual revenue that popped up on our income statement, and that was a result of just some of our older customers that have yet to migrate to the cloud, doing some true-up activities. But the real driver of growth and new sales is coming from the cloud products. So we've been very pleased with the progress we're making. This is just a quick view into some of the targets that we have as we started this journey given the -- that V-shaped chart I showed previously and the disruption to the margins as we went through the cloud transition, we felt it was important to give some near-term and longer-term markets -- markers on what we thought the margin trajectory would look like and what the profile would look like at different scale markers. And so we did that for FY '25 and then we have a longer-term target. So we're in this kind of uncomfortable zone of somewhat having 2 years of guidance that we're executing against. But the FY '24 numbers have firmed up quite a bit. Going into the year, we expected subscription and support gross margins to be closer to 59%. We're now tracking to 65% to 66%. So we're running ahead of plan with respect to the subscription and support margins. And that is also having an impact on our operating margins running a bit ahead of plan. As we look to next year, we haven't updated our FY '25 targets. We do that once a year. So these targets are from Analyst Day last year. What we said on the earnings call earlier this week is that we are clearly tracking ahead of our subscription and support gross margin targets. And we do expect to see further margin expansion on that line next year, but there's also some pretty exciting investment opportunities that we have. And so we still feel that the operating margin targets that we have on this page are appropriate. But we'll update that in a more fulsome manner on the Q4 earnings call. And then finally, this is to that -- to the comment I made -- or this is the view of some of those longer-term targets. We put a marker out there of what we should look like once we hit $1.5 billion in ARR. And it's important to note that, that is also a point in time measure, and that is not how we think about terminal margins or in-state margins as we do think that there should be future margin expansion beyond those points. But it's a reasonable target for us to march towards. So with that, I will sit down and turn it to questions.

No, that's a fantastic context. Jeff, I know you guys did report earlier this week, maybe just to kind of start the conversation there. What you guys -- for those that haven't had a chance to catch up, how did the company do? What were kind of some of the main takeaways?

Yes. So it's a very strong Q3 for us. The company experienced a very strong Q4 last year. And our usual cadence for us would be after a very strong Q4, it would be to take Q1 and rebuild the pipeline and then start executing on that. But given where we are in the transition, we're seeing a broader and deeper pipeline. And so we were able to translate Q4 into a very successful Q1. And a big emphasis of ours has been driving more linearity. So we are less dependent on a herculean Q4, and we're quite pleased with that progress. So a big theme of the call was linearity of bookings. And where we are for the year, we have seen improved linearity of our bookings that has been -- it's very helpful from a CFO's chair going into Q4. Q4 is always our biggest quarter and our most important quarter. So there's plenty of nerves, but the progress we've made so far has been great. That was a key theme. In the year, we closed 4 deals in Australia, which was great to see Australia is a very important insurance market for us. I would say that marketplace in general has been a bit slower to adopt cloud. So seeing a bunch of our existing customers make that commitment was really great to see. We talked a little bit about some of the international investments we made with some of our insurance forms and marketing events that we've been doing internationally, and we also touched on our inaugural developer conference in India. I got the opportunity to go to Bangalore over the last quarter and visit our office there that's growing rapidly. We have a very robust ecosystem of developers that are building on top of Guidewire in that marketplace. We don't have any customers in India yet, but it's a very exciting office for us. But the thing I was really blown away is going to visit PricewaterhouseCoopers and they said that they have over 1,500 people in Bangalore 100% dedicated to building on top of Guidewire. And going to visit that operation was really cool.

Sure, sure. And you touched on kind of how the business is executing. Can you give us a backdrop on what you're kind of seeing in the core insurance market, right? What's incentivizing these customers to modernize now?

Yes. I think the insurance market in general, from an overall backdrop perspective is in a relatively healthy pace. There's a lot of catch-up in overall premiums to account for inflation and rising claims cost. And so we're starting to see insurers find that equilibrium point that is important for the industry to find. I think that's maybe creating a little bit more stability from a macro backdrop perspective. It's also causing premiums to grow and we price our software on premiums. So a bit of a healthy backdrop for us. But more important in terms of what's driving buying behavior is the micro of what's going on at Guidewire and cloud core systems to support this industry. A lot of the industry, for a period of time, would not -- was not willing to buy on-prem core systems because all the vendors were investing their R&D budgets towards their cloud products. But we're waiting to see the maturity of the cloud products and to some extent, waiting to see kind of if new competitors would emerge as this transition from on-prem to cloud software played out. And we feel like we're in a much more mature place with respect to that question that was foundational for customers. The other thing is a big part of these programs is just there is a lot of work to unwind all the business logic that's been codified in the mainframe base system and repurpose that and rebuild that in a more modern context. And so providing more surety into the programs to support a cloud transition and having more proof points in the marketplace is also creating more comfort in terms of why now is a good time to make a decision like this. So there's a lot -- there's been a lot of hard work over the last 4 or 5 years, I think, to unlock this demand curve that we're seeing right now. And then hopefully, things like Gen AI and some of these initiatives that are -- everybody is thinking about and trying to figure out how they are going to be ready to support some of those initiatives. If you're running a 40- or 50-year old mainframe-based system, you're probably not in the best place to unlock potential of Gen AI or some of these newer capabilities. So I think that's also playing into some of the decision.

Right, right. Maybe from a customer perspective, who is a core kind of target insurance carrier for you? What does that look like? You touched on kind of premium and the opportunity to expand, what does their typical adoption or business evolution look like as they buy more with Guidewire?

Yes. So we have a pretty broad reach within the P&C insurance segment. Guidewire is historically viewed as best-in-class in servicing the needs of the larger insurers in the market. But if you look at our distribution of ARR across different insurance tiers, it's pretty broad. And what's exciting about the cloud as well is we've architected in a way that is pretty efficient. And so we can scale down and also service the needs of smaller insurers at a price point that works for them. And by the size of insurer, the evolution of their spend with Guidewire is different. So if you're a smaller insurer, you're usually looking to buy a full suite and go with one vendor and make that decision all at once. So that would include ClaimCenter, PolicyCenter and BillingCenter and what we call our full insurance suite package. If you're a larger insurer, you might have a very complicated IT infrastructure stack. You may choose a module at a time, you may choose a module by an insurance line at a time. So there's a variety of ways that we will engage some of the larger customers. So it's not uncommon for us to grow on 2 vectors, like find a landing point, demonstrate the value and then sell more modules into that customer or penetrate more lines of insurance within that particular customer.

Sure. And we touched on what the cloud migration opportunity can look like. There's obviously a healthy installed base there. But how should we think about the evolution of the economics throughout this transition process even for those that are existing Guidewire customers?

Yes. So the economic model on-prem was we were selling software, right? And we sold that software on-premise, but we sold it in a term license context. So always had an annual recurring fee attached to the software sale. In a cloud context, we're selling the software, we're selling the infrastructure and architecture layer to support that software. We're selling the cloud operations function to make sure that, that software is up in performing and running at a high level. And so the division of labor between us and our customers has changed. And as a result, the price point has changed. And so we capture a pretty meaningful ARR uplift as we migrate a customer from buying our on-premise software to buying our cloud solution. If you go back in the early days, we talked about this 2 to 3x uplift. We've tried to move away from that relative blunt way of talking about it, but in general, that economic framework still holds up.

Sure. And it's easier when you align with the value as well to in justifying that.

Yes.

How do we think about competition? There's obviously a multitude of players, maybe more localized internationally, but how do you think about the competitive landscape and where Guidewire fits?

Yes. So Guidewire has done a very good job being the market leader in terms of modernizing this industry. So as folks are thinking about moving off of mainframe-based systems and selecting a modern partner to work with, Guidewire has historically been the market leader. And I would say we've done a very good job at addressing the needs of a complicated insurance carrier. And so when you get to the kind of higher levels of Tier 3, Tier 2 and Tier 1 insurers, we've done a tremendous job competing at that part of the market. As you get to smaller insurers, there are a number of vendors that can do that. And so it tends to be more competitive in that part of the marketplace. And then as the cloud transition occurred, there are -- we do have a number of competitors that we compete with in day in and day out. As the cloud transition occurred, some of our competitors were a bit earlier in moving some of their investments to the cloud and did so as a way to differentiate from Guidewire. And so there was a bit more question marks around, hey, how would this evolve? Who would the long-term winners be? And we feel very good about the investments that we've made and the competitive position that we are in today. We still have a number of competitors that are very credible competitors. We still compete on a regular basis. But we clearly have seen our win rates improve and getting to levels that are akin to or even better than they were before the cloud transition occurred. My thesis and our thesis has always been that market leadership is going to matter more in the cloud than it mattered on-prem because it's one thing to trust a vendor to sell you software, then you take that software and run it behind your 4 walls and you manage it. It's another thing to entrust a vendor to kind of deliver that core system of record as a service. And so we think market leadership is going to matter more in the cloud domain, and that's part of the reason why we invested aggressively to ensure that we could preserve and extend our market leadership position as the industry moved about.

Sure. You did touch on in your presentation as well to the linearity that you guys are trying to more normalize throughout the model. Can you touch on kind of some of the sales initiatives that enable that, how that resonates with the maturation of the platform?

Yes, yes. Yes, so our business is -- these deals are fairly large and they can be lumpy. And in general, there's a certain number of modernization activities that might occur every year, and we tend to be involved in all of those conversations. As we moved into the cloud, what we saw was this kind of hesitancy to buy for a period of time as there was trying to appreciate the maturity of the platform, right? So nobody wanted to buy on-prem anymore because we're investing in cloud, but insurers are a conservative bunch. So waiting to see the maturity of the platform was paramount. As a result, we saw overall bookings kind of slow down during a period of time when those evaluations were occurring. And on a smaller quantum of deals, the sales team was very focused on hitting their annual number, and we saw our overall bookings cadence become more back-end weighted than it was previously on-prem. And that got to levels that were kind of not sustainable and not healthy. And so we've -- with our new sales leadership team, really been making a push to drive more linearity that included some comp plan incentives, but it also just included more sales management and driving the quarterly targets and holding people accountable to quarterly targets. Driving the monthly targets, we're seeing much better month-to-month linearity. But I think the biggest driver of our ability to do that is not comp plan driven, is not even behavior-driven, and it's the pipeline. It's the breadth and depth of the pipeline to kind of enable that. And also as targets increase, you recognize that, okay, I need to start making sure I'm doing more in Q1 and Q2 if I'm going to hit my target.

Sure, sure. And as a function of all of this as well, too, a part of the cloud transition is a ramped component of the deal structure. Can you talk without getting too into the weeds on the accounting, but can you talk about what that ends up looking like and how that kind of drive some of the visibility as you think about kind of the longer-term outlook?

Yes. So typically, when a customer decides they want to buy cloud, they think about what this is going to look for them and we enter into an initial contract term of 5 years. 5 years is our standard. We have examples that are longer than that, we have examples that are shorter than that, we have examples that are shorter. And then after 5 years, they move into an annual renewal cadence. And if you're a customer that's running a legacy system or maybe running a system from a competitor of Guidewire on-premise and you're going to go cloud, there's a lot of expense during the migration period. You're paying another vendor kind of license fees. You have to kick off a fairly large services program to go from on-premise to the cloud. And so there's a lot of non-Guidewire software expense that occurs during the first 2 years of a Guidewire relationship. And so it's not uncommon for us to discount the fees in year 1 and year 2, and they're also not fully utilizing the software at that point in time. The number I care the most about as the CFO is what is the fully ramped number we get to into that contract. So what is the terminal value by which we exit that contract because that is the ARR level that will set up the basis for ongoing renewals, hopefully for the next 20 or 30 years is that -- as we build that relationship with the customer. So we typically have 5-year committed contracts. There is, in many cases, a somewhat steep ramp. And that is a nice fact pattern from my perspective because I create this backlog of ARR that I get visibility into. I can model that out. We can measure the cohorts and have a pretty good perspective into how it's all going to play out.

And you pointed to the fact that even on the medium-term framework kind of operating at a bit ahead of schedule or ahead of plan on that. Can you dig into even some of those cohorts that you're seeing now, kind of the incremental contribution that gives you confidence in maybe that longer-term outlook?

Yes. So that was -- the big outcome of Q4 of last year was it just provided a lot of visibility into that particular cohort and how that cohort was going to play out from an ARR perspective. One of the things that you'll note when you dissect our guidance disclosures is that we're guiding to an ARR growth rate kind of around 13% this year and the implied ARR growth rate next year is then kind of 16%, 17%. So we are guiding to this accelerated growth rate in FY '25. Just like V-shaped curve, nobody likes to see accelerating growth. But we have a lot of visibility into the ramps underpin that outlook, and we provided some of that visibility in our Analyst Day and kind of a view of the cohorts. And so what jumped off of the page in Q4 of last year was the ramping events in year 3, which align to our FY '25. It's not uncommon for the first 2 years, that's when the services program is going on to see a little bit lower initial fees. And so we have really good visibility into that. And what we're seeing now is a healthy willingness to mid- to long-term programs. I think that's a symbol of the customers feel that the platform is mature, that they feel confident that they can make long-term commitments.

Sure, sure. Maybe one last one before kind of giving a high-level overview to wrap. How do you think about the partner side of the equation, right? And maybe the services component here? Because it seems like as the platform has matured, obviously, the partners see the opportunity ahead, too. And maybe there's a willingness or an enablement component that they're fully capable and functional now to help deliver. So there's not a capacity constraint internally.

Yes, yes, yes. Absolutely. So Guidewire has always had strong partnerships with the global SIs. I kind of referenced my visit to India. That blew me away. It was super energizing to see the commitment and the investments that they've made. Early in the cloud program, we kind of -- we've led more services programs and typically makes us comfortable, and that was because cloud was new. We had to go out and implement it ourselves before we could enable our SIs on how to do that. And now we're at a point where we're returning to more of a legacy model where the SIs are taking the lead on most of these implementations. That's great. This is a huge amount of work to do to modernize this industry, and we're thrilled that the SI see a big opportunity in partnering with Guidewire to tackle that work. The investments that they've made in certifying their personnel is a nice indicator of the opportunity that they see. So we are certainly supporting that. That came a little bit faster this year than what we had expected. And so it did create some revisiting of our services revenue expectations this year and kind of how we think about the margin profile. As I look ahead, I feel the services organization that we have today is the right size and scale to support us. It's a strategic investment. We need to have a world-class services organization to support customers. And if we're running that at a healthy level, at healthy utilizations, we have capacity to do a little over $50 million a quarter and can do that at a nice margin. We're not a services company, so we're not maximizing for services margin. But we think kind of getting into the high teens from a services margin perspective is appropriate. So that's kind of how we think about services.

Okay. Great. Maybe as one final one as kind of a form of parting words, Jeff. You've been in the role for a little while now. You've seen a lot of the overall business evolution. And as you're kind of on the other side of this inflection point, I guess, what excites you most about the next 5 years or 10 years opportunity for Guidewire?

I mean, the last 4, 5 years has been tremendous in terms of bringing organizational commitment and alignment around -- I'd like to say our 3 important objectives over the last 4 years was cloud, cloud and cloud. And so driving that type of focus and executing on that has been very rewarding and now to see. But what is really exciting is that now we have the opportunity to instantiate this platform that can unlock all sorts of opportunity when you build on top, right? And so that's the marketplace that we're building, where insure techs can access and build on top of Guidewire in a much easier way than you could ever accomplish on-prem. It also is exciting because it creates new ways for us to bring new capabilities that are easy to kind of tap in and build on top of a Guidewire. Some of that will be organic, some of that may be inorganic. But yes, that's what's really exciting right now as we look ahead.

Fantastic. Thank you, Jeff. Thank you, everybody, for listening in. We will continue the conversation in the Mara room upstairs. Thank you.