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

Thank you, everybody. My name is Dylan Becker. I'm the research analyst here at William Blair that covers Guidewire Software. We have the CFO, Jeff Cooper, here with us today. Jeff, thank you for joining us. Before we get started, he's got a presentation. We'll run through about 10 or 15 minutes on the background on the business. Before that, all of the necessary disclosures for this presentation and the conversation can be found on williamblair.com. With that, Jeff, I'll pass it to you.

Great. Yes. Thank you. I appreciate everyone joining me today. I will run through these slides pretty quickly, and then we'll get to the Q&A session. Guidewire is a software company, 100% focused on one mission, and that is delivering agility to the P&C insurance industry through a cloud-based platform that focuses on the core operations of an insurance company. We sell policy administration, claims management and billing systems into the insurance industry. And we do that via our cloud delivery platform, which you might hear us call Guidewire Cloud Platform. The industry that we serve is a very important one and it is one that is pretty concentrated at the high end, but then highly federated as you kind of move down in the tiers of insurers. And Guidewire has done a good job over the life of the company, meeting the needs of some of the largest and most complicated insurers and so has done a really good job tackling that top of the pyramid, that 80 insurers that make up a very meaningful part of the industry, but also delivering a platform that serves the needs of kind of what we call Tier 2 and Tier 3 and below. We kind of operate across the P&C insurance market, and that would include both personal lines and commercial lines. These are obviously -- many of these lines of insurance are nondiscretionary, so highly durable end market that we service. And it's an industry that's going through a lot of change. We've been seeing inflationary impacts, regulatory impacts. And so our platform is here to help them address all of those requirements and make sure they operate efficiently. Many of these arrangements that we sell into are quite complicated. And at a larger insurer, our software really sits at the center of their operations, and it's not uncommon for there to be upwards of 100 or 200 integration points into our software. Many of those integration points are to one-of-a-kind systems, legacy systems that exist within an insurer's IT landscape. So this is a very hard problem to solve and a hard problem to solve in a cloud context. We have spent and some of you may have been along the journey with us as we've kind of transitioned the business to the cloud, but invested quite heavily in our cloud platform to support our ability to deliver these core transactional systems of record in a cloud context. It's a hard problem. And we're just talking about the throughput and what our engineering team has been able to deliver because I think it is really tremendous what they've been able to accomplish. But these are very kind of important systems with many touch points. This is a view into kind of how we think about our suite of applications. The big investment that we've made over the last 5 years is on this cloud infrastructure side and the core services side that support our application layer. And now we have a lot of core services that have been kind of delivered more as a cloud-native micro service that is helping a lot with the efficiency in terms of how we deliver our core business applications. But the business applications are the ones that I mentioned, policy centers, policy administration, claims centers, claims management and billing center is the billing system to support the core functions of an insurer. InsuranceNow is a product that we sell to smaller insurers that covers all of those kind of core functions in a single suite, and that's the core of our product portfolio. And then we sell some analytics applications and other applications that are attached opportunities to the core suite. We maintain a very robust ecosystem. A big part of our strategy is working with the global SIs to help us modernize this industry together. We intend to deliver the software, and we are happy to have them kind of tackle the very important services work. They do maintain a highly strategic services organization as well. But that they do a very small fraction of the overall work that's being done in the industry. And more and more, as we deliver a common cloud platform and service to the industry, we're creating an opportunity for third-party software vendors to build and integrate into that common cloud platform, and that's creating a marketplace of ISVs that we work with as well. So this is creating a pretty exciting ecosystem for us that we sit at the center of. The momentum has been strong recently. So we've had -- this is an industry that is conservative in nature and risk averse. And the shift to the cloud is a very consequential one, especially in this use case. And so we have seen a very measured approach to the cloud, but we are now starting to see the impact of the investment and the referenceability of some of our early cloud customers is helping accelerate demand. And that is a big part of this industry, word of mouth and referenceability is something that is very important. And we get asked a lot around other macro drivers that's driving this acceleration right now. And the answer is no. The answer is this is really the micro of the blocking and tackling of delivering the platform proving the referenceability so that CIOs at large insurance companies can feel confident that this is a good time to make this shift. I need to modernize my stack. This is something I've been delaying for too long, but now is a good time to go. And so that's showing through in how we think about ARR, but also subscription and support revenue. And the margin story as well, if you look at the subscription and support gross margins, you can see not too long ago, we were at 44%. That was coming out of a pretty meaningful investment cycle. We also knew how important referenceability was in the early part of this journey. And we invested in building out a cloud operations function to make sure that all of those early cloud customers were successful. So we threw headcount at the problem initially and then work to kind of deliver the platform that would drive more efficiency and automation. And that strategy has played out. Those early cohorts were absolutely critical to make sure that they were successful. And now we're realizing a lot of the investments we made in the platform, and that is showing through to the gross margin line. Subscription and support gross margin line is the most important number on this page. It drives overall gross margin and operating margin in a meaningful way. And then we just had our earnings call on Tuesday. It was our Q3. It was a very strong Q3 for us. From a seasonality perspective, Q4 is always our strongest quarter, and then it's usually Q2 and then Q3 and then Q1. But this Q3 had a nice designation of being more meaningful than Q2 for us, which is a little bit unique. And our CEO referenced that it was our third strongest bookings quarter in history. Our Q4s are always very strong. So you can -- but that was something that we're excited about. And then we were able to update our guidance ranges for the fiscal year. And this is just a reconciliation page. And then I think we can move to Q&A.

Perfect. Maybe that's a good place to start as well, Jeff. You highlighted kind of the recent strength in the quarter that you guys just reported earlier this week. We talked about the investments that take place to kind of get to this point from a cloud perspective. Can you maybe kind of double-click on why all of that is resonating now from a market perspective? And what's giving carriers the confidence to invest in these cloud core systems?

Yes. I think this was an industry that is very measured, very thoughtful and very pretty slow in going to the cloud, especially for this use case. And this is a hard decision for us as a kind of company to think through when do we -- because we had a very highly profitable business on-prem and are viewed as the market leader. But we knew long term that was not the optimal way to deliver software to the industry. It was not the optimal way to deliver innovation to the industry. And so when do we kind of think about this transition and how do we make the switch? I think when we finally kind of said we're going to go down this path, we moved with a lot of intention. But it did change how the industry thought about adopting core. I think you saw insurers decide to sit on the sidelines for a period of time and wait and see how the cloud transition would play out, maybe doing smaller initiatives, kind of testing the water style initiatives. And then we've kind of worked through that over the last 2 or 3 years. And now we have enough referenceability on the platform. We have enough customers on the platform that we're seeing higher confidence that, okay, now is a good time to make bigger commitments. Two years ago, we were seeing -- I'm going to take one of my lines of insurance to the cloud or I'm going to do PolicyCenter in this line, but I'm not going to do ClaimCenter. And so now we're seeing much bigger commitments. And so that's an exciting place to be.

And maybe it's a good point because I think that was a big takeaway out of the earnings in and of itself is not only deal velocity has stepped up, but also the size of those commitments to your point. How do you think about -- I think you mentioned earlier in the presentation, that 100 to 200 kind of integration points within the core today, what that looks like from a vendor consolidation kind of opportunity for the business over time as you get more of those core components across the end-to-end nature of a book from a P&C perspective.

Yes. We are certainly seeing more willingness to adopt more broadly Guidewire throughout. And we are seeing -- it's not uncommon for especially large insurance companies that have been acquisitive to have, in some cases, 5 or 6 different core system vendors and pockets of their business. And so cleaning some of that up and standardizing is something that we're seeing a bit right now and is working to our benefit. And then there's like -- if you think about all those integration points, most of those are kind of internal systems and so not something that a vendor would consolidate. But there is a lot of stuff that we're doing with our insurtech partners to bring more innovation to the marketplace as well.

Yes, yes, for sure. And maybe obviously, the momentum is very clear, but how should we think about sort of the overall opportunity ahead? Where do we sit relative to the cloud transition as it is today and then the opportunity to continue to increase as well?

We're still early. And when we think about our strategy, Phase 1 of the strategy is executing on this cloud transition and aggregating a meaningful part of the industry on a common cloud platform. And then that opens up just so much opportunity for us to sell through and kind of bring new products there. But in terms of the Phase 1, I think we're seeing really healthy momentum. We have now about 50%, a little over 50% of our customers are on the cloud journey with us, but there's still 50% that we have to go and still work through. In addition to the amount of the industry, which we estimate is in the range of kind of 40% to 50% that still runs on mainframe-based systems in terms of the workloads that exist in the industry. So there's a lot of work to do just on kind of getting to this Phase 1 state of aggregating the industry on a kind of highly efficient, highly effective common cloud platform.

And if we think of those 2 pillars, not only the migration opportunity, but the ability to expand as they look to land larger as well as kind of that 50% of legacy systems, what does that mean to the business from kind of a durable ARR perspective?

Yes. It creates a very healthy backdrop for us to feel confident in the TAM that we have, just right with the core business that we're operating in today to drive -- we talk about being a long-durated durable mid-teens grower. We have some metrics that around fully ramped ARR that we've talked about that have been growing faster than that, that gives us reason to believe that maybe we can grow a little bit faster than that, but our ambition is still the same. It's just to kind of create a very long durated durable grower.

Sure. And maybe from a profitability perspective, right, we've seen kind of the inflection in the model as a function of this transition as well. We've seen highly efficient vertical software models in the past, too. But how should we think about Guidewire in that context?

Yes. So as we embarked on this cloud transition, we unveiled what we called our midterm and longer-term targets to help investors understand the trajectory because we did kind of negatively impact margins and then now we're kind of returning them to a healthy level. And so we have those targets set out for -- we now are kind of -- our FY '25 was our original midterm targets and now FY '28 was our original long-term targets. Those are now kind of our midterm targets. And then we have a longer ambition around what we call our 80-40 plan, which is getting to 80% subscription and support gross margin and 40% operating margins. And everything that we see in the business, we feel confident in our kind of path to that. The time line to that is a little bit uncertain, and there's so much opportunity to invest in areas that are adjacent and kind of add more value to the insurance offerings that we offer to customers today that somewhat depends on kind of how growth tapers to when we ultimately get to those kind of terminal margins, but that's how we think about the long-term margin potential.

Sure. And coming from the CFO seat as well, it's a good place to be to have the opportunity to kind of pull each of those individual levers as well. But how do you think about that balance of capitalizing on what seems to be kind of an uptick in momentum from a carrier perspective and willingness to adopt more of the software versus that sustained kind of margin inflection given the balance between the 2?

Yes. Yes. We, as a management team, are very focused on if we can drive incremental growth, that's what's going to drive most enterprise value and shareholder value. So it's a growth orientation, but we also recognize that we service an industry that moves at its own pace. And so we are not going to kind of throw money at growth that we don't think will materialize. And so we're going to be very disciplined about that. As we think about areas of spend -- within R&D, that's where there's the most area for us to maybe accelerate some investment. But our team there has been quite disciplined and has an orientation that adding a lot of headcount doesn't necessarily drive incremental productivity or efficiency and sometimes that can create disruption. And so they've been pretty cautious and measured about how they think through. We have the largest engineering team. We have the largest investment. So we feel confident that we can continue to drive innovation and new product creation largely with the team that we have today. From a sales and marketing perspective, we have the largest sales and marketing organization in the industry. We service a vertical market. We know everybody in our market, like we are very close to our customers and our prospects. So it's not like we need to add breadth from a sales and marketing perspective. There are investments like we made some investments in customer success. We've made some investments in more strategic advisory for Tier 1 insurers that are so critical to our ability to execute towards our TAM. But in general, we have really good coverage and so don't feel the need that we need to rapidly grow sales and marketing spend. And then G&A is about just driving more operational efficiency. And so you won't see a lot of growth. So I think as we thought about our targets, we feel even if we can drive accelerating growth, not necessarily need to kind of spend a lot in order to capture that.

Sure. Sure. And you touched on kind of the momentum that you're seeing in Tier 1 and Tier 2 a second ago as well. As we think about the competitive landscape, what does that look like? How much of it is actual or if they're external to the vendors? How much of that is internal? How should we think maybe even across the carrier segment of the ecosystem there?

Yes. So there's a healthy competitive environment. We have a number of competitors. Most of our competitors are now private equity owned capacity. We have a lot of pride in the amount that we invest and kind of how our engineering team is driving innovation into the industry and differentiating. And our thesis in the cloud has always been that market leadership is going to matter a lot more in the cloud domain than it mattered on-prem. It's one thing to buy software from a vendor and run it behind your 4 walls. It's another thing to rely on a vendor like Guidewire to run a mission-critical service for you as a service. And so that was part of our thesis. And I think that's playing out. It's hard to compete with the -- when you kind of build the scale and the investment that we have. However, there are certainly a number of credible competitors, and we see all of these deals go to RFP. Our win rate has been quite strong recently as these investments have been realized.

Sure. Maybe you could talk to the positioning and the opportunity of the partner ecosystem in support of that kind of competitive positioning as well, too. You talked about the SI piece, but also maybe talk about kind of the technology ecosystem as well, too, and what that means from a platform profitability.

Yes. This is a very exciting part of the story from my perspective. And it was a part of the story that we were just not able to unlock on-prem because our customers had implemented our software in such different ways that it was hard for third parties to build on top of Guidewire in that context. And so as we move to the cloud, we get all of our customers on a common cloud architecture. We are investing aggressively in the ecosystem of insurtech vendors that can then integrate into that environment. Our CEO came from Salesforce and was attuned to how Salesforce built this out. And so I think this is a very exciting part of the story for us. It also creates an avenue for M&A or other activities. But getting the cloud done is the most important thing to unlocking that. And we talked about over 50% of our customers are now on the cloud journey, but a smaller number is fully running and operational cloud because there's lots of work going on implementing and going live and doing all those activities. So that's a -- I think the team is doing a really good job building out that marketplace and even thinking through kind of how the long-term economics would work. But right now, it's still a little bit dependent on kind of running through the base of the cloud transition..

Sure. And it's very clear the transition that has taken place within Guidewire as a business. But if we think about the industry as well, can you talk about kind of some of the factors that are pushing for digital change, if you will, around consumer expectations, frequency and severity, a handful of things that are helping validate the motion that Guidewire is bringing to market.

Yes. I mean, The industry is -- it's a nice industry to service because there are those pressures, but it's also such a durable nondiscretionary industry that the industry has kind of been adopting and reacting to those in a very measured and conservative way. As a market leader in this industry, that gives us a little bit of an advantage because we can watch how certain things are adopted, digital disruption, GenAI, cloud and other verticals that have moved faster and then apply those best practices and do that with intention rather than doing a lot of testing and other things and having failed experiments. So our experiment hit rate is very high. But the industry is always under a lot of pressure, regulatory pressure, pricing pressure, inflationary impacts. And so the ability to have a system that can support you with more agility is becoming more and more important, especially as your competitive set adopts those kind of systems.

Sure. And if we were to think about how you go to market kind of the pricing mechanism on a premium basis as well, too, how should investors be thinking about?

Yes, a good point. So we price our software on basis points of an insurer's direct written premiums or effectively their revenues. And so that is always in our pricing model. It works really well. It aligns to the value that we deliver. It's also how insurers think about their income statement. They think about IT spend as basis points of direct written premium. And so we fit into how they think about it. And an environment helps a nice fee-based model and kind of an environment where some seats are coming under pressure from agentic models and other types of models. So it's been a good way for us to go to market. We also capitalize on a bit on our customer success. So as our insurers grow their premiums, they will move through baselines in the contract, and we can charge true-ups as they grow, we also grow.

Sure. And you do have your own internal services function as well. Can you maybe speak to the strategic nature that helps you kind of understand those problems and pain points for customers that may help curate a little bit of that innovation road map as well.

Yes. I think our service -- we think about ourselves as a software company, first and foremost. But a big part of Guidewire's success throughout the history of the company has been this focus and dedication on driving successful outcomes. Core system replacement and modernization projects throughout the industry are ripe with failures and our track record on this is very, very strong. And it's a big part of kind of why we're able to be successful. Our partners do an amazing job. And as global SIs do 80% to 90% of the work associated with Guidewire implementations. But our services team is kind of tip of the spear, especially as it relates to new capabilities, and they're the best of the world. And so we can drop them in if the project starts to go a little sideways to make sure that we drive the right outcome. So we do a little over $200 million of services revenue. We try to make sure that we -- it's very strategic for us to maintain that services capacity. And so kind of growing that much slower than software, but kind of maintaining that kind of resource that Guidewire is very important for us.

Sure, sure. And we kind of hinted at it a few times here as well, too, but you serve as a foundational system of record for the industry, right? You help facilitate a lot of those core complex workflows. How do you think about the advent and opportunity for AI to help kind of drive process efficiency throughout insurance business?

Yes. I spoke earlier that this industry tends to get technology laggard. And so that gives us the luxury of being able to watch what works in other places. We may not have that luxury with GenAI or some of these -- because this industry is so ripe with unstructured data and manual processes that GenAI lends itself very well to helping with. In many cases, there will be a human-in-the-loop, but there's a lot of very interesting use cases. We have investments in infusing it into the core product set. We have investments in new adjacent areas. One of the ones that we've talked about is the submission intake process for commercial lines of insurance, how much documentation and unstructured data goes to in those submissions and how inefficient that process is today. And then we have use cases around how we do code development. We have use cases around how we support services engagements. One of the biggest hurdles to adopting our cloud application is the cost and uncertainty of the services program to get from point A to point B. And we always like to say, if we can bring down that cost of services associated with the cloud migration by 50%, we would double demand because that's often the biggest sticking point. And we have a number of initiatives around kind of how we use GenAI to assess the legacy environment and modernize. So there's endless use cases here. And we believe that we will have permission to drive a lot of these use cases that are more horizontal across the P&C insurance industry. And then the SIs are working with customers on more kind of highly specific customer use cases. But I do believe that this industry is going to be on the front foot as it thinks about adopting. And that's good for us from an overall demand perspective because if you're running a 40-year-old mainframe-based system that's on a back processing arrangement, you're not set up for success in a GenAI world, and that is certainly part of the message that our sales team is delivering. And I think that's resonating. I ask my team all the time, is it driving some of this acceleration in demand? I think it feels like what's driving this acceleration in demandand is just the referenceability of the platform and the blocking and tackling, but I also think that this backdrop is helping.

Is that maybe helping too, with the conversations that you're having with that on-prem-based compliant and support as you kind of think about end of life and transitioning into support for one singular system?

Yes, I think that's right. I mean I think it's more acute if you're running a legacy system rather than a modern on-prem system. But everybody is thinking about how are they set up to capitalize on some of these themes..

Perfect. And we've covered a lot of ground here today, and it's been incredibly helpful, Jeff. Thank you. Maybe if we were to -- I mean, again, the company has come a long way as we think about kind of the initial iteration of moving to the cloud 5 years or so ago. If we think about what the next 5 or the next 10, right, talking about durability here can look like for the business. what excites you the most about the opportunity ahead? And what's kind of your measure, the way that investors should think about kind of tracking that success over time?

Yes. Yes. I mean, I think, what excites me is once we get through this cloud transition is this opportunity, we've built this platform that the industry runs on and the opportunity to just flow more innovation through that platform. Some of that will be just kind of building out new capabilities on our ClaimCenter and PolicyCenter products. So a lot of that will be kind of new products that we can attach and focus on. We did a small acquisition in the quarter for a European company that does pricing. And so moving into pricing and rating is an area of ambition that we have. Our systems today can be thought about as being focused on what we call post bind. So once the policy is found, it comes into our policy administration system, we manage the claims. There's a ton of work that happens prebuying in the underwriting process where you price and rate insurance policies that we can have a more active role in. So there's a lot of new opportunity out there that's exciting for us as we look ahead.

Perfect. I think that's a great place to wrap for now. Jeff, thank you very much.