Duck Creek Technologies, Inc. (NASDAQ:DCT) Q1 2023 Earnings Call Transcript

Duck Creek Technologies, Inc. (NASDAQ:DCT) Q1 2023 Earnings Call Transcript January 5, 2023

Operator: Thank you for standing by, and welcome to Duck Creek Technologies’ First Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the call over to Brian Denyeau from ICR. Please go ahead.

Brian Denyeau: Good afternoon, and welcome to Duck Creek’s earnings conference call for the first quarter of fiscal year 2023, which ended on November 30th. On the call with me today is Mike Jackowski, Duck Creek’s Chief Executive Officer; and Kevin Rhodes, Duck Creek’s Chief Officer. A complete disclosure of our results can be found in our press release issued today, which is available on the Investor Relations section of our website. Today’s call is being recorded and a replay will be available following the conclusion of the call. Statements made on this call may include forward-looking statements regarding our financial results products, customer demand, operations, the impact of COVID-19 on our business and other matters.

These statements are subject to risks, uncertainties and assumptions that are based on management’s current expectations as of today and may not be updated in the future. Therefore, these statements should not be relied upon as representing our views as of any subsequent date. You should not rely on forward-looking statements as predictions of future events as actual results and events may differ from any forward-looking statements that management may make today. Additional information regarding the risks, uncertainties and other factors that could cause such differences appear in our press release and Duck Creek’s latest Form 10-K and other subsequent reports filed by Duck Creek with the Securities and Exchange Commission. We will also refer to certain non-GAAP financial measures to provide additional information to investors.

A reconciliation of non-GAAP to GAAP measures is provided in our press release, with the primary differences being stock-based compensation expenses, amortization of intangibles, the change in fair value of contingent earn-out liability and the related tax effects of these adjustments. With that, let me turn the call over to Mike.

Mike Jackowski: Thank you, Brian, and good afternoon, everyone. Let me first start by wishing all of you and your families a very happy new year. I’m pleased to report that Duck Creek is off to a strong start in fiscal year 2023 as we exceeded all of our key operating metrics in the first quarter. We continued our business momentum from the fourth quarter and signed a number of transactions with new and existing customers for Duck Creek’s OnDemand core products as well as our expanded portfolio of strategic insurance solutions like distribution management and reinsurance management. As expected, P&C insurers are successfully adapting to the changing macro environment, and we believe that insurance continues to be one of the better positioned industries in uncertain times.

This, together with strong execution and focus from the Duck Creek team, helped drive the quarter’s positive results. Overall, we are encouraged with our recent performance and the opportunity ahead of us for the remainder of fiscal 2023. We are certainly mindful of how fluid and uncertain the macro environment is, but we are confident in Duck Creek’s ability to drive continued profitable growth with our products that are critical for the insurance industry as they migrate away from legacy applications and adopt modern cloud solutions. On today’s call, I’ll provide some color on what we’re seeing in the market, highlight some key wins in the quarter, update you on progress towards some of our key priorities this year and highlight an important and strategic acquisition that we signed this week.

Let me start with a quick overview of our financial results for the first quarter, which exceeded our guidance on both the top and bottom line. For the quarter, we reported total revenue of $80.6 million, up 10% year-over-year. And this was underpinned by subscription revenue, which is our revenue derived from SaaS of $43.8 million, up 23% year-over-year. Our annual recurring revenue, or ARR, was $180.6 million, which resulted in 24% growth over the prior year. And we are also profitable in the quarter with adjusted EBITDA of $3.2 million, our 16th consecutive quarter of profitability. We believe our best-in-class SaaS platform continues to address many of the most pressing business challenges facing P&C insurers. Modernizing their core systems enables insurers to respond to market changes with innovative new solutions more quickly and provide a better customer experience more efficiently and cost effectively than legacy solutions can.

Duck Creek OnDemand’s ability to positively impact a carrier’s top and bottom line ensures that we remain a strategic investment priority even in challenging economic conditions. As we discussed on recent earnings calls, we have been confident that the various headwinds facing the economy, including inflation, geopolitical uncertainty and supply chain delays would largely be transitory issues for the P&C industry. Our confidence was driven in large part because the mandatory nature of insurance in many facets of life. In most cases, insurance is a requirement to operate a business, own a car or carry a mortgage, making it a nondiscretionary expense for most businesses and households. When you combine this with the ability of carriers to take rate increases to offset cost pressures in their business, we believe their willingness to invest in new technology solutions would improve.

So, while the economy remains uncertain and new spending continues to receive additional scrutiny, we believe our improved performance over the past two quarters has proven our thesis to be correct. In the first quarter, we signed 9 SaaS deals for a variety of our core and strategic insurance solutions with new and existing customers of all sizes. This includes a strong start, closing reinsurance management deals following the acquisition of Ephesoft. We are pleased with the pace and the mix of business in the quarter, which was an important demonstration of the success of our land-and-expand go-to-market model. Here are some highlights which reflect the breadth of our success. We made important progress on our objective to migrate on-prem customers to the cloud, signing HUB International, a global top 5 insurance brokerage, to migrate policy, billing and insights to Duck Creek OnDemand.

A customer since 2011, HUB chose to move to the cloud to further optimize customer service and maximize operational efficiencies while removing administrative overhead by automating workflows on the Duck Creek platform. This is a great example of the types of migrations we can look to. It highlights the growing interest among on-premise customers in deploying cloud solutions. We are pleased with the progress we have made with migrations and expect this to be an important growth driver for Duck Creek in the coming years. We had an another exciting win with a prominent Tier 1 insurer who selected Duck Creek Policy, Billing and Insights to modernize one of their strategic commercial line portfolios. Our ability to move with speed and agility, along with our demonstrable depth in their use cases made Duck Creek a standout technology provider.

This Tier 1 insurer was impressed with our software, service and hands-on support, and they chose Duck Creek because of our specialization in the commercial and specialty segments. We had a particularly strong quarter with our Distribution Management and Reinsurance Management solutions. We signed 3 new Distribution Management, or DM deals, in Q1 and including a significant DM agreement with one of the world’s largest Tier 1 P&C insurance companies. This global carrier has one of the largest networks of producer relationships in the industry and will leverage Duck Creek’s Distribution Management solution to bring even greater value to their channel partnerships. The ability to more effectively manage and communicate with agents has become increasingly important to many carriers, given the pace of change in the industry.

Duck Creek is leading this category as our largest competitors and many other P&C insurtechs do not have an offering in this space. As I mentioned earlier, we had a great quarter in Reinsurance Management, or RM, as well. We signed 2 Reinsurance Management deals in the quarter. Our first deal was a cross-sell win with Core Specialty Insurance, an existing full-suite Duck Creek OnDemand customer. We also had an RM deal that added a significant Tier 1 P&C U.S. insurer as a new Duck Creek SaaS customer. This is a great example of how Reinsurance Management can provide a new entry point into a new customer and provide us an opportunity to expand our relationship in the future. Both of these reinsurance wins are notable for the speed of which we signed them as they were originated and completed in less than 6 months following the closing of the Ephesoft acquisition.

We remain very excited about the opportunity in reinsurance, and we continue to receive strong customer feedback on the breadth and depth of our solution in the market. These Distribution Management and Reinsurance Management wins with existing customers are also a great example of the sizable cross-sell and upsell opportunity we have with our more than 100 existing SaaS customers. Another great example where Duck Creek is adding value to our existing customers is with Hollard Insurance, a leading international insurer who expanded their Duck Creek OnDemand deployment in Australia to include our global policyholder solution. Our policyholder solution will enable Hollard to improve real-time service to their premium paying customers through a modern digital channel.

We also continue to enable customer success by quickly bringing customers live on the Duck Creek OnDemand platform with 8 new implementations going live in Q1. Two notable go-lives in the quarter were: Novo, an exciting new innovative insurtech auto insurer who went live with Policy, Billing and Insights as part of their launch. Novo has a mission to redefine, reimagine and reinvent the insurance industry by shifting the power dynamic back to the consumer. A key part of their decision to deploy Duck Creek is our reusable and scalable deployment framework and architecture, which will enable them to deliver on their multistate rollout plans as quickly as possible. FCCI, a leading commercial and casualty insurer, went live with our Distribution Management solution, which when fully implemented, will make it dramatically faster and easier to onboard and manage the agent appointment process.

We now have nearly 75 customers live on one of Duck Creek’s core or strategic insurance SaaS solutions, which is roughly 75% of our Duck Creek OnDemand customer base. Our ability to get customers into production quickly often in only a few months is a key competitive differentiator and a significant value driver for insurers. On the product front, we continue to deliver leading insurance capabilities to our customers as part of executing on our road map. Our teams also remain focused on delivering core technology enhancements that will better enable and smooth the on-prem to on-demand transition. Automation is a key focus across our platform, and our product and engineering teams continue to improve end-to-end suite-wide connections to bring operational ease and efficiency to Duck Creek OnDemand customers.

In addition, we released several product enhancements in the quarter. The following three will help further our goal of expanding our strategic insurance solutions and expand internationally. We extended our leading Reinsurance Management solution to provide more functionality for international insurers, including the improved management of claims incurred but not reported, or IBNR; enhancements to our inuring update calculations and supporting international rate accommodations. We also launched a new line of business offering that will help insurers capture market share of the fast-growing pet insurance opportunity in the UK, which is expected to exceed £1.5 billion of gross written premium by 2025. The pet insurance market is still in its early stages of customer awareness, so we have developed an easy-to-use solution that combines relevant content, including 4 standard pet insurance plans, prebuilt partner integrations to enrich pet-related data and out-of-the-box mobile-first digital journeys for sales, service and claims.

We also launched our Policyholder OnDemand product internationally. As mentioned earlier, Policyholder will be deployed at Hollard Insurance as a charter customer in Australia. I’m very excited to announce that we further expanded our product footprint with the acquisition of Swiss-based Imburse, an exciting technology start-up who is connecting insurance to the global payments ecosystem with a modern digital payment gateway platform. Through this acquisition, Duck Creek will simplify the payment process for insurers by providing technology that easily integrates into multiple PSPs and digital payment options, providing greater choice and flexibility to customers. Imburse’s out-of-the-box offering allows insurers to go to market faster at lower cost with a broad range of payment provider choices.

This is a natural extension of our product vision to create solutions that solve critical business challenges facing insurers and their policyholders. Imburse offers a cloud-native platform that is purpose-built for the insurance industry, and we are confident that it will fit seamlessly into our land-and-expand go-to-market strategy. Our plan is to integrate the Imburse SaaS payment gateway platform into our Duck Creek OnDemand offerings and fully enable the use cases for premium payments, claim payments, agent and broker commissions, reinsurance fees and insured policyholder payments. This will unlock substantial value to our customers, and it’s also a fantastic growth opportunity for Duck Creek. Overall, it was a terrific first quarter, and we’ve gotten off to a strong start in fiscal 2023.

While we remain mindful of the macro environment and recognize that market conditions continue to create cautious buying behavior, we are executing well, and we believe that we are well positioned to deliver on our key financial and operational objectives for the year. We are encouraged by the continued growth of our pipeline and customer interest in core systems modernization. We remain confident that this will continue to be a top investment priority in the P&C industry for many years to come and will support strong, durable and profitable growth for Duck Creek. We are excited about the opportunity in front of us and are focused on delivering significant value for our customers and shareholders. I’d like to finish by thanking all of our employees, partners and customers for everything they do to make Duck Creek successful.

With that, let me turn the call over to Kevin to walk you through the numbers. Kevin, over to you.

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Kevin Rhodes: Thanks, Mike. Today, I will review our first quarter fiscal 2023 results in detail and provide guidance for the second quarter and full year of fiscal 2023. First, I’ll briefly comment on the pending acquisition of Imburse. We are really excited to have the Imburse team join Duck Creek. This is another strategic acquisition that we believe will position us well for the future as we integrate this technology with our core offerings. Now, let’s cover Duck Creek’s strong first quarter results. SaaS annual recurring revenue, or SaaS ARR, at the end of the first quarter was $180.6 million, up 24% year-over-year and up $11.3 million or 7% sequentially. The strong performance in SaaS ARR primarily reflects a strong start to the year for our business as well as approximately $1.8 million from contracts that were signed in the last two weeks of the first quarter that would not have been normally reflected in SaaS ARR under our prior calculation.

As a reminder, starting this quarter, we have updated the calculation for SaaS ARR to be the annual value of all active contracts in force at the end of the quarter, and the calculation is not dependent upon a full month of revenue recognition in the quarter. We believe this better represents our future expected revenue and will eliminate the timing impact of deals that are signed at quarter-end. We also think this is a more transparent metric. Total revenue in the first quarter was $80.6 million, up 10% from the prior year period. Within total revenue, subscription revenue, which is comprised fully of our subscriptions to our SaaS products, was $43.8 million, up 23% year-over-year. In the first quarter, subscriptions represented 83% of our software revenue.

Revenues from on-premise software licenses was $1.8 million and maintenance was $7.2 million. This represented 11% of total revenue and was in line with our expectations. We expect these line items to continue to decrease as a percentage of revenue, given the strong growth in our subscription revenue and the growing interest in our cloud migrations among existing on-premise customers. Services revenue was $27.9 million, down 6% year-over-year. The year-over-year revenue reduction reflects our ongoing efforts to have our systems integration partners manage an increasing portion of our implementations, while we focus our services teams on delivery assurance and the higher value-added components of a project. We’ve undertaken a conscious effort to make this a reality.

SaaS net dollar retention in the quarter was 107% and in line with our expectations. SaaS net dollar retention is likely to continue to be below some of the historic levels that we have seen, in large part due to the fact that on-premise migrations are not typically captured in our retention calculation. That has historically been a small part of our overall bookings but is expected to increase going forward as it did in Q1. Now, let’s review the income statement in more detail. These metrics are on a non-GAAP basis, unless otherwise noted. And we provided a reconciliation of GAAP to non-GAAP financials in our press release. First, on a GAAP basis, our gross profit for the quarter was $43.4 million and we had a loss from operations of $6.6 million.

We had a net loss in the quarter of $5.2 million or $0.04 per share based on a weighted average basic shares outstanding of 132.7 million. In our financial tables, you will notice a $645,000 expense related to severance. This was related to a modest workforce reduction we undertook at the end of November. We expect annualized cost savings from this action to be several million dollars. Turning to our non-GAAP results. Gross profit in the quarter was $46.5 million or a gross margin of 57.7% compared to 60.1% in the first quarter of fiscal 2022. Subscription margin in the quarter was 65.3% compared to 63.3% in the first quarter of fiscal 2022. As a reminder, there can be quarterly variations due to the timing of when revenue recognition begins for certain contracts and the timing of expenses at the early stage of new deployments.

We believe our subscription margins are an important demonstration of the scalability, ease of use and performance of our SaaS platform. Professional services margins were 35.8% in the quarter, in line with our expectations and our long-term target of the mid- to high 30% range. We continue to balance sustainable utilization rates and our ongoing efforts to increasingly leverage our systems implementation partners. Turning to profitability. Adjusted EBITDA in the first quarter was $3.2 million, which was ahead of our guidance, primarily due to better-than-expected timing of revenue in the quarter and our ongoing discipline around expense management. This represents our 16th quarter of adjusted EBITDA profitability, an important indication of our ability to profitably generate high levels of subscription revenue growth.

Non-GAAP net income per share for the quarter was $2.6 million or $0.02 per share based on approximately 137.4 million fully diluted weighted average shares outstanding. Turning to our balance sheet and cash flow. We ended the quarter with $264 million in cash, cash equivalents and short-term investments, and we remain debt free. Free cash flow in the first quarter was negative $7.4 million, which was a meaningful improvement from negative $25.5 million in the first quarter of fiscal 2022 due to improved cash collections and overall working capital benefits. I would now like to finish with guidance, but first, let me add some color on the acquisition of Imburse. In terms of timing, we anticipate closing the transaction within the next 30 days.

We are excited about this acquisition from a product and technology perspective as it will add to our lineup of modular strategic products that are integrated with our core platform. From a contribution perspective, Imburse has been operating as a startup. We anticipate it will contribute several hundred thousand dollars of subscription revenue and will negatively impact EBITDA by approximately $3 million, which is being included in our guidance today. We do expect Imburse to be EBITDA positive in fiscal 2024 as we launch it as a stand-alone product to the U.S. and have it integrated into our core suite. Inclusive of Imburse, we expect our second quarter results to be as follows: total revenue of $79.5 million to $81.5 million; subscription revenue of $43.5 million to $44.5 million.

This equates to about 16% to 18% subscription revenue growth after taking into consideration approximately $2 million of onetime subscription revenue in the second quarter of fiscal 2022 related to a contract buyout. We expect adjusted EBITDA of $4 million to $5 million as we had some expenses defer from the first quarter and into the second quarter, and we will pick up some of the incremental expenses from the Imburse acquisition. That said, we are looking to — for acceleration of EBITDA in the second half of the year. And lastly, our non-GAAP net income is expected to be in a range of $3 million to $4 million or $0.02 to $0.03 per fully diluted share. For the full year of fiscal 2023, we are raising our guidance as follows: total revenue of $331 million to $338 million; subscription revenue of $177 million to $181 million; adjusted gross margins are projected to be at 60%; we expect adjusted EBITDA of $26 million to $28 million, an increase from our previous guidance; and lastly, our non-GAAP net income is expected to be in a range of $17 million to $19 million or $0.13 to $0.14 per fully diluted share.

We continue to take a prudent approach to forecasting deal close rates. While our go-to-market team did a great job in the fourth quarter and now again in the first quarter, we are continuing to adapt to the increasing scrutiny on all transactions. And while we are encouraged by our performance, the macro environment remains fluid, and we believe it’s too early to assume further improvements. To wrap up, we are pleased with how we performed in the first quarter and our position heading into the remainder of the year. We’re at the early stages of a global growth opportunity and believe that we are well positioned to build upon our results in fiscal 2023 and beyond. And with that, we would now like to open the call up to questions. Operator?

Q&A Session

Operator: Our first question comes from the line of Dylan Becker of William Blair. Please go ahead.

Dylan Becker: Hey, guys. Thanks for taking the questions here. Maybe on the macro, starting off, Mike. Maybe some of the puts and takes you guys are seeing in hearing from customers. You’re starting to maybe see rates go up for the first time. You may be seeing some of that inflationary pressure ease slightly relative to used autos and some others. We’re clearly not out of the woods yet. But how should we think about that landscape evolving over the next, I don’t know, what, 6, 12 months and unlocking some of that willingness for modernization? Maybe that has been somewhat of a gating factor that led to some of the elongations we saw in the last couple of quarters.

Mike Jackowski: Yes. Thanks for the question, Dylan. Yes, we — as we’ve communicated all along, we’ve seen — we’ve continued to see a strong demand in the environment and interest from insurers to invest in their technology. But we are seeing, as you indicated, that they are adapting to changes in the market conditions. And really, this comes down to their ability to recapture their loss cost pressure by taking more rates in the industry. Now, we are seeing the carriers on the commercial side of the business are getting some rate more quickly. We saw the earlier half of the year, carriers were able to get more rates in. On the personal lines or consumer lines, it takes a little bit longer just because of the regulatory environment.

There’s a little bit — there’s more challenges getting rates through there. But overall, what I would say is insurance companies typically have just a long-term horizon and they look at investing over the long term. And I think they are getting more comfortable. But with that, they’re keeping top of mind transformations, cloud deals. We think that the environment has improved a bit from a year ago, but we also recognize it’s still a challenging environment and deal cycles do remain elongated today. But we do feel better about it, and we feel like we’re operating very well under the current conditions right now.

Dylan Becker: Got it. Yes. I think that’s evident in the results but it’s good to hear as well. Maybe switching over to the Imburse acquisition, too. Could you dig into, again, obviously, insurance is a complex landscape, but the complexity of payments in this ecosystem relative to maybe other verticals and how it can unlock? I think there was a lot of information on their website around things like parametric insurance, things that can be unlocked with kind of some of that real-time payment capability. Could we dig into that a little bit? Thanks.

Mike Jackowski: You bet. And when insurers really look at how they have to work with payments technology, there’s a couple of things that they’re really looking at. They’re looking at, first, how do they plug into various PSPs or payment service providers and what are the best ways to connect? The second thing they look at is the overall workflows on behalf of the premium paying customer, whether they’re paying their premium or receiving a claim payment or with their distribution channel. And then finally, what they look at also is overall reporting and balancing and reconciliation of those payments. And so Imburse, what they do is give us a nice way to plug into those PSPs, manage that overall insurance processes and those workflows as well as all the reconciliation and reporting.

And this is certainly an issue that carriers are always dealing with. And having these capabilities preplumbed into our backplane, where in our SaaS solutions, we can manage the processes of policyholder payments and claim payments and even managing commission payments back to the agent, we think this is a real strong opportunity for Duck Creek.

Operator: Our next question comes from the line of Saket Kalia of Barclays. Please go ahead.

Saket Kalia: Mike, maybe just to start with you. That was like some good traction with those strategic products that you mentioned, Distribution Management and Reinsurance Management. I was wondering if you could just dig into those products a little bit for us. Remind us how those products are priced, maybe a little bit about the competitive landscape. And also, if tactically those tools can also work with your competitor core solutions. A lot there. Does that make sense?