Guidewire Software, Inc. (NYSE:GWRE) Q1 2023 Earnings Call Transcript

Guidewire Software, Inc. (NYSE:GWRE) Q1 2023 Earnings Call Transcript December 6, 2022

Operator: Greetings. Welcome to the Guidewire First Quarter and Fiscal 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Alex Hughes. You may begin.

Alex Hughes: Thank you, operator. I’m Alex Hughes, Vice President of Investor Relations. And with me today is Mike Rosenbaum, Chief Executive Officer; and Jeff Cooper, Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today as well as in our related Form 8-K furnished to the SEC, both of which are available on our Investor Relations section of our website. Today’s call is being recorded, and a replay will be available following the call. Statements made on the call today include forward-looking ones regarding our financial results, products, customer demand, operations, the impact of local, national and geopolitical events and 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, which should not be relied upon as representing our views as of any subsequent date.

Please refer to the press release and the risk factors and documents we file with the SEC, including our most recent annual report on Form 10-K in our quarterly report on Form 10-Q to be filed with the SEC for information on risks, uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements. We also will refer to certain non-GAAP financial measures to provide additional information to investors. All commentary on margins, profitability and expenses are on a non-GAAP basis, unless stated otherwise. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are also posted to the supplement on our IR website. And with that, I’ll now turn the call over to Mike.

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Mike Rosenbaum : Thank you, Alex. Good afternoon, everyone, and thanks very much for joining us today. We’re off to a solid start in the fiscal year with steady and consistent execution towards our goal to modernize the technology platforms supporting the global property and casualty insurance industry. ARR and subscription revenue both finished ahead of our expectations and notably, subscription and support gross margin came in better than our expectations. You have heard me say before that we feel privileged to serve a critical and essential industry, one that helps families and businesses manage risks so that they can better plan and grow Insurers need an agile core platform that effectively engages, consumers that supports faster innovation with new products and distribution channels and that enables them to grow efficiently.

Guidewire Cloud Platform delivers this agility, and I’m pleased to share the progress we continue to make in expanding its depth, adoption and deployment. The momentum around Guidewire, our ecosystem and our cloud platform was on full display at our recent connections conference held in October in Las Vegas. With nearly 2,800 people attending in person, we saw record attendance more than doubling from the prior year and representing broad participation across customer segments, partners and regions of the world. At Connections, we announced Flaine, our sixth platform release. Flaine built on our previous releases to deliver improved self-service tooling for faster production deployments and introduces a new approach to release updates. Cloud customers can now update their implementations to new releases far more easily, which will structurally change how customers approach upgrades allowing them to stay on the latest Guidewire version and take advantage of platform and application innovation more continuously.

We also released our digital framework Jutro which enables customers to launch new digital experiences built on InsuranceSuite quickly and easily. Together, these product capabilities provide much greater speed and agility to our customers, and help us manage our customers’ cloud deployments far more efficiently. But the real highlight of Connections was hearing customers share their cloud visions, journeys and outcomes with Guidewire. USAA, which has served U.S. veterans and their families for 100 years and has over 13 million members, is halfway through a multiyear modernization journey to increase engagement, innovation and efficient growth. Guidewire Cloud Platform is a key foundation of this journey and already USAA has been able to introduce a touchless claims experience for members and launched its new small business insurance line of business in less than nine months.

Tryg the largest property and casualty insurer in Scandinavia with over 5 million customers move to Guidewire Cloud platform with the goal of fully automating the claims process to further drive efficiency and customer satisfaction. Tryg has already been able to reduce the amount of time spent per claim by 26% and the percentage of claims leakage by 58%, while also significantly increasing customer satisfaction. AOE Insurance, part of Insurance, the eighth largest insurer in the world was able to replace its core system with Guidewire Cloud platform in 12 months, and through greater flexibility, security and optimization, they were able to double their new business capacity by reducing manual steps and cutting claims acceptance time and half.

As we continue to increase platform maturity with each release, we are driving healthy adoption across existing and new customers. Over 20% of our core InsuranceSuite customer base has already adopted Guidewire Cloud Platform and we added another four cloud wins in the first quarter. Buda Group, a Swiss Tier 2 insurer, founded over 125 years ago, chose to upgrade to InsuranceSuite on Guidewire Cloud Platform for a major part of its book of business to achieve greater operational excellence. Boda Group initially adopted InsuranceSuite self-managed, but before deploying, elected to upgrade to Guidewire Cloud. Santa Lucia SA, a Tier 2 insurer in Spain, selected InsuranceSuite on Guidewire Cloud Platform for their largest line of business, funeral insurance and end-of-life support.

Santa Lucia decided to modernize policy, claims and billing on GWCP because of our market-leading presence, combined with our platform adaptability and flexibility. This is our first InsuranceSuite cloud customer in Spain, and we’re excited about the future potential in this market. Builders, a midsized mutual insurer specializing in workers’ compensation and construction operating in 22 states, selected full InsuranceSuite on Guidewire Cloud platform to replace their legacy mainframe-based system and to establish a new technology framework that improves their customers’ experience, increases productivity and supports future growth. Finally, RVOS Farm Mutual Insurance based in Texas adopted InsuranceNow for its functionality, configuration, upgradability and self-service capabilities.

In addition to these cloud decisions, we also saw three insurers including one in Japan and one in South Africa, ought to begin a modernization with Guidewire on-prem. While the vast majority of sales activity over the past few years has been cloud, we do see cases where an insurer decides it makes sense to begin on-prem. Our technical approach facilitates this path and our perspective is that as long as the customers understand the strategic direction we are following and acknowledge that an eventual transition to cloud will come, we can support this approach. In one of the deals in existing Tier 1 on-prem ClaimCenter customer selected PolicyCenter for a new modernization project, to support specialty lines. In another, the selection was based on the native integration of data and analytics into ClaimCenter, which will enable the creation of a better claims experience through real-time modeling and targeted straight-through processing.

This example supports our strategy to deliver a fully modernized score platform with data and analytics embedded throughout the insurance life cycle. We also saw HazardHub continued to accelerate in the quarter. This was highlighted by a meaningful deal at Frontline Insurance Company, a large home and commercial property insurer operating in Florida, Alabama, Georgia and the Carolinas. Frontline will use HazardHub’s granular risk scoring for their direct-to-consumer business, Open House, to inform customer acquisition and core underwriting strategies. We are very pleased with the continued success of this product as it offers us a new faster sales cycle and a more flow-based business that might in the future, complement our core system sales dynamic.

Turning to operations. At Analyst Day, we talked about our focus on driving improved platform efficiency as we expand breadth and adoption. In the first quarter, this translated into progress in subscription and support gross margins. This is an area we will continue to stay focused on and expect to improve steadily as we deploy more customers in the cloud, roll out new self-service capabilities and generally improve the efficiency of our cloud platform, while at the same time, always continuing to ensure that our customer implementations are resources managed to ensure that the greatest possible degree of success. In the first quarter, we executed a number of new InsuranceSuite production deployments on Guidewire Cloud Platform, including DEFINITY Insurance, a Tier 2 insurer in Canada known for industry-leading innovation, a two-time winner of Guidewire’s Innovation Awards, migrated to Guidewire Cloud platform with over $2.5 billion in personal lines and production.

Already, it is seeing 40% faster consumer transactions, 12% faster broker transactions and an 8% increase in quote volume. We also saw a Tier 2 insurer with over 90 years of history, offering auto, homeowners and other personal lines to members in 23 states go live with ClaimCenter on Guidewire Cloud Platform. This deployment lays a strong foundation to build on as this customer embarks on further transformation. In addition, a large farm mutual insurer in Texas went live with InsuranceSuite on Guidewire Cloud Platform. This is a company with over 100 years in operation and Guidewire Cloud platform will help them maximize operational efficiency as they pursue further growth. And finally, let me just close by discussing our partner community and ecosystem.

Our system integrator community has been and will remain critical to our differentiation and long-term success. SIs are currently involved in over 60 Guidewire Cloud projects and growing this total will remain a strategic focus for us. The number of Guidewire consultants at systems integrators grew to over 20,000 at the end of Q1, up by 28% year-over-year. We also continue to see cloud momentum build in this community with a number of cloud certified consultants, sustaining growth of over 100% year-over-year and passing 5,800 at the end of Q1. This gives our customers a valuable bench of cloud trained professionals to draw on as they start down the path of modernization or embark on cloud upgrades. We are also seeing momentum in our solution partner community.

In the first quarter, 19 more solution partners joined Guidewire’s Marketplace, bringing the total to nearly 180. We also announced a few important new strategic partnerships at Connections. We partnered with One Inc., a digital payment solution for P&C insurers that offers comprehensive digital payment options and automated inbound and outbound payments. Our collaboration will make it possible for our cloud customers to deploy these solutions significantly faster than they were able to in the past. We’ve also partnered with Appian, a leading workflow automation platform, to enable our cloud customers to rapidly create and manage cloud-based digital experiences and business process automation. And we partnered with Ernix, a leading dynamic pricing engine, to accelerate insurers’ speed to market in defining, updating and optimizing insurance products that are already in market.

In summary, Q1 was a great quarter and a solid start to the fiscal year. We continue to expand our platform in critical areas. We continue to sell new modernizations and cloud upgrades. We continue to expand our ecosystem and deliver successful production go-lives and continue to make steady progress on cloud operating efficiency. All of these critical elements of our plan that reinforce each other and demonstrate steady progress towards strategic cloud leadership in our market. With that, I’ll turn it over to Jeff.

Jeff Cooper : Thanks, Mike. First quarter ARR ended at $673 million ahead of our expectations. Q1 is always our slowest quarter, but we are pleased to see some exciting cloud wins, most notably meaningful progress in EMEA. Total revenue was $195.3 million, just above the high end of our outlook. Cloud strength continues to be visible on subscription revenue, which was $79 million, up 38% year-over-year. Subscription and support revenue was $99.1 million, up 25% year-over-year. License revenue was $41 million, up 2% when compared to Q1 last year. Services revenue was $55.3 million, up 18%. Services revenue benefited from ongoing increases in the number of cloud implementation programs. Turning to profitability for the first quarter, which we will discuss on a non-GAAP basis, gross profit was $83 million.

Overall gross margin was 42%. All of our margin disclosure for the quarter and for the comparison periods reflect our updated allocation methodology for headcount-related costs for IT, payroll and procurement. As a reminder, and as we discussed on our Q4 earnings call in September, we moved headcount-related costs of IT payroll procurement to G&A expense. Previously, we allocated these headcount costs out to other expense lines. Subscription and support gross margin was 49% compared to 45% a year ago. This was ahead of our expectations due to increased cloud infrastructure efficiency and slower-than-expected hiring. And services gross margin was negative 9% compared to positive 10% a year ago. As discussed in prior quarters, we are working through some complex early cloud projects and have been leveraging subcontractors at higher than normal levels.

We are making steady progress through these programs and expect services to return to positive margin in the second half of the fiscal year. Operating loss was $35.9 million. This included $2.9 million of severance expense, half of which impacted sales and marketing expense. Also, as previously mentioned, G&A expenses were negatively impacted by the reallocation adjustment. This had an $11.3 million impact on G&A expenses in the quarter. Overall stock-based compensation was $35.1 million, up 9% from Q1 of last year, which is generally in line with our growth in overall compensation expense. We ended the year with $868.5 million in cash, cash equivalents and investments. In Q1, our Board authorized a $400 million share repurchase program. And as part of that, we initiated a $200 million accelerated share repurchase program that we expect to complete in Q3.

Turning to our outlook for the fiscal year 2023, we are maintaining our ARR outlook of $745 million to $760 million. Per our usual approach, our ARR outlook assumes foreign currency exchange rates as of the end of our last fiscal year. We are adjusting our outlook we now expect to be between $886 million and $896 million. The only change, we now expect subscription revenue to be $342 million, an adjustment of $2 million. All other components of revenue are largely unchanged. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we expect subscription and support gross margins to be 49% for the year, an increase of 3 percentage points when compared to our outlook last quarter. We now anticipate lower cloud infrastructure costs, and we redeployed some headcount from COGS to R&D, as their work transitioned from supporting specific customers to building platform capabilities that will benefit all of our customers.

This adjustment reflects increasing confidence in our margin trajectory as we execute toward our mid- and longer-term margin targets. We expect services margins in the mid-single digits for the year with significantly better services margins in the second half of the year. This improvement reflects the successful completion of ongoing arrangements with investments from Guidewire, the ramp of new services hires replacing subcontractors and the redeployment of some Guidewire services resources from non-billable to billable roles. As a result, we now expect overall gross margins to be just under 52% for the full year. With respect to operating income, we expect an operating loss of between $28 million and $18 million for the fiscal year. We now expect stock-based compensation to be approximately $138 million, representing a 1% growth rate year-over-year.

We expect stock-based compensation expense growth to slow as we temper overall hiring. There is no change to our cash flow from operations expectations. Turning to our outlook for Q2. We expect ARR to finish between $695 million and $700 million, which represents 16% growth at the midpoint on a constant currency basis. We expect total revenue of between $221 million and $226 million. We expect subscription revenue of approximately $83 million and services revenue of approximately $52 million. We expect subscription and support gross margins of approximately 50%, and we expect services margins of approximately negative 2%. We expect an operating income of between negative $4 million and breakeven in Q2. Operator, you can now open the call for questions.

Q&A Session

Operator: At this time, we’ll be conducting a question-and-answer session. And our first question comes from the line of Dylan Becker with William Blair. Please proceed with your question.

Dylan Becker : Hey, guys. Thanks for taking the question. Maybe Mike, double-clicking on the Connections conference about a month or so ago. The cloud messaging there was very apparent and you guys emphasized the plans of getting 100% of that customer base to the cloud over time. So I guess how is the initial feedback been from a customer perspective following that event? And how important are those conferences being in person as you think about building out that pipeline progression with some of those initial reference points?

Mike Rosenbaum : Yeah. Dylan, thanks for the question. I would say — let me take the second half of it first. I think these in-person events are critical for us. There’s just nothing that you can do to replace the ability to connect with customers and the ability to connect customers with other customers, to be able to hear firsthand their experience, the things to do, the things not to do. That event is just invaluable just both for us and the community. When you add to that the opportunity to connect with the different partners, different application partners, the new fresh innovation that you’re seeing in the ecosystem, it’s just great to be able to get people back in person, and we were really excited, so like I said in the prepared remarks, a set a record in terms of in-person attendance.

So really, really great to see. I think — I was pretty direct, I guess, in terms of our intention to get 100% of the customer base to the cloud. I think at first, people saw that as a sort of a more direct statement of that strategy. But I think as it sunk in over maybe a couple of hours or 24 hours and then certainly over the past few months as we’ve engaged with customers following the event. I think everybody understands and appreciates why it’s important for us to be so clear about where we’re taking the company and where we intend to take 100% of our customers. These implementations in these projects have to last for 20-30 years, the decision time frame that people have when they’re thinking about how to approach it is not measured in months, it’s certainly measured in years.

And it’s not to say that we’re going to abandon any one. That’s not the intention. But I thought it was necessary to be crystal clear that there’s just so much more of the innovation, the thrust of the creativity and the physical investment in the product going into cloud that I really wanted to make sure that every single one of our customers sees that and thinks about it and thinks about how they can take the appropriate steps right now to ensure that they’re aligned with that eventual outcome. And so the initial feedback was a bit of, wow, that was interesting that you said that. But I quickly got the follow-up that, yeah, thank you very much. We actually had 1 customer who, as I said in the prepared remarks today, we do occasionally sell even today, even in this quarter, an on-prem deal but we had a customer had a long conversation.

They had done an on-prem deal previously in the year. And they said after Connection in my keynote and the sessions that they were able to participate in, they were sitting down to make a more concerted effort about making a plan to get to cloud. And so it was, I’d say, received on the whole very constructively, is the summary way to answer your question. So hopefully, that helps. And thanks for the question.

Dylan Becker : Yeah. No, absolutely. Great to hear. And maybe piggybagging off of that as well, too. I think there was an important implementation in the quarter at Massif and maybe one of the largest ones you guys have done to date, particularly in Europe and some where you guys called out strength from an ARR perspective, so I guess wondering, first, how important is that implementation relative to kind of a market validation perspective and then also driving kind of some nice initial margin leverage here. Maybe how are you thinking about some learnings of moving that complex book of business as some of those other customers are kind of thinking about their own migration road maps.

Mike Rosenbaum : Yeah. So thanks for that. Thanks for the question about them. One thing I would say is our attitude is every single one of our customer implementations is just as important as every other. I’m 100% committed to ensuring that we’re doing everything we can to make sure that every single implementation is a success. This was an important — it’s funny like when I first was talking to the board and talking to Marcus about joining Guidewire, this was one of the most memorable parts of the way that they talked about the company is that there — because of the nature of these projects, we have to make such a huge commitment to ensuring that they are successful. And that’s sounds emotional, but it’s really strategic, right?

Because if you think about what do you want from a core system vendor, you want somebody who’s completely committed to ensuring that the project is successful. And for them and for us, if these implementations last 20, 30 years. And this is going to, in the end, be sort of economically positive for both of us. But we are committed to everybody being successful. So you talked about Massif. That project is going well. It’s critical to us that we have a success in Europe at scale. It’s critical to us that we have a success in the market in France. And so we are very focused on that just like we are many of our other customers. So I wouldn’t call out anything in specific there, but it is certainly one of the programs that we pay close attention to, maybe not so much because we care about it being successful more, but just because it’s big and complicated and requires that level of focus.