Guidewire Software, Inc. (NYSE:GWRE) Q1 2024 Earnings Call Transcript

Guidewire Software, Inc. (NYSE:GWRE) Q1 2024 Earnings Call Transcript December 7, 2023

Guidewire Software, Inc. beats earnings expectations. Reported EPS is $-0.00033, expectations were $-0.17.

Operator: Greetings. Welcome to the Guidewire First Quarter Fiscal 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Alex Hughes, Vice President of Investor Relations. 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 our related Form 8-K furnished to the SEC, both of which are 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 include forward-looking ones regarding our financial results, products, customer demand, operations, the impact of local, national and geopolitical events on our business and other matters. These statements are subject to risks, uncertainties and assumptions and are based on management’s current expectations as of today and 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 and our prior and forthcoming quarterly reports on Form 10-Q filed and 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 in the supplement on our IR website.

With that, I’ll now turn the call over to Mike.

Mike Rosenbaum: Thank you, Alex. Good afternoon, and thanks, everyone, for joining today. We’re off to a strong start to the year, and it’s great to see this momentum continue following a record Q4 where we had especially high close rates. I characterize this quarter as one of continued solid execution. We are seeing good progress on the deal front as well as in operations and also had a tremendous customer conference at Connections last month. We had record attendance with about 3,000 in-person attendees. The enthusiasm and support for our strategic direction and Cloud Platform was noticeable, and the event provided great validation of our progress and the tangible business impacts we are providing to our customers. We are steadily building a franchise that will have a lasting and positive impact on the P&C insurance industry, and that will produce the durable, profitable long-term growth that is commensurate with a vertical market leader.

Since we had a chance to speak at Analyst Day last month, I’ll keep today’s remarks fairly brief and share my key takeaways on the business. First, Guidewire Cloud Platform continues to advance steadily and consistently with each new release. The ninth release of Guidewark Cloud Platform, Ins Brook, was made available December 1, and builds on the automation, orchestration, integration and monitoring capabilities in Hakuba and will deliver greater functionality in digital analytics, data, straight-through processing and pricing. Each release brings greater and greater benefits to customers, which helps to grow interest in our platform. Second, we continue to see this interest manifest in sustained sales momentum. We closed another seven cloud deals in the first quarter, including six for InsuranceSuite Cloud.

This, despite Q1 typically being a seasonally leg quarter probably will be available following — we closed four InsuranceSuite migrations in the quarter, including the first Japan-based insurer to commit to the full suite in the cloud. And also closed three net new deals, including another competitive takeaway. Insurers are responding to the greater agility, efficiency and innovation that Guidewire Cloud Platform offers and increasingly view it as aligned with their technology and strategic road maps. Third is data and analytics, which is something I am excited about as a longer-term opportunity and as something our cloud success positions us well for. As a core systems provider, we have a unique opportunity to layer on data and analytics offerings to core workflows and to drive greater real-time analysis and decision-making around policy, underwriting and claims.

I was pleased to see HazardHub adopted by a Florida-based property insurer, just a few months after it adopted our InsuranceNow core solution. HazardHub was chosen for its proprietary hazard risk scoring and its seamless integration with InsuranceNow. Fourth, we continue to nurture and grow an ecosystem of partners, including SIs and solution providers, which helps to drive sustained activity and greater value from the platform. In the quarter, we had nine more go-lives and leading SIs, Capgemini, Cognizant, Deloitte, EY and PwC all now have achieved cloud migration certifications. As I mentioned previously, Connections was a tremendous success and highlighted for me the advantage is Guidewire and our ecosystem deliver for our customers. The stories that were shared drove home the impact of the improved agility, speed and innovation our platform delivers.

Definity Insurance, a leading Canadian insurer with a 150-year history, adopted Guidewire Cloud Platform in 2021 to achieve greater scale, resilience, agility and innovation. They have now already seen deployment times improve 63%, quote response times, improved 30% and downtime reduced by 75% and platform setup times improved 10x. The speed Guidewire Cloud platform delivers was best illustrated by GM OnStar who spoke about successfully creating and launching an embedded insurance product from start to go live in only nine months. And I thought CNA Insurance, one of the largest commercial and specialty insurers in the United States, really illustrated the complexity that large insurers have to manage through when moving to the cloud and how Guidewire Cloud Platform continuous release cycle supports much greater agility for these insurers, while also providing the strategic optionality they need to stay current with the market.

As we continue to sell, innovate and expand the community around our platform, an additional key objective has been to drive greater and greater platform and company efficiency. Jeff will talk more about this, but we were all pleased to see continuing margin expansion in the quarter, even above our objectives and forecast. The work we are doing to manage all of this while also improving efficiency through our organization is critical and not always the most glamorous part of the job. It has been exciting to see the results of these efforts continued to flow through to our financial outcomes these past few quarters. And finally, we also announced in today’s release that Priscilla Hung sabbatical is ending soon, and we are all very excited to have her back.

While we do not plan for her to return to the same operating role, we are very pleased that she’ll continue to be an employee and an invaluable senior adviser at the Company. With that, I’ll turn it over to Jeff to discuss the financials.

Jeff Cooper: Thanks Mike. We’re off to a strong start in fiscal 2024, and it is great to see sustained momentum in the business. From a financial perspective, we entered into this year very focused on, one, increasing ARR and the subscription mix of our business; two, expanding overall gross margins, primarily led by subscription and support gross margin, but we are also prioritizing services margins; and three, driving greater cash flow from operations. Today, I’ll talk about how we’re doing in each of these areas as I go through the details, and we’ll finish with our updated outlook. ARR finished just above the high end of our outlook at $770 million. Total revenue was $207 million, also above the high end of our outlook, and this beat was primarily due to higher-than-expected subscription and support revenue and services revenue.

Other components of revenue were largely in line with our expectations. Turning to profitability for the first quarter, which we will discuss on a non-GAAP basis. Gross profit was $121 million, representing 46% year-over-year growth. Overall gross margin was 58% compared to 42% a year ago. Subscription and support gross margin was 65% compared to 49% a year ago. This was ahead of our expectations due to higher-than-expected revenue, increased cloud infrastructure efficiency and the timing of some cloud services credits from our cloud infrastructure provider. We are thrilled with this result as it gives us confidence to raise our profitability targets for the year. Services gross margin was positive 10% compared to negative 9% a year ago. This profitability turnaround is a result of many quarters work that we have discussed in prior earnings calls.

And this start to this year to the year sets us up well to hit our annual target of $30 million in gross profit for services. These results demonstrate exciting progress and margin expansion. On a year-over-year basis, subscription and support gross margins expanded 16 percentage points. Services gross margin expanded 19 percentage points and total gross margins expanded 16 percentage points. While we still have work to do to get to our long-term margin targets, I do want to recognize all the hard work by a number of teams at Guidewire, including the cloud operations team, the support team, the product development teams, the services organization and our FinOps team to help us unlock this potential. All this positive momentum on gross margins led to an operating profit of $4.1 million.

This is a strong result when compared with our prior outlook of negative $22.5 million at the midpoint. About $15 million of this beat came from the gross profit line and $11 million came from operating expenses. On the operating expense side, we saw slower hiring and lower travel expenses than we expected. But approximately $5 million to $6 million of the $11 million is due to timing of certain expenses now expected later in the year. Overall stock-based compensation was $36 million, up 3% and from Q1 last year, which was generally in line with our expectations. We ended the quarter with $854 million in cash, cash equivalents and investments. Operating cash flow ended the quarter at negative $72 million, which is a bit better than our internal expectations.

As a reminder, annual employee bonuses and commission expenses related to Q4 sales are paid out in Q1. And as a result, Q1 cash flow is always lower than the other quarters in the fiscal year. Now let me go through our updated outlook for fiscal year 2024. Starting with the top line, we are maintaining our outlook for ARR. ARR is still the best way to measure overall sales momentum, and we feel confident in our pipeline and are on track to hit our annual targets. We are also maintaining our outlook for total revenue. We expect approximately $471 million in subscription revenue and $542 million in subscription and support revenue. We now expect term license revenue to be a bit higher than prior expectations due to higher DWP true-ups, and we have tempered our expectations for services revenue to approximately $195 million.

Our services model is shifting away from lower-margin subcontracted revenue a bit faster than we previously forecasted. Additionally, our partners are continuing to lead more and more of the implementation engagements, which is great. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we now expect subscription and support gross margins to be 62% for the year, an increase of 7 percentage points when compared to fiscal 2023. This puts us ahead of schedule with respect to hitting our FY ’25 target of 63% to 65%. It is clear that the product investments we have made and the hard work of teams focused on efficiency for having the desired impact on scalability and product gross margins. We continue to expect services gross margins of approximately 15%, as I mentioned last quarter, we will measure professional services success this year by: one, our ability to deliver in conjunction with our partners’ excellent customer outcomes; and two, our ability to deliver $30 million in services gross profit and we are on track to hit these goals.

As a result, we now expect overall gross margin to be approximately 62% for the full year. This is already at the midpoint of our FY ’25 target, so we are tracking ahead of schedule. With respect to operating income, we are raising our operating income outlook to between $82 million and $92 million for the fiscal year. We are thrilled by this momentum as we work towards unlocking the profitability potential of the business. We expect stock-based compensation to be approximately $150 million, representing 5% year-over-year growth. We are increasing our cash flow from operations expectation to between $115 million and $135 million for the fiscal year. Turning to our outlook for Q2. We expect ARR to finish between $793 million and $798 million.

Our outlook for total revenue is between $237 million and $243 million. We expect subscription and support revenue of approximately $130 million and services revenue of approximately $43 million. We expect subscription and support margins of approximately 63%, services margins to be around breakeven and total gross margins to be between 61% and 62%. We did conduct a small services reorg in early Q2, which carried an approximately $2.5 million onetime charge. Our outlook for operating income is between $15 million and $20 million. In summary, it was a strong start to the year. And as we mentioned at Analyst Day, we are at an exciting flection point with respect to profitability and our ability to demonstrate margin expansion. Operator, you can now open the call for questions.

Operator: [Operator Instructions] And our first question comes from the line of Dylan Becker with William Blair. Please proceed with your question.

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Q&A Session

Dylan Becker: Appreciate the question here. Maybe, Mike, starting with you, you called out kind of the Connections Conference and a lot of discussion coming out of that around aligning kind of the decisioning with tangible value towards business applicability versus kind of the IT infrastructure side. I wonder how important is that conversation around business applicability as we think about kind of championing change in the industry and maybe to what extension you’re seeing that evolution play through or flow through into your conversations and interactions with customers?

Mike Rosenbaum: Yes. Great question and Connections is a great example of an opportunity for us to talk about this and hear from customers directly on the subject. I think if you think about the the history of the cloud transformation here at Guidewire. The story really began with IT-focused infrastructure, operational value proposition, reduce complexity, support upgrades, things like that. But what’s so exciting about the momentum we’ve achieved in the product organization with our ski resort releases and first, shifting to a twice-a-year release schedule and then subsequently shifting to a three times a year release schedule, and then really importantly, doing all the work necessary to facilitate customers receiving those updates.

All that — you can think of it as like all of that work, engineering, plumbing, so to speak, of a cloud system gives us the ability to ship business value improvements consistently release over release over release, and that’s increasingly the story really of Guidewire Cloud, which is not just, hey, we have a core system that runs effectively, but we have a core system that can help you differentiate in the market. We can help you make changes to your products more efficiently and faster. We can help you adjust your prices, assess the risks associated with the insurance that you’re writing. We can help you optimize your claims processes more effectively predict outcomes more efficiently. And all those capabilities are delivered legitimately more efficiently through these cloud releases and that is much, much more part of the conversation and what the customers are excited about effectively buying when they buy into Guidewire and our cloud story.

So for sure, this is a shift in a way that we’re taking the product and the Company to market it’s been very, very well received. Somewhat I feel like we’re really just getting started, honestly, this is really just starting to kick in and these updates are starting to take hold. And — that was — we were talking today actually about our key takeaways from Connections. And the reality of the — just how fluid these update processes are going for our cloud customers was one of the big takeaways. So I appreciate the question. I think it’s absolutely part of the story. And probably one of the things that’s helping us continue to drive and improve sales momentum in the business.

Dylan Becker: That’s great. Maybe switching over, Jeff, on the operating side. A lot of healthy momentum here and outperformance from a margin perspective, I guess, maybe help us think through kind of some of the seasonality, maybe any variable puts and takes on a quarterly basis and how we should think about some of the sustainability. I know you called out some kind of reallocation there, but sustainability of the outperformance here relative to even when we met 30 days ago, maybe versus what was more onetime in nature, if anything?

Mike Rosenbaum: Yes. No, it’s a good question. We are obviously very thrilled with the margins we saw in Q1. It caught me a little bit by surprise. I wasn’t expecting to be at 65%. And there was some onetime elements in there. We did benefit from a bit higher revenue. Some of that revenue was tied to platform usage that was billed in arrears. So think about that as kind of catch-up revenue that was recognized in Q1 that flowed through to the margins. Additionally, we did have a little bit higher credits from our infrastructure provider in Q1 than we’re expecting in the back half of the year. But in general, we’ve made really strong progress in how we think about the efficiency of the platform that we’re delivering and it gives us a ton of confidence as we kind of start to march towards those longer-term targets.

So, there was a little bit of a onetime effect. I would couch it around 2% to potentially 3 percentage points when you factor in the top line that was some of that catch-up revenue and you factor in some of the credits that may not recur throughout the end of the year, but in general, just really healthy progress.

Operator: Our next question comes from the line of Kevin Kumar with Goldman Sachs. Please proceed with your question.

Kevin Goldman: I guess I’ll start with the cloud deals. I think seven in the quarter, pretty impressive, particularly given it’s a seasonally slow typically seasonally slow. And I think that compares to four deals maybe last year. So curious, Mike, how are you thinking about maybe carrier appetite for cloud modernization today versus perhaps a year ago? And maybe what are the key drivers that you would attribute to the stronger deal activity that we’re seeing out of the gate?

Mike Rosenbaum: Thanks for the question. I would say sort of probably two things. One, steadily building confidence in the — just the stability of the operating conditions for insurance companies feeling more confident about the future, enabling them to make these decisions pull the trigger on these projects. That’s part of it. But I think the bigger part of it is just growing confidence in our direction, our capability to deliver success, follow through and see the projects live we’ve talked for years about sort of how conservative the customer base is and how they want to see other people sort of pave the road, so to speak, for them to drive down in the future. And I think, we’re starting to see that, that factored into the momentum in Q1.

And I think it’s also helping us feel comfortable and confident about the pipeline over the next three quarters and the outlook for the rest of the fiscal year. We really just are seeing all the hard work and energy that we’ve put into the platform and the products and the customer stories that are — positive customer stories and the business impacts that we’ve achieved with them helped improve the propensity of these either migrations or net new deals to come to the platform. So, it’s all those things, I think, adding up to result in a very positive start to the year for us.

Kevin Goldman: That’s great. And then, Mike, you called out analytics? And I guess Guidewire now is a fairly robust portfolio of analytics applications, so curious kind of which applications are seeing the most traction? Where is there room to maybe improve attach rates? And how do you think about the overall kind of add-on strategy going forward?

Mike Rosenbaum: So yes, we mentioned the deal that we did with HazardHub, which we’re really excited about. We think that there’s a revolution maybe coming, if I’m not exaggerating too much in the way that people approach property analytics. We talked a lot about that at our Connections Conference. We think that the approaches that most of the insurance industry is taking to measuring the risk associated with properties can be vastly improved by taking a much more specific and much more local, even address by address, location-by-location approach. And HazardHub is our mechanism for driving that change in the industry. We think it will have broad applicability to multiple different lines of business, and there’s a lot of excitement about driving traction and adoption of that product in our customer base, but also throughout the industry, where there’s an opportunity for us to maybe drive more attach is with our Predict product.