Guidewire Software, Inc. (NYSE:GWRE) Q2 2023 Earnings Call Transcript

Guidewire Software, Inc. (NYSE:GWRE) Q2 2023 Earnings Call Transcript March 6, 2023

Operator: Greetings. Welcome to Guidewire’s Second Quarter 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. At this time, I’ll turn the conference over to Alex Hughes, Vice President, Investor Relations. Alex, you may now begin.

Alex Hughes: Thanks, Rob. 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 the Investor Relations section of our website. Today’s call is being recorded, and a replay will be available following the conclusion of this 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 of any subsequent date.

Please refer to the press release and risk factors and documents we file with the SEC, including our most recent annual report on Form 10-K our quarterly reports on Form 10-Q filed to be — and to be filed with the SEC. For information on the 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 a reconciliation of additional data are also posted to please a supplemental on our IR website.

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

Mike Rosenbaum: Thank you, Alex. Good afternoon, and thanks for joining us today. I’m pleased to share the results of what was another great quarter by Guidewire. We continue to steadily execute and improve in all key of our business, and second quarter results were a good demonstration of this. We combined strong sales execution, great cloud adoption and improve cost discipline delivered than expected. We exceeded our targets for ARR, subscription and support gross margin operating margin products and our performance this quarter gives us a strong fundament to build on for the remainder of this fiscal year. As we continue to lead an industry transition to modern cloud-based core systems, we enable our P&C insurance customers to better engage with their customers, innovate with new products, channels and agile approaches to risk management and structurally grow more efficiently than is possible with the legacy core system.

We continue to make steady progress in the key pillars of our strategy, cloud adoption, cloud deployment, cloud efficiency also growing our ecosystem of partners by amplifying everything we do on sales. On the call today, I’ll talk about our quarterly progress in each of these areas. Starting with adoption; Q2 sales activity was strong with eight cloud deals including two new customer wins, three migrations, and three insurance suite expansions at existing customers. In the Americas, we had two new customer wins, including one for InsuranceSuite with a $2 billion DWP insurer and another for ClaimsCenter with a $1.4 billion DWP insurer. We also closed two cloud migration dealers, including one for ClaimsCenter with a Global Tier 1 insurer and another for InsuranceSuite with a long time Guidewire regional customer In addition, we continue to work with one of the largest insurers in the world to steadily expand on Guidewire Cloud with a new greenfield initiative.

In EMEA, we had three cloud wins, which is a strong quarter for us in this region. two of these deals were with one of the largest insurers who will be migrating an on-prem implementation of InsuranceSuite to Guidewire Cloud platform while also with InsuranceSuite to a new line of business. In addition major UK base insurer will adopt BillingCenter on Guidewire Cloud platform after adopting on the platform last year. All of these transactions repricing confidence in our platform and cloud capabilities and unique center partners can provide cloud-based modern core systems. Turning to cloud deployment, we continue to build momentum with nine more go-lives on the Guidewire in the quarter. The breadth and pace of deployment in Q2 was exciting and has kept us all very busy.

The go live activity this quarter was international with three departments in the United States, three in EMEA, three in Canada customers and it goes up market with one Tier 1 and five Tier 2 deployments. In the quarter, we saw a Tier 1 insurer and a Top 20 P&C insurer in the United States deploying ClaimsCenter on Guidewire Cloud illustrating new GWCP’s ability to scale with the largest insurers. At the same time, a startup insurer was able to deploy PolicyCenter and BillingCenter on Guidewire Cloud platform in just a few moments, demonstrating that GWCP can be deployed quickly. I was also pleased to see insurers successfully modernize and transform their core systems to GWCP . This Included AMA Insurance Company, one of Canada’s largest motor insurers, deploying InsuranceSuite on GWCP to deliver greater efficiency and better experience for its customers and its agent network.

We also saw a major U.K. insurer with over a 300-year history deploy ClaimsCenter on Guidewire Cloud platform to begin its transformation journey. 31 customers have gone live on Guidewire Cloud platform. This total includes migration and modernization in greenfield deployment and I believe this speaks to the capability, agility and stability of our cloud platform. We would obviously continue to increase this total in the quarter, and as we do, we continue to improve our operating capabilities and efficiencies with each new deployment and each new lead. We also still have a lot to learn. Every time we complete a go live, we learn something. We identify ways to improve both for our operating efficiency but more critically, we learn how to make these experiences and projects better for our customers.

We remain determined to relentless drive further improvement in our cloud operations liability performance security. So while we are thrilled to now have doubled our production with customers and proud of the work we have done to achieve it. We also recognize that eventually and I might say inevitably, this number will be in the hundreds or maybe even the thousands. So the work we are doing right now to improve the efficiency of our operations in the future is critical to our long-term success and is a key component of our intention to be a source of durable long term profitable growth. One of the assumptions we have made coming into this year was that we can hold our cloud operation head count flat while continuing to scale cloud adoption.

This was based on a significant investment we have made and continue to make in our cloud platform. In the past 6 months, we have nearly doubled the number of the production customers on Guidewire Cloud and have been able to effectively control the infrastructure and headcount expenses required to support that growth. The significantly improved subscription gross margins we saw this quarter were driven by these decisions and the determined execution of our team. We’ll continue to learn and improve as we grow and continue to leverage the experience and feedback we get from each project go-live so that we can confidently position Guidewire Cloud for every relevant insurer everywhere in the world. Turning to Guidewire Partner ecosystem, we continue to build momentum with both our SI partners and our agency partners.

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The number of Guidewire consultancy and system integrators grew to operating 21,000 at the end of Q2, up by 27% quarter-over-year platform. The number of cloud certified consultants increased year-over-year passing 6,300 at the end of Q2. It gives our customers a valuable bench of cloud trained professionals to draw on as they start down the path of modernization or embark cloud upgrade. The importance of this community is illustrated by the fact that SIs have participated in over 70% of our cloud projects to date and of these, 15% have been SI-led. Now before I hand it over to Jeff, let me just comment on what we see regarding our headquarters. Around 4 years ago, we moved into a beautiful new building in San Mateo, California with approximately 180,000 square feet of cases.

But shortly after this move, the COVID pandemic changed the world. Post-COVID, our teams have become more distributed and our hiring strategy has become more global. This move allows us to realize significant savings while rightsizing and aligning our office footprint with needs of a more distributed, flexible and global workforce. Jeff will comment in more detail about the financial impact of this move but basically it will save us $10 million to $12 million a year starting next fiscal year. And I want to congratulate our real estate team on executing this transaction in a very challenging environment for these sorts of activities and I look forward to discussing this move further through Guidewire policies this coming weeks. With that, I’ll turn it over to Jeff.

Jeff Cooper: Thanks, Mike. We are thrilled with our second quarter cloud momentum with improved operational efficiency and cost discipline, all of which resulted in a great outcome in Q2 and a strong foundation to build upon as we execute forward our fiscal ’23 and longer-term financial targets. Second quarter ARR ended at $707 million ahead of our expectation. This represents 17% year-over-year growth on a constant currency basis. The first half of fiscal ’23 benefited from minimal ARR attrition and healthy growth in ARR coming from deals years sold in prior years with escalating fees, which we refer to as a ramp deal. Total revenue was $232.6 million, above the high end of our outlook. Cloud strength continues to be visible within subscription revenue, which grew 37% year-over-year to $86 million.

Subscription and support revenue was $105.8 million up 25% year-over-year. License revenue was $73 million, up 5% year-over-year. Services revenue was $53.7 million, up 6% year-over-year. Turning to profitability for the second quarter, which we will discuss on a non-GAAP, gross profit was $131.9 million. Overall gross margin was 57%. Subscription and support gross margin was also 57%, compared to 49% a year ago. This was significantly ahead of our expectations. Strong subscription revenue growth, combined with our focus on cloud infrastructure efficiency, is having a positive impact. We are also recognizing benefits associated with our new agreement with our cloud provider including some onetime savings that positively impacted Q2. We are expecting some higher costs in the back half of the year related to cloud customer upgrades to the latest release and healthy go-live activity.

Collectively, we were pleased with our margins in the quarter and with how subscription and support margins are tracking for the year. And services gross margins in Q2 was just below breakeven compared to positive 8% a year ago. We continue to make steady progress working through complex early cloud programs and other programs that have been leveraging subcontractors at higher-than-normal levels, and we still expect services to return to positive margin in the second half of the fiscal year. Operating income was $15.1 million. This was significantly higher than our expectations due to better-than-expected subscription and support gross profit and lower-than-expected operating costs. Overall stock-based compensation was $36.2 million. expense was down year-over-year in Q2 and up 2% year-over-year in the first half of ’23.

We expect unit growth in BC in the back half of this year. This is consistent with our slowdown in hiring as we scale our business without adding additional headcount. We ended the quarter with $870 million in cash, cash equivalents and investments. In Q1, we announced a $400 million share repurchase program. As part of that program, we executed a $200 million accelerated share repurchase program, which was finalized in February 2023, an aggregate share delivery of 3.2 million shares at an average price of $61.93 per share. The initial tranche of 2.6 million shares were delivered in Q1. The remaining approximately 600,000 shares were delivered in February which is in our Q3. Outlook for fiscal year 2023. We are maintaining our ARR outlook of $745 million to $760 million.

We are pleased with our progress in the first half and feel confident in our pipeline for the back half of the year, but feel it is prudent to maintain our outlook at this point in the fiscal year. As I previously noted, the first half benefited from a strong ARR coming from ramp deals and very low ARR attrition. The second half of this year has more difficult year-over-year compares in these two areas, which was already embedded into our guidance. We are excited by the pace of new modernization this year, whereas in the early part of the cloud transition, much of the bookings activity was focused on customer cloud migrations. This momentum is exciting for two reasons. One, it indicates increasing confidence in the maturity of our cloud platform; and two, it is demonstrating our ability to compete and win at a high level since most of these deals are competitive.

We are raising our outlook for total revenue, which we now expect to be between $894 million and $904 million, representing 11% growth at the midpoint. The primary change is we now expect subscription revenue to be $348 million, an upward adjustment of $6 million and representing 34% year-over-year growth. This adjustment was driven by better deal linearity and some meaningful cloud contract extensions on existing customers. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we expect subscription and support gross margins to be between 51% and 52% for the year, an increase of two to three percentage points when compared to our outlook last quarter and five to six percentage points from the Q4 call. This reflect — this adjustment reflects increasing confidence in our margin trajectory as we execute towards our mid- and longer-term margin targets.

We continue to 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 assumes the 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 margin of approximately 53% for the year. With respect to operating income, we expect an operating loss of between $17 million and $7 million for the fiscal year. We expect stock-based compensation to be approximately $139 million, representing 1% growth year-over-year. Given this and the impact of the accelerated share repurchase program, we expect a decline in our fully diluted shares outstanding this fiscal year.

There is no change to our cash flow from operations expectations. In general, the positive margin progression gives us confidence in our ability to scale cash flow, but the timing of collections can cause cash flow to fluctuate in a given quarter or year, given how much of our annual collections are due at the end of our fiscal year. Turning to our outlook for Q3. We expect ARR to finish between $715 million and $720 million, which represents 16% growth at the midpoint on a constant currency basis. We expect total revenue between $211 million and $216 million. We expect subscription revenue of approximately $88.5 million. Subscription and support revenue of approximately $107 million and services revenue of approximately $56 million. We expect subscription and support margins of approximately 50%, and we expect services margins of approximately 10%, and overall gross margin of between 50 and 51%.

We expect a non-GAAP operating loss of between $20 million and $16 million in Q3. Finally, as Mike noted, we have entered into an arrangement to complete an office swap with another company in San Mateo. Our new office space is just a couple of blocks from our current headquarters and it is less than half the total square footage. As part of this arrangement, we expect to take a write-off of the leasehold improvements, the right-of-use asset and lease liability in the existing location, and we expect the aggregate amount to be between an $8 million to $9 million loss, and this charge will hit G&A. This will impact our Q3 GAAP financial results, but given the onetime nature of this write-down, we will exclude this from our non-GAAP financials, and therefore, has no impact on the outlook provided above.

We also have approximately $1.5 million in advisor and moving fees in the back half of the fiscal year, which is included in our outlook for the year. Looking ahead to fiscal 2024 and beyond, we expect to save approximately $10 million to $12 million per year as a result of this move. With that, operator, you can now open the call to questions.

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Q&A Session

Operator: And our first question comes from the line of Dylan Becker with William Blair.

Dylan Becker: Nice job here in the quarter. Maybe starting with Jeff this time on the margin front. I understand there’s maybe some onetime dynamics there; as you called out, but I wanted to dig into the reallocation from customer specific to kind of platform-specific investments. How big of a portion is that headcount and the margin delta, if I recall correctly? And how much does that capacity shift from that small select number of projects contribute in the quarter, but also give you kind of confidence in that long-term margin outlook you guys have called out?

Jeff Cooper: Yes. Look, I think in total, we are seeing — as we realize benefits of the investments we’ve made in the platform to be run and executed much more that will afford us the ability over time to repurpose some headcount. And we talked a bit about this in Q1, where we had folks that were previously in our R&D organization, our product development organization that were for a period of time doing customer-specific work and so ended up in our cost of goods sold, our subscription product. And then over time, those headcount have now moved back into the product organization as they are kind of building product sets for the totality of our customers rather than doing customer-specific work and almost like a support life function.

So we did see that in Q1. There was no movements in Q2 that drove the number was healthy momentum in terms of overall platform efficiency. There was a little bit more update work that we had modeled into our number that is now going to happen in the back half of the year. And so that was a little bit of the explanation for the outsized beat vis-a-vis our expectations. But in general, this is just us kind of managing steady progression in terms of how we think about our cost structure to support our cloud business.

Dylan Becker: Got it. Got it. Super encouraging there. Maybe switching over to Mike. As you talk to customers, again, a lot of emphasis on kind of core back office efficiency and what that improved from an underwriting standpoint. I guess how are carriers thinking about utilizing kind of some of the integrated data as well to prove their own marketing and efficiency? I would assume the challenges in attracting but maybe the bigger challenges in retaining those customers that get kind of that preferred risk profile. I guess how is that discussion evolving from a core adoption standpoint?

Mike Rosenbaum: Great question. I think the component of the platform and on both PolicyCenter, ClaimsCenter, BillingCenter side, but I’d say from a new business perspective, mostly claims are quoting. The digital capabilities around that gives them flexibility and agility to roll out new channels, new mechanisms to quote and price products, new places to put those products better and more effective mechanisms for staying connected with agents and agencies and MGAs are very, very important to a significant number of our customers. And so we support both companies that go direct but also that go through distribution channels. And even you might think if you’re going through a distribution channel, the digital component doesn’t quite matter as much.