Guidewire Software, Inc. (NYSE:GWRE) Q4 2023 Earnings Call Transcript

Guidewire Software, Inc. (NYSE:GWRE) Q4 2023 Earnings Call Transcript September 7, 2023

Guidewire Software, Inc. beats earnings expectations. Reported EPS is $0.74, expectations were $0.34.

Operator: Greetings, and welcome to the Guidewire Fourth Quarter and Full-Year Fiscal 2023 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] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Alex Hughes, Vice President, Investor Relations. Thank you, Alex. You may begin.

Alex Hughes: Thank you, operator. Good afternoon, everyone. 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 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 of any subsequent date. Please refer to the press release and risk factors and documents we file with the SEC, including our most recent quarterly report on Form 10-Q and our prior and forthcoming annual reports on Form 10-K filed 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 in the supplemental on our IR website. With that, I’ll turn the call over to Mike.

Mike Rosenbaum: Thank you, Alex. Good afternoon and thanks everyone for joining today. I want to start the call by expressing a sincere appreciation to everyone on the Guidewire team for all of their hard work and determination these last few years. Pivoting a software company, leading its category to a new cloud delivery model was never going to be easy, but I think that if we’re being honest, sometimes it felt harder-than-expected, but the culture of this company and the determined approach to steady and daily progress all contributed to and culminated in would ended up being a fabulous result for us this fiscal year. The fourth quarter sales results were unprecedented and validate that we are very on the right track. We are steadily building a franchise that will have a lasting and positive impact on the P&C insurance industry, and will produce the durable, profitable, long-term growth that is commensurate with a vertical market leader.

We closed 17 cloud deals in the quarter, bringing our total for the year to 37. We finished the year at $763 million in ARR, up 15% and just under $900 million in fully ramped ARR, up 17%. And something that I’m particularly proud of, we finished the year at a positive operating margin, significantly ahead of our plan. Underlying these results is a growing acceptance in the industry that the cloud solution we have built, the geological next generation platform capable of supporting the P&C industry’s requirements, goals, and aspirations. We are uniquely positioned to be the industry’s innovation platform and are now working with carriers of all sizes all over the world to help them engage with customers in new and more efficient ways to innovate and respond to market dynamics quickly with new products and distribution channels and to optimize their operations to help manage through a very challenging business dynamic.

The financial results this fiscal year clearly demonstrate a market position and sense of conclusion to what I would say was our cloud transformation. We are very clearly now the leading cloud platform serving our industry and this position affords us the opportunity to redirect our focus towards the products and innovation that enable insurers to engage, innovate and grow efficiently. As I said, it was an incredible end to an incredible year and I want to call out several key takeaways that are important for us strategically. First, we saw a broad-based strength for insurance suite on the Guidewire cloud platform. We made notable progress up market with Tier 1 insurers. We saw momentum in all key geographies and continued to see balanced momentum in both new logos and on-prem to cloud migrations.

The sales success this quarter is a great validation of our platform and ecosystem centered approach and bolsters our confidence in our go forward position in the market. Sales highlights in the quarter include phenomenal progress with Tier 1 insurers, closing 11 Tier 1 deals this quarter. This includes a win at Progressive Insurance, one of the leading insurance brands in North America, where our partnership is specific to their non-personal auto lines of business and a full suite win at Allstate Canada. Based on the success this quarter, we now have some form of core systems relationship with 13 of the top 15 insurers globally, including 12 with Guidewire Cloud and with exciting potential to expand these relationships over time. This fact validates the strategic focus that we have always placed on this specific segment of the market and it’s very demanding and unique set of requirements.

We also drove further global expansion of GWCP with three wins in Europe and two in our Asia Pacific market. This international success was highlighted by a major commitment from IAG, a leading Australian insurer to adopt policy center on Guidewire Cloud platform. This is a tremendous validation of our platform approach and combined with the local insurance content required to ensure Guidewire is the right choice in every key market we serve. As I have mentioned in previous calls, we continue to see signals from the market that there is opportunity for us in competitive takeouts. And in Q4, we completed an agreement with West Bend Mutual Insurance to move their claims processes to claim center on the Guidewire cloud platform, competitive displacements are rare in our industry and I believe our recent momentum in this area speaks to our track record strength of platform and growing market alignment to our vision.

And finally, it was great to see insurance now also achieve a competitive takeout at a Tier 3 insurer, which represented its largest win in the last five years. As I mentioned in last quarters call P&C insurers are working through a challenging and complex environment that has stress almost every insurance company in the world. The decision to embark on a core transformation in the midst of this market dynamic is consequential and I believe supports the fact that our relationship with these carriers is highly strategic and expected to last decades. It was very gratifying to see so many of the deals we were working on this quarter close, and I look forward to driving the follow through expected of us based on the trust that they have placed in our company.

Turning to adoption, we continue to make progress in cloud deployments with 13 go lives on Guidewire Cloud Platform in the quarter, and we enter our new fiscal year position for continued success. Supporting this momentum is a healthy and growing ecosystem of Sis, who continue to be valuable partners as we transition the industry to cloud. We finished the core with over 23,000 Guidewire consultants in our system integrator ecosystem and over 8,000 of these are now cloud certified a total that grew 53% this fiscal year. Additionally, we continue to drive more efficiency in our cloud product and company overall. Jeff will talk more about this in a minute, but the significant improvements we are driving in cloud efficiency, along with better operating leverage means we crossed back into positive operating margin this year.

The work that Diego Devalle and our development teams are doing to not only ensure we’re building out a secure and reliable service, but also beat their efficiency targets was tremendous. This is a meaningful milestone that we were able to achieve ahead of plan and it gives us increased confidence that we will continue to grow steadily grow into our target model. Finally, our pipeline entering fiscal ‘24 is healthy. As we continue to enhance the capability of our platform with each release, as we continue to grow our ecosystem of partner applications on our marketplace as we continue to hone our analytics and data offerings. The value proposition we offer to our customers improves and our competitive position improves. This sets us up well for the new year and gives us a clear path to our fiscal ‘25 targets of $1 billion in ARR and 14% non-GAAP operating margin.

Jeff will talk more about our deal dynamics and how they translate to ARR and fully ramped ARR. But coming out of a tremendous Q4, we feel great about the business, our pipeline, the success customers are seeing in our platform, and how we are tracking towards our long-term targets. Last comment before turning it over to Jeff. While we are proud of the work we have done to put us in a position to hit our financial targets, we are more proud of the potential we’ve created to meaningfully and positively impact the industry we serve. Our position as the leading cloud platform for the P&C industry affords us the opportunity to now amplify our focus on the business processes and decisions that drive improved insurance outcomes. We can legitimately improve the efficiency of the broader industry, which ultimately helps people, families, and corporations better manage and transfer risk.

I’m very excited about this potential and I’m confident in sitting on behalf of everyone at Guidewire that we are all motivated to continue driving this mission forward. With that, I’ll turn it over to Jeff to discuss the financials.

Jeff Cooper: Thanks, Mike. Fourth quarter ARR ended at $761.4 million, up 15% year-over-year on a constant currency basis ahead of our expectations. As a reminder, we measure ARR on a constant currency basis throughout the year and then update ARR for year-end FX rates. Making this update modestly impacted ARR by $1.1 million, resulting in ARR of $762.5 million. This outcome was ahead of our expectation due to very strong sales activity in the quarter. As Mike noted, this Q4 saw tremendous execution and was our largest quarter ever. Fully ramped ARR, which is defined as the fully ramped annual price outlined in our customer contracts grew 17% year-over-year on a constant currency basis. This is a meaningful acceleration compared with 14% growth last year and again, is a reflection of the better-than-expected Q4 sales activity.

Our sales activity in Q4 is a validation of our investment strategy as we work to modernize this industry. Total Cloud ARR, which includes ARR for all of our cloud products and for customers that have contracted to move to the cloud, grew 28% year-over-year and comprised 59% of total ARR. Total revenue for the year was $905 million, ahead of our expectations due to stronger performance across all components of revenue. Notably, cloud strength continues to be visible in subscription revenue, which was $352 million, up 36% year-over-year. It is exciting to see the progression of our subscription revenue line. In 2018, our subscription revenue was just over $30 million, primarily from acquired products. Since that point, we have delivered a five-year CAGR of 60%.

Subscription and support revenue was $430 million, up 25% year-over-year. Turning to profitability for the fiscal year, which we will discuss on a non-GAAP basis, gross profit was $495 million. This was up 18% year-over-year. Overall gross margin was 55%, compared to 52% a year ago. Subscription and support gross margin was 55%, an 8 percentage point increase over last year, driven by margin improvement on our subscription line. We are delivering on the expected benefits associated with running a cloud platform at scale. Services gross margin was just under breakeven, compared to positive 3.5% a year ago. Notably, in Q4, services gross was positive 10.5% compared to negative 6.4% a year ago. This is due to the multi-quarter strategy that we have been talking about for some time that includes moving away from fixed bid arrangements, lowering our reliance on subcontractors, and increasing overall services utilization rates.

We are pleased with our progress here and expect this to continue into FY ’24 and beyond. Operating income was $11.7 million, better than our guidance range due to higher-than-expected total revenue, strong expense management and better-than-expected services gross profit. Overall stock-based compensation was $143 million for the year, up 4% and a little higher than our expectations due to low employee attrition levels. Share repurchase activity in 2023 more than offset the effects of stock-based compensation dilution. Total shares issued and outstanding ended at $81.4 million compared with $84.1 million ended last year. For the year, we bought 4 million shares at an average price of $64.78 per share. Operating cash flow ended the year at $38 million.

We are pleased with our collections in the quarter. We ended the quarter with $927.5 million in cash, cash equivalents and investments. After multiple years of strategic investment in our business to drive our industry’s adoption of cloud core systems, a key priority in 2023 was to drive efficiency and margin expansion. We are pleased to see strong progress with key profitability measures this year. We are confident in the long-term cash generation potential as we have established our cloud leadership and accelerated our market-leading position. Now let me turn to our outlook. For fiscal 2024, we expect ARR of between $846 million and $858 million, representing 12% constant currency at the midpoint. In FY ’25, we expect ARR growth to accelerate to 16% to 17%.

The driving force behind these growth rates are committed to ramps embedded into our cloud contracts. As I’ve already noted, full ramped ARR grew 17% this year. This is the highest growth on this metric since 2019. When we look at the shape of the ramps for deals sold in fiscal 2023, we see a pronounced acceleration of annual fees in year three, which is our fiscal 2025. Total revenue for the year is expected to be between $976 million and $986 million. We expect that subscription revenue will be approximately $471 million, representing 34% growth. Support revenue will decline by about $8 million year-over-year as a result of the continued migration of our installed base to cloud, resulting in approximately $541 million in subscription and support revenue.

As a reminder, support revenue attaches to term license customers for cloud customer support activities are included in the subscription fee. We expect license revenue to decline due to steady progress on cloud migrations. Our outlook for services revenue is approximately $200 million. We are shifting more services work to our partners who have made large investments to align with our cloud approach. This approach allows us to work together with our partners to standardize this industry on Guidewire Cloud Platform. We expect total gross margins for the year to be approximately 60%. Subscription and support gross margins to be approximately 59% and professional services gross margins to be approximately 15%. We are pleased with this progression as we work to continue to drive margin improvement.

With respect to operating income, we expect an operating income of between $62 million and $72 million for the fiscal year. We expect growth in operating expenses to continue to be muted in fiscal year 2024. Cash flow from operations in fiscal 2024 is expected to be between $95 million and $125 million. Our CapEx expectations for the year are between $20 million and $25 million, including $15 million in capitalized software development costs. Our Q1 outlook can be found in our earnings press release, but let me provide a bit more color. Given the strong sales activity in Q4, we did not have many deals slip into Q1, so we expect typical seasonality for our first quarter, which impacts sequential ARR growth expectations. We expect subscription and support revenue of approximately $123 million and services revenue of approximately $43 million.

Also, annual employee bonuses and commission expenses related to Q4 sales are paid out in Q1, which impacts cash flow. As a result, we expect cash flow from operations to follow a similar pattern to what we experienced last year. Finally, let me make a comment about our FY ’25 targets that we have been tracking for some time now. We will address this in more detail at our Analyst Day, but I wanted to make a comment quickly here. As Mike noted, we remain focused on achieving our target of $1 billion in ARR and the strength of Q4 sales activity demonstrates the path to achieving that goal. Total revenue is also tracking to our prior range. On the margin side, we’re progressing a bit ahead of plan that we discussed at the last Analyst Day and our expectations for subscription and support gross margin, total gross margins, operating margins and cash flow from operations margins for fiscal 2025 are now expected to finish closer to the high end of previously discussed ranges.

We are thrilled with the progress we made in FY ’23 to allow us to deliver increasing confidence towards our long-term targets. We have built a tremendous cloud company at Guidewire, and I want to give special thanks to the finance team for helping Guidewire manage through what has been a complicated business model transition. In summary, we’re proud of what the team was able to accomplish in fiscal 2023 and are excited for what fiscal 2024 will bring. With that, let’s open the call to questions.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from Dylan Becker with William Blair. Please proceed with your question.

Dylan Becker: Hey, guys. Great job here. And Mike and Jeff, it seems like the tone is really clear on the model transition. I guess starting with Jeff, obviously, the encouraging sales activity here, there’s still some moving parts and appreciate the color on kind of the ’25 targets. I guess can you help us kind of give a sense of what’s instilling that confidence relative to the time-based outcomes of the ramped activity sounds like subscription is very healthy, maybe a little bit of an offset on the services front, but just kind of level set some of the puts and takes relative to the guide outlook for ’24 and ’25? Thanks.

Jeff Cooper: Yes, absolutely. We’re thrilled with the activity we saw in Q4. And as you know, we are cloud contracts typically contain multiple years of committed fees in the contracts. We call these ramps, right? So the shape of these ramps can be impacted by a number of factors, including our insurers rollout schedule, their implementation strategy and the business case to potentially support that investment. We noted last quarter that we were thrilled with the activity and what we’re seeing in the environment and our ability to transact with some of these ramps, we’re taking a little bit more time to develop. Ultimately, I really care the most about getting to an attractive fully ramped value and I was thrilled with the activity that we saw in the quarter to drive to that outcome.

That also is what underpins our fully ramped ARR growth of 17%. And so as we inspected the cohort analysis and the deals that underpin kind of the activity in Q4, we did see a little bit of a slower development and that had an impact in how we — in our outlook for how much of our ARR will come off of the backlog in FY ’24. But we also see a material acceleration in FY ’25, giving us really good line of sight into some of the longer-term targets that we talked about. So in general, just thrilled with the activity to set us up the foundation for as we think about FY ’24 and FY ’25.

Dylan Becker: Great. Okay. That’s very helpful. Thanks, Jeff. Mike, maybe switching over to you to kind of from a foundational level, right, the idea of what an intelligent core and embedded analytics can look like and how that courses a shift in these underwriting models. You called out an emphasis on product innovation, but how does this shift the strategic importance of what a core system can look like versus maybe what it was in the traditional sense and how that incentivizes change from both a carrier perspective but also kind of fuels your ongoing innovation road map there as well? Thank you guys.

Mike Rosenbaum: Thanks, Dylan. Great question. And I think it winds up very much to what we — what I was talking about in the script in terms of carriers being aligned with our strategic vision for the platform and where we’re taking Guidewire. I think if you think about just the most basic maybe boring definition of what a core platform needs to be. It needs to be a system of record database for policy claims and builds. But we see an opportunity to do so much more with that platform because really doing anything innovative with — at an insurance company necessitates a connection to that core system of record. And so it’s not just analytics, it’s integration, it’s the digital interfaces that they need to be able to build to connect to customers, to connect to agents, to connect to brokers, it’s also workflow systems to drive better efficiency and automation.

And obviously, as you say, is analytics and embedding intelligence into the system. We’ve worked incredibly hard to ensure that any piece of data, any business process you’re running on this core platform, we’re capturing every transaction. We’re storing every change, every single thing that’s happening on that platform in stored in our data platform, available to these companies to be able to run the operational analytics that they need to be able to run just to do business to be able to connect into the financial systems as they need to be able to use to do business and to do the complex sort of multi-period, period-over-period predictions and deep analytics that really basically allowed them to make better insurance decisions. We want all of that to be easier and easier and easier for our customers in this industry to harness and leverage.

And like I said, it’s like broad and more efficient, better insurance industry. We think we’ve done that with this platform, and we’re starting to see that I don’t know, attitude, that reality picked up in the demand that we see for the product and the execution that we saw in Q4 in this fiscal year. So I really do like the question, because we think that the industry is going to get smarter and get more efficient, and we’re excited to be part of it.

Dylan Becker: Perfect. Thank you guys. Appreciate it and congrats again on a very solid Q4.

Mike Rosenbaum: Thanks a lot.

Operator: Thank you. Our next question is from Kevin Kumar with Goldman Sachs. Please proceed with your question.

Kevin Kumar: Thanks for taking the question. Mike, on your comment on displacing other vendors. I think that’s 2 quarters in a row that you called that out. So I’m curious, is there a specific pain point or some common themes that’s catalyzing these modernizations? Do you view this as a durable theme going forward?

Mike Rosenbaum: There’s — yes, thanks for the question. It certainly depends. I would say part of it is just a bit of frustration with incumbent vendors. And it’s not specifically one. It’s like the — there’s multiple installed vendors where this is coming up. I’d say there’s a bit of frustration associated with this. But maybe that frustration is better understood in the context to, what I’d say, alignment to our innovation vision and the track record that we have been able to establish with our platform and with the successful production implementations that are now live and running on the system. I think if I think about my four years at Guidewire, there’s been an absolute change in the perspective around us painting a vision and partnering with companies to go ahead and sell it and get through the project to get it implemented and get it live and get it running.

But this is now much more something that’s becoming the norm something we’re feeling very confident in something that the systems integrators are feeling very confident in and alignment to that vision helps sort of juxtaposed to the experience that these companies might be having with other vendors. And so it is a couple of quarters in a row that we’re seeing this. We called it out because we thought it was important to sort of identify that this is a reasonable redefinition of how we think about total addressable market like in one case, you could think of Guidewire is only targeting what you might call legacy systems. But if you open that up, broaden the perspective to systems that are already kind of modernized, but not modernized to Guidewire.

That’s a significant positive change for us. And so every quarter that we see these examples, we’re very, very excited about it. And excited to tell you, but more excited to welcome other customers to the fold and to the Guidewire ecosystem.

Kevin Kumar: Great. That’s really helpful. And then I wanted to ask about the migration acceleration, specialization that’s being rolled out to your partners. I guess what’s the implication there in terms of TCO to migrate? And in general, are you feeling more confident in terms of the pipeline of migrations?