GWRE 2024Q2

Greetings. Welcome to the Guidewire Second Quarter 2024 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, Vice President of Investor Relations. You may begin.

Thank you, Shamali. 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, and other matters. These statements are subject to risks, uncertainties, and assumptions based on management's current expectations and should not be relied upon as representing our views as of any subsequent date. Please refer to the press release and documents we file with the SEC for information on risks and uncertainties that may cause actual results to differ materially. We will also 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. And with that, I'll now turn the call over to Mike.

Thank you, Alex. Good afternoon, and thanks, everybody, for joining today. I'm pleased to report another strong quarter with continued momentum in both sales activity and operational performance. Our results in Q2 put us in a great position halfway through our fiscal year, driven by outstanding execution and progress across sales, customer success, finance, product, and engineering. We reached $800 million in ARR in the quarter, and our performance through the halfway point allows us to raise our ARR guide for the fiscal year. Our continued sales momentum is clear validation of the investments we have made in our cloud platform. The approach we have taken to cloud updates and cloud services enables us to deliver a new level of agility to our customers in the P&C industry and will unlock the innovation the industry requires to continue to transform and evolve. Our suite of insurance products is winning in the market, gaining momentum, and continuing to fuel a very durable and successful business. Increasing market confidence in our cloud strategy was reflected in record sales results in the second quarter with continued strength in the Americas and improved momentum in Europe. Overall, we closed 11 cloud deals in the quarter; 10 of these were InsuranceSuite cloud deals, including three in the EMEA region. We were thrilled to close four Tier 1 deals and saw a healthy distribution of demand across migrations, expansions, and net new customers, indicating good traction in each of our core growth opportunities. Some of the takeaways were: migration activity picked up at larger insurers with three migrations in the quarter, including a Tier 1 commercial and personal lines insurer based in the United States who elected to migrate InsuranceSuite and another Tier 1 European insurer who will migrate their ClaimCenter implementation. We also continue to attract net new customers, adding three more insurers in the quarter. This included a rapidly growing newcomer to the home insurance market, who adopted Guidewire Cloud Platform for its scale and ability to embed analytics and core workflows, as well as a significant state insurer in workers' compensation that adopted Guidewire Cloud Platform for the maturity of our platform, our roadmap, and the strength of our ecosystem. With the foundation of Guidewire Cloud platform now pre-established, we are better positioned to layer on additional data and analytics offerings and core policy underwriting and claims workflows. These capabilities improve customer performance and business outcomes, and it's exciting to see them continue to take shape. Cloud expansion activity also remains strong as customers look to build on their initial success with Guidewire Cloud by moving new lines of business and modules to the platform. Turning to cloud and company operations. We continue to improve and optimize our performance around deployments, utilization, and platform efficiency. We now have nearly 70% of our cloud customers in production and have conducted hundreds of updates to customers' implementations on our cloud platform over the last few releases. This new cloud update capability marks a material change in the ongoing relationship between Guidewire and our customers and creates the framework for us to constantly deliver innovation to our customers and the industry we serve. We also continue to drive improved cloud operations efficiency, which is improving cloud margins. Subscription and support gross margin improved 8 points year-over-year in the second quarter to 65%. This gives us increasing confidence that we have the right approach, the right team, and the experience in place to support our growth and financial objectives through $1 billion in ARR. In addition to our work to shift our product and customer base to cloud, we are working to better position Guidewire to achieve our long-term model by transforming the services side of our business. We have invested in our SI partner ecosystem to ensure that we are not capacity constrained as our industry adopts cloud. Our strategic focus is for the vast majority of implementation revenue to be delivered by our SI ecosystem with our services revenue to be less than 20% of Guidewire revenue. The result will be a more powerful software-oriented business model, better overall long-term gross margins, and a better structure to serve the P&C industry. In the second quarter, we saw lower-than-expected services revenue, and this shortfall impacts our full-year total revenue guidance, which Jeff will cover. But to be clear, lowering services revenue is not correlated in any way to the overall demand we are seeing. We add the most value to the P&C industry by running a world-class cloud platform that can be integrated and configured for our customers by a market-leading and global ecosystem of SIs that is enabled every day by the Guidewire Professional Services team. This strategy is working well, and I was pleased to see Guidewire's partner ecosystem continue to expand meaningfully in the quarter. We finished Q2 with 24,000 consultants now in the Guidewire SI ecosystem, and there remains a strong uptake in those getting Guidewire Cloud Certified. Cloud certifications increased 33% year-over-year to nearly 9,000. We also added 15 solution partners in the second quarter, bringing the total to over 200. We are working with partners to drive greater content and coverage across geographies and technology, which drives greater utility to customers and will further drive adoption. We want customers to choose Guidewire, but also the value-driving ecosystem we are building around our platform. In summary, it was a great quarter and a great first half, and our teams continue to execute well across the key pillars of our strategy. Demand for Guidewire Cloud Platform and our suite of insurance applications remain strong. We continue to drive greater efficiency gains in cloud operations, our cloud platform, and the company overall. We are progressing through a services transformation to better serve the enormous opportunity we see and further position us to grow into our long-term model. I'll now turn the call over to Jeff.

Thanks, Mike. The financial highlights in the quarter included better-than-expected ARR, 65% subscription support gross margins, and robust operating income and cash flow from operations. I will touch on these points as I go through the details. Starting with ARR, strong sales activity in the quarter led to ARR of $800 million, which was above our outlook range. Total revenue was $241 million. Subscription and support revenue was largely in line with our expectations, and license revenue benefited from DWP true-up activity. As a reminder, we generally price our software as basis points of direct written premium or DWP. So when a customer sees their DWP grow, we often see their fees increase in the form of DWP true-ups. Services revenue was lower than expectations as we saw our partners take the lead in more cloud programs. In our cloud transition, we led most of the cloud programs and often subcontracted much of the work. This approach allowed us to maintain control and at the same time, train our partner community. By design, we are now transitioning away from this approach. We are pleased with our partner's ability to step up in leading cloud programs and our progress to decrease reliance on subcontractors. As a result, we saw services revenue from subcontracted work decline in Q2 by approximately $12 million year-over-year. And the cost of contractors declined by $14 million year-over-year. We have adjusted our model to reflect the fact that this transition is occurring faster than we originally estimated, and it will take a bit more time to build a backlog of Guidewire-owned programs to offset the decline in subcontracted revenue. I will touch on this more when I discuss our outlook. Turning to profitability for the second quarter, which we will discuss on a non-GAAP basis, gross profit was $151 million. This result benefited from overall strength in subscription and support margins, combined with higher-than-expected term license revenue, which carries a high gross margin. This strength more than offset the services gross profit shortfall. Overall gross margin was 63% compared with 57% a year ago. Subscription and support gross margin was 65%, which compares favorably to 57% a year ago. This continues to track ahead of our expectations due to increased cloud infrastructure efficiency. With respect to services, gross profit was negative $4.2 million, including approximately $3 million in severance charges. Services gross margin was negative 11%. Overall operating profit was $26 million in the second quarter. This was better than expected as cloud efficiency and lower operating expenses more than offset the lower services gross profit. Overall stock-based compensation was $36 million, up 1% from Q2 of last year. We ended the quarter with $933 million in cash, cash equivalents, and investments. Operating cash flow of $69 million for the quarter was a great result and benefited from better-than-expected collections. Let me go through our outlook for the fiscal year 2024. We are pleased to be in a position to increase our ARR outlook to between $852 million and $862 million. We continue to see strong sales momentum and an improving competitive position as this industry continues to modernize in the cloud. We now expect total revenue to be between $957 million and $967 million. This is a $19 million downward adjustment, which is driven by a $20 million downward adjustment to our services revenue expectations. As Mike noted, we have a robust ecosystem of implementation partners, and we have invested in that ecosystem to ensure that collectively, we can execute on the cloud demand. Services revenue is now expected to be approximately $175 million, and our expectations for other components of revenue is largely unchanged. We now expect subscription and support gross margins to be between 64% and 65%. 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 the teams focused on efficiency are having the desired impact on scalability and product gross margins. We are tempering our services gross margin expectations on a lower revenue base and now expect services margins to be between 5% and 8%. As a result, we expect overall gross margins to be approximately 62% for the full year. With respect to operating income, we are maintaining our outlook of between $82 million and $92 million for the fiscal year as better-than-expected cloud gross margins and operating expenses offset the adjustment in services gross profit. We expect stock-based compensation to be approximately $147 million, representing a 3% growth rate year-over-year. We are also increasing our cash flow from operations expectations to between $120 million and $140 million for the fiscal year. All of these dynamic situations give us confidence to increase our outlook.

At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Alexei Gogolev with JPMorgan. Please proceed with your question.

Thank you. Hi, Mike. Hi, Jeff. Congratulations on the results. I wanted to ask you about your visibility into the pipeline. Obviously, increasing ARR for the year is very encouraging. But could you maybe talk about how you're seeing the second half of the year panning out?

Yeah. Sure. Great question. Thank you very much. We feel very, very good about the business right now. Certainly, win rates, competitive win rates are solid. As you know, the deal cycles are very long in the industry, so we have a lot of forward visibility, and that gives us some confidence to increase the guidance that we set out at the beginning of the year. The pipeline, the number of deals and the quality of those deals back up the perspective that we can raise that guidance. The close rates and win rates continue to be solid, giving us more confidence in the demand for the product and our ability to differentiate ourselves and win those deals. So we feel very, very good about the second half.

And the only thing I would add is the first half was really tremendous from an overall sales activity perspective. Q2 was a record sales activity quarter for us. So we're seeing really healthy linearity in the year, which also helps inform our outlook.

And Mike, just to clarify, do you still feel confident about the $1 billion 2025 outlook?

Yeah. We do. As I said, the deals that we work on last longer in the year. We have a picture of what next year might look like and a certain amount of pipeline that we measure and track very carefully. The ARR backlog related to the ramp deals that we've closed in prior years still exists, which gives us confidence that the structure we put in place at the beginning of this fiscal year and the objective of $1 billion in ARR is achievable.

Perfect. And my second question was about the SI partnerships. I was wondering if you could elaborate a little bit more about which SIs have been gaining share with your partnerships? I remember at your conference, there was a big focus on Accenture. Are there any other names that you would highlight?

Probably not appropriate to comment on who's gaining what share. I would just say that we've seen broad-based interest among partners to work with us to expand and dig into the cloud offering and to be prepared to step up either on migration or on new implementations. That's not limited to any one partner. There's broad-based interest in stepping up and going to market with us, which is a positive signal. It shows the growing partner ecosystem. It’s a key component of our strategy.

Amazing. Thank you very much, Mike.

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

Thanks for taking the question. Mike, I wanted to ask about kind of the growth of the Guidewire marketplace. It looks like the number of apps and partnerships have grown significantly. And I’m curious about the adoption trends and anything you can share that highlights the value that's being delivered to customers, just given the breadth of solutions offered?

We do track adoption. We look at how things are being either tried or deployed into production. There is an uptick in the adoption of these applications, but we're happy with it. Partners are excited to deepen their relationships with us to ensure that the offerings are certified to work effectively with our cloud and update processes. This helps create confidence among our customers that these applications can be efficiently deployed and maintained. We're also excited to see that continue to grow.

That's great. And maybe one for Jeff on the services side. I understand the revenue impact as you shift towards SIs and some near-term margin pressure as you're making progress there. But how are you thinking about the sustainable margin profile over a longer term?

This is going to revert almost to where we were pre-cloud as we focus more on targeted services done by our personnel, delivered at an attractive margin. In the early cloud transition, we ramped up leading programs in a much more active role than was traditional for us. Now we're returning to a more classic role where the SI ecosystem takes the lead in most engagements. The result is a robust ecosystem that can help deliver on the demand we're excited to see.

Thank you. Our next question comes from the line of Ken Wong with Oppenheimer. Please proceed with your question.

Jeff, you mentioned earlier some kind of DWP true-ups. Just wanted to understand what drove that. Is that something that could potentially trigger that type of action?

As premiums grow in the industry, we price on basis points of direct written premium, so that will create a bit of a tailwind for us. We generally model this, but it is a tailwind for us.

I appreciate the question. Absolutely, this is healthy for our market. The industry is designed to address the balance of risk and modify prices accordingly. This period of adjustment is important for ensuring a sustainable future for insurers.

Got it. I appreciate the thoughtful response. If I can just sneak a quick one in on just the partner side. I think you mentioned partners leading services at a faster pace than expected. How much of that is just their ability to take the baton from you versus your improved efficiency in deploying customers?

I think there's a part of this that we had to ensure that the product was ready to be implemented by partners, and we have invested significantly in this. That's great to see. This aligns with our strategic objectives focusing our services organization on real strategic implementations, the new product introductions. This is simply seeing that strategy come to fruition faster than expected.

Got it. Thank you very much.

Thank you. Our next question comes from the line of Rishi Jaluria with RBC Capital Markets. Please proceed with your question.

Thanks. This is Richard Carlin on for Rishi Jaluria. Thanks for taking my question. Just on the services side, you mentioned accelerating the transition. Was there anything in particular that drove the decision to accelerate?

The urgency around this shift was largely a reflection of our need to return to a more sustainable long-term margin profile for our services business.

On the gross margin side, any expectations on when we can expect recovery to pre-cloud margin levels?

We could see a sustainable, low double-digit margin profile as we work through this transition. There is capacity for more services revenue than we expect this year, and we believe we will return to that sustainable margin profile.

I appreciate that.

Thank you.

The commentary is pretty consistent. The press release mentions 11 cloud deals. Maybe you can level set how you would score cloud progress for fiscal '25 thus far?

We're very happy with progress so far this year. We've done a phenomenal job driving rigor into the organization, hitting our targets through all quarters. This is a really good start to the year, and we feel good about it.

We're at this exciting inflection point in this cloud transition, starting to see that part of the model flex. So that's great to see and supports our increased cash flow forecast.

Thank you. Our next question comes from the line of Matt VanVliet with BTIG. Please proceed with your question.

Mike, you mentioned that you signed a number of new partners this quarter. Are there pockets of regions or specific markets where you feel like you still need to deepen the roster of partners?

We think a lot about progress in North America, in specific countries. We have an opportunity to optimize our approach in terms of product offerings and partners that we're working with in those markets. This is a strategy we will execute to grow faster in regions where we have bigger opportunities.

Got it. Very helpful. And when you look at customers adopting HazardHub, how much can we capture in terms of wallet share?

We focus on the business impacts we can create for our insurance customers. We believe there's a significant opportunity for the industry to improve efficiency through data and analytics. This allows us to create value and ultimately promotes a better understanding of the insurance risks.

HazardHub is interesting for its organic growth market motion, allowing us to land, let customers test out the product and grow their footprint.

Thank you. Our next question comes from the line of Parker Lane with Stifel. Please proceed with your question.

Mike, I wanted to focus in on the three net new customers you announced during the quarter. Anything interesting about the processes or mix of systems that you're replacing?

One opportunity we had was with a company with a bold vision to scale significantly, and we are thrilled to be chosen as their platform. Another deal we won after a lengthy back-and-forth process was a specialty lines commercial insurance solution. We're excited as this proves the strategy and strengthens our market position.

Are you seeing a notable pickup in how quickly customers are coming back to discuss expansion opportunities?

We're earning the trust of our cloud customers that we can effectively support them with updates. This shows that we're establishing a good cadence in a very positive way. While the overall demand remains strong, the success creates opportunities to add more lines of business.

Got it. Thanks for the feedback.

Thank you. Our next question comes from the line of Joe Vruwink with Baird. Please proceed with your question.

I know you've addressed the macro a couple of times, but is there a preemptive pattern that you're seeing that may influence customer investments?

We don't see anything that suggests a slowdown in investments. We've learned how to structure deals, and we're continuously seeing good visibility into the year ahead. Despite potential challenges, we still see healthy demand for Guidewire’s products.

We feel good about the micro dynamics as we progress, where Guidewire sits in terms of cloud maturity and the momentum we see in the industry.

Thank you. Our next question comes from the line of Tyler Radke with Citibank.

I had one question here on macro regarding inflation and the scrutiny on investment decisions. Have you seen any improvements there and what contributed to the recent success in migration wins?

Inflation impacts the decisions of insurance companies, but they have adopted a long-term perspective regarding IT investments. This stability helps them greenlight modernization projects, and we're happy to see that.

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.