Guidewire Software, Inc. (NYSE:GWRE) Q2 2024 Earnings Call Transcript March 7, 2024
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Operator: 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. [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, 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, the impact of local, national and geopolitical events on our business and other matters. These statements are subject to risks, uncertainties and assumptions 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 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 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.
Mike Rosenbaum: 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 puts us, excuse me, 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. Approach we have taken to cloud updates and cloud services enable 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 are 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 road map 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 is historically different than the upgrade experience of our past. It 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. As our partners take on an increasing share of the prime work, the Guidewire services team will focus on a targeted portfolio of programs and strategic roles in customer programs.
Our strategic focus is for vast majority of implementation revenue to be delivered by our SI ecosystem to 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 it is enabled every day by the Guidewire Professional Services team.
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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. Here, we are working with partners to drive greater content and coverage across geos and technology and this 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.
Jeffrey Cooper: 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. Really in our cloud transition, we led most of the cloud programs and then often subcontracted much of the work to SIs and a large or, in some cases, negative margin. 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 lead cloud programs and our progress to decrease reliance on subcontractors. As a result, we saw services revenue from subcontracted work declined 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 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, and this included 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. We continue to be thrilled with the operating profit and operating margin momentum. 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.
Now let me go through our outlook for the fiscal year 2024. Starting with the top line, we are pleased to be in a position to increase outlook for ARR 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 at the midpoint, 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. So we are moderating our services revenue expectations but we continue to see high levels of demand for Guidewire Cloud.
Services revenue is now expected to be approximately $175 million, and our expectations for other components of revenue is largely unchanged. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we now expect subscription and support gross margins to be between 64% and 65%. As we mentioned last quarter, 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. Our collections cadence, cloud margins and cost discipline gives us confidence to increase our outlook there. Turning to our outlook for Q3. We expect ARR to finish between $815 million and $820 million. Our outlook for total revenue is between $228 million and $234 million, we expect subscription and support revenue of approximately $134 million and services revenue of approximately $42 million.
We expect subscription and support margins of approximately 64%, services margins in the mid-single digits and total gross margins of between 61% and 62%. Our outlook for operating income is between $4 million and $10 million. With that, we will open the call for questions.
