I'm Kevin Kumar. I cover software here at Goldman, and I'm pleased to have Jeff Cooper, CFO from Guidewire. Thank you for being here.
Thank you for having me.
I thought, Jeff, maybe a good place to start would be just a brief overview of Guidewire. Obviously, a lot of change over the last couple of years as you transition to cloud. Maybe a brief rundown of the business.
Sure
And where you're at?
Sure, yeah. So Guidewire is a vertically-focused software company, 100% focused on serving the needs of the property and casualty insurance industry. We sell a suite of applications that kind of make up the core functions of an insurance company: policy administration, claims management, billing systems that are part of what we call our InsuranceS uite product set. And then we also sell a suite of digital and data applications that surround the core. Primarily sold on premise for the history of the company. Always sold in a term license model. More recently have moved to a cloud-delivered model, so have been working to transition our software to be cloud delivered, and then working to move the industry to adopt cloud core systems of record.
So that's been a big focus over the last five years or so. You know, going through a period of time where a lot of emphasis on building out that platform. Also an environment where the industry we serve is pretty conservative, and so reticent to buy emerging platforms to a period of time where we are now, which is growing confidence in the maturity of the platform that we have to sell, and so yeah, that's where we are.
Yeah, that's great. And I definitely want to touch on the cloud transition there. But maybe to start with, you know, you recently reported earnings, and Q4 historically has been a big, big quarter for Guidewire. So maybe any key takeaways in terms of the quarter, how it kind of turned out relative to expectations and kind of the demand trends you're seeing there?
Yeah, a really strong quarter for us. So we were thrilled with our sales activity. Saw healthy demand across what we call cloud migration. So a cloud migration would be an on-premise Guidewire customer making the decision to transition to our cloud, in addition to new modernization activity. So that would be an insurer that's running on a legacy IT stack, making the decision to buy Guidewire, so kind of new logos. So broad adoption, broad demand across different types of cohorts. Pretty healthy demand environment. Really positive progress on the financial model as well.
We've been. You know, I think the first step of our cloud transition was building out the platform, and then making sure that all the early adopters were successful, and spending a fair amount ahead of the demand curve to ensure that no early insurers had major hiccups with adopting cloud, 'cause referenceability in our industry is paramount. And now we've transitioned a bit to kind of focusing on driving efficiency of the platform, so that's manifesting itself in the gross margin line. We had an over 10 percentage point increase in the subscription and support gross margins in fiscal year 2024, which is tremendous and a little bit ahead of where I expect it to be. So and then that kind of then also flowing down to the bottom line and cash flow, just had a really strong cash flow quarter, so that was great to see.
Yeah, and we'll definitely dig into some of those dynamics. Maybe to start with just macro. You know, we get the question around: What are the macro dynamics within P&C? Kind of where are we in that cycle? It seems like there's a lot of change during COVID, and, you know, we've kind of come out of that. Carriers are raising rates.
Yeah.
And maybe just how you think about kind of the willingness and readiness for these carriers to do these larger commitments and larger modernizations. Where are we in terms of that?
Yeah, I always try to distill it between, I still think the primary driver of adoption and the willingness to buy and consume our products today is more micro-driven than macro-driven. It's kind of where the maturity of the platform is, and coming out of a period of time where we actually saw pretty soft demand, because this is such a conservative industry, and wanted to see more reference points, and we've been working hard to build those reference points. And so, in terms of where we are with the maturity of the platform, I think that's the biggest driver.
Yeah
I n terms of why we're seeing some acceleration and demand. The macro backdrop has certainly improved, as insurers are taking rate in a meaningful way, given where we were a year or so, or two years ago. 'Cause there, there's a lag factor in terms of how many within, especially personal lines, are able to raise their rates. So sometimes the claims cost goes up faster than the rates can go up, and it takes a little while for those models to resolve themselves. But we're seeing kind of healthy rate taking amongst the insurance industry, and that's probably helping as well in terms of the overall willingness to take on big projects like this.
Yeah. And in terms of, you know, you talk about the cloud maturity, but when you think about kind of buying patterns across your customer base, can you talk about ... Has there been any changes? Like, obviously, Tier 1s buy differently than perhaps Tier 2, Tier 3. How can you maybe run through those buyer dynamics and if there's been any change over the last, say, you know, one or two years?
Yeah. We service a pretty diverse customer set within the P&C insurance industry, so that can include insurers that have 100 million of direct written premium to very large Tier 1 insurers that have 20, 30, or even in some cases larger than that in terms of billions of direct written premium that they manage. So the buying patterns vary. Smaller insurers will typically buy full suite and make a, you know, make a decision and kind of go all in with one vendor. The larger insurers have very complicated IT stacks. Some of them grew through acquisition. There may be thirty or forty different core system vendors that exist in that overall landscape, and they tend to buy in a more piecemeal, modular fashion. I think one of the themes that we've seen more recently. Two years ago, we were seeing a willingness to do some test and learn in the cloud, maybe bring a small line of insurance into the cloud, see how that goes, and then build on success. I think what we've seen in the last two Q4s, in particular, is an increasing willingness to make big commitments.
Yeah.
There was a customer that we signed in Q4 that was a ClaimCenter migration opportunity. The sales team did a good job of selling the whole suite and the value of the whole suite. Their original intention was just to do a ClaimCenter migration, but then ultimately said: "Hey, we're likely going to go all in with Guidewire eventually, and so why don't I just make the decision and buy the whole thing now, and then create a roadmap where I'll ultimately move to PolicyCenter and BillingCenter?" And we're seeing more willingness to do that today than two years ago. So that's been the biggest theme in terms of the buying behavior that we've seen.
Yeah.
Tier 1s, I think, the large Tier 1s, right, we expect to buy in a more modular fashion. We are working with some of them around, you know, how do we create a framework-style agreement where, you know, maybe you don't need to negotiate every single time you want to buy. You have a kind of an understanding of how that would work. And so we are kind of actively working on some of those negotiations.
Yeah. Maybe taking a step back and just looking at cloud. I mean, it feels like the debate over whether to go into cloud or not is pretty much over. And most of the new deals being done across the industry are cloud. I guess, you know, in the past, you've talked about a pricing uplift, 2-3x .
Yeah.
You know, I guess, what, what are the benefits to the customers? What- and why are they going down the cloud route? Why, why, why is... How do you think about, like, total cost of ownership, and why they're willing to pay the premium for cloud?
Yeah. Foundationally, I mean, we went down this cloud path because we think this is the best way to deliver software to the industry, right? And so if you go back in time, on-prem, we would typically do a major version upgrade of our software, release of our software every two years, and a customer would usually skip a release or two. And so take an update or an upgrade every four to six years, which is not necessarily best in class in terms of delivering innovation to our customer base. And so the cloud flips that dynamic pretty significantly.
We now do three releases a year. Our customers are able to take those releases in an increasingly frictionless fashion, so, staying very current. It also, like, managing these environments is pretty complex, and so we unburden our customers of that. Many large insurers kind of had armies of SIs that were in there managing these environments on their behalf. It's quite expensive, and so the overall total cost of ownership of moving to our cloud, even though they're paying Guidewire a fee that is two to three times higher than what they would've been paying on-prem, the division of labor has changed such that it should result in a lower total cost of ownership. We work.
You know, each case is very different, and we do business cases with our customers to try to model this out. I don't think there's a kind of a perfect formula, but in general, by the time you kind of get through a five-year program, you are exiting in a much better total cost of ownership place.
Yeah. And Jeff, you talked about migration activity being healthy. I guess maybe walk through. You know, are you noticing any themes, or are there certain catalysts that kind of incentivize the customer to transition? And, you know, I think there's eventually going to be an end of life for the on-premise customer base. So how are they thinking through the timeline, and do you see this happening in kind of waves, or what's kind of the cadence?
Yeah, I think if you're a customer on-prem, the most natural time to think about making a migration to our cloud is when you are thinking about doing a major upgrade. So let's say we had 10 versions of our on-prem software. If you're on version 8, you were thinking about doing an update. It's like, "Well, do I update to version 10, or I go directly to cloud and just skip that step?" So that's the most logical time.
Yeah.
And then, now we're seeing a bit more. You know, early on, there was maybe a hesitancy around being an early adopter. Now we're into the middle part of the demand curve, and I think that's also increasing some appetite to buy, and maybe don't want to be a late adopter either. We are generally pushing through price increases each year. I mean, the early customers took a bigger risk. The later customers, the platform is much more mature, and it's been de-risked quite a bit, and so we're raising prices as we go through these releases. There's a lot of different things that a customer will think through. I think what we're seeing today a bit more is this kind of recognition that, "Okay, I get it now. I'm comfortable with the innovation that Guidewire is delivering. I'm comfortable with the maturity of the platform. I'm likely going to go there and so I should probably start getting organized." We're seeing that a lot more today, but there's still a lot of work to do.
Yeah
And you know, we still haven't, you know, if you look at about 66% of our overall ARR is now coming from our cloud products, but on the core side, still, you know, over half of our customers are on-prem, so we still have a lot of work to do to migrate our customers.
Yeah. No, that's helpful. Maybe just a little bit about competition, especially maybe compare and contrast what the competitive dynamics were in the on-prem world, and if that's changed kind of in a cloud world. Most of the other, you know, vendors have also gone through a similar-
Yeah
Transition. And, obviously, Guidewire's focused on the higher end of the market, but maybe talk about some of the dynamics you're seeing in terms of competitive dynamics.
Yeah. So Guidewire did a really good job carving out a market leadership position on-prem and delivering our suite of applications to the industry. It's always been a competitive marketplace, so there's a number of vendors that operate in this space, that we've, you know, been the largest of those, that cohort of vendors. We did see. You know, for Guidewire, there was always this debate internally about when is the right time to really think about transitioning our investments in R&D towards the cloud? 'Cause we knew once you do that, you somewhat disrupt your pipeline. 'Cause once you've said, "Hey, we're now gonna focus our efforts on building cloud," you're gonna create a chill over those that were planning to buy on-prem, right?
So it was a very considered decision for us, and we did see some of our competitors, I think, differentiate from Guidewire by posturing cloud-first earlier than we did, and you know, I think that was helpful for us to some extent, 'cause it kind of caused us to kind of move a little faster and challenge ourselves, you know, I think that earlier, the early part of the shift to the cloud, we saw some competitors put up some nice wins.
That was still very much the, like, inning one or warm-ups for what was the ultimate cloud journey, and then, you know, we kind of went through this process of being almost pretty introspective, heads down, focused on building. It happened to align a little bit with COVID, and a time in the marketplace when there probably wasn't a lot of buying appetite anyway, and have now emerged and feel very confident in the cloud platform that we've built. You know, the win rates we're experiencing today are, you know, at parity or higher than what our on-prem win rates were.
Our thesis all along has been that, you know, market leadership's gonna matter even more in the cloud domain than it mattered on-prem. It's one thing to buy software from a vendor and put it behind your four walls and run that software, especially mission-critical software. It's another thing to entrust a vendor to run your kind of core suite of applications as a cloud service. And, you know, we felt very strongly that market leadership would matter more in the cloud, and that was kind of part of, you know, the big investment cycle that we put in place to make sure that, we, you know, distance ourselves in the cloud. Not just kind of meet the moment, but also kind of you know, distance ourselves from competitors. And we think. We, we feel very confident in the progress that we've made.
Yeah. The interesting dynamic has been maybe some competitive displacements, that historically, that's not been the case, right? It's usually net new, going after custom solutions, but it feels like you're seeing a little bit more traction with competitive displacements. Is that, is that a durable trend? Is it too early to tell?
Yeah.
Like, any thoughts there?
Yeah. There's a unique element of our market that is a little bit different, 'cause when you go into a competitive situation and you lose. Our old paradigm is that you've lost that customer for 20 years. Because the complexity around taking a mainframe-based system and recodifying all of that business logic into a new modern system, and the program you put in place to kind of get that instantiated, it's such a big effort that the kind of, you know, the friction to move off of that is so high. So you kind of have to have that mentality when you go into competitive environments.
And what we're seeing now, which is kind of interesting, is things that we would've deemed as previously modernized, as insurers are thinking about their cloud strategy, maybe they kind of modernized on-prem 10 years ago, and are saying, "Hey, well, now I want to revisit that, and I want to revisit the vendor decision that I've made." So some of that stuff that we've kind of mentally put in a box as no longer in our TAM is coming back into our TAM, which is great to see. The big part is still the massive amount of the industry that still runs on mainframe. So it's nice to see these competitive displacements, but. And I think they make good reference points and proof points.
Yeah.
But, the big part of the opportunity is still that mainframe workloads that are out there.
Yep. Understood. I wanted to talk about kind of some of the growth trends. You ended the year at ARR 14% growth, ramped ARR was 19%. I guess, you know, what-- how do you interpret that dynamic? And maybe just touch on kind of the ramp dynamics of the business and what that 19% means in terms of kind of maybe durability or even visibility of growth over the next, you know, call it year or two.
Yeah. Yeah, so, so we have this construct that we call fully ramped ARR. We disclose that on an annual basis. Fully ramped ARR looks at our customer, our customer contracts, and the fee tables in our customer contracts, and looks at the terminal year of each of those, and then calculates that, right? And so we benefit from pretty long-duration contracts, and in many cases, they ramp during the initial contract period, and when we first disclosed this, back in 2019, when we had a couple large wins in American Family and USAA, where the fully ramped events were really quite compelling, but the incremental year one ARR was not that big. And so it was kind of a view through into the selling activity that occurred that may not manifest itself in ARR.
And then it also gives a visibility into this concept of we have this ARR backlog that is very clearly spelled out in contracts that will come to the company over time, and that is time-derated. It's not based on any success criteria. The dynamic's been pretty interesting. What we saw early on was there was a couple large commitments, and then we moved into COVID, and we moved into a point in time when we were very actively building Guidewire Cloud Platform, and we saw a little bit resistance to make big commitments, so we saw people doing testing the waters, making smaller commitments, but not making the big commitments.
The amount of fully ramped ARR was a little bit lower, and some of those events, that ARR backlog that was coming into our ARR, actually became a bit of a headwind versus a tailwind. And then that started to reverse itself last year, when we started to see insurers have an increasing willingness to make big commitments, and now that's turning into a tailwind. So fully ramped ARR last year grew 17%. This year it grew 19%, and that benchmarks to overall ARR growing in the 14% range. So it's becoming a bit of a tailwind, and that gives us just visibility into future ARR growth coming from these accounts. So that's a little bit of why we disclose that metric. It's a little bit unique.
Yep. Yep. You know, another dynamic that's come up is some of these GWP true-ups that you're seeing in the contracts. So maybe walk through. I think you talked about a couple of points of tailwind for from that, in the business, so maybe just talk about, like, is that a durable trend? Is that... How staggered is that in terms of when customers come up for renewal, and how do you see that kind of playing out from a growth tailwind perspective?
Yeah. So we have a wide variety of customer contracts, but foundationally, we price our software on basis points of direct written premium. So we don't sell seats. You know, it's not like this, this is just how the company has always priced their software, and it aligns with how the insurance industry thinks about their cost structure and their income statement. So it's been a model that's worked very well for us. A customer will very often have. You know, so they have a what's called a baseline direct written premium in their contract, and then we have rights to, if they go over that baseline, to charge true-ups.
And in this environment, where we're seeing inflation and insurers taking rate, we are seeing more true-ups than normal, and so that added, we said, about two percentage points to growth this year over a normal year. We're seeing a little bit more in our on-prem base, although the overall gross dollars was pretty balanced, but on a percentage basis, more on our on-prem base. Those contracts are all pretty old. In a new contract, it's not uncommon for a customer to buy a bit more direct written premium than they're currently managing, to give them some growth or some room buffer before they hit a true-up.
But we are seeing more true-ups, and we do expect the true-ups to be kind of durable. It takes a little while for insurers to take rate and for that to flow through their models, and then it also takes a little while for it to flow through our model, i n terms of when the renewal hits or when they go through some buffer that was built into the baseline. So, as we look ahead to next year, maybe not quite as much of a tailwind as this year, but we do still expect it to be a tailwind vis-à-vis a typical year.
Yeah. That's helpful. Maybe a question on your non-core product. I think the focus has been on cloud, rightfully so and the transition and selling the core systems. But you have a broad portfolio. You have analytics, you have other products you can sell. I guess, what's kind of the, you know, is that a meaningful contributor to growth? How is that evolving? It feels like the attach rates for AI, excuse me, analytics, is pretty compelling. So how do you think through kind of that as a growth driver?
Yeah. So we have a nice kind of recurring revenue engine with our digital products. There's some re-architecting of how we're doing that that I think can make that more compelling over time and more easy to adopt. We have a broad suite of analytics products that include reporting capabilities. We have a predictive analytics capabilities. We have some data products that help insurers drive better underwriting outcomes. And so a fairly robust suite of analytics products. In general, I think with where we are in the cloud, those kind of ancillary products haven't been an accelerant to growth because the cloud is kind of at this adoption curve. And, you know, we think over time, as the cloud becomes more instantiated, those products will be a bit more compelling.
The first step for an insurer is to get live on the cloud, and then we see them pop their head up and look at some of these ancillary products, but you know, we're excited about the potential there. And especially around on-prem, all of our customers adopted our software in quite different ways and, you know, utilized maybe different database technologies that are, a nd there's just a variety of different ways that they ran the software. And in the cloud, it's very standardized. And so it enables us to more easily kind of sell through, and also more easily create a marketplace.
Yeah.
That is something we're excited about, so.
Yeah.
This is like, it's becoming a focus more and more as we now feel that the cloud is in a really healthy place. You know, how do we start thinking through some of these new product areas that we can drive forward?
That's great. I wanted to ask about the partner ecosystem, and that, that's been, you know, it feels like that's a key part of the strength of the Guidewire platform, is the extensive partner ecosystem. You know, it felt like Guidewire was doing more of the heavy lifting in the early days of the cloud.
Yeah.
It feels like you've gotten more comfortable offloading more work. I guess what's left to be done in terms of partner enablement, and what are the ramifications, I guess, for kind of the services side of your business and kind of the overall revenue mix going forward?
Yeah. Yeah, so when we talk about partners, there's really two categories of partners. There's our SI partners, who do a lot of the implementation work, and then there's our solutions partners that kind of tap into our marketplace and kind of create some innovation and interesting work. So on the SI side, early on in the cloud transition, we felt it was important to lead a lot of the programs to, one, we were early, we had to figure out how to run these programs right? Before we could train our SIs, we had to figure out how to do them ourselves. And we wanted to be really intimate to the programs from a product perspective.
Yeah.
So we were driving a lot of the early programs. The intention all along was to make sure that over time, the SIs do the majority of that work. If we tried to do all the work ourselves, we would not be able to do this many cloud deals, 'cause without building a massive, massive services organization. And so we've done a really good job. That team has been focused on it. I'm thrilled with the investment that the SIs have made to kind of drive certification.
Yeah.
I saw the guy who runs the PwC program recently, and he was kind of touting about the social media campaign, about how when the latest release came out, how quickly they all got certified on it, and they were sharing it on LinkedIn.
Yeah.
And so kind of that's been really positive to see, to see that. And as a result, our services revenue has come down, which is great because the software revenue is continuing to be very strong, which is emblematic of the fact that our partners are taking a lot of this work. And that's what we need to do in order to address this modernization of an industry together.
Yeah. I wanted to touch on specifically cloud gross margins. You talked about the improvement there this year. You know, I think the guidance for fiscal 2025 implies pretty healthy incremental gross margin.
Yeah.
So is it just a function of more scale now, as you get more customers on board? Like, what and maybe that's part of the question, and the second part would be just kind of how high can gross margins get with the kind of current architecture that you have at Guidewire?
Yeah, I told Diego I'm super disappointed because we're not doing a third year of over 100% incremental margins. I mean, there's been a lot of work to drive efficiency into the platform, and we are seeing the benefit of that. So, and it... The accounting can get quite complex- in terms of cloud migration accounting and ASC 606 and the impacts on subscription revenue, but you know, what I try to look at is kind of looking at our margins on a cash basis, on an ARR basis, to get confidence in how we think about the long-term targets, and you know, there's so much movement in terms of the efficiencies we've delivered to the platform, that it can get a little bit cloudy from an overall investor looking at the financials to try to understand, 'cause, you know, over 100% incremental margins is not kind of sustainable.
Yeah.
But as we kind of look at the cash margins and think about how that compares to our long-term targets, it gives us confidence that, you know, we should be normalizing some of those model impacts, delivering incremental margins in line with or slightly better than some of those targets that we have.
Yeah.
That should kind of allow the model to continue to march up towards those targets.
Yeah. Any questions from the audience? Maybe one on, you know, I think the cash flow generation of the business, it really inflected this year.
Yeah.
I guess what's. You know, how do you think about, y ou know, you touched on the gross margins, which is a pretty critical piece of it, but I think investors often ask about, like, you know, it's a vertical model, how high can kind of margins get? And I think a big part of that is free cash flow generation.
Yeah.
And so I guess, you know, what were the drivers of the inflection this year? And I think you put a pretty healthy kind of guidance for next year as well.
Yeah.
Maybe just to walk through kind of the free cash flow generation of the business and the levers to kind of get that in line with maybe some other vertical software names out there.
Yeah, I mean, we were thrilled with. The biggest element is the work that Diego has done in delivering gross margin to the platform.
Yeah.
There are some nuances there in terms of, like, the timing of rev rec and how it compares to invoicing, that has caused cash flow from operations and free cash flow to run kind of meaningfully ahead of operating margins or operating cash flow, or operating profit. But, the biggest driver is that we've now built a machine that can add customers without needing to add headcount, and can do it in a way that's highly efficient from an overall AWS workload perspective.
Yeah.
And that's, you know, was a huge part of the investment that we made over the last two years. And that's coming to fruition. That's what's driving it. And we have, you know, a relatively efficient go-to-market motion. It's a vertical that you know, there's not that many insurers out there. We know all of them, so we don't have to kind of throw a bunch of money at sales and marketing, trying to get G&A more efficient as well.
Yeah.
And so you take all those things together, and the model's starting to play out the way we knew it would. And there's nothing that I see that kind of gives me pause to say that, "Hey, we can't achieve what some of the best-in-class vertical software names out there have achieved.
Yeah. On that point, you know, I think you talked about some incremental investments, particularly in R&D.
Yeah.
Maybe walk through kind of where you're investing. I think you kept your kind of EBIT targets kind of, or you alluded to perhaps having, you know, the EBIT margins kind of being on track with your prior kind of targets, and so maybe why now, in terms of those investments? How do you think about that balance going forward?
Yeah, it's the right time for us. 'Cause, like, for the last three or four years, we were just so downward focused on driving cloud execution. And now we feel that that's in a very healthy place, and we are very aware of the opportunity that exists once we aggregate a meaningful part of the industry on a common cloud platform, to sell through real value-added stuff on the data side. You know, and we have a, we have a ratings engine that's been maybe under-invested in, that we wanna reinvest in. There's kind of areas in pricing that we think are super interesting. There's a lot of opportunity within GenAI, for there's numerous use cases there. So there's a lot to invest in.
Yeah
A nd there's a lot of opportunity. And now that we have the foundation set, it's the right time for us to start making those bets. And Diego, I mean, from an engineering perspective, Diego manages the biggest part of our R&D line. He has a lot of investment to just kind of tweak some of the allocations, right? So he's shifting more of his effort away from platform and infrastructure, and more towards the application layer. And then there's also some incremental investment that we're making to drive some of these in-product investments, that we think will pay off years from now and kind of allow us to kind of maintain an exciting, kind of durable grower within this industry.
Yeah. Great, and maybe last one from me on just capital allocation. I think you're close to $1 billion in cash in the balance sheet. How do you think about... I think you, you know, in the past, Guidewire did more M&A, but curious kind of uses of cash, M&A strategy. You did a buyback a while ago. So maybe just a kind of update on the capital allocation.
Yeah. We'll, we're probably gonna talk a little bit more about this at Analyst Day in October. The framework we've had out there historically is conservative industry, they like to see a vendor that is doing a mission-critical service for them, have a well-capitalized balance sheet. And so we've talked about $400 million minimum, run the business cash. We think we've earned the right to be a long-term consolidator, acquirer in the industry, and so wanna make sure we preserve strategic capital for M&A. We haven't done a lot of M&A because we've been so focused on making sure we got the cloud transition right, and didn't wanna take on incremental distraction when we were in the meatiest part of that transition.
But now, kind of looking ahead, I think we feel more confident that inorganic should be part of our growth story. And then, you know, we also wanna do some building. We have a convert that is maturing in March, and our expectation is that we will pay that down in cash, and net share settle. And so we're kind of making sure we preserve the right balance sheet to be ready for that as well.
Yeah. Great. Well, I think we're just about out of time. Thanks, everyone. Jeff, thank you so much.
Yeah. Thank you.
Appreciate it.
Sure.