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spk01: Good day, and thank you for standing by. Welcome to the Duck Creek Technologies second quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Brian Denue from ICR. Please go ahead.
spk03: Good afternoon, and welcome to Duck Creek's earnings conference call for the second quarter of fiscal year 2021, which ended on February 28th. On the call with me today is Mike Jakowski, Duck Creek's chief executive officer, and Vinny Chapari, Duck Creek's chief financial officer. A complete disclosure of our results can be found in our press release issued today, which is available in the investor relations section of our website. Today's call is being recorded and a replay will be available for the conclusion of this call. Statements made on this call may include forward-looking statements regarding our financial results, products, customer demand, operations, the impact of COVID-19 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 and may not be updated in the future. Therefore, these statements should not be relied upon as representing our views as of any subsequent date. We will also refer to certain non-GAAP financial measures to provide additional information to investors. A reconciliation of non-GAAP to GAAP measures is provided in our press release, with the primary differences being share-based compensation expenses, amortization of intangible assets, depreciation of property and equipment, and related tax adjustments. With that, let me turn the call over to Mike.
spk02: Thank you, Brian, and good afternoon, everyone. I'm excited to say that Duck Creek delivered excellent operational and financial results for the second quarter. We had great momentum in the market, and our growing number of cloud wins continues to reinforce Duck Creek's position as a leading SaaS platform for the global P&C industry. I'll begin with a quick overview of our financial results for the second quarter, which were well ahead of our guidance for all metrics. We reported total revenue of $62.7 million, up 19% year-over-year. And that was underpinned by our subscription revenue, which is our revenue derived from SAS, of $30.6 million, which yielded 51% year-over-year growth. And we were also profitable in the quarter with adjusted EBITDA of $3 million. Overall, we were very pleased with our performance in the quarter. We experienced robust demand across all segments of the P&T market. and signed a number of notable wins, including two Tier 1 customers that expanded their existing Duck Creek on-demand deployments by increasing their adoption of our platform, an exciting core system win with a new customer, two on-premise customers that chose to convert and expand their Duck Creek deployments by migrating to Duck Creek on-demand, and several non-core wins with distribution management and reinsurance management. I'll provide some more detail on these great wins in a moment, But first, I'd like to step back and highlight what we are seeing in the market. The global P&C industry is one of the most complex and highly regulated markets in the world, with products that span a significant number of diverse categories and different regulatory bodies. It's also an industry that is undergoing significant change, with the entry of new competitors and increasingly sophisticated customers who now expect a simplified digital experience and tailor product choices that best fit their needs. This new industry paradigm represents exciting opportunities for carriers to increase innovation and reimagine how they operate. However, one of the key constraints limiting most carriers is their IT stack, which is typically legacy on-premise code-based solutions that are brittle and very inflexible. As we've talked about on prior earnings calls, core systems modernization is the number one IT spending priority for carriers. In large part, because modern core systems are vital for driving better business performance. We increasingly hear from customers and prospects that they view a SaaS cloud-based core system platform first and foremost as a competitive differentiator, as well as providing a load of total cost of ownership. This is exactly the vision we had when we began developing Duck Creek On Demand in 2014. We believe that a well-designed SaaS core platform could accelerate innovation and empower business users to dynamically react to changes in the market and customer preferences. Said differently, we believe Duck Creek On-Demand could transform core systems from a performance constraint to a performance advantage for carriers of any size. One of our great insights was that modern core systems needed to be built with the business user at the center of the experience. This is why we built Duck Creek On-Demand as a low-code platform. that empowers business users to quickly and seamlessly meet the needs of the customer. Providing a powerful yet intuitive user experience that is fully compliant with the carrier's business rules and regulatory requirements was a significant achievement for our development team and is an essential aspect of the competitive strength of the Duck Creek on-demand platform. The breadth of customer conversations we are having has been particularly exciting for us in recent quarters C-level executives are carriers of all sizes that embrace the need for true digital transformation, and they are looking for a technology platform that they can build their business on for the long term. While this is a process that will take many years to play out across the industry, we are seeing real urgency among customers to develop a comprehensive long-term cloud strategy. Re-platforming core systems to the cloud is a once-in-a-generation undertaking. The carriers know that they must get right. Our customer wins in the second quarter are an exciting demonstration of our success in customer demand for our SaaS platform. First, Ameritrust, a leading specialty commercial insurance underwriter, selected Duck Creek Billing On Demand, our SaaS solution, after an extensive and highly competitive evaluation process. This competitive win is a great example of the strength of our products on a standalone basis to meet the needs of highly innovative and complex customers. while setting the stage for future expansion opportunities. Second, we had two Tier 1 carriers that are existing Duck Creek on-demand customers expand their adoption of the platform with meaningful upsells. In both instances, these customers are rolling out Duck Creek on-demand in new areas to drive growth in their business. These wins are great examples of the significant ongoing opportunities for expansion within Tier 1 carriers as they see success in their initial deployments. In both cases, these expansions represent meaningful addition in scope to our original projects. Third, we had multiple wins for distribution management and reinsurance management. An insurer embarking upon a Greenfield project will be deploying reinsurance management as part of their strategic initiative. Additionally, a leading Tier 2 multiline insurer with a significant independent agent network is adopting distribution management to better manage their agent relationships. Both are great examples of the opportunity to build relationships with insurers with our non-core add-on solutions. Finally, two of our existing on-premise customers decided to adopt Duck Creek On Demand. I'd like to provide some color on these wins as they are great examples of how we think about the conversion opportunity with our on-premises customers. First, Core Specialty is a leading specialty insurer that recently completed a recapitalization and carve-out from NSTAR Group. Historically, they had been running Duck Creek policy and billing on-premises for a portion of their book. As part of the carve-out process, the company is taking a tech-forward approach to their strategy. After an extensive evaluation process, Core Specialty chose to deploy Duck Creek on-demand for the full suite across multiple lines of businesses, including the launch of new product lines, as well as converting many of their existing products that are currently running on their on-premises Duck Creek deployments. We are excited to partner with Core Specialty and help them leverage leading technology as they maintain a vigilant focus on niche markets, local distribution, and superior underwriting knowledge. Next, Distinguished Programs, a longtime Duck Creek customer, will modernize their technology and will ship multiple product lines to Duck Creek on demand as part of their overall digital transformation. This is an important step in their modernization effort that will shift premium from a legacy platform and our on-premises installation. Their focus is to improve their efficiency and overall operations, and one that we are excited to partner with them on. Both of these wins serve as a blueprint for how we think about on-premises conversions. As we said from the beginning, we are not focused on converting customers to the cloud just for the sake of converting them at the time of renewal. We want to be a strategic partner for our customers and position Duck Creek OnDemand to accelerate their strategic initiatives. We believe this collaborative approach will generate sizable opportunities to expand while always keeping our customers' needs as our number one focus. In addition to our strong sales activity, we also continue to partner with our customers to help them deliver on their business objectives, and in some cases, with deployment times that are much better than the industry average. One great example is the exciting go-live we saw at a notable Tier 1 insurer for their small business insurance. This is a highly innovative approach to serving the small business insurance segment with a true digital platform and engagement model. We partnered with this carrier to deliver a new commercial auto product to production in just four months, showcasing the power of our SaaS platform and extensive insurance functionality of Duck Creek Policy & Done. Similarly, we are very proud of a recent core system, GoLive, that was delivered in just six months for Hollard Insurance, a leading insurer in Australia. Together with one of our SI partners, Exceedance, we leverage the power of our low-code platform to enable Hollard to meet their aggressive timelines and quickly deploy a broad set of insurance products, including personal motor, landlord, and homeowner insurance lines, and bring these products to market through a new broker distribution network. The time to value in many of our implementation cycles is an important differentiator and generates significant value for customers. From a product perspective, we continue to release new innovations on a regular basis. This is a new and exciting shift in the approach that we are embracing. During the quarter, we released several significant updates to our SaaS platform that will enhance carrier self-sufficiency, automation, and will drive meaningful efficiencies for our customers. One great example is Mutual Benefit Group, a Tier 4 regional insurer who migrated their on-premises installation of Death Creek to Death Creek On Demand as a more effective platform to support the new target operating model. In a recent webinar, they shared how they can more quickly respond to requests from agents, new partnerships with third parties, and deliver new products by embracing the power of the Death Creek On Demand platform. This kind of innovation is showing the power of a SaaS model to create a true digital transformation. This successful implementation was done together with LTI, one of our premier systems integration partners, and is a great demonstration of the value that our partners' domain expertise and industry knowledge can deliver to our customers. Before I turn it over to Vinny, I'd like to welcome the newest member of Death Creek's senior management team, Courtney Townsend recently joined us as our new Chief People Officer, where she will lead our efforts to grow our team, foster and develop our culture, and promote diversity, equality, and inclusion within the company. We are building Duck Creek to drive a transformation in insurance, and that will require Duck Creek to continue to expand with the right team while maintaining our strong culture. Courtney has great experience scaling multinational teams, which is a key priority as we grow our international footprint. I'm excited to partner with Courtney on this critical part of our growth strategy. Let me wrap up by reiterating how pleased we are with our performance so far in fiscal year 2021. Duck Creek On Demand has clearly established itself as a preferred SaaS core assistance platform for the P&C industry and is being adopted by customers across all segments of the market. We are well positioned to build upon our early success in the digital transformation of the P&C industry to become a primary beneficiary as it's moved to the cloud. We are excited by our success to date and the opportunity ahead of us to build a much larger, increasingly profitable business over time. I will now turn it over to our CFO, Vinny Chapari. Vinny, over to you.
spk10: Thanks, Mike. Today I'll review our second quarter fiscal 21 results in detail and provide guidance for the third quarter and full year of fiscal 21. Total revenue for the second quarter was $62.7 million, up 19 percent from the prior year period. Within total revenue, subscription revenue, which is comprised solely of subscriptions to our SAS products, was $30.6 million, up 51 percent year over year. In Q2, subscriptions represented 76% of our software revenue and 49% of our total revenue. License revenue was $3.6 million of 61% year-over-year due primarily to timing of term license renewals. Maintenance revenue, our revenue tied to on-premise licenses, was $5.9 million of 1% year-over-year and in line with our expectations. Services revenue was $22.6 million down 8% year-over-year. Services revenue was in line with our expectations as we faced a particularly hard year-over-year comparison, and some of our larger service engagements are scheduled to start in the second half of the fiscal year. SAS ARR, which we calculate by annualizing recurring subscription revenue recognized in the last month of the period, was $118 million as of February 28, 2021, up 75% from the prior year. SAS ARR continues to show strong momentum and reflects the strength of our SAS business. As a reminder, SAS ARR is a snapshot in time of subscription contracts that are generating revenue during the last month of a period and can be impacted by timing. For example, our largest deal in the quarter began generating revenue within the quarter and is included in the ARR number as of February 28th. SAS net dollar retention as of February 28, 2021, was 121% above our recent historical range. Over the past two years, our quarterly SAS net dollar retention has been in a range of 113% to 118%, driven by a combination of high growth retention rates, sales of new products to existing customers, and growth of DWP for products already operating on our SAS platform. The strength in SAS Net Dollar retention in Q2 was a result of some large sales within existing accounts in recent quarters. We currently expect SAS Net Dollar retention to return to our historical range later this fiscal year, as our pipeline includes a relatively balanced mix of land and expand opportunities. Now, let's review the income statement in more detail. Several of these metrics are non-GAAP, and we provided a reconciliation of GAAP to non-GAAP financials in our press release. First, on a GAAP basis, our gross profit for the quarter was $35.1 million, and we had a loss from operations of $6.4 million. We had a net loss in the quarter of $6.4 million, or 5 cents per share, based on a weighted average basic share outstanding count of $131.0 million. Non-GAAP gross margin in the quarter was $38.1 million, or a gross margin of 60.8 percent compared to 57.7 percent in the second quarter fiscal 20. Subscription margin in the quarter was 67.7 percent driven by scale benefits as we continue to generate strong subscription revenue growth and certain timing items. Subscription gross margin performed well in the quarter versus our expectations. Margin moved down slightly from Q1 as expected, and we expect a slight additional decrease in the second half of the fiscal year as we continue to add resources and scale operations. As a reminder, there can be quarterly variation due to timing of when revenue recognition begins for certain contracts and the timing of expenses at the early stages of a new deployment. We believe our subscription margins are an important demonstration of the scalability and performance of our SaaS platform. Professional service margins of 39.4% in the quarter came in slightly above our expectations and declined from the strong performance in the prior year period as expected. The sequential decline in professional services margin is in line with our plan to gradually bring down margin to a sustainable level by increasing hiring to achieve a sustainable utilization rate. Turning to operating expenses, R&D costs were $12.5 million, or 20 percent of revenue, up slightly from prior year as a percentage of revenue. R&D costs increased 25% from the prior year based on continued investment in product technologies. Sales and marketing expenses were $10.2 million, or 16% of revenue, consistent with the prior year as a percentage of revenue. Sales and marketing expense increased 19% from the prior year period. The growth reflects continued investment to expand our global sales footprint and engagement efforts, partially offset by COVID-19-related savings on T&E and events. G&A expense was $13.2 million, or 22% of revenue, up from 18% in the prior year period and in line with expectations. The increase as a percentage of revenue is primarily attributable to public company costs, which did not exist in the prior year period. Adjusted EBITDA for the quarter was $3 million, or a 5% adjusted EBITDA margin. Non-GAAP net income per share for the quarter was $0.01 based on approximately 134.8 million fully diluted weighted average shares outstanding. Turning to the balance sheet and cash flow, we ended the quarter with $364 million in cash, cash equivalents, and short-term investments, and we remained debt-free. Free cash flow in the quarter was negative $1.6 million compared to negative $3.6 million in the prior year period. The improvement in free cash flow is due primarily to a decrease in capital expenditures. I'd now like to finish with guidance beginning with the third fiscal quarter. We expect total revenue of $62.5 to $64.5 million. Subscription revenue is expected to be $31 to $31.5 million. Adjusted gross margins are projected at 58 to 58.5 percent. We expect adjusted EBITDA between negative $500,000 and positive $500,000. And our non-debt net loss is expected to range from 2.5 to 1.5 million, or a loss per share of two cents to one cent. For the full year fiscal 2021, we are raising our outlook to the following. We expect revenue of 250 to $254.5 million, subscription revenue is expected to be $120 to $121.5 million. Adjusted gross margins are projected at 59 to 59.5 percent, and we expect adjusted EBITDA of $6.5 to $8 million. Our non-GAAP net income is expected to be between $500,000 and $2 million for fiscal 21, and our non-GAAP income per share will range from break-even to one cent. Please note that effective this quarter, we have made two adjustments to the methodology used for non-GAAP net income. First, to arrive at non-GAAP net income, we are now calculating taxes by applying a tax rate of 24% to non-GAAP income before taxes. Please note that this is currently a non-cash tax rate. Second, now that we are guiding to profitability for the full year, non-GAAP net income per share is being calculated using a fully diluted share count. To summarize, Duck Creek continues to perform at a very high level. Our results reflect growing customer interest in adopting Duck Creek on demand as an essential part of their strategic plan for cloud adoption. This is a trend that we expect to benefit our business for years to come and to support high subscription revenue growth rates for the foreseeable future. We believe we have the ability to deliver an attractive combination of strong top line growth and improving profitability in the coming years which we are confident can generate meaningful value for shareholders. And with that, we'd like to open up the call for Q&A. Operator?
spk01: As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Sterling Audie from J.P. Morgan. Your line is now open.
spk10: Great. Thanks, guys. This is Jackson Ader on for Sterling tonight. First question, Mike, you mentioned a couple of migrations, right, the on-premise to the cloud. But can you give us an update on the strategy there? I don't know if there's any kind of a formal migration or conversion program. And so any update on what you're thinking about the existing on-premise customer base at the moment?
spk07: Sure. Thanks, Jackson. Well, I will say, and I've said this in the past, that our strategy is to align to our customer strategy in terms of their overall business strategy of what they're looking to achieve, perhaps launching new products, going into new lines of businesses, et cetera. We find that those are better inflection points, if you will, to position our SaaS solution. So we're having strategic conversations with all of our customers and really understanding, you know, what are their ambitions in terms of what they want to achieve moving forward. So as I said in prior calls, we're not going to go after aggressively converting customers just for the sake of lifting up on-premise and moving them to the cloud. Now, we're very encouraged by the progress. We now have five customers that have committed to Duck Creek On-Demand and three that have already migrated and are full in production, and two that are in the process. And we know that working with our customers, that they will ultimately benefit by a larger and broader business case. And when I look at it, Our new deals when we're converting customers in the cloud actually look like almost new deals. In fact, the two that I talked about in the prepared remarks, not only are we moving the existing book of business or some of the existing products, we also cross-sold some additional Duck Creek products into the base in Duck Creek On Demand. So we're expanding the scope. And we're also aligning the delivery and the go-lives of that platform with some of their broader business initiatives. So, you know, we're excited about the opportunity sitting in front of us, but I also want to temper everybody's enthusiasm on this in terms of pace. We're going to go at the pace when they're ready, so it's difficult for me to forecast how quickly they will occur over time.
spk10: Okay, great. Thanks for that update. And then, Vinny, the follow-up for you on the net dollar retention issue. So expecting it to go down kind of maybe into that 100 and teens range, like you mentioned you've seen in recent quarters. Is any of that due to the fact that maybe the initial land is getting a little bit bigger than you've seen in the past? Or is it just some oddities in terms of getting some existing customers that just happened to jump up really big in this last quarter? No, Jackson, I think it's more just about mix over the last couple of quarters. And the mix has been skewed in recent quarters to expansion deals in the existing base. But we don't expect that to be an ongoing, immediate trend. Our pipeline is split reasonably balanced between land and expand deals. And we think we'll start moving back down towards that more historical range. So I think this quarter was a bit of an upside aberration in terms of net dollar retention and really just deal specific as opposed to any ongoing trends.
spk04: Excellent. All right. Thank you.
spk10: Sure.
spk01: Thank you. Our next question comes from the line of Chris Merwin from Goldman Sachs. Your line is now open.
spk10: Okay, great. Thanks so much for taking the question. I just wanted to ask about the two Tier 1 customers that expanded their offering in the quarter. I think you mentioned it was through upsells. I was curious if you could provide any other detail there. Was it specifically going into other lines of business, or was there actual expansion in terms of modules they were taking? Just any other color you can share on those two deals would be appreciated. Thank you.
spk07: Sure, Chris. Thanks for the question. We're pleased with, obviously, the momentum of on-demand and adoption within the Tier 1 community. I think it really showcases the advantage of our SaaS low-code, you know, offering in the marketplace. You know, in terms of the two deals that I talked about, you know, we saw that these were expansions that were tied to the core assets that they already subscribe to as part of our on-demand service. So in this case, it was the expansion of them using a product into a new product line as well as expansion to the committed DWP level. So we think it's a great example of just ongoing expansion within an account. And then one thing that we're very, very pleased with is that, you know, this is more than just carriers, you know, adopting our SaaS platform for the first time. They're seeing success. They're seeing success with their initial implementations, and because of that success, buying more. So, again, we think it's a great example of future upside within Tier 1 carriers.
spk10: Okay, perfect. Thank you. And maybe just one follow-up. I wanted to ask about international. I know that's an area where you've been investing in Europe in particular.
spk08: Anything you can share about progress there, notable wins, or just timelines about when we might start to see the – the impact of some of the investments you're making there, and there's a long-term project.
spk10: So just curious any mile markers you could share with us. Thanks.
spk07: Yeah, Chris, as you said, it is a long-term initiative, so we think it's really a longer-term growth lever for Duck Creek. We're making good progress in our investments. We're pleased with the high-quality people that we've brought into our business in both Asia Pacific and in EMEA as well. Our investments in the product, and we continue to invest in our products. Specifically, we'll be launching a multi-currency capability within our billing product that's going to be helpful and some localized content for EMEA and Asia Pacific. And then in terms of overall momentum, I would say that not a lot has changed since last time I talked about it on the earnings call. We're thrilled with the go live that we had at Hollard Insurance in Australia. They're a very notable and highly respected carrier. And I think proof points of our success is always great. But as I said on our prior call, you know, we think we got a little bit of a headwind with COVID just because us to build a brand in local countries and to continue to expand where we're not known is going to take a little bit longer. And we really don't expect, you know, some of these investments to really be felt until fiscal year 22. So, you know, but again, I'm pleased with the progress so far.
spk08: Great. Thanks a lot, Mike.
spk07: Sure.
spk01: Thank you. Our next question comes from the line of second, Kalia from Barclays. Your line is now open.
spk05: Okay, great. Hey, guys, thanks for taking my questions here. Mike, maybe just to double-click on a prior question just on conversion activity. And, again, to be clear, you said consistently that this is being driven by the customer. But maybe you could just talk about what you're hearing from those conversion, those handful of customers that have converted thus far, on what drove the decision to convert. And maybe qualitatively, Mike, can you just talk about the cadence of future conversion activity, understanding that it's driven by the customer?
spk07: Yeah, certainly. And I would say that we are getting nothing but very, very positive feedback from our existing customers. You know, we just did an announcement I talked about in the prepared remarks with Mutual Benefit Group. They're a small carrier in the state of Pennsylvania, a regional player. They do both personal and commercial lines and migrated to Duck Creek On Demand. And it's really giving them a lot of benefits in terms of how they interact with their agents, how they can better enable their claims adjusters. And what they really love about the platform is the incremental delivery of new capability and functionality. With them, we're deploying new capabilities in a very repeatable basis, sometimes as quickly as every two weeks. So we're on a whole different cadence of release of technology to them. And I think they're just very excited. With a very small IT shop internally, that they can have access to this type of continuous deployment technology. And I think it's really meaningful for them. And then in terms of cadence going forward, I would say it's difficult for me to forecast because again, we're really looking for these strategic inflection points from carriers as opposed to really driving a straight up conversion. When we just drive into straight up conversion, A, you know, it puts a little more price pressure perhaps on it because They already have servers. They already have infrastructure. Some of them don't have a means of how they're running that off, so it's just not a good point in time for them. And some of the strategy around aligning around their strategy is based on my own experience. I was a prior CIO for a large Tier 1 insurer. And at times I had software vendors kind of keep me beholden to strategies of converting and doing something that perhaps was not in my immediate budget or plans. And that's just not going to be the way that we roll. We're really looking for the strategic alignment with their business initiatives. Do they want to bring a new product to market? Do they want to launch in a new channel, maybe perhaps bring an existing product to market direct to consumer? And we know that those are great inflection points, and then we could talk about value of our SaaS solution. So this is very intentional, but to get back to your question, it's very difficult for me to predict the cadence of that because we don't always know when they're going to get funding and budget unlocked for some of these strategic initiatives. So it'll look more like the cadence of New Deal origination for us as we go forward.
spk05: Got it. Got it. That's helpful. Vinny, for my follow-up for you, again, just to sort of stay on the topic of conversions and understanding that there have only been a handful of them, but just to make sure we're all sort of level set, can you remind us sort of what you've seen in terms of economic impact when conversions happen? I mean, clearly it sounds like the conversions that you've seen, you know, can also lead to some cross-sell as well. So just any data points you can give us in terms of what a conversion could mean to the financials?
spk10: Yeah, hi, Saqib. So let me give you kind of an apples-to-apples comparison from an economic perspective and then contrast that with the two we just did recently. So generally speaking, if you had an equivalent loan on-premise deal, same DWP, same products, et cetera, there'd be a revenue uplift to move on demand of call it 2 to 2.5x. So that's 2 to 2.5x of an annual term license plus its maintenance versus the on-demand fee. Now, just as a reminder, you can't do that off an income statement because license revenue is recognized all up front. But just if you were looking at just kind of an apples-to-apples comparison, it's about two to two and a half times the revenue. So, it's obviously revenue accretive, it's gross profit dollar accretive, gross profit margin, not accretive because obviously the license is nearly all profit at the margin. But it's certainly accretive from both the revenue and profit perspective on a dollar basis. In the case of the two that we just did more recently, you almost can't even consider them conversions because of the magnitude of the upsell. So they were contributing, you know, what was on our income statement at this point for those was a relatively small amount of maintenance with the license already having been recognized. And they went with, you know, there were much bigger deals. So these conversions happen to look much more like a brand new sale as opposed to conversion economics.
spk05: Got it. Very helpful. Yeah, that does. Thank you. Okay.
spk01: Thank you. Our next question comes from the line of Brad Sills from Bank of America Securities. Your line is now open.
spk06: Great. Oh, hey, thanks, guys, and congratulations on a nice quarter. I wanted to ask about just a general question here on the industry. This is one of the few industries where, you know, forget about cloud. The vast majority of the technology that's being run for core systems is legacy technology. and there's a lot of custom built, a lot of mainframes still. So my question is, you know, do you think the cloud is going to provide a catalyst for the industry to kind of move over towards and how so? I mean, what are you hearing from customers? Just in terms of app modernization, you know, what does the cloud do for that adoption cycle? Thank you.
spk07: No, thanks. And the short answer is yes. We do think the cloud is a great enabler at this point in time for carriers to revisit their overall technology stack. And to your point, the majority of what we are replacing out there are legacy systems. Not always. Sometimes carriers, what they're doing is consolidating some legacy systems. And in the case of one of the customers that we just talked about in the prepared remarks, we're converting a legacy platform as well as what's on premise of Duck Creek into our cloud. But I think this is a great inflection point for carriers, especially in a post-COVID world where many of their their employees are working remotely. They want access to all of the data, the processes, the information just via a browser and all the data at their fingertips. And cloud technologies just gives them a new means to do that. And then also, as I said in some of my earlier remarks, the speed of implementation using the cloud is making a meaningful difference And I noted a tier one that went live on a new commercial product in just four months. And we just know without cloud technology, those type of timeframes would really not be that feasible when you're worrying about infrastructure and lifting and putting up infrastructure as opposed to just leveraging capability in the cloud that's already available to them. So, you know, we think that's really just changing the conversation as carriers look at their core systems.
spk06: That's great. Thanks so much, Mike. And then one more, if I may, Vinny, for you. The subscription gross margin continues to show real good scale and results year over year. Can you remind us if there's a target you have in mind for subscription gross margin and what are the puts and takes in terms of kind of where are you today and how do you achieve that over time? What are some of the key levers for subscription scale, especially as you're ramping in the cloud? Where are the investments? Where is the scale coming near-term and long-term? Thank you so much.
spk10: Sure, Brad. So, you know, we've said we think, you know, over a longer term we expect subscription margins to get into the low 70s. We're at 60, you know, we're at 67.7 this quarter, although that was higher than we expected and probably not normalized for where we are right now. So we're probably on a normalized basis running around in the mid-60s right now. To scale that up, you know, five, six, seven points, Part of it is just pure scale benefits. We can spread more customers across existing staff and technology. So, you know, we think it's just kind of a natural progression up using, you know, automation tools, getting more leverage around the existing staff. And we think it'll be, you know, from kind of the mid-60s, a fairly, you know, rateable step up as we go quarter by quarter out into the future. So we think we can see gradual improvements from here. We did mention this before. We do think we're probably going to step down a little bit from this quarter's rate in the second half of this year just because we've benefited from both cost timing and revenue timing in the first half of this year. We had some deals generating revenue that weren't fully cost burdened yet. And we were a little, you know, we were not a little bit behind in our hiring plans. We are continuing to hire aggressively in our SAS operations group. And we think, you know, as we get through the second half of this year and out into next year, we'll see a steady progression up.
spk06: Thanks, Vinny. Appreciate it. Sure.
spk01: Thank you. Our next question comes from the line of Tom Roderick from Stiefel. Your line is now open.
spk08: Gentlemen, thanks for taking the questions.
spk10: Mike, let me start with a question for you here.
spk08: I mean, there's obviously a handful of levers that are driving some of this fantastic ARR growth. And, you know, you've talked a lot about product and customers moving to the cloud. What I'd love to hear a little bit more about is the customers, once they're in the cloud, does that element of being in the cloud sort of help to accelerate the percentage of DWP that they start putting towards you know, towards your platform. You know, in other words, I think historically we might see that take, you know, five to seven years for a sizable carrier to move all of their DWP over. But the cloud would seemingly make that easier. So I'd love to just hear a little bit more about, you know, the expansion efforts as you go across different line items and products and how fast that DWP can move once you get into the cloud.
spk07: You bet. Thanks, Tom. The answer is yes. I do believe the cloud accelerates how fast we can continue to grow DWP on the overall platforms. But please know that there are some limiting factors that are out there in the industry that sometimes temper how fast that can occur over time. And I think we're best in class in leading the industry in terms of our ability to do this with speed. So there's two ways I want you to look at it. There's some carriers that have a more simplified product set, but a more, you know, and I'll say a more homogenous book of business that they need to scale onto a new platform. This is many of the personal lines carriers, and they could scale more quickly, but what you need to know is that these products, especially in the personal line side, are still regulated state by state. So they have filings by specific states. They have to get, in some states, they have to get those filings cleared ahead of time, Some states are filing you so that they can go and catch up on the filing. And their ability to react to that, get those filings complete, will sometimes kind of, you know, regulate, if you will, how fast they can move on. And then there's another type of carrier that has a whole disparate set of products, product lines. Maybe they do personal lines and commercial and some specialty lines. And there, the long pole in the tent for putting more premium on the platform is the implementation costs, right? Because implementations tend to be wrapped around the specific product line that you're implementing for. So, for instance, as one of the carriers I talked about, we put up commercial auto. That was the initial product. And now we're in discussions around what that might mean for broader products across the company. And those each would be a different project. But I think, you know, showcasing that we can do such an implementation in about a four-month timeframe. So the more that you can execute that with more velocity, the more, you know, we can start to scale premium on the platform. So perhaps maybe a little bit more than you bargained for, Tom, but that's really the way we look at it. And if we can continue to speed implementations and help carriers be more agile in terms of their product development and filing process, we know we can do this with more speed going forward.
spk08: Yeah, and that's really helpful, Mike. And I wanted to follow up on your point just on the implementation sort of being the long pole and the tent. Can you sort of talk a little bit more about the buildup of your partner practices, you know, what they're doing on their end to sort of keep their teams really fully aligned with the product innovation that you're bringing to the marketplace and making sure that they're appropriately trained and staffed for, you Just talk a little bit more about partner implementations, how that's going, and how partner practices are building out there.
spk07: Yeah, thanks for that. And as I've indicated earlier, the systems integrator partner community and, you know, that overall ecosystem is a really large tenant of our overall strategy. And, you know, we're not going to report on a recurring basis on all of our accounts, but we have over, you know, 16 systems integrators and delivery partners that we work with, and they're investing quite heavily in their overall practices. In fact, in our prepared remarks, I was delighted that I could talk about Hollard and how exceedance helped us there, and with Mutual Benefit Group, LTI helped us there. So now we're getting really a lot of diversity of partners, and we love the diversity because now customers can look at their overall strategy and look at our variety of partners and really choose who's best fit and aligned with their overall strategy. Now, Tom, back to your question around what are they doing, we're thrilled with how much they're investing in their practices. And we see that show up just in the hundreds of resources that are coming through Duck Creek University and allowing us to bring forward our training and really learning the latest on our cloud technologies and our SaaS platform. And at the same time, we see many of these partners developing accelerators, things that they can do to really make delivery cheaper, faster, and easier on behalf of the customers. And I think the more investments they're making collectively, they're investing in the overall ecosystem and the success of our joint customers.
spk08: Yeah, that's really helpful. Thank you, Mike. Appreciate it. I'll jump back in the queue.
spk01: Thank you. Our next question comes from the line of Bhavan Suri from William Blair. Your line is now open.
spk09: Hey guys, thank you for taking my questions and nice job. I want to just follow up on Rodri's question there a little differently and bring in the idea of content, right? So content has been critical and content templates have been pretty critical as you think about implementation. How do you think about the partner's ability to drive more of that to ease implementation And I guess, are you seeing any changes in that, especially around commercial, in that sort of content and content template space? I'd love to understand how the partners play into it and sort of what the competitive environment, especially in commercial, where at least my perception is you have a pretty material lead in the commercial line content space. How should we think about that?
spk07: Yeah. Bhavan, you are right with investment in content. Really, for those listening, that is about strengthening the the very vertical aspect or the line of business aspect, so being the best at workers' compensation or being the best at inland marine insurance and really going much, much deeper. And to your point, we have a lot of strength in our content and in our line of business specific bureau products. But those expand outside of just the features and functions that you need within those lines of businesses, which we're very, very strong at. But also, some of these require very specific integrations to outside third parties. So, for instance, you know, we announced an integration with Split Limit Studios that helps us with pay-as-you-go or billing workers' compensation. So, it's allowing... workers' compensation insurance to bill more effectively. And then we think about investing in content on a regional basis as well. An example that we invested in is EBICS. They have a platform called the Sunrise Exchange that we integrated in the Asia Pacific or the Australian region, and that allowed a carrier to get live with more velocity and speed plugging directly into Sunrise. So we're going to continue to make those investments because we know the more that we can have these integration points pre-plumbed out of the box, the more that we can speed implementation times. And in fact, last quarter, you know, we announced six new partners in our solution partner program, and that's why we continue to invest in that side of the business. Now, our systems integration partners also invest in integration as well. Some of that isn't productized, but it shows up to the customer as a reduced number of workdays when they actually have to go do an implementation. So we're constantly encouraging them to invest in those practices, have those accelerators, and make those implementations cheaper and easier.
spk09: Got it, got it. And then I do have a follow-up, but just on the competitive environment, I guess as you think about commercial lines and the content, which, again, I believe you guys certainly have a moat around, have you seen any changes in behavior largely from the largest competitor out there or the larger competitor out there? Are they doing more in this space? Are they trying to come after you in this space? How do you think about any changes, I guess, in that competitive space where certainly you guys have a great deal of proprietary knowledge and integrations?
spk07: No, I appreciate the comment and the observation of our advantage in this area. And I would say, no, there's nothing that our competitors are doing of note. I would say some of the stronger competitors we actually see in this industry, I won't name them, but have somewhat of a legacy-based architecture, but they're really strong in the functional depth of it. But when I go look at our more common competitors, You know, this is not a business problem that you can solve overnight. And I might have referenced this in past calls, but as part of our ability to support that bureau content, we have to actively support thousands of insurance forms. that are pre-integrated with our software out of the box. We can pre-fill those forms and issue those out to an insured, perhaps, when we bind a policy. And when you have thousands and thousands of forms and you need to have some real deep industry acumen, that's a tough hill to climb for competitors. And to your point, that's why we have such a moat around that aspect of our business, for sure.
spk09: No, that's really helpful. And I guess one quick follow-up I had, you know, you touched a little bit about international investments. I'd love to understand sort of both international and U.S., how you guys are sort of thinking about investing to grow the middle market opportunity. Like, you have a good number of middle market customers, Tier 3, Tier 4 type customers, but, you know, obviously have a good set of Tier 1, Tier 2. But internationally, if you think about Europe especially, just give us some call on sort of what that investment looks like and how you're planning to sort of penetrate that middle market. I'm spaced a little more. It would be helpful. Thank you.
spk07: Yeah. Yeah, I would say one thing we're very, very proud of at Duck Creek is the fact that we have a single platform that not only scales to carriers across a multitude of lines of businesses, you know, your comment around our superior capabilities in commercial lines, and then also we've done some great things with personal lines carriers as well. but also a common investment that scales to carriers of all sizes. I talked about Mutual Benefit Group, who's just about over $100 million of premium, a regional player, and then we work with very complex, large tier ones like AIG as another example. But to go back to your question, the investments we're making in the middle market, these are carriers that really look for rich, out-of-the-box functionality that works for them. So I think that is why we've done so well in the middle market in North America. Those carriers that have several hundred million of premium, commercial carriers all the way up through a couple of billion of premium, we've done really, really well in that segment of the market. And that's another reason why we're investing internationally in more localized content for some of the markets that we want to pursue. And we have a team that is carved off, and they are explicitly focused on that business problem. And we think that our platform provides us an advantage there. But again, some of those investments take years to make over time. We think we have an advantage with our low-code platform, but some of these are also regulatory forms. very specific interfaces in the market that we have to worry about, and we have a team that's working on that problem today.
spk09: Gotcha, gotcha. Thanks for taking my questions, guys. Appreciate the color. Also appreciate the depth you went to, especially in my first question. Thanks, guys.
spk07: Thank you.
spk01: Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Our next question comes from the line of Brian Peterson from Raymond James. Your line is now open.
spk08: Hi, gentlemen. Thanks for taking the question. Just one for me. So, Mike, I just wanted to get into kind of a hardening insurance market, and we're seeing premiums go up. What do you typically see in terms of IT purchasing from some of the customers as they think through that, and how should we be thinking through the ramifications of what that could ultimately do to DWP? Thanks, guys.
spk07: Thanks for the question, Brian. And those that don't understand the insurance market, when we talk about a hardening of the market, a hard market means that carriers are increasing their prices, or we say taking more rate, because they're trying to improve the profitability based on their loss history. And we're seeing that as a trend today broadly across the market. Back to your question around what we've seen, what we are seeing, is it's a good time for Duck Creek. Carriers are... you know, taking rates up, when they're doing it, the carriers that are having more success are those that are more surgical in their rate taking. They're doing more analysis around what aspects of their book of business do they need to raise rates on. So instead of taking a blank 5% increase in premium, they will get much more surgical and perhaps take a 15% rate increase for a small segment of the book, maybe leave another segment of the book with a 0% percent increase, and then maybe a 5% increase in other segments. And when they want to be more surgical with their strategies, they want better access to data. They want a platform that allows them to make these rate changes with more velocity to test them, deploy them out to production. And we give them a means to do that. And I think that is one reason why it is so popular now for these mid-market commercial insurers that are looking at this hard market to and they know that they need to modernize their platform to be more successful moving forward. So we're engaged in some very thoughtful conversations with them to give them more agility as they're thinking about how they're going to work their way through this hard market.
spk08: Great call. Thanks, Mike. Yep.
spk01: Thank you. Our next question comes from the line of Patrick Walravens from JMP. Your line is now open.
spk04: Oh, great. Thank you. And let me add my congratulations.
spk10: Hey, Mike, can I talk a little bit about your ATI modernization journey?
spk04: And I guess I have two questions on that. One is how is that progressing if you look at it by sort of, you know, claims, policy, billings?
spk06: And then secondly, more broadly, I don't know if you've read this book that the founder and CEO of Twilio wrote.
spk04: It's called Ask Your Developers. But he's basically arguing over time that sort of API-based models are going to do to product clouds what the cloud did to on-premise. And so I'd just love to hear your thoughts about how that might play out in the insurance industry.
spk07: Pat, I'm thrilled with the question. It's not often I get asked about APIs in insurance. I will first and foremost say, this is very strategic for us. It's very near and dear to my heart as a technologist. And I think you're spot on around the API is reinventing, if you will, new platforms and how carriers can use the cloud. And what I'll say is, we're very proud of our overall system all the way through the user experience. However, we have a number of customers that use our cloud platform as a headless overall system, which means they're talking to us through an API set because they want to embed the transaction processing in a broader strategic user experience or maybe co-integrate, if you will, within an existing user experience, and that's quite popular. So we've been on just a journey, and I'm going to say it's a continuous journey that's never done before, We have a whole team that continuously enhances our RESTful APIs, modernizing our APIs, going through our whole API stack. We have a means of which those APIs are documented through Duck Creek Solution Center and the way that we train people on how to use our Duck Creek APIs through Duck Creek University because it's a big part of being successful on top of our overall platform. So we're very, very proud of it, and we're going to continue to invest because we know that carriers are going to continue to try to drive products to market using an API and go into a market in a profoundly different way.
spk06: That's super helpful. And is one area further ahead than another, if you look at, like, claims policy billings?
spk07: You know, I don't believe that that's really the case. You know, perhaps historically policy has been ahead, but I think this past year, you know, I can't even express to you how much investment we've put into our overall claims and what we call our party file API to make sure that everything is has a balanced view because we're really looking at the whole suite and parity across the suite. So I think we've done a nice job. And here's the beauty of the cloud platform, too, is we continue to iterate on these APIs and deploy them continuously. So it's not like a once-and-done big upgrade strategy all the time. We continue to refine these and push these out to customers all the time. So we're thrilled with the overall advantage of that the cloud gives us to have a more consistent release cadence and schedule with our customers.
spk04: Awesome. Thank you.
spk07: Thank you.
spk01: Thank you. Our next question comes from the line of Alex Cavalli from DA Davidson. Your line is now open. Thanks.
spk04: Hi all, thanks again for the color and congrats again for a solid quarter. This is Alex Cavalli here on for Rishi. You mentioned that, well, I guess I wanted to hear if you could potentially quantify any of the cost savings that you've seen over the last four quarters or 2020 calendar year per se. What are your plans for going back to the office and back to normal expenses for the coming calendar year and what's been factored into the guidance, the adjusted EBITDA guidance itself. Thanks.
spk07: Yeah. How about if I will give just high level about going back to office, and then I'll have Vinny talk about the expense side of it. But, you know, I've been saying this on the past several earnings calls that, you know, I'm very pleased that the way that our business has been performing in a very virtual manner. We do plan on opening our offices in the fall with some trial openings in July. But we also know that we're moving to an environment where we're going to have, you know, a lot more flexibility for work location for our employees going forward. And that's a big part of our culture here. and our commitment, you know, I have a personal belief that, you know, when everything reopens up, that talent will move across companies. And we certainly plan on being on the winning side of talent acquisition. And we know that we got to have some workplace flexibility policies to entice some of that talent to come to Duck Creek. But with that, you know, we have seen some expense savings, most notably less travel and one of our largest marketing expenses, called Formation, which is our users conference. We've been doing that virtually and investing in a virtual digital platform to do that on an ongoing basis. And we don't have a target date of doing that in person yet. But Vinny, you could perhaps talk about some of the savings and what we're planning in our overall forecast moving forward.
spk10: Yeah, sure. So I think where we're seeing the bulk of the savings is from a P&L perspective in the sales and marketing line. That's where we have the heaviest T&E and events. And those are running favorable to our original budget, of course. And the way sales and marketing came in at about 16% of revenue for the quarter, we might have been expecting it to be more like 16.5% to 17%. So on a normalized basis. So, we'll probably move back towards that once we're fully back engaged in travel and events. We're not planning for that to happen immediately. So, we've got a gradual, you know, an expectation there'll be a gradual increase in T&E. Not much in the coming quarter, but a little bit more in the following quarter after that. And then we'll, you know, we'll get out of our fiscal fourth quarter. We'll have a new budget for next year. And we'll be evaluating that as we see how things start coming back online. We, you know, we're not expecting to, you know, the rest of, certainly in the rest of this year, we don't have any big event spending. We will be doing that virtually for the rest of the fiscal year. So, I think the short, you know, the short answer is, you know, we'll get through the next few months, then we'll be in a new budgeting cycle, and we'll have some more guidance when we get towards the end of this year.
spk04: Thanks for that. Sure.
spk01: Thank you. At this time, I am showing no further questions. I would like to turn the call back over to Michael Joukowsky, CEO, for closing remarks.
spk07: Okay. Thank you, everyone, for participating in our Q2 earnings call. We certainly appreciate your interest in Duck Creek. And let me wrap up by again highlighting that we're very pleased with our current results and our substantial growth in our subscription revenue of 51% is really reflective of growing customer interest in our Duck Creek on-demand product. So we're obviously excited about Duck Creek's growth opportunities in the industry as the industry continues to transition to run core systems in the cloud. I appreciate everyone joining today. Thank you, and please be safe and healthy. Take care.
spk01: This concludes today's conference call. Thank you for participating. You may now disconnect.
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