Guidewire Software, Inc. Q4 FY2020 Earnings Call

Greetings, and welcome to today's conference call. Welcome to Guidewire's Fourth Quarter Fiscal Year 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jeff Cooper, CFO. Thank you. You may begin.

Good afternoon, and welcome to Guidewire Software’s earnings conference call for the fourth quarter of fiscal year 2020, which ended on July 31st. My name is Jeff Cooper. I am the Chief Financial Officer, and with me on the call is Mike Rosenbaum, Guidewire’s Chief Executive Officer. A complete disclosure of our results can be found in our press release issued today, as well as in our related Form 8-K furnished to the SEC, both of which are available on the Investor Relations section of our website. Today’s call is being recorded and a replay will be available following the conclusion of the call. Statements made on this call include forward-looking 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 should not be relied upon as representing our views as of any subsequent date. Please refer to the press release and the risk factors and documents we file with the SEC, including our most recent quarterly report on Form 10-Q and our annual report on Form 10-K to be filed with the SEC for information on risks, uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements. We will also refer to certain non-GAAP financial measures to provide additional information to investors. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Additionally, reconciliations and additional data are also posted in the supplement on our IR website. With that, let me turn the call over to Mike.

Thanks, Jeff, and thanks everyone for joining us today. It has now been a little over a year since I joined Guidewire and this call marks the assessment of my first fiscal year as the leader of this incredible company. People say a leader should expect the unexpected and I can say without a doubt we exercised that principle pretty thoroughly this year. When I joined we talked a lot about the cloud transformation we are embarking on and now a year later, when I assess the progress we have made, I can say I have absolutely no doubt that we are on the right path. We continue to build proof points and momentum across product, services and our ecosystem, and most importantly, with our customers. Each of those proof points builds confidence, credibility and trust, and helps us continue to build cloud momentum. Regarding COVID and our operating model, things have changed a little since last quarter. We have opened a few of our international offices in accordance with local guidelines, but the vast majority of our employees are still working from home and not traveling. The company continues to operate effectively as you will see in our product and sales momentum in Q4. One of the positives I have personally experienced is that social norms now allow me to connect with customers virtually, a lot more than I might have before using airplanes and hotels. This has given me an opportunity to do almost 50 checkpoints with insurance technologies executives across our customer base and around the world. These conversations, even more than the objective measures of our progress in Q4, have validated to me that we are on the right path. As we execute on our product vision for Guidewire as a cloud service, I believe it's just a matter of time before each customer makes the decision to upgrade to Guidewire Cloud. So while I was excited when I joined a year ago, I'd say I am feeling much more confident now that we are on the right path. Turning to our financial results, we ended fiscal 2020 beating our guidance for revenue and profitability, with ARR finishing the year at $514 million. Driving this performance was very strong momentum in Guidewire Cloud products with 10 InsuranceSuite cloud deals and three InsuranceNow deals closed in Q4, combined with sales of on-premise add-ons, expansions and new sales that exceeded our expectations. Subscription revenue grew 84% to $120 million in the fiscal year and we are positioned well for subscription growth into fiscal 2021. We were pleased to see customers and prospects transact in a meaningful way in Q4. Despite a degree of uncertainty due to COVID, overall the insurance industry remains a strong market and continues to be focused on the digital transformation projects that drive our business. We are in a great position to be the technology and cloud platform leader that powers the P&C industry's digital transformation for decades to come as we extend our leadership position and transition the industry to our cloud platform. Last quarter, I mentioned that we are poised to release Aspen, our first cloud optimized product release for InsuranceSuite. In June we did exactly that with a virtual public launch attended by more than 1500 people. Aspen unifies digital analytics, AI and our core transaction system into one platform delivered as a cloud service. Aspen introduced our cloud services architecture featuring new cloud native services for rating and business rules and a new cloud data pipeline which provides access to core system data in real-time. It is truly the next generation P&C cloud platform. We've already seen existing Guidewire Cloud customers upgrade to Aspen with EMC completing the first stage of their upgrade to Aspen in only a week. USAA and American Family have started their Aspen implementations. Aspen is already contributing to our momentum with cloud upgrades and new customer adoption with 10 customers selecting InsuranceSuite Cloud in the fourth quarter. This brings the total number of InsuranceSuite Cloud customers to 26, doubling since the end of last year. InsuranceNow, our full suite cloud solution purpose built for smaller U.S. insurers also had a great year with six new deals, three of which were in the fourth quarter. 62 insurers have now purchased InsuranceSuite or InsuranceNow on Guidewire Cloud. Our early success with Aspen is just the beginning, as we look forward to introducing new releases every six months, with our Banff release next scheduled for November, followed by Cortina early in 2021 and so on and so on. We expect each new release will have new capabilities and cloud native services our customers will use to improve how they engage with their policyholders and agents, innovate and grow efficiently. As evidenced by the early indicators from Aspen upgrades, these upgrades will be easier and easier for our customers to adopt, accelerating the value they derive from running Guidewire. Looking at the fourth quarter in more detail, of the 10 InsuranceSuite Cloud deals we closed, six customers purchased upgrades from self-managed to a full InsuranceSuite Cloud offering. This includes three tier 2 insurers Aviva Canada, Texas Mutual Insurance Company and Wawanesa Mutual Insurance Company and three tier 3 insurers, Germania, La Capitale, and Western National. Germania's cloud upgrade included a major expansion in the DWP scope of their planned deployment. La Capitale's upgrade included a significant expansion from BillingCenter only to the full suite in the cloud. CSAA Insurance Group, a AAA insurer, selected Guidewire Cloud to migrate ClaimCenter. CSAA offers automobile, homeowners, and other personal lines of insurance to AAA members through AAA clubs in 23 states and the District of Columbia. Finally, three customers selected InsuranceSuite Cloud for insurance lines not previously managed by our Guidewire Core System. MAPFRE North America selected PolicyCenter on Guidewire Cloud, including digital for commercial lines. A tier 1 insurer chose ClaimCenter Cloud for a new insurance brand to support a greenfield digital first renters insurance line, and another tier 1 insurer selected all of InsuranceSuite Cloud for a new innovative insurance brand targeting commercial auto use cases. As I previously mentioned, we also continued our cloud momentum with the all-in-one core solution InsuranceNow, with three deals in the fourth quarter. An existing tier 1 customer purchased InsuranceNow for a $100 million DWP commercial auto line. The oldest insurer in the United States, The Philadelphia Contributionship, which by the way was founded by Benjamin Franklin, will be migrating their InsuranceNow deployment to Guidewire Cloud and CURE Auto Insurance became a new InsuranceNow customer in the quarter. InsuranceNow has proven to deliver very tangible business benefits for our customers and we look forward to seeing the success these new customers can achieve. I am very pleased with the turnaround we activated at InsuranceNow over the last year. I am confident that we have the right product, team and go-to-market motion to build on the success in fiscal 2021. In addition to cloud momentum, we continue to expand the relationships and sign new customers for on-premise products. This new on-premise business was particularly strong internationally, reflecting our belief that customers in North America are earlier in the cloud adoption cycle. We added three on-premise customers in Europe. Vaudoise assurances of Switzerland and Colonnade Insurance based in Luxembourg selected InsuranceSuite. Sky Distribution, a VIG Group startup based in Poland selected InsuranceSuite and Digital. Additionally, Hannover Re, a tier 1 insurer in Germany and Guidewire are undertaking a pilot to prove out the ability of PolicyCenter to be used as an underwriter's cockpit. Hannover Re will take inward reinsurance policies created by brokers and populate PolicyCenter in order to provide a consistent view to their underwriters. Rounding out our new on-premise business, a tier 5 insurer in Canada selected InsuranceSuite, Digital and Data. At the end of fiscal 2020, $518 billion of direct written premium was under license for at least one Guidewire core application, up 3% from last year. This growth rate is a result of new sales activity this year being more focused on expanding our footprint at existing customers, through add-on business and cloud upgrades versus previous years. Turning to Go-Live, a Go-Live event is always an exciting time for our customers and customer adoption is how we ultimately define our success. In the fourth quarter, I was pleased to see 14 customers go live on implementations for 27 Guidewire products, including three cloud products going live. It is great to see our services team and our system integration partners continue to drive successful Go-Live in a primarily virtual delivery context. Meanwhile, our growing partner ecosystem continues to be an important contributor to our increasing market leadership. Our partners facilitate customer implementations and help us accelerate customer success with value-added solutions for InsuranceSuite. We ended the year with approximately 620 consultants from 28 partner companies who have now earned the advanced certifications required for Guidewire InsuranceSuite Cloud implementations, up from approximately 475 as of the end of last quarter. We believe that this growth is an exciting proof point for the opportunity our partners see and the future of Guidewire Cloud. The Guidewire Marketplace has also been a valuable resource for customers to drive value and simplify integrations across the insurance lifecycle. For example, the general estimates they will generate $1 million per year in cost savings and reduce payment cycle times by 80% as a result of automating their claim payment process using Guidewire and our marketplace partner InsurPay. In fiscal 20, our Marketplace ecosystem grew to include 91 solution partners, up from 52 a year ago, providing more than 140 apps. We introduced a number of new partners in Q4. One new partner provides an app that connects claimants directly to approved contractors seamlessly after a claim is entered in ClaimCenter. The app locks the contractors through the inspection limiting the need for adjuster inspections, contractor bids and significantly reducing cycle times, costs for insurers, and increasing customer satisfaction. This is just one example of the many innovations our ecosystem partners are delivering to the insurance industry through our Marketplace. I continue to be energized by what they can accomplish by integrating into our foundational core systems. In summary, we had a great fourth quarter that capped off an important year for our company and specifically for Guidewire Cloud. We are starting fiscal 2021 with growing optimism for the business. As excited as we are about our cloud success, it's also important to realize that Guidewire Cloud is still in the early days of penetrating a large market opportunity. The vast majority of our customers and the broader industry have yet to take the first step in their core cloud journeys. The strides we have made towards advancing our cloud platform and demonstrating customer success are important reference points for the industry. We look forward to leading and supporting new and existing customers as they evolve to core cloud-based core systems and look forward to serving them as effectively as we possibly can. Now I will turn the call over to Jeff.

Thanks, Mike. As Mike noted, we had a very strong Q4, highlighted by 10 new InsuranceSuite Cloud deals. ARR ended the fiscal year at $514 million, up 12% from a year ago. We measure ARR on a constant currency basis during the fiscal year and revalue ARR at year end for current FX rates. Rate changes between July 2019 and July 2020 resulted in a $5 million benefit to ARR. As a result, ARR grew 11% on a constant currency basis. A little more than half of the new ARR added in the fiscal year came from new deals sold to new and existing customers and a little less than half came from ARR step-ups from ramp deals sold in prior years. Fully ramped ARR, which is defined as the annualized recurring value of all active term licenses, subscription and maintenance agreements at the fully ramped annual price outlined in the customer contract, ended the year at over $600 million representing 13% year-over-year growth and 12% growth on a constant currency basis. We will continue to discuss fully ramped ARR on an annual basis as we work through this cloud transition. Turning to the income statement, I wanted to remind you all that we have adjusted our income statement presentation and we will address this new presentation on the call today. Between our press release and the financial supplement, which can be found on our IR website, you should have all the details to reconcile to our prior presentation. Total revenue in fiscal 2020 was $742.3 million, ahead of the expectations we discussed last quarter. Subscription revenue for the year was $119.7 million, up 84% year-over-year due to ongoing InsuranceSuite Cloud activity. Subscription new sales ended the year at just under 70% of total new sales. Subscription and support revenue ended the year at $203.5 million, up 35% over last year. License revenue in fiscal 2020, which no longer includes subscriptions, was $301.6 million. To compare with our prior presentation, license and subscription revenue was $451.2 million, well above our prior expectations. The fourth quarter benefited from $17.6 million in incremental revenue from deals with durations longer than our standard two-year initial terms followed by annual renewals. Going into the fourth quarter we had about $2 million of deal duration impact embedded into our outlook. Even when normalizing for deal duration, license revenue was ahead of our expectations due to higher term license bookings. For the year, license revenue benefited from $33.5 million in incremental revenue from longer duration deals. Services revenue ended the year at $207.3 million, down $41.4 million from last year, but ahead of our expectations as our services organization effectively managed ongoing projects while working from home. The year-over-year decrease is primarily driven by the completion of large Guidewire Insurance Suite implementations since the end of last fiscal year, increased involvement by SIs in cloud implementations and reduced billable travel associated with COVID-19. Turning to profitability, we will discuss these metrics on a non-GAAP basis. Gross profit was $452.7 million for the year compared to $442.6 million a year ago. Overall gross margin was 61% and ahead of our expectations because of higher than expected term license revenue. Subscription and support margin for the year was 55% compared to 66% a year ago. The decline was a result of significant investments in our cloud operations function to support our growing Insurance Suite Cloud customer base. Operating income was $104.8 million, exceeding our guidance range due to higher than expected revenue. We ended the year with $1.4 billion in cash, cash equivalents and investments. Operating cash flow benefited from strong collections and ended the year at $113.1 million. Free cash flow finished at $98.5 million excluding $11 million in final expenditures associated with our new headquarters. Turning to our outlook for the first quarter and the fiscal year 2021, we are energized by the momentum we see in our cloud business, and at the same time we recognize the unique macroeconomic environment we and our customers are currently facing. In the first quarter, we expect ARR to be between $509 million and $512 million. A large contract consolidation and the sunsetting of support for acquired on-premise ISCS customers are unique events expected in Q1 that contribute to the sequential decline. The contract consolidation occurred with one of our largest customers who had 12 active licenses, including licenses for non-core products that were not in active production and a co-product license for a small insurance line that they are exiting. We have worked with this customer to consolidate the contractual framework, and put in place one enterprise license agreement with a five-year four-month commitment. This customer is still an active Guidewire supporter and in our top five as measured by ARR. For the year, we expect ARR to grow between 9% and 11%, which implies fiscal 2021 ending ARR of $560 to $571 million. Continued adoption of our cloud products by new and existing customers is a key driver of ARR growth. We expect the industry shift to cloud-based core systems will allow us to accelerate ARR growth over time. However, we are still in the early days of this transition, and we recognize that insurers tend to be cautious in their decision making when re-platforming core systems. Over the longer term, this conservative nature plays into our strengths as the proven market leader who has demonstrated that we can tackle the most complex core system modernizations. In prior quarters, we have discussed the impact to our income statement from the business model shift to subscription revenue, and the new revenue pattern for term licenses because of our adoption of ASC606. We expect the impact of business model shift to be apparent in fiscal 2021. ARR can help investors normalize varying revenue recognition patterns to provide a better measure of our overall software sales growth. Total revenue for Q1 is expected to be between $162 and $166 million. This includes $14 million of term license revenue from contract duration that deviates from our standard, primarily due to the large contract consolidation that I just referenced. Subscription revenue is expected to be approximately $35 million in Q1. Total revenue for the year is expected to be between $723 million and $733 million. We expect that our subscription revenue will be approximately $165 million, representing 34% growth, and support revenue is expected to decline by about $2 million year-over-year. Services revenue is expected to be approximately $190 million, a decline of 8%. License revenue is expected to decline due to our shift to subscription sales as well as the impact of multi-year license revenue recognized last year that will not recur this year. We have not modeled any positive impact of multi-year term license revenue above the $14 million we have visibility into in Q1. We expect total gross margins for the year to be approximately 55%, but this gross margin will ultimately depend on our final revenue mix. Services margin is expected to be similar to what we experienced in fiscal 2020. The business model shift and revenue complexity are also visible in the divergence between our expectations for operating income and cash flow from operations. With respect to operating income, we are expecting an operating loss in Q1 of between $10 million and $6 million. For the year, we expect an operating loss of $5 million to positive operating income of $5 million. Our operating income is significantly impacted by the revenue recognition patterns reported on our income statement, which may vary depending on whether we sell a multi-year term license, or a subscription agreement. Thankfully, our customers continue to pay us in the same way, which is primarily annually upfront. As a result, just as we believe ARR is the best proxy for momentum, we believe that cash flow from operations is a better measure of our profitability than operating income. Our cash flow from operations expectations in fiscal 2021 are between $60 million and $70 million. We expect a decline in cash flow from operations as we continue to build out our cloud operations function and invest in cloud capabilities. This is a once-in-a-generation platform shift for the industry that significantly expands our TAM, and we are investing today to capitalize on this opportunity for decades to come. Additionally, we expect approximately $15 million less in interest income in fiscal 2021. We expect to spend approximately $40 million in capital expenditures, including $25 million in build out expenses, as we are moving to new offices in Dublin, Ireland, our European headquarters, and Toronto, Canada. Project dates may be delayed due to the pandemic and may stretch into the next fiscal year. Additionally, our planning for these and other locations, takes into account a new approach to offices as we consider more flexible work arrangements that may require less office space in the future. In summary, we are proud of what the team was able to accomplish in Q4. A tremendous result. We look forward to providing more detail at our Analyst Day, which will be a virtual event on October 13th. Operator, you can now open the call for questions.

The first question comes from the line of Ken Wong with Guggenheim Securities. You may proceed with your question.

Thank you for taking my question, and great quarter guys. Let me first talk to you, Mike. We would love to get a sense of what you're hearing from customers in regard to Aspen. Obviously, a very strong quarter from a cloud deal perspective, but just wondering how they're thinking about adopting Aspen with all the new features, potentially dragging out sales cycles or has that shortened the sales cycles?

Yes, thanks for the question. I wouldn't say at all that it's dragging on sales cycles. I think the biggest thing customers are excited about with respect to Aspen is just this philosophy of making the upgrades easier and easier for them to take and the proof points that I talked about, which are early. You know, we've had a couple customers begin the process but those proof points are positive. And I think, you know, what I'm hearing from people is just real, real excitement about the shift in the strategy, the product strategy that we've taken from a two-year cycle to a six-month cycle, and a shift in the design approach to the idea that we expect these to be just easier and easier to adopt. You add on top of that sort of the idea that you can take these cloud native services and you can use them to add to the approach, that they're taking to building out new lines of business on a Guidewire core platform, and it just offers them more flexibility in terms of how they use the system to address business problems. And so I wouldn't say it slows it down at all. It's been really, really positive, the feedback that I've gotten from customers in terms of our strategic project direction.

Got it, fantastic. And then this could be either for you or Jeff, but as you look at ARR growth, you guys in the past have obviously thrown out a number of 20% over the longer term. Just wondering as we look at this trajectory, is it fair to assume that fiscal 2021 is the trough and any color you can provide there?

Yes, I think I'll let Jeff chime in, and I think, we know we intend to provide a little bit more longer term visibility on the Analyst Day presentation that we will provide. Certainly we see the potential for that when you look at the installed base and the potential that we see, but the guidance we provided this year is just based on what we see in the pipeline and what we feel very confident in our ability to go execute on this year. Jeff, anything to add?

Yes, and I think that's, you hit it Mike. The only thing that we've talked about in the past Ken is just the pace of this migration activity is a big driver of growth and you know we're trying to be thoughtful about how we approach that, and you know this industry moves at its own pace. So as Mike said, we have, I would say better visibility to our guide for this year than we did in prior years. And, you know, we want to be conservative as we think though the next year.

Right. Thanks Jeff, thanks, Mike.

Our next question comes from the line of Chris Merwin from Goldman Sachs. You may proceed with your questions.

Thanks so much for taking my question. I wanted to ask you about ARR. I think in fiscal 2019 ARR grew at 11% and your full year ramp is over 20%. In this year if I've got the numbers right, ARR was 12% and full year ramp was 13%. So it looks like the gap between those two metrics has come in quite a bit. I just was curious, like what in particular is driving that, is there anything changing with the way that you're pricing these deals, and anything you could say about what fully ramps ARR might look like next year relative to your guidance? Thanks.

Yes, that's a great question. There are a couple of factors at play. As we wrapped up fiscal 2019, the year-over-year growth in our ARR backlog was actually over 300%. This was due to the way we engaged with customers in a cloud context, particularly during migrations, which accelerated our growth. Now, coming out of fiscal 2021, we noticed that in Q4 we signed a significant number of larger customers with steeper ramps, creating a tougher year-over-year comparison. Last quarter, we indicated that we expect the fully ramped ARR to be roughly in line with ARR growth this year. However, we're pleased to see some cloud activity resulting in a slight increase over ARR growth.

Got it. Thank you, and then maybe just a follow up on-premise demand. In the last quarter, I think there was a headwind there from a slowdown in on-premise demand, not just, I guess it wasn't in isolation in the sense that it seemed like more customers were thinking about a cloud migration. This quarter sounded like you saw a pickup in activity and on-prem. I think you called out a few deals there, so maybe Mike can you just talk a bit about the state of demand for on-premise? And I mean, in particular for customers that either are considering going on-premise or cloud, I mean, what is their mindset today and what have you factored into the outlook for next year as it relates to the health of the on-prem and cloud business? Thanks.

Well, so first thing I'd say is that we are in a particularly good position technically, to be able to support both customer choices right. The fact that we're starting from a core application, that's really market-leading in its feature and functionality complete as anything in the market, puts us in a great position to be able to provide customers the sort of operating model of choice. As we discussed previously, I think North America is ahead of the curve relative to Europe and Asia, and how they're thinking about cloud deployments and cloud implementations. I expect in the long run that everybody will make this switch to the cloud just because the characteristics or the upgrades and the functionality that we can provide in a cloud modality are just significantly better. But that said, different customers have different approaches and different mindsets about when that's going to make sense. Like I said, I've had a lot of conversations with customers, and some of them start off by saying, we've already made the decision strategically to start moving assets to the cloud, and we are already underway, others are just saying, we're going to wait maybe until the next cycle, maybe even five years, that they're just not ready and that's sort of customer, by customer, and so projecting that and making an estimate for how much demand we'll see quarter-to-quarter, we work with them, and we try to predict it. But my sense is that as we're able to show more and more functional value, and more and more agility, that customers that make the decision to go with our cloud approach, we're going to see that shift. But like I said, we're in a great position to be able to offer both, and that's why it is exciting to be able to call those out, call out those wins, because for those customers who are trying to drive a digital transformation, but they haven't made the decision to go with a cloud strategy in their IT shop. It's great to be able to support and serve those customers as well.

That's great. Thanks so much.

Our next question comes from the line of Bhavan Suri with William Blair. You may proceed with your question.

Hey, guys, congrats and thanks for taking my question. I guess I wanted to touch a little bit on competitive environment. You've obviously seen one of your competitors go public, and that's one I would love to hear, if you are seeing more or less of? The other one, Mike you obviously Salesforce got Velocity. And they've got an insurance offering, and they sort of if you read the marketing materials talk like the advertising engine and policy engine everything else, but I look to understand sort of as you think about the space and the insure tech space getting quite a bit of investments, how you view the competitive environment, have there been any changes?

Yes, we haven't observed any changes in the competitive landscape. We've seen a lot of activity and success in our market, which is not surprising. Other companies also recognize the significant opportunity that digital transformation in insurance presents. We are confident in our position, supported by hundreds of customers across various tiers. Our competitive position remains strong, and we haven't noticed a change in competition. As I mentioned in previous calls, we strive to win every deal, but it's a competitive environment, and we don’t win them all. I appreciate your question about insuretech investment; it's one reason I'm excited about our marketplace. Our open API philosophy allows us to integrate innovative startup technologies into our core systems. Customers often express gratitude for having implemented the Guidewire core program years ago, as it enables them to work with modern systems and connect with insurtechs to innovate customer engagement. The insurance market poses unique technical challenges that require deep expertise in core systems. I've learned a lot about the significant investment Guidewire has made in core systems across claims and policies, which is validating. It’s essential to view this market through the lens of all lines of business in various states and countries where we've invested, allowing our customers a head start in launching modern insurance products. Regarding Velocity, I believe this will enhance our partnership with Salesforce. Their acquisition indicates their serious commitment to the vertical strategy and the insurance industry. Integrating the Velocity team and their intellectual property will further strengthen our partnership, making it easier for insurers worldwide to have top-notch CRM platforms along with first-class core systems for claims, policies, and billing.

Yes, that was very helpful. Thank you and then one quick one for Jeff. Obviously, historically, Q4 has been sort of seasonally your strongest quarter. And I know, you just commented about how difficult deals are in terms of how hard it is sort of to predict sort of the deal timing. But as we think about next year, should we expect the same seasonality on a quarterly basis? Or is there some sense of the demand partially pent up and also interested on Aspen sort of help support growth earlier throughout the year that maybe weren't expected, any deals maybe pushed out due to the current environment, might close early in fiscal 21, anything like that that would change seasonality in the coming year? Thank you.

Yes, I don't think anything significant is changing seasonality in the coming year, and we did have a very strong Q4. Steve handed the reins over to Frank as a new sales leader now. I mean he did a good job of running the table on the deals that he had in his pipeline. So, that was embedded in our guide for Q1 a bit that we're not expecting a lot of new sales activity in Q1 and the pipeline will build. We are thinking about ways to increase the linearity and we have a couple initiatives in place that we think we can do that better. And then as we get into more of the six-month release cadence and the cloud demand becomes more pervasive rather than where we are today as still with the early adopters. I think we can lessen some of this backend weightiness, but I don't expect to see that in this fiscal year.

Great, thank you, and really nice job in the quarter. Thanks again, guys.

Hey, thanks.

Our next question comes from the line of Sterling Auty with JP Morgan. You may proceed with your question.

Great, thanks for taking our questions. This is Jackson Ader on for Sterling tonight. Our question actually is a clarification just on the mechanics. I mean, when we think about closing 10 InsuranceSuite deals and three InsuranceNow deals in the fourth quarter, when should we actually expect that to hit ARR and is that different from when we would expect those deals to actually hit subscription revenue?

Yes, it's a good question. So as soon as the deals are executed they will hit ARR. Now a lot of the migration activity we've noted in the past can tend to have a relatively muted year one ARR impact as that customer is already paying a full term license fee. And then we expect to see the incremental ARR ramp over a five-year period. So that is one of the dynamics that exists for a migration agreement. The other thing, revenue occurs on the subscription side once we've delivered the software, and we can usually do that within 30 days in most instances, so the revenue wouldn't hit until Q1. On a migration deal, because the customer continues to need to use their on-premise software through a migration period, we do have to allocate some of that revenue for that cloud deal towards the term license component of the deal. And as a result, migration revenues can actually contribute to term license, migration deals can actually contribute to term license revenue in the quarter and we did see that a bit in Q4.

Okay, that's helpful and interesting. Our follow-up question on the Direct Written Premiums the 518 for the core, but do you have any sense for maybe what kind of DWP you have under the hood for non-core products that maybe aren't linked to the core platform?

It's a good question. The DWP that we report is always tied to the core. And we think about, our core systems will manage that DWP. And then the ancillary products are typically tied to a core. Obviously, things like science can be purchased independently, but that's not a metric that we've broken out in the past.

Thank you.

Our next question comes from the line of Mayank Tandon with Needham and Co. You may proceed with your question.

Thank you. Good evening. I just wanted to piggyback off of Bhavan’s question on the competitive landscape? Could you share maybe some qualitative data around win rates across the various tiers of the market? And then sort of tied to that would be any noticeable shift within the tiers that you're competing in today?

Yes, let me comment on it. I think we will provide a little bit more detail at Analyst Day, but like, I just want to repeat what I said is like, we have not seen a change in the competitive dynamic in the market that's based on tier, based on field type, whatever, it just basically looks pretty stable to us, relative to what we've seen over the past couple years. I would say, the turnaround in the InsuranceNow business has been a real, real positive for us. It was one of the things that when I joined the company a year ago, when markets and I were talking about what's important to really focus on and help ensure that we're getting traction, sort of month after, month after, month. That was one of the major, major objectives, so that we are really able to compete in all the tiers. And so, seeing the turnaround in that part of the business is a real positive for me, and like I said, in sort of the prepared remarks, I think that the momentum that we've established there should do well to help carry us forward into next fiscal year and beyond. I'm really excited about this company being able to put the best foot forward in terms of core systems for every tier in this market. So hopefully that makes sense.

Yes, that's helpful. And then Mike, you mentioned the international expansion. I just wanted to get a sense given how localized the insurance industry is and how regulated it is by region. Are you thinking more on the lines of M&A as an expansion driver or do you think you can go about it organically and still be competitive with some of your peers out there that are maybe more European-centric?

I don't want to comment on acquisitions, but I will say this. Our philosophy is, we have a common core platform that provides all the mechanisms that are necessary worldwide and then we have a very significant investment in providing the specific integrations and the specific functionality on top of that core platform for each region where we want to compete. I believe very, very strongly that when you think about a long-term cloud platform, that's going to exist for let's hope, 100 years. That is exactly the type of architecture that you want to bring to bear in solving a problem like this. So when you sort of piece together different technologies that are suited to a particular market, you don't end up with the economies of scale and you don't end up with being able to deliver as much value to each and every customer, regardless of where they're located. With the Guidewire model, we're able to make an enhancement to the cloud data platform that works in Japan, and it works in Germany, and it works in Luxembourg, and it works in every single state in the United States when we make an enhancement to our API, that that becomes true. That's the philosophy of this company. I think that's why this company has been so successful for 18 years. Now we're bringing that to the cloud and I think it's really going to help us win in the long run. Now, it's got to have a very determined, steady approach to taking that sort of strategy. But I think it served us really, really well to this point, and I am excited about our ability to sort of continue that investment internationally and continue to make progress internationally, because I think that's what's allowing us to serve this industry most effectively.

That's very helpful. Thank you so much.

Our next question comes from the line of Tom Roderick with Stifel. You may proceed with your question.

Yes, hi gentlemen. Thank you for taking my questions. I'll echo the earlier sentiments you're getting 10 cloud deals across the goal line when everyone's working remotely is quite significant. So congratulations on that. Mike, first question for you. Just we've heard this concept of data gravity. It's something that's a real driver of cloud adoption for years now. And I'd love to hear how your customers are thinking about the role of predictive analytics, AI and machine learning, broader insights, that’s having or catalyzing their desire to move to the cloud and perhaps you could talk a little bit more about science, with some success there more recently, and how that is linking up with the cloud strategy. That'd be great. Thank you.

Yes, thanks for the question. There's no doubt that analytics and basically taking advantage of the data asset that is produced by running a core system in a modern way, is one of the key drivers behind a lot of these projects and that's what's behind the strategy. We've taken Aspen around more completely integrating the predictive analytics assets as well as the science asset into our core system. Because, we really think that you know, what you think of, maybe previously as an insurance core system will change that the necessity to have easy access to the data, easy access to the insights that you are deriving from that data, and then pushing that information back to the each individual user so that they're intelligent in the moment that they're using the system. Right? That's the real key, I think, to transforming this industry. And that's what some of the more forward-thinking customers are doing already with Guidewire and other innovative insurance assets. Making all of that easier and easier and easier, every single release, as we make progress on our cloud platform, is what's going to drive the incremental value and the incremental differentiation that our customers are after. I really, really just love the question because science and predictive analytics and our cloud data platform all sort of coming together on a cloud platform that makes it easier for insurers to be able to deliver these innovative use cases, it's very, very exciting. Now, I think we all sort of sometimes tend to get bogged down and how difficult and hard work it is to do one of these modern transformations and migrate off that legacy mainframe platform and instantiate Guidewire across a set of lines of business. But once it's done, and once you start to see that value, you start to see the customer's eyes light up with the exciting things that they're able to do now. All these ideas people have about how you can use machine learning and AI to provide that insight to the agents and the adjusters and the underwriters. It's really exciting. And so anyway, I really appreciate the question and I think it's sort of central to the product strategy that we have here at Guidewire.

And I'm glad you brought up the context of Aspen in that answer Mike, that's sort of where I wanted to go next. As you've already started to move and migrate some of your customers, I think you mentioned USAA and American Family, earlier on the call. Have you started those migrations? I'd love to hear you talk a little bit about some of the challenges and some of the sort of inputs from a capacity standpoint, whether that services heads, implementation heads, just talk about the challenges and how you're managing through those challenges, getting those customers in the beginnings of their migration to Aspen that seems important to have some early, successful use cases there? Thank you for all this. This is great.

Thank you for the question. It highlights a significant shift in Guidewire's role concerning our customers' technology strategies, which is to stay current. Rather than viewing Guidewire as a one-time installation that we set up and forget for five years, we are collaborating closely with our cloud customers to adapt their thinking. Each time we release an upgrade, we want it to be integrated into their testing and development cycles. This transformation emphasizes the need for our teams to effectively execute this change, as we build strong partnerships with our customers and align our product evolution with their implementation plans. Our partnership with USAA exemplifies this commitment, as we are both dedicated to a synchronized approach that ensures they benefit from each innovation we introduce. This level of collaboration is not typical in the insurance industry, and we aim to change that over time, which may take a few releases and years of dedicated work with each customer. From my previous experience, I've witnessed how much value a software company can deliver when following this model, and I am genuinely excited about the path we are taking. As we engage with our customers, we acknowledge the challenges and recognize the substantial incremental value we can offer them. Thank you again for the question.

Really helpful, thanks again. I appreciate it.

Our next question comes from the line of Matt VanVliet with BTIG. You may proceed with your question.

Yes, hi guys, thanks for taking my question. I guess thinking about the numbers you talked about, you have over 600 consultants now on the more advanced cloud implementation certification here, but as we think about what the demand looks like, when you get a partner involved, especially one of the big global SIs are you seeing them also pushing harder on cloud projects as part of maybe bigger digital transformations that they're engaged with that these customers, are they skewing the mix even maybe more towards the cloud? Or is it pretty consistent around a lot of those partnerships right now?

I wouldn't draw a distinction between the partners, but I can say we are achieving excellent alignment with them. The best way to assess this objectively is by noting that we are encouraging our partners to enhance their capabilities by getting trained and certified in new technologies and approaches that deliver greater value, and they are rising to the occasion. We appreciate their commitment, as it represents a significant investment on their part. This aligns with the value they see in implementing these solutions, and they also understand that this represents a better model. Today, it's difficult to find a technology or IT executive who doesn't agree that the cloud model is superior, where having a vendor manage service upgrades and maintenance is more efficient because the R&D investment can be effectively distributed for the benefit of the customer base. The question remains about timing and when it makes sense for each specific customer considering their other projects. As I mentioned before, we are well-positioned to provide both on-prem and cloud core platforms, and this depends on each customer's timeline for their IT landscape, which will influence what the system integrators and Guidewire recommend. However, they are advocating for it, and we are too, because over time, the value will increase. The flexibility and agility that customers will gain from implementing projects on a Guidewire cloud platform will be significantly enhanced. In summary, we're dedicated to educating customers about our vision for the future, while remaining adaptable to their timelines that suit their business needs.

Could you elaborate on the earlier discussion regarding the expansion of the marketplace and the introduction of new digital and data-driven features? At what point do you envision offering certain add-on functionalities exclusively to cloud-only customers? While you've previously mentioned your commitment to supporting self-managed customers in the long term, when do you anticipate developing features that are designed specifically for the cloud deployment model as a way to encourage customers to migrate and invest in the cloud?

I want these decisions to be driven by care rather than obligation. My goal is to establish a value proposition for the cloud that encourages customers to make the switch voluntarily and with enthusiasm. Ultimately, the decision is very technical and largely hinges on cost and the level of investment required to adapt certain capabilities or features for on-premise deployment. Sometimes, this is straightforward; for instance, a cloud-native service for ratings is inherently designed for the cloud and doesn't make practical sense to consider for on-premise use. However, there will be occasions when we engage in discussions with our customers to evaluate and decide on these matters. The idea of service is integral to our culture, which I believe contributes significantly to our company's success. Our customers are our primary stakeholders, and we should do everything we can to empower them to make upgrade decisions that align with their timelines and business needs. These projects can be incredibly complex. It’s sometimes difficult to grasp the level of detail and commitment required from insurers for such projects, especially during abstract discussions. This year, I have focused on understanding this complexity and empathizing with the decision-makers at these insurance companies. Therefore, I feel we owe it to them to put forth our best efforts in enhancing our services and improving the cloud so that when the time is right, they will be inclined to make the transition. I hope this clarifies my perspective on the matter.

That's very helpful. Thanks for taking my questions and great job on the quarter.

Hey, thanks a lot.

Our next question comes from the line of Michael Turrin with Wells Fargo Securities. You may proceed with your question.

Hey there, thanks. Good afternoon. Just one from me on the marginal outlook, you commented on the impacts from revrac and think it certainly makes sense from the point of cash flow as a better metric during the transition, but given you had services coming down here and the increasing involvement on the partner side, seemed like you should also see some offsets. So just helping to revisit the impacts driving that expected compression, is it primarily a function of cloud and are your expectations for cloud margins still holding given, what you've observed at these initial cohorts of customers thus far? Thank you.

Yes, the major investments we are currently making focus on cloud operations and product development. As we enhance our products for greater efficiency, we expect our cloud operations to become more efficient as well over time. These investments are significant, and we are still in the early stages of this replatforming process, which is the main reason for our cash flow dynamics. Additionally, we experienced a strong year in collections, including past due payments that have impacted this year but are not expected to recur. However, the main reason for the year-over-year decline in cash flow from operations remains our ongoing investments.

Got it, thank you.

Our next question comes from the line of Joe Vruwink with Baird. You may proceed with your question.

Great, hi, everyone. Thanks for squeezing me in. I'll keep it to one as well. But I want to go back to the conversation on just the feedback related to Aspen since the release of that, and I'm curious if there were any use cases for segments of the broader customer audience that, I don't know, maybe surprised you, now that there's finally a cloud optimized insurance re-released in market. And a few things Mike, you brought up like the digital first Greenfield efforts, that's not new to Guidewire of course, or even this new crop of all digital insurers targeting home owners or renters lines. Are there things about the product itself, where there's suddenly a broader set of new opportunities, which may be injected a new element for Guidewire as opposed to what might have been the case before the Aspen release was out there?

Thank you for the question. To answer it in two parts, first, one aspect of Aspen is what we’re calling the advanced product designer, which is intended to help insurers design and launch new lines of business much more efficiently and quickly than before. I spoke with one of our Tier 1 clients who mentioned that they are managing multiple lines of business with Guidewire. Some of these lines account for a significant portion of their direct written premium and revenue, leading to increased attention from their IT team. However, the smaller lines of business often receive less focus, resulting in frustration due to the slower pace of change. With the advanced product designer and Aspen, they can better balance this, allowing users of the smaller lines to have a system that’s more flexible and real-time. This feedback was enlightening as it highlights the complexity of our implementations and the significant benefits of enhancing agility in a digitally driven IT organization. In response to the second part of your question, what excited me about Q4 was the range of compelling factors driving the deals. It wasn't a single issue that led to these transactions; rather, there were upgrades, digital transformations, and the launch of new business lines involved. During Q3, I had some concerns about the macroeconomic environment and its potential impact on the insurance sector and Guidewire itself. However, Q4 reassured us that this is a strong industry with various dynamics at play. If we continue to deliver our platform effectively, we can sustain growth and better serve our customers. This aspect of Q4 was particularly inspiring for me, and I hope this answers your question.

It does, thank you very much.

Our next question comes from the line of Rishi Jaluria with D.A. Davidson. You may proceed with your question.

Hi guys, this is Rishi Jaluria. I'll just one, one that I would want to squeeze in, and thank you for squeezing me in. But on the cloud gross margin side, if I do kind of the quick math between the new presentation and the old presentation, you're sitting around 35%, give or take non-GAAP subscription gross margins, which I think feels a little lower than I would have expected at this point. Maybe, can you walk us through a) is that even directionally correct or is my math entirely off and b) is that a function of just the ramps and all the investments that you're making right now and there's going to be natural leverage coming from here to get towards that 65% cloud gross margin target in FY24? Or is there a lot of kind of more multi-tenancy on services and things that need to happen to get from here to there? Thanks.

Yes, Rishi, so there's a lot of investment going on in the product to build more multi-tenancy into our platform that we expect to realize over time. And, those investments will take time to kind of work their way through our product, and then into our customers and how we support and maintain those customers, making big investments in building out our cloud operations team. And I think we've commented on this in the past that to some extent, these are really critical initial implementations and we have to get these right. And we need to make sure that we invest the time and resources to bring every customer along that chooses to go on this path, assess them and make them successful. And so, there may be a little bit of over investment in terms of making sure we get this right. And then we can leverage those investments over time as we continue to migrate our customer base over. There's one other small dynamic that, we'll get into a bit more on the accounting and how cloud migrations in particular, we end up allocating a pretty significant part of the overall contract value to term license revenue, which depresses the subscription value over the initial contract duration, even though we're fully investing and building out cloud operations to support those customers. So that is a small dynamic. I think that my team estimated that that is a 3 percentage point to 4 percentage point in tax in this fiscal year and we expect that to grow a little bit into the future and we can talk about that a little bit more on Analyst Day.

Okay, wonderful. Thank you.

Our next question comes from the line of Pat Walravens with JMP Security. You may proceed with your question.

Hi, this is John for Pat. Thank you so much for taking our questions. Just a quick one, on the Aspen, the actual product architecture, can you just talk about how if and how that architecture is differentiated from some of the other cloud offerings in the space of your competitors? Thank you.

Sure, that's a tough one to answer quickly. But I would say this is what's important to understand about Guidewire's approach, okay? As we have 18 years invested in developing the world's leading claims, policy, and billing systems and insurance we very, very complete offerings, what we've done with Aspen is we've invested in a cloud layer that enables us to run those instances of ClaimCenter, PolicyCenter, BillingCenter efficiently across many, many instances and across all of the non-production instances necessary to manage a complex implementation of a core system like Guidewire. What you want to picture in your head is maybe one of the most complex IT environments in the world, at some of our Tier 1 insurers, with many, many instances of Guidewire that support development and testing and performance testing, and then UAT testing and finally, production. And so we've invested a very significant amount of time and effort into building a layer on top of AWS that facilitates our ability to run what will ultimately be tens of thousands of these Guidewire instances. Additionally, we have developed what we're calling cloud native services to support and augment the functionality in those core systems. Rating is a very, very good simple example. Now we have a rating engine inside a PolicyCenter. Each customer that runs PolicyCenter can use that rating engine. We've added now, a cloud native service for rating that can be used alongside the PolicyCenter implementation. That's a very flexible approach to doing it. We don't replace it. We don't force a customer to move to that cloud native rating engine, but they can, over time, start to leverage that cloud native rating engine. And then what that does is, it enables a customer to have more flexibility in terms of how they architect and how they manage the system. Like I said, in the call, we expect more and more of these cloud native services to be built and delivered on top of Aspen, Banff, our cloud platforms and those services, whether they be rating related or rules related or claims related or data related, those will support the overall ecosystem of the Guidewire implementations. So, hopefully that helps.

It does. Thank you.

Our next question comes from the line of Brad Sills with Bank of America. You may proceed with your question.

Hey, guys, thanks for fitting me in here. I just wanted to ask one on the term licensed customers that you had a good quarter here on customers adding more term, I guess for those customers, are they thinking about kind of a hybrid deployment here? We're going to add more term. But, think about migrating over to the cloud over time as in the roadmap, any commentary on just customers that are kind of adding more term license and kind of their roadmap? Thank you.

Yes, that's a great question. Jeff and I consider this every time we speak with our customers or sales team about these deals. These customers are fully aware of our long-term plans, and most of them have a timeline in mind for when it makes sense for them to transition to the cloud. One of the advantages of our approach is that if the cloud doesn't align with their needs, they can still opt for on-premise solutions. They can implement an on-premise setup now, with the intention of moving to the cloud later. This is a topic we've addressed with all of our customers, and each one will have a strategy that aligns with their overall corporate goals.

Great, thanks so much.

Okay, I think that is, yes I think that's the last call, right?

Yes, please. Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to Mr. Mike Rosenbaum for closing remarks.

Okay, thanks, everybody for participating in the call today. Just wanted to say, this was a really phenomenal quarter at a really critical time for the world really and especially for Guidewire. We're excited about the continued demand we see for our platform and the advancement of the cloud strategy and more as optimistic as ever about the long-term vision and opportunity for all of our stakeholders. So I really appreciate everybody joining today and thanks very much.

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time. Thank you for participation. Have a great day.