Guidewire Software, Inc. Q1 FY2021 Earnings Call

Greetings and welcome to the Guidewire First Quarter 2021 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alex Hughes. Thank you, Alex. You may begin.

Thank you, Operator. Good afternoon. And welcome to Guidewire Software’s earnings conference call for the first quarter of fiscal year 2021, which ended on October 31st. My name is Alex Hughes. I am Vice President of Investor Relations and with me on this call is Mike Rosenbaum, Guidewire’s Chief Executive Officer; and Jeff Cooper, Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today, as well as in our related Form 10-Q and 10-K filed with 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. This call includes forward-looking statements regarding our financial results, products, customer demand, operations, and 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 annual report on Form 10-K and our quarterly report filed at Form 10-Q 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 also will 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. Reconciliations and additional data are also posted in the supplement on our IR website. With that, I will now turn the call over to Mike.

Thanks, Alex, and thanks everyone for joining us today. We are all very excited about our start to the fiscal year and feel great about the momentum we have established in our business. Q1 is typically a quiet quarter for us and coming off a strong fourth quarter, we were happy to see both ARR and revenue come in above the high end of our guidance ranges. More importantly, we made significant progress in all key areas of our business. Specifically, further strengthening our cloud momentum and executing our Connections Customer Conference, which, as you know, was done as a virtual event this year. We believe we’re well-positioned for the year and well-positioned to continue to execute on our mission to be the platform P&C insurers trust to engage, innovate, and grow efficiently. Before getting into the details of our first quarter, I’d like to take a step back to review the unique position Guidewire has established in the pursuit of this mission. The opportunity we see ahead with Guidewire Cloud and what we’re focused on to continue driving successful customer outcomes in the P&C industry. Since our inception, we have focused on serving the more than $2 trillion global property and casualty insurance industry. Over the last 19 years, we’ve established ourselves as the most capable and complete P&C platform in the world. Many of the largest insurers in the world rely on Guidewire software to support the most complex and robust environments, and to do so at scale. Today, we touch approximately 20% of the industry’s direct written premium, with at least one of our core products and we’ve completed over 1000 implementations at over 400 P&C insurers. While this penetration is impressive, these metrics also inform us that there is still considerable whitespace available and considerable opportunity for both Guidewire and especially our customers. We believe the imperative for modern core technology in the P&C industry is stronger than ever. To stay competitive, P&C insurers are responding to rapidly evolving policyholder and agent expectations by rethinking customer interactions with user-friendly digital experiences. Insurers are also looking to technology to help them grow by bringing new insurance products to market and expanding geographically. Insurers need to do these things as quickly and efficiently as possible with effective IT and enterprise systems all optimized through modern data systems and analytics, which make machine learning and artificial intelligence-powered solutions possible. We believe this imperative presents a tremendous opportunity for Guidewire and specifically Guidewire Cloud, which brings a new level of speed, agility, and ease of upgrade to insurers. As we help leading P&C insurers modernize and innovate, we are executing on multiple vectors, including delivering a six-month release cycle that enables customers to adopt new capabilities faster, accelerating our cloud momentum with each new cloud win and successful go-live, and growing our industry-leading ecosystem of partners and marketplace applications. We continue to make great steady and determined progress in each of these areas. A measure of that progress can be seen in our recently held customer conference Connections Reimagined, where we welcomed over 7,700 registered members of the P&C community. At the event, we announced the release of Banff and showcased customer stories in more than 65 online sessions, which have already been viewed over 50,000 times, making it by far the biggest event in our history. Banff demonstrates the reality of our new six-month release cycle and builds on the cloud-native services introduced in Aspen and the Guidewire Cloud Platform. In Banff, we’ve introduced several new capabilities that cloud customers can benefit from now. Advanced product designer, which empowers insurers to build, deploy, and manage insurance products quickly, has added new APIs to support integration with third-party systems, additional cloud-native services, and science risk insights. We unveiled a new developer program available at developer.guidewire.com, which represents our first step towards better supporting the unique needs of the tens of thousands of developers in the Guidewire community. We announced CloudDirect, a new breakthrough program that allows the vast majority of our current on-premise customers to upgrade directly to Guidewire Cloud. The transition expense required to upgrade to Guidewire Cloud has been discussed here previously, and CloudDirect is a tangible example of the investment and development we are focused on to accelerate our cloud transformation by making the process faster, easier, and less expensive for our customers. Banff was also a major release for InsuranceNow, where we introduced a new consumer sales portal and extended our marketplace program so it can support InsuranceNow. This announcement aligned with the introduction of several partner apps for InsuranceNow customers and is a very important signal of things to come as we gain more and more engineering and business leverage from the combination of InsuranceNow and InsuranceSuite. Finally, we outlined our ability to help insurance carriers unlock more value and insight through closed-loop analytics. Our customers can now access their own core data through Guidewire’s Cloud Data Platform, generate contextual insight, then enrich that insight through behavioral data captured in sciences data listening engine, and finally apply predictive analytics to the combination, allowing everyone in an insurance company to make better decisions at every step in the insurance lifecycle. The system is designed to absorb these insights and adjust them over time, making the system smarter with usage and time in a closed-loop cycle. Connections also gave us an opportunity to outline our vision for Cortina and future releases. One highlight was Claims Autopilot, a new approach to claims management and automation that will leverage AI, analytics, and digital to enable an automation-first approach to claims handling and ClaimCenter. In the last year, we have spent a high percentage of our focus on the policy side of our product suite, and I’m very excited about our potential to also radically improve customer efficiency and experience in the claims side of our customers' businesses. Connections was also a great opportunity to hear from our customers. We heard from Pekin Insurance, who’s using our analytics platform to improve speed to market and create predictive model-driven pricing. Pekin realized that to grow efficiently they needed analytics capabilities that are integrated with their core platform; and with Guidewire, achieved double-digit improvements in their loss ratio. We also heard from Aviva Italy, who described their ambition to significantly grow their P&C market share by leveraging the latest digital technology to rethink insurance from a customer’s perspective. Macif in France is another insurer focused on transforming their business to one that is customer-centric by upgrading from decades-old in-house systems to Guidewire Cloud for a seamless customer experience across all their lines of business. Finally, we heard from USAA, where we are playing a key role in a modernization journey that leverages Guidewire Cloud to better serve their members in an agile and flexible way by using the best that the industry has to offer and positioning themselves for the next 100 years. Q1 was also a very important quarter for us with customer deployments. We saw 18 customers go live on implementations for 45 Guidewire products, including 11 InsuranceSuite Cloud product go-lives at seven customers. A handful of notable advances include TD Insurance, part of TD Bank Group, successfully going live on ClaimCenter in the cloud, which was a large joint effort and an important reference customer in Canada. This is just the first leg of our journey with TD, as we now turn our attention to the PolicyCenter and BillingCenter projects. Mobilitas Insurance, a wholly owned subsidiary of CSAA Insurance Group, went live with PolicyCenter and BillingCenter less than four months after signing the cloud agreement in Q4 and is now our third production customer on the Guidewire Cloud Platform. Toggle, a member of the Farmers Insurance family, went live on ClaimCenter via the Aspen release of the Guidewire Cloud Platform. They were our first customer to go live in production on the Aspen release. Additionally, a Tier 1 insurer went live on the Guidewire Cloud Platform via Aspen with a Greenfield deployment that is part of a much larger Guidewire Cloud modernization. Finally, just this month, Co-operative Insurance Companies went live on InsuranceNow with commercial farm, farm umbrella, and personal umbrella lines. Turning to new sales activity in the quarter, Church Mutual Insurance, an existing on-premise customer, selected ClaimCenter on Guidewire Cloud as the first step in their migration to the cloud. In addition, Buckle Insurance, a startup insurer offering policies specifically built for rideshare drivers, adopted Guidewire ClaimCenter. Notable expansions in the quarter include a Tier 1 specialty insurer broadening its use of ClaimCenter to include the London market, Colonnade purchasing our digital products, and Safety Insurance adding digital capabilities to supplement their use of ClaimCenter. I’m also pleased to see our partner ecosystem continuing to grow. In the area of systems integrators, which continues to be an important contributor to our increasing market leadership, we ended the quarter with approximately 730 consultants from 28 partner companies, who have now earned the advanced certifications required for Guidewire Insurance with cloud implementations. This is up from approximately 620 just three months ago, and we believe that this growth continues to be an exciting proof point for the opportunity RSI partners are seeing in the future of Guidewire Cloud. We’re also seeing great momentum with our marketplace partners. Innovation beyond Guidewire is a true measure of a platform, and our open API-first approach enables insurtechs to innovate on top of our platform, and for customers to more easily build these innovations into their core workflows. Today, there are over 600 applications offered from Guidewire and 95-plus partners that enable customers to engage, innovate, and grow efficiently. This quarter we also invested in two exciting insurtechs, San Francisco-based Hover, which has developed a smartphone app that accurately produces 3D exterior property models and is used to dramatically improve the homeowners' claim experience; and Denver-based Flyreel, which has developed an AI-assisted inspection solution for underwriting loss control and claims management of residential and commercial property. We expect to continue to make similar investments to accelerate innovation and develop an even more robust ecosystem on and around our cloud platform. In addition to attracting the attention of insurers, partners, and marketplace participants, we continue to gain visibility and accolades in the industry analyst community. Forrester Research recently recognized ClaimCenter in their Forrester Wave for claims management systems. ClaimCenter received the highest score in the current offering and strategy categories, as well as the highest market presence score, reflecting the size of our customer base and our growth. In addition, for the sixth time in a row, Gartner has named InsuranceSuite a leader in its Magic Quadrant for P&C core platforms for North America. It’s very gratifying and validating to see independent analysts recognize our platform and the customer success it consistently delivers. In summary, this is an exciting time for Guidewire, with a lot of activity as customers seek to leverage technology to engage, innovate, and grow efficiently. The transformation of our customer base and ecosystem to the cloud is key to this. By combining the deep end-to-end capabilities of Guidewire with the benefits of cloud, we’re offering tremendous value for our customers and further advancing our global leadership position. We’re making excellent progress in important areas as we execute on this mission, and we look forward to sharing more proof points and successes as the year plays out. Now, I’d like to turn the call over to Jeff for more details on our financial results and our outlook for Q2 and the rest of the year.

Thanks, Mike. We were pleased with our first quarter financial performance. ARR, total revenue, operating income all finished above our outlook provided last quarter. Activity levels across all parts of the company are high, especially as we exit our first virtual Connections Conference. Q1 is always a seasonal slow quarter and per usual cadence, most of the year’s deal activity is still in front of us. As such, our financial expectations for the year remain consistent with what we discussed last quarter and during our Analyst Day, albeit with a bit more data to reinforce that view. On today’s call, I’ll start with a summary of our first quarter results before turning to our outlook. For the first quarter, ARR ended at $513 million, up 11% year-over-year and ahead of our expectations. On a sequential basis, ARR declined slightly due to the large contract consolidation and the sun setting of support for acquired ISCS on-premise customers. Both of these factors were discussed last quarter when we provided our outlook. Total revenue was $169.8 million, ahead of our expectations due to stronger-than-expected subscription revenue and licensed revenue. Subscription revenue was $37.2 million, up 33% year-over-year and driven primarily by cloud activity. Subscription and support revenue was $58 million, up 18% year-over-year on the strength of subscription revenue. Licensed revenue was $65.3 million. Licensed revenue benefited from $15 million in incremental revenue from deals with duration longer than our standard two-year initial terms or annual renewals. This is $1 million higher than the $14 million that we discussed when providing our outlook on the Q4 call. As previously noted, the incremental revenue was primarily due to the large contract consolidation that took place in Q4, with much of the associated revenue being recognized in Q1 as a result of renewal accounting under ASC 606. This was because many of the components of that deal were up for renewal in Q1, requiring revenue recognition in Q1 versus Q4 when the contract was executed. Services revenue was $46.6 million, down 13% year-over-year. There are a number of factors driving this decline. First, we have seen a small number of project delays associated with COVID, which impacted the quarter and has an impact on our expectations for services revenue for the year. Additionally, as we were doing 100% virtual delivery of professional services, we have seen billable travel expenses decline, which has a comparable downward impact on expenses. Finally, we continue to see new projects being led by our partners, which is a positive trend that we expect to continue. This is critical for our ability to scale our cloud migrations and new implementations in the future. Now, let me turn to profitability for the first quarter, which we will discuss on a non-GAAP basis. Gross profit was $91.8 million. Overall gross margin was 54%, down from 56% a year ago. Subscription and support gross margin was 48%, down from 62% a year ago as a result of significant cloud operations hiring over the last year to support new and future cloud customers. While we are well on our way towards building out the cloud operations team that we will leverage as we continue to see growth in our cloud products, we do expect continued headcount additions through the end of this year. Services gross margin was 2%, down from 10% a year ago. The decline in services margin is due to the factors impacting services revenue, which I already touched on. Operating income was $2.8 million, exceeding our guidance range due to higher-than-expected revenue and expense favorability. We ended the quarter with $1.4 billion in cash, cash equivalents, and investments. And we did initiate our stock repurchase program in the quarter, investing $5 million on the repurchase of 49,000 shares in the quarter. Now turning to our outlook for the fiscal year and the second quarter. For the full year, we are reiterating our outlook for ARR, total revenue, operating income, and cash flow from operations. We anticipate ARR to be between $560 million and $571 million at the end of the year. We expect total revenue to be between $723 million and $733 million. As we look through to the components of revenue, I wanted to make a couple of comments. We continue to expect subscription revenue to be approximately $165 million, an increase of 38% from fiscal 2020. The higher-than-expected term license revenue in Q1 and visibility into term license new sales activity for the remainder of the year gives us increased confidence in our term license expectations. But this is offset by lower services revenue expectations, which we now expect to be approximately $185 million. We still expect total gross margins for the year to be approximately 55%, as our licensed revenue mix is expected to grow slightly, and the positive impact of this mix is offset by lower services margins. Operating income and cash flow from operations expectations for the year are unchanged at negative $5 million to positive $5 million and $60 million to $70 million, respectively. Turning to our outlook for the second quarter, we expect ARR to be between $518 million and $521 million. Total revenue is expected to be between $168 million and $172 million. Subscription revenue is expected to be approximately $38 million, an increase of 34% from a year ago. Support revenue is expected to be the same as Q1, and services revenue is expected to be approximately $42 million. Non-GAAP operating loss is expected to be between $5 million and $1 million. In summary, we recognize that, like prior years, much of our sales activity this year is expected to occur in the next three quarters. We are energized by the activity we’re seeing coming out of Connections. We hope many of you were able to participate in our virtual event as we open the audience up to the investor community this year. Connections content is also available to be consumed on-demand on our website.

Thank you. Our first question comes from Sterling Auty with JP Morgan. Please proceed with your question.

Yeah. Thanks. Hi, guys. Mike, in your prepared remarks, you talked about a number of go-lives and activities with customers. And I think investors are wondering, when you look at those, are there any of them that are Tier 1, where they’re migrating the core biggest book of business into the cloud? And in particular, USAA, I think, you said you heard from them, but I think investors are curious if that’s going to be the lighthouse account that begins the domino effect to drive those big books of business into the cloud?

It's a great question, and I'm happy you brought it up. I've been thinking about what we can do as a company to boost sales and encourage cloud adoption. The key is establishing customer go-lives and proof points. The first quarter was significant for us, as we now have live production customers on the Guidewire Cloud Platform. Our project with USAA is progressing well, and I recommend checking out the Connections materials we published after the event, where you'll find positive feedback about our partnership and the momentum we've gained. To answer your specific question, our experience with Guidewire Cloud Platform has shown its flexibility and agility, evidenced by new lines going live as part of production implementations. Next, some of our existing cloud customers will transition to the Guidewire Cloud Platform, which will facilitate significant implementations of our existing book of business on that platform. I anticipate these will occur in the upcoming months or quarters, and we will keep building the proof points necessary to accelerate cloud sales.

All right. Great. And then the one follow-up would be around InsuranceSuite 8, in particular. You talked about at the Investor Analyst Day, the end of life. But for investors that didn’t hear it, can you kind of remind us the timing of when that happens and how big that book of business is that might be motivated to move to the cloud directly from Version A?

There are several important events related to a specific version of Java, especially for customers using particular database versions and those on Version 8. I believe these events will unfold over the next year to a year and a half. It's important to emphasize that the upgrade decisions are complex for customers, and we collaborate with them to determine the best timing for their upgrades. Most of our clients are on Version 8, Version 9, or Version 10, and while I don't have the exact percentage for Version 8 handy, it's safe to say that over 50% of our customer base falls into that category. Our ability to align the success stories from customers using the Guidewire Cloud Platform with these version and infrastructure upgrades is crucial for promoting cloud adoption among our customers.

Make sense. Thank you.

Yeah. Thanks for the question.

Thank you. Our next question comes from Bhavan Suri with William Blair. Please proceed with your question.

Hey, gents. Thanks for taking my question, and good to see those cloud wins start to ramp up. I guess, following up on Sterling’s question maybe a little differently. You’ve talked about sort of getting scale and leverage at a certain number of customers in the cloud. And so I’m not asking the question of which situation drives more migration and Flyreel effect. But how many customers do you think it takes to sort of get a sense for the comfort? So it’s not one big book of business, but as a four of the top 10, three of the top 10, two of the top 10, whatever the number is that you think sort of breaks down those barriers, like we saw it with Salesforce in the early days, right? It took a couple of very large customers and people began to realize, okay, we’re going to put CRM and service in the cloud. I’d love to learn how you think about the number of customers as opposed to the book of business of a specific customer? And then maybe a couple of, I mean, when do we see the leverage on the gross margin line? What sort of numbers do we need to sort of see, but to start seeing some of the leverage on a gross margin line, given the investments you’ve made?

I’ll address the first part of your question and then let Jeff give his thoughts on the gross margin aspect. I don’t view it strictly as a count of customers. Looking at our current cloud customer base, particularly with USAA included, we have a substantial mix of Tier 1, Tier 2, and Tier 3 customers that allows us to effectively demonstrate the system's capabilities. This helps us establish trust and reliability among our customer base. Unfortunately, this process translates into various project timelines related to go-lives and upgrades while we establish these proof points. We are making significant progress toward achieving the critical mass needed to gain everyone's trust. We have a diverse range of customers, and now it’s about executing those projects. That’s why I’m thrilled about the milestones we've reached in the past six months, including the shipment of Guidewire Cloud Platform, the delivery of Aspen, our transition to a six-month release cycle, the launch of Banff, and getting customers live on Guidewire Cloud Platform. These developments are crucial. You can see how I’m running the company; we’re focusing on a pipeline of project activities that are organized in sequence and will lead to an increasing number of Guidewire Cloud Platform customers. This pipeline is what enhances our margin; as we transition more customers to this new cloud delivery model and implement upgrades more efficiently, we expect to see margin improvements. Jeff, do you have anything to add regarding margins?

Yeah. No. I agree. I think, if you think back to Analyst Day, we talked about this year being a critical year for us as we really build out the cloud operations function and also gain insight into these new ski resort releases and the potential margin benefit we can garner by running those in our operational environment, right? So with Aspen, we’re in the early days. We’re starting to see proof points. Our expectation is very consistent with how we thought about it at Analyst Day, with respect to starting to see some of those benefits more meaningfully as we exit this year.

Yeah. No. It’s helpful. I guess the follow-up, just on the services comment you made, Mike, there, which was you sort of seen services come down a little bit, some projects get delayed? Is that potential because of any surge as people are saying, is there any hesitation, or is that largely because it’s going to partners? I’d love to kind of mix shift that; which part is sort of maybe a little bit of hesitation, and while there is light at the end of the tunnel with vaccines and things like that, sort of people still waiting for that? Or was it really just a shift to the partners? Thank you.

Yeah. So I will say...

I want to be clear that I wouldn’t say there’s any hesitation.

Okay.

COVID presents challenges, as I discussed with our Head of Sales recently. We are navigating through it and making progress. We have successfully closed deals, which highlights the dedication of our sales team and our customers in coordinating and launching these projects. It's important to note that this is a very complex enterprise sale, and typically we would engage with customers through in-person workshops and significant meetings. We are eager to return to this method of managing these multiyear initiatives as we see a light at the end of the COVID tunnel. However, I can assure you that there is no hesitation regarding our ability to execute; that is not the reason for the change.

And to be clear, the COVID commentary related to services is more on the year-over-year compare, as we look kind of at Q1 this year versus Q1 last year. As we think about the adjustment to the expectations with respect to services revenue, that is more a function of our partners continuing to take more and more of this work. In addition, we’ve talked in the past about our willingness to invest a bit in helping our customers overcome what is a common objection to going into the cloud, which is the amount of services work that’s required in order to get there. And so with some of these early customers, we’re working hand-in-hand and investing in those relationships as well.

Great. That color is really helpful, guys. Thank you so much. Appreciate you taking the question.

Yeah. Thank you.

Thank you. Our next question comes from Chris Merwin with Goldman Sachs. Please proceed with your question.

Keeping on the theme here, I was wondering if you could give us a sense for how many of your cloud customers are up and running on Guidewire Cloud Platform? And maybe just any qualitative color about how easy or challenging it is to take a customer who says running InsuranceSuite in the cloud and get them over to the Cloud Platform such that they can get the benefit of all the updates you’re rolling out?

Sure. One of the highlights I mentioned in the keynote at Connections is that we currently have three customers actively using the Guidewire Cloud Platform in production. I am truly pleased with this achievement in the first quarter because it builds confidence in our approach moving forward, and this confidence enhances our ability to sell effectively. Regarding the work involved, while you mentioned v9, that's not exactly how I view the situation. Primarily, we are moving customers from v10 to the Guidewire Cloud Platform, Aspen, and the latest versions of the ski resort release as appropriate. We're paying close attention to the efforts involved, and I can say that it has gone exceptionally well in terms of measuring this effort and estimating the complexity of incorporating it into customer projects. This gives us a lot of confidence that we can maintain this pace. Overall, the transition has been smoother than we anticipated and aligns well with our expectations, making the process much easier. So, everything is progressing very well.

Great. You mentioned that CloudDirect was part of the Banff release. Can you provide more details on how you're reducing costs for customers who are migrating to the cloud? What has changed? Additionally, is there any way to quantify the savings, as this could encourage more migrations? Thanks.

In the past, we indicated that customers needed to go through a two-step process to upgrade to Version 10 of our InsuranceSuite product, followed by an upgrade to Guidewire Cloud. After thoroughly examining the numerous project steps involved, we found a method to streamline this process into a single step. This results in a faster and easier transition, and importantly, it simplifies the sequencing of different teams involved, reducing the overall complexity of the project. For customers, this means a more straightforward undertaking, allowing them to view this step as a unified process. Previously, we led our customers to focus on reaching Version 10 of InsuranceSuite before discussing the move to the Cloud. Now that we can consolidate this into a single step, we can engage with customers on different versions, like Version 8, 9, and 10, to directly explain the project for migrating to the cloud. This is a positive development, as it reduces complexity and time for our customers and fosters a more effective discussion about the cloud.

Great. Thanks so much.

Thank you.

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

Thank you for your question. Building on the recent example, the situation with CloudDirect involved a customer going live in four months using PolicyCenter and BillingCenter. Can you help us understand how typical this scenario is, what it might have looked like in a standard InsuranceSuite environment, and how CloudDirect is changing that? Additionally, what impact might this have on the timeframe for other customers moving forward?

Thank you for the question. You're addressing an important aspect of the market opportunity related to Guidewire and Guidewire Cloud. The initial implementations on Guidewire Cloud are creating new lines of business for our customers. This is part of understanding the dynamics within the insurance industry that are driving significant activity and value for our clients. Insurance companies are looking to grow and introduce new products, as well as expand existing ones into new markets. When launching a new product, they view Guidewire Cloud as a quick and effective method. Implementing a new insurance product using a Guidewire Cloud PolicyCenter, BillingCenter, or ClaimCenter instance allows them to bring products to market faster. This process, which can be completed in about four months, stands in stark contrast to transitioning an existing system that has operated for decades. That transition involves a complex project to configure Guidewire to handle the existing book of business, including various intricacies related to premiums, customers, and claims from the legacy system. Even with an excellent core system, this transition requires extensive study, testing, and planning, which contributes to the lengthy multiyear projects we often mention. While we have conducted thousands of these implementations, transitioning an existing system cannot be done in just four months. Instead, we work with our customers according to their timelines and how quickly they wish to proceed with these projects. Our role is to provide a cloud infrastructure and product capable of accommodating the complexities of these types of implementations. We are definitely noticing increased interest from our customers in launching new innovative lines quickly and utilizing the same platform for managing their entire book of business in property and casualty insurance. Does that clarify things?

Great. Yeah. That’s great. And then maybe shifting gears a little bit towards the competitive front, obviously, it’s been you and a couple of others kind of leading the way for many years. But the insurtech market is really kind of changing those dynamics pretty quickly. Just curious in terms of the two elements you just mentioned in the previous answer, for net new lines of business, is that a different set of competitors that you’re going after? And then on the more traditional side, has anything changed? Are you seeing win rates fluctuate at all, our decisions being put off in the current environment, or is that side of the business still kind of in line with what your expectations were?

I’ll address the second part first. The competitive landscape remains unchanged, as we've discussed in earlier quarterly calls. We did not see any change in Q1 either. Regarding insurtech, particularly for the CIOs responsible for integrating these systems into their existing operations, it makes much more sense for them to adopt a platform that will ultimately manage their entire book of business. Although I don’t have a visual to share since we haven’t moved to Zoom calls yet, the architecture diagrams that our customers use with Guidewire at the center are extremely complex. A policy system is not just an addition in an enterprise architecture; it is central to it, linking to nearly every other system you can imagine. Implementations can require anywhere from 50 to 100 integration points for policy, billing, and claims systems. Therefore, it’s essential to have a platform that can deliver rapid, agile innovation on the product side while also supporting the robustness needed for core business operations. This capability, provided by Guidewire on a single platform, is a significant selling point of our solution. Consequently, when people mention insurtechs, I don’t view them as competitors but rather positively. These companies are developing mobile solutions that will enhance the value our customers gain from running Guidewire. They are not positioning themselves to compete with us as a core system provider; instead, they aim to augment the value we deliver to our clients.

Great. Thank you for taking my question.

Yeah. Thanks for the question.

Thank you. Our next question comes from Rishi Jaluria with D.A. Davidson. Please proceed with your question.

Hey, guys. Thanks for taking my questions. Nice to see continued cloud momentum in the business. I wanted to follow up first on some of the earlier gross margins questions that got asked and really specifically dealing with subscription gross margin. So if we do the math, you’re somewhere in the neighborhood of mid-20s and maybe higher 20s subscription non-GAAP gross margins, which is actually down. Now I know, Jeff, you’ve talked a lot about there’s some accounting here, especially with migrations from term to cloud. But I’m still surprised to see the gross margins on the subscription line continuing to decline. Maybe help us understand besides that, what else is going on here, given that you’re at a much larger scale than you were when gross margins were higher on that line? And maybe more specifically outside of just more Banff and Cortina adoption, as well as just more customers, what are the levers should we expect to see that line go up towards, I guess, more typical SaaS gross margins? Thanks.

I believe that our significant investments in cloud operations will begin to yield efficiencies from the new releases we've implemented. While these changes will positively affect our margins eventually, they won't be evident this year. This aligns with our previous discussions during Analyst Day. There are many factors at play, but one that we've touched on before is that many of our initial cloud agreements involve substantial cloud migration efforts. In these cases, we often assign part of the total contract value to term licenses instead of subscription revenue. We're making significant investments in these customers as they transition to cloud services, which affects their margin profile during the contract's initial term. However, once the contract is renewed, this allocation for term licenses will cease. As you know, customers must utilize both systems throughout the migration, which does have a slight impact—previously estimated at around 3 percentage points last quarter. This will continue as we assist with customer migrations. The primary takeaway is the investments we're making this year, which we expect will benefit all our customers in the future within our cloud operations.

All right. Great. Thank you so much.

Thank you. Our next question comes from Ken Wong with Guggenheim Securities. Please proceed with your question.

Great. Thanks for taking my question, guys. Hey, Mike. One common theme I noticed coming out of Connections was that there was a much greater focus on data initiatives and how cloud enables these data projects for customers and obviously, a lot of the automation you guys talk about versus in the past where it seemed like the talking points were cloud for cloud sake. How did that messaging align with how P&C carriers are looking at their IT priorities? Is this something as customers start to focus more on what they can do with data? Is that something that could potentially accelerate cloud adoption? I would love your take there.

Thank you for the question. I completely agree. My goal is not to sell cloud services just for the sake of selling them. Instead, I want to provide cloud solutions that support our customers’ initiatives and contribute to their success. Data and analytics are crucial whenever I discuss technology initiatives with customers. What we've delivered with the Guidewire Cloud Data Platform is truly unique. From day one, customers in production can access all transactions processed through Guidewire on a modern data platform, opening up numerous use cases and improving decision-making at every stage of the insurance lifecycle. Additionally, we believe that Guidewire will be implemented alongside digital solutions in every instance. There will not be a Guidewire implementation without a consumer-facing or agent-facing digital interface. This integration enhances the overall value of a Guidewire InsuranceSuite implementation. We’re excited about this and anticipate that customers will soon recognize the significant value they gain from transitioning to the cloud, which goes far beyond where the software operates and who performs upgrades. It involves the essential capabilities we can offer as a cloud service, allowing us to manage the cloud data platform and provide access to vital data, which is a key selling point.

Got it. Got it. Thanks for that. And Jeff, maybe a follow-up on the services side of things. I think most of us were expecting that after last year and the year before where services were reduced pretty meaningfully and now adjusting for kind of life after COVID that we were probably approaching a floor there. I guess as we look at the now reduced guide there, is it fair to assume that that’s probably the bottom for services, or is there any potential outcomes that could surface in the coming months that might bring that lower that you can think of?

Yeah. Ken, I mean, look, we’re working hand-in-hand with our partners and continue to try to push as much work as possible to our partners, and we’re seeing great pickup in their ability to take and lead these cloud projects, which is a great thing for the long term. We will commit to updating you on a quarterly basis and helping you understand the puts and takes and what’s going on there. The way I think about services is, ideally, what’s the lowest services and how we need to drive our ARR targets, and that’s kind of what I’m focused on. Although, we do want to make sure that we provide that visibility and transparency in terms of how we expect that business to grow and evolve over the future. So what we provided is our best view into what we see at this point in time in the year with respect to where we think we’ll get to by the end of the year.

Got it. Very helpful. Thanks, Jeff.

Thank you. Our next question comes from Tom Roderick with Stifel. Please proceed with your question.

Hi, gentlemen. Good afternoon. Thanks for taking my question. So, Mike, you just responded to a question earlier with an interesting answer regarding line of business and new kind of Greenfield growth being a driver of your cloud adoption. And I guess, as we sit here in December, kind of nine months into this pandemic, and I guess, the way that customers interact with agents and the way their claims are assessed and processed, all these things are seemingly very different than what they were looking like a year and two years ago, so perhaps there’s been some acceleration. But maybe you can kind of comment on your conversations with your counterpart execs at big carriers on this concept of digital transformation. And is this accelerating their view for opening up these new lines of business and framing up growth opportunities for themselves, which would theoretically accelerate your cloud pipeline?

Thank you for the question, Tom. It's really exciting for us to be involved in the growth initiatives of these companies. You can view these initiatives in a couple of ways. Firstly, we aim to create a better digital interface that allows agents and consumers to obtain insurance quotes and complete transactions more smoothly. This is a significant driver for Guidewire projects. Secondly, we are focused on bringing entirely new products to market through innovative channels. I have many discussions with customers who are eager to explore new avenues for launching innovative products, and having flexible IT systems is crucial for this. It's important to keep the cost of experimentation as low as possible, as this enables more trials. You never really know which channel or product will succeed, so minimizing costs allows for more experimentation and helps identify what works. If Guidewire Cloud can help these insurers launch new products swiftly to have a meaningful impact on their businesses, that's an incredible advantage for us. One of our customers mentioned that this is now their new approach to product launches. It's essential to use a robust platform like Guidewire, as these companies prefer a cohesive system over a patchwork of different solutions. All of their systems need to integrate back into their financial, reporting, and analytics frameworks. If they are modernizing their legacy systems with Guidewire, being able to quickly bring products to market represents substantial value, which I find very exciting. I hope this provides more insight into the conversations we are having.

Yeah. That’s great color. And as you talk, again, a little bit about some of these, I guess, ski resort releases here, but talking about Banff being released out here in November. I’d love to hear a little bit more about the six-month release cycle, the complexities of that, that you’re starting to see and understand and how customers are thinking about it or embracing it from a training and adoption standpoint. Maybe you can talk a little bit about some of the early feedback on that six-month cycle and how customers are working within the bounds of that?

I'm very proud of our product development team for successfully achieving our goal. While it's easy to state our plans for a six-month release cycle, executing it with Aspen and then following up six months later with Banff is a significant accomplishment, especially during the pandemic. The feedback has been overwhelmingly positive. Initially, many perceive Guidewire as difficult to upgrade, leading to concerns about whether a biannual release would complicate things further. However, we’ve found that our approach to these innovations has actually made the upgrades easier for customers using Aspen. Banff is therefore simpler to implement than it would have been if we had delayed for two years. The initial feedback is primarily around the transition to cloud and Aspen, and that’s been encouraging. The upgrade projects are progressing well, with three customers successfully going live on Aspen, which is an excellent indicator. We’ve just launched Banff, and we’re in the early phases of deploying it to customers and integrating it into their projects. We will provide further updates in the next quarterly call. Overall, everything is aligning positively for us, which is truly exciting.

Really helpful. Thank you, Mike. Appreciate it.

Thanks very much.

Thank you. Our last question comes from Brad Sills with Bank of America. Please proceed with your question.

Oh! Great. Hey, everyone. Thanks for taking my question. I wanted to ask about the improved outlook on term licenses. What feedback are you receiving from customers about their plans for managing their roadmap with Guidewire regarding on-prem term licensing, while also planning to transition to the cloud? It seems like there’s positive movement in both areas. This is the first time in quite a while that we’ve seen an increase in term licenses. So, what do you think is driving this, and how are conversations with customers going about retaining their current on-prem term license systems while considering a gradual long-term shift to the cloud?

Let me quickly address that and see if Jeff has anything to add. For the most part, customers are either deciding to transition to Guidewire Cloud, which would replace their term license with a cloud subscription, or they’re exploring new lines of business that can be established more quickly as a way to familiarize themselves with the approach required for a successful cloud implementation. It's important to remember that their experiences and proof points will influence their decision on when, and if, it makes sense to move to Guidewire Cloud from their term on-prem implementation.

And Brad, the only thing I would add, as we see term license deals work their way through our pipeline. It’s one of the interesting things I’m noticing is almost a lot of them will have committed cloud pricing in them. So a lot of customers, they may not be quite there yet, but even as they embark on a term or on-premise journey with us, they’re thinking about how that will eventually go to the cloud. So that’s a real strength of ours to have the really strong on-premise offerings that we have today combined with the cloud offering that we’re building and we are rolling out to customers. So kind of having a bit more flexibility with when customers want to take that is a big strength of ours.

That's great. Thanks, everyone. I have one more question. At the Analyst Day, you mentioned that more investment is being directed towards R&D for the cloud. Is it possible that we will see more features in InsuranceSuite Cloud compared to the on-premise solutions, creating an advantage or incentive for customers to migrate more aggressively to the cloud? Thank you.

Yeah. I’d say, we’re already there, right? And think about it like this, the feature advantages in what we call these cloud-native services. Think of it as characteristics to support rating, to support rules generation, the data platform that I talked about previously. Those features are only available as cloud services. And so I think those things will build over time. We will keep advancing as we can and as it makes sense for our business and our customer base the characteristics of InsuranceSuite self-managed or on-prem. But there will be a feature advantage to the cloud. And our customers understand that, right? I think that there are just certain things that you can do as a cloud service provider with these services that you just can’t do in an on-prem modality. Our customers understand that and it makes sense. And so I think that will grow as a mechanism to convince customers to move over and to take advantage of those capabilities.

Great. Thanks, Mike. Thanks, Jeff.

Thank you.

Thank you. Our last question comes from Joe Vruwink with Baird. Please proceed with your question.

Great. Hi, everyone. Just one from me. Maybe a bit of an overarching question that dovetails with what’s come up earlier, but it seems like a lot of events and strategies have popped up over the last 12 months and they seem individually pretty important. So the end of life milestones with iOS 8 or the CloudDirect path so you avoid the two-step database move, the annual releases just came up. And I guess my question is, when you step back and consider everything, is there one thing that is particularly important or maybe it has the potential to drive be it decisions to invest earlier or maybe it drives go-lives faster, just relative to maybe your expectation for some of those things 12 months ago?

It feels like a combination of shipping and delivering the Guidewire Cloud Platform, along with the supporting services, and getting customers to go live with real production use cases that they can reference, giving them confidence that this is a viable alternative. I’ve had numerous conversations with customers who express their support and enthusiasm for what we’re doing, while also indicating that they are conservative organizations. They want to see certain proof points established before making decisions for their companies. I’m focused on execution, and I believe that following a determined and steady approach is the right strategy for our customers. If I had to highlight one critical aspect, it would be those production proof points. Establishing them allows us to show our customer base that others are successfully utilizing our services, and we are beginning to see that happen. The first quarter was crucial for us in this context.

Great. Thank you.

Thanks.

Thank you. Our last question comes from Michael Turrin with Wells Fargo Securities. Please proceed with your question.

Hey, there. Thanks and good afternoon. Just one for me, maybe two parts on it. On ARR, you mentioned the impacts that caused that slight shutdown in Q1, you are guiding for consistent 10% to 12% growth for the fiscal year. I am wondering if we could maybe just take a step back and you could share with us with some of the key factors you’re watching out which could help that ARR growth number pick back up over time beyond the consistent profile you’ve seen? And Jeff, maybe you can also just help level set where we are in terms of ramp contribution or impacts we could see from that advantage point, as some of the newer cloud customers also layer on to the model? Thank you.

Yeah. So maybe I’ll start Mike and you can jump ...

Yeah. Go ahead. Go ahead.

I think there are a number of levers that we’re watching very closely with respect to ARR. The first is new bookings activity and how that bookings activity translates into year one ARR. As we think about bookings, as the average total contract value over what could be a longer period and then that translates to year one ARR at different levels, depending on the profile of the deal. We’ve talked in the past that migration deals often translate to year one ARR at much lower levels because they’re already paying a term license and some other things. So, first and foremost, is always kind of keeping an eye on what the bookings activity looks like. The next one that we track, which you hinted at, is this, how much activity are we going to get from ramps, deals that were sold in prior years. What does that look like in the year? And in the past, we’ve talked about, this year being roughly similar contribution from those two factors to our gross ARR that we expect to add over the year. And then the third vector is ARR attrition. The one thing I would note on ARR attrition is in line with how we fix it, built out our expectations for the year and how we thought about last year. This year we are seeing a little bit of that coming more in Q1 and Q2 versus Q3 and Q4. And we work very closely with our team to look at every single renewal and if there’s any sort of impact or risk that’s out there. And so those are the drivers that we focus on a very regular basis.

Great. Thank you.

Yeah. Thank you.

Thank you. Our last question comes from Tyler Radke with Citi. Please proceed with your question.

Hi. Good afternoon. This is Ji Cheong going on for Tyler today. I just want to quickly touch on the better OpEx discipline we see inequality here and with margins usually improve in early, like towards the end of the year? And then given margin guidance was unchanged, could you kind of help us understand the puts and takes here and what kind of cadence that we should be looking at towards the flat margin for the year? And then have you built in any expectation of like T&E expenses returning as we start to recover in the next six months to nine months? Thank you.

Yeah. So with respect to overall operating margins, we did see a fairly significant overperformance via-a-via the expectations, about half of that came from the revenue and the timing of revenue. There were some unusual items in the quarter that benefited us from an operating expense perspective. There was a credit from AWS tied to significant usage that we have there that we were expecting that would hit in Q2. It ended up hitting in Q1. There were some other more project-based work that was a bit delayed, which is why the overall operating expenses in Q2 are a bit lower than what we expected, but as we inspect budgets for the full year pretty much consistent with the expectations that we said at the beginning of the year. So didn’t change our overall outlook even though we did see a bit less expense in Q1 than we’d originally modeled.

Okay. And the years like you give any expectation for T&E returning actually came with that?

Oh! For T&E returning.

Yeah.

T&E has several components and is a significant expense for our sales and other departments. We anticipate a partial return in this fiscal year, which is reflected in our models. Regarding billable T&E for our services team traveling to customer sites, we have projected a small amount for Q4, but we don't expect much from that. Historically, billable T&E has been around $15 million or $16 million, so this year represents a notable change compared to previous years.

Great. Thanks for fitting me in.

Thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mike Rosenbaum for any closing comments.

Hey. Thanks very much. Hey just wanted to say thanks everybody for joining. Really, really happy with the momentum we’ve established in Q1 and happy with the prospects and the outlook that we have for the year. I appreciate that you joined, and also just I’d put in a plug if you really want to understand Guidewire we work real hard to get some of the content posted online, public access on Connections and I think it’s a great way to really understand and assess, especially from a customer perspective, the value that we’re delivering and so that’s all out there now and published if you’re interested. So thanks everybody for joining and have a great day.

This concludes today’s call. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful evening.