Earnings Call Transcript - GWRE Q3 2020

Operator, Operator

Greetings, and welcome to Guidewire's Third Quarter 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 Jeff Cooper. Thank you. Please begin.

Jeff Cooper, CFO

Good afternoon, and welcome to Guidewire Software’s earnings conference call for the third quarter of fiscal year 2020, which ended on April 30th. 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 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, certain leadership changes 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 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 with the primary differences being stock-based compensation expenses, amortization of intangibles, the amortization of debt discount and issuance costs from our convertible notes, changes in fair value of strategic investments and the related tax effects of these adjustments. 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.

Mike Rosenbaum, CEO

Thank you, Jeff, and thanks to those of you joining us for our third quarter earnings call. Quite a lot has changed since our last call in March, and I'm proud of how everyone at Guidewire has adapted and responded to the changes required by the COVID-19 pandemic. A lot has also changed in just the past week. And so before I get to the quarterly results, I want to take a second and relay to everyone how deeply saddened every single member of the team here at Guidewire is regarding the death of George Floyd and the underlying inequality and racism that reflects in our society. I sent a message to our company yesterday that said it's just fundamentally not acceptable to me that a portion of our community feels that the system we live with values their lives less than mine. We are all committed to doing our part and working to address this at Guidewire and in our communities. And I’m confident that we will find some value from this senseless loss of life. It's forcing us to have a conversation we are uncomfortable having. And even though that seems like a very small step, I think it will lead to positive change. With that, I'll proceed to the quarterly update. We had a good quarter, all things considered. As you can imagine, we spent a lot of our time working to adapt to a new approach to work in addition to the normal things we do to operate the company. We're happy to report that ARR grew 10% from a year ago to $483 million, in line with our expectations. Additionally, we exceeded our guidance ranges for revenue and profitability in the third quarter. We have adapted to working from home company-wide and I expect us to operate this way through at least our fourth quarter and most likely our first quarter, which ends in October. I've been particularly impressed with our team's flexibility and eagerness to support one another as our colleagues juggled sometimes less than ideal work environments with personal responsibilities and the long list of new stresses and uncertainties we are all now facing. Like many others in the technology industry, we've been pleasantly surprised by how smoothly this transition has gone, and we are working to ensure that we take everything we have learned from this experience and apply it logically to how we operate going forward. I have no doubt that we will support a greater percentage of remote work and find new and more creative uses for our office spaces going forward. While we continue to execute effectively as a company, there are COVID-related impacts to our business that we are dealing with. As you know, we sell large heavily negotiated deals for complex IT projects that have long sales cycles. We have been happy to see existing deals and projects continuing to move forward and in many cases our customers are just as motivated to continue to make progress on these initiatives as we are. A large majority of our new sales in any given year come from existing customers and we very often have long-standing relationships with customers and prospects that have transitioned well to virtual engagements. However, we have seen lengthening sales cycles and in some cases, delayed decision-making related to the very significant amount of uncertainty many of our insurance customers and prospects are facing. We expect this to continue in Q4, which is a critical period given the seasonality of our business. We consider ourselves fortunate to operate in a very resilient vertical with a strong recurring revenue business model based on delivering mission-critical applications, but we do expect that the current environment will have some impact on our ability to close new business, and that is considered in our outlook for Q4, which Jeff will discuss in more detail. Looking at some of the details of our third quarter, we delivered solid results in an uncertain environment, and while new business activity was not as strong as a typical Q3, we did add four new customers and seven existing customers selected additional Guidewire products. Momentum for Guidewire Cloud continued in the quarter with over 60% of new sales from cloud, which included InsuranceSuite Cloud, InsuranceNow, and Cyence products. A particularly notable win was with Aviva Italia, an existing customer who has opted to migrate their InsuranceSuite instance to Guidewire Cloud. Given the environment in Italy during the quarter, I found it to be a remarkable example of the perseverance and resilience of our community, and we were all very inspired to get this transformation started in the midst of these difficult circumstances. We also saw momentum continue with InsuranceNow, our all-in-one cloud offering. CFM Insurance, a provider of farm, homeowners, and renters insurance, selected InsuranceNow to modernize their operations in the third quarter. Also, and as discussed on our last call, Tuscarora Wayne Insurance decided in Q3 to migrate their on-premise instance of InsuranceNow to Guidewire Cloud. Cyence contributed three notable wins in the quarter, showing the breadth of our reach by adding to our client base an insurer, an MGA, and a reinsurer. A German insurer selected Cyence Risk Selection and Accumulation for its international corporate underwriting business. And in the U.K., Optio Group Services selected Cyence Accumulation and Risk Selection for small business for cyber. And finally, a market-leading reinsurer based in Bermuda licensed Cyence Risk. Finally, we closed one new on-premise suite customer and an on-premise core system expansion in the quarter. British Columbia Automobile Association, a $225 million DWP insurer serving one in three households in British Columbia, selected all of InsuranceSuite as well as data and digital. Admiral, a Tier 2 insurer in the U.K., expanded their relationship with Guidewire to add ClaimCenter. As part of our move to work from home, our services organization has successfully transitioned to 100% remote implementations very effectively. In Q3, we completed nine core data or digital go-lives, including a go-live on InsuranceSuite Cloud at MACIF in France, an InsuranceNow go-live and a full InsuranceSuite go-live. In addition to customers who went live on new products, six customers completed major version core upgrades. Our continued momentum would not be possible without our partner community. Notably within our partner community, approximately 475 consultants from 19 partner companies have now earned advanced certifications required for Guidewire Cloud implementations, up from approximately 270 as of the end of last quarter. We believe that this growth is an exciting proof point of the opportunity our partners see in the future of Guidewire Cloud. I'm grateful for the efforts throughout our ecosystem for the continued service and leadership to the P&C industry. I'm also pleased to announce that we closed two small venture investments in exciting innovators in the InsurTech landscape, Betterview and CLARA Analytics. Betterview is a geospatial analytics provider that helps underwriters manage property risk and helps adjusters to remotely manage property claims. CLARA Analytics is a provider of predictive analytics solutions focused on workers' compensation and commercial claims. These investments totaled $2 million and closed in Q4. We look forward to working with both companies, as they help support what we measure as the largest and most vibrant applications ecosystem in P&C insurance. As I previewed in our previous quarterly call, we completed in May what I think is one of the most important releases we've ever done as a company. We're calling this release Aspen, and it is our first cloud optimized release of InsuranceSuite. This is the first release to take advantage of our Guidewire Cloud platform on AWS and introduces a cloud-native rating service, a cloud-native rules engine, a completely new approach to integrated digital experiences, and a number of enhancements to PolicyCenter designed to allow insurers to launch new insurance products more quickly and more easily. Our mission is to enable insurers to engage, innovate and grow efficiently, and the Aspen release of InsuranceSuite is a major milestone in that journey. I'd also like to take this opportunity to discuss some leadership changes that we are making in the company. First, after 15 years at Guidewire and an incredible career in enterprise software, Steve Sherry has decided to retire. Steve will continue with the company as Chief Sales Officer through the end of our fiscal year and will stay on after as SVP Strategic Accounts through at least the end of the calendar year, to ensure a complete and seamless transition. We are all incredibly indebted to Steve for the contribution and leadership he provided during his years at Guidewire. He's an incredible sales leader and has built a truly first-class sales division here at Guidewire that will surely outlast him. In anticipation of Steve's retirement, we're excited to welcome Frank O'Dowd to the leadership team here at Guidewire. Frank is a 20-year sales veteran and leader from Oracle, a company that we all deeply respect in his professionalism and approach to NFI sales. Frank was most recently a Group Vice President at Oracle's cloud sales division. We're lucky to get him and excited for him to join. He will start with us on June 15 and have an opportunity to work with Steve and the team as we close out the year. At which point, Steve will smoothly pass the Chief Sales Officer baton to Frank on August 1. Second, I'd like to congratulate Jeff Cooper, our new CFO, who you will hear from in a minute. After an extensive and thorough search, we have decided that there really is no one better to lead our finance organization right now than Jeff. His command of the very complex financial details of our business model transition, in addition to the trust the organization has in him and the leadership he has shown during this interim period in the COVID-19 transition, all demonstrated to me and our Board that Jeff was the right financial leader for Guidewire right now. During the process, I continually asked myself, who do I trust to financially manage and lead this company and I just kept coming back to Jeff. He had the command of the business and a belief in our potential and I'm excited about what we will build together. Third, I'd like to congratulate Priscilla Hung on a promotion to President, in addition to her role as COO of Guidewire. Priscilla joined Guidewire in 2005. She has for many years been a key driver of the most critical Guidewire initiatives, and I expect will remain a key leader of the organization for years to come. She embodies the grit, determination, and resilience of our culture and I'm excited to continue to partner with her as we drive the next chapter for Guidewire, Guidewire Cloud, and our partner ecosystem. She's been an invaluable partner to me in coming up to speed here at Guidewire, and I look forward to her continued leadership and partnership. I hope that these leadership changes signal to you how extremely optimistic we are about our strategic direction and the long-term opportunity to serve the P&C industry. We are not slowing down investment in our cloud platform and cloud operations team. The investments we are making today will be key to our future success as the industry increasingly recognizes the benefits of our cloud products. In summary, like many others we are facing new uncertainties as a result of the COVID-19 pandemic, but we are optimistic that these impacts are temporary when considered against the multiyear timeframe and time horizon we optimize for and the fundamental market pressures driving demand for modern insurance platforms. As our cloud offering matures, we expect demand to continue to strengthen. We're building the most comprehensive cloud-based platform and ecosystem in the world and I'm confident that Guidewire in the insurance industry we serve will weather the storm. We'll get through this period of social and economic uncertainty and come out a stronger, more efficient company, and I hope a stronger and better world. Now I'll turn it over to Jeff.

Jeff Cooper, CFO

Thank you, Mike. ARR ended the third quarter at $483 million on a constant currency basis, an increase of approximately 10% year-over-year. New ARR added year-to-date has been split pretty evenly between new deals sold and ARR step-ups from ramp deals sold in prior years. ARR retention continues to be in line with our expectations established at the beginning of the year, which given the current environment demonstrates the resiliency of our recurring revenue model. Total revenue in the third quarter was $168.2 million, above the high end of our guidance range. Subscription revenue in the quarter was $30.1 million, up 105% year-over-year due to ongoing InsuranceSuite Cloud activity and some positive Cyence usage resulting in $1.1 million of variable revenue true-ups. License and subscription revenue was $93.2 million, which was also above the high end of our guidance range and the primary driver of our total revenue outperformance. Through the end of the third quarter, subscription sales as a percent of total new sales was 61%. New term licenses and renewals with contract durations that were longer than our standard two-year initial and annual renewal terms contributed approximately $13 million in incremental revenue when compared to our standard term durations. As a reminder, last quarter we mentioned that we expected approximately $10 million of incremental revenue from longer than standard deal duration contracts embedded in our outlook for the back half of the year. Maintenance revenue and services revenue in the third quarter were largely in line with our expectations at $20.7 million and $54.3 million, respectively. Turning to profitability, we will discuss these metrics on a non-GAAP basis. Gross profit was $94.2 million in the third quarter, compared to $94.1 million a year ago. License and subscription margin for the quarter was 76%, down from 87% a year ago as a result of large investments in cloud operations. Services gross margin for the quarter was 12%, down from 16% a year ago. Overall gross margin for the quarter was 56% compared to 58% a year ago. The impacts on margin declines from license and subscription and services revenue were partially offset by a mix shift in total revenue away from services revenue. Total operating expenses were $88.5 million in the third quarter, an increase of 8% from a year ago. Operating income was $5.8 million, exceeding our guidance range due to revenue upside and to a lesser extent, expense favorability. Global work-from-home efforts reduced travel spending in the quarter, which was partially offset by initiatives to better support our employees working from home. Net income was $7.7 million or $0.09 per diluted share. We ended the quarter with $1.3 billion in cash, cash equivalents, and investments. Operating cash flow for the quarter was $4.6 million, and free cash flow for the quarter was $1 million, excluding $5.3 million in final expenditures associated with our new headquarters. Operating and free cash flow in the quarter were negatively impacted by approximately $10 million as a result of early partial payment of annual bonuses that would have typically been paid in September 2020 for all active bonus eligible employees, excluding senior executives. Turning to our outlook for fiscal 2020, we are very pleased with the number of active cloud conversations we have going on with existing and potential new customers. Global shelter-in-place mandates have reinforced the need for modern core systems. However, the current environment is expected to impact deal closings in Q4. As a result, we are updating our ARR growth outlook to between 9% and 11% for the year. Also, we did want to comment briefly on fully ramped ARR. As a reminder, fully ramped ARR is defined as the annualized recurring value of all active term license, subscription, and maintenance agreements at the fully ramped annual price outlined in the customer contract. In fiscal 2019, fully ramped ARR benefited from a flurry of cloud deal activity in the back half of the year with significant ramps. Given the current environment, we are not expecting similar activity levels this year and as a result, year-over-year growth comparisons for fully ramped ARR at year end are expected to be closer to ARR growth levels. Our current outlook assumes that new subscription sales as a percent of total new sales will be at the lower end of our previously disclosed range of 70% to 80%, and our subscription revenue outlook is expected to be between $116 million and $118 million this year, representing 80% growth at the midpoint, a small increase from our prior guidance. We are updating our license and subscription revenue outlook to between $419 million and $427 million for the year as a result of updating our higher subscription outlook, combined with more than expected multiyear term license activity, partially offset by increased uncertainty on deal timing given the current environment. Currently, incremental revenue from term licenses that are longer than our standard terms is expected to be approximately $2 million in Q4 or $15 million in the back half of the year, which is higher than the less than $10 million that informed our back half outlook last quarter. There is no change in our maintenance outlook. We are adjusting our services revenue outlook to between $198 million and $204 million. This $4 million adjustment at the midpoint is largely due to the fact that our services teams are no longer billing customers for travel expenses since we are not going on-site. Billable travel expenses run through our services line at a 0% margin. We have also seen a small number of projects slow down or be put on pause, which has an impact on our expected results. Overall, we are extremely proud of our services organization's ability to execute ongoing projects remotely with limited disruption. We expect total revenue to be between $703.5 million and $711.5 million for the year compared to our previous range of $702 million to $714 million. With respect to gross margin, we still expect overall non-GAAP gross margin to be between 58% and 59%. We still expect license and subscription margin to be between 78% and 79%, even with a higher overall subscription mix, and we still expect services gross margin to be between 6% and 7%. We now expect operating income to be between $65 million and $73 million, representing a non-GAAP operating margin at the midpoint of 10%. We expect free cash flow to be between $65 million and $75 million, excluding approximately $11 million of cash outlays associated with our new headquarters. This outlook reflects approximately $10 million impact of the partial early payment of annual bonuses. While it has been customary for us to provide some preliminary insights into the next fiscal year during our third-quarter call, given the uncertainty of the macroeconomic environment, we are not in a position to do that now. That said, despite the near-term uncertainties, we are confident in our ability to execute against the exciting opportunity in front of us and we plan to continue ongoing investments to build upon our market leadership as insurers embrace the cloud. As we transition into our next fiscal year, we are evaluating our approach to guidance with the goal of simplifying the number of metrics to focus investors on the metrics that matter. We will discuss this in more detail on the Q4 call. Additionally, we will be changing the presentation of our income statement, starting with our 2020 10-K. As subscription revenue has grown to more than 10% of total revenue, we needed to revisit our income statement presentation to comply with SEC guidelines. On the face of the income statement, we will report license revenue, subscription and support revenue, and services revenue. License revenue will include term license and perpetual license revenue. Subscription and support revenue will include software subscriptions and what is currently maintenance revenue, both of which are recognized ratably. And services revenue will remain unchanged. This will create a more simplified presentation for investors by segmenting the upfront revenue components, the ratable revenue components, and the time and materials revenue components on separate lines. We will also continue to present the details of revenue in the footnotes to our financial statements to allow investors to compare with the current presentation and break out subscription revenue as a standalone item. Finally, I would like to thank Mike and the Board of Directors for entrusting me with the permanent CFO role. I'm very honored to move into this position. As some of you know, I was part of the underwriting team on Guidewire's IPO when I was at Deutsche Bank, and I have always had a ton of respect for this organization. I'm most excited about the massive opportunity in front of us, as we deliver the agile cloud-based systems that our chosen industry needs. In summary, we executed well in the third quarter, despite the constraints faced by our employees and customers during the COVID-19 pandemic. The current environment highlights the need for flexible modern core systems, and we look forward to helping our customers navigate these uncertain times. Operator, you can now open the call for questions.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Chris Merwin of Goldman Sachs. Please proceed with your question.

Chris Merwin, Analyst

Okay. Thanks so much for taking my questions. I just wanted to ask about COVID, and in particular, how that relates to the conversations that you're having with insurance companies right now. Are they starting to rethink their approach to digital transformations at all? I know before COVID, you talked a bit about some of these companies were maybe not as willing to jump to on-prem, because they're on a mainframe, and they wanted instead to go all the way to a cloud system. But just curious, like as you have the dialogue with your customers who are seeing, in some cases, some disruption to their business, how are they thinking about progressing their digital transformation efforts? Thank you.

Mike Rosenbaum, CEO

Yes, there is no doubt that every insurance company worldwide is considering the digital interfaces they use to connect with their customers. I spoke with one of our top customers who mentioned that recently, individuals and companies have taken the opportunity to review all their recurring payments and bills digitally. This has led to an unusual increase in the use of digital engagement methods by these companies, prompting them to think about how to implement related projects more effectively. As for the solutions we provide, Guidewire is not designed for short-term projects aimed at immediate problems. Insurance companies that have invested in their digital capabilities over the past few years are well-positioned to adapt and respond quickly. Overall, I believe that the assessment of digital transformation strategies in light of COVID will benefit us, but we need to navigate the current period of economic uncertainty before that potential begins to manifest. Does that make sense?

Chris Merwin, Analyst

Yes. That's perfect. Thank you. And maybe just a follow-up on cloud gross margins. I know one of the focuses at the Analyst Day last year was figuring out how to scale up this gross margins in terms of time. Based on what you've seen so far, I mean, can you talk about your confidence level and the long-term outlook that you gave for gross margins for the cloud business? And could we even see a multi-tenant version of Guidewire for the future?

Mike Rosenbaum, CEO

Yes, that's a good question. Thank you for bringing it up. I’d like to briefly discuss Aspen, which was mentioned in my earlier statement. We have made a significant investment in the infrastructure on top of AWS to enhance our ability to run multiple instances of Guidewire more efficiently across our services. While it may not fully fit the definition of multi-tenancy, it incorporates some of its benefits. Additionally, the services we launched as part of this release are indeed multi-tenant services. Thus, we can think of it as a mixed model that allows us to provide insurance companies a single instance with a separate database and isolated data, while also delivering services that are extremely efficient for us to manage, update, and enhance the value they receive from the core service. I am confident that we will ultimately achieve the long-term margins we have projected. The main question is how long it will take us to reach that point. Aspen was a crucial milestone in this process, and I’ll let Jeff add more details on it.

Jeff Cooper, CFO

Yes. The only thing I would add is as – Aspen is a really critical step for the company. And as we inspect our financial models, each one of these steps we take, that path, that visibility to that end state becomes more and more clear. And so now, as we inspect our financial model, we have a number of inputs that we have some history with. We have some meaningful expectations about where they would go and we can start managing the business with that. So it's becoming more and more clear with each one of these new – more cloud native releases that comes out, so that's been a helpful backdrop.

Chris Merwin, Analyst

Thanks so much.

Operator, Operator

Our next questions come from the line of Sterling Auty of JPMorgan. Please proceed with your questions.

Sterling Auty, Analyst

Yeah, thanks. Hi, guys. I was curious in terms of the commentary around elongated sales cycles, obviously, unprecedented environment that we're in. But if you peel back the onion a little bit further, how much of that elongated sales cycle is concerned by the customers around their own internal IT budgets versus just the logistics of negotiating in this environment versus something else?

Mike Rosenbaum, CEO

It's an interesting question. I want to emphasize that we do see real demand for these projects. Under normal circumstances, before COVID, we would have more confidence about how these initiatives would progress. Currently, there's increased hesitation regarding the timing of these decisions and a greater focus on the risks tied to the operating budgets of insurance companies, leading to thorough reassessments of our assumptions. In a typical environment, this level of scrutiny wouldn't occur. However, I am hopeful that as the economy begins to recover and macroeconomic certainty improves, we will see an uptick in activity. We are monitoring the situation closely and noticing signs that even longer-term deal cycles are gaining momentum, with customers becoming more open to engagement on what is often a multi-year process. While it's a challenge to navigate, I remain confident in the long-term demand and potential for our business.

Sterling Auty, Analyst

Got it. And then one follow-up. Is there any hindrance to implementations by not being able to get on to customer presence in the current environment?

Mike Rosenbaum, CEO

That's a great question, and I'll be straightforward. Our biggest concern when this began in early March was whether we could continue to implement projects in this environment, and the clear answer is yes. It's truly impressive what not just Guidewire, but the entire insurance industry, has achieved in transitioning to a work-from-home setting. Upgrades are ongoing, releases are being made, and systems are functioning. Call centers are operating from home, which is a remarkable indicator of the digital transformation in our industry. What initially worried us has shifted to a place where we feel quite confident moving forward. In the long run, I believe this will lead to changes as well. Many are now asking what we can learn from this and whether we need to be on-site as much as we used to. We have an opportunity to find new ways to improve efficiency and effectiveness in our projects going forward, and I see that as a positive development.

Sterling Auty, Analyst

Thanks, guys.

Mike Rosenbaum, CEO

Thank you.

Operator, Operator

Thank you. Our next questions come from the line of Tom Roderick of Stifel. Please proceed with your questions.

Tom Roderick, Analyst

Hi guys. Thanks for taking my questions. Appreciate it. I guess I'll kind of piggyback on Sterling's question there. Mike, I'd love to hear a little bit more just in terms of the cadence of conversations. We've heard this time and time again from companies throughout software with big transformational deals. They just hit the pause button in the spring. So, I think we all understand that. Understanding that it's a little bit of a race against the clock with your fiscal year, I'd love to just sort of hear how these conversations with your Tier 1s and your potential cloud deals are shaping up with respect to giving you visibility going into the fourth quarter. And then naturally, some of those will push out a little further. And again, we all understand that. But with respect to the idea of a fiscal year sort of ending, does that kind of put a pause on that sales cycle or do you sense the urgency as you reengage with these Tier 1s and cloud customers that say it doesn't really matter in July or August or whatever. They're ready to do it when the budget is available. Can you kind of take us through the cadence of your conversations at C level?

Mike Rosenbaum, CEO

Certainly. I am considering what else to add. The opportunities are still present. In reviewing our pipeline for Q4, we have seen a deal postponed and are observing additional factors influencing these decisions. My viewpoint is to ensure that our customers have all the necessary information to make informed choices. There’s considerable complexity they are navigating due to the challenges posed by COVID and how it affects their businesses and economic forecasts. As conditions improve, it appears we will be able to finalize these deals. However, we have experienced some delays. I believe Guidewire is positioned as a long-term player, and we’re focusing on a vision that spans five to ten years, aiming to build a system that serves the entire industry and our customer base. Although I do not wish to diminish the situation regarding the COVID-19 pandemic, I believe we will overcome it. The industry shows significant resilience, and the demand for our core systems, along with their modernization, remains strong. Whether these deals close in Q4 or get pushed to Q1 of the next fiscal year, we will strive to encourage completion in Q4, but we are aware of the overall demand landscape and maintain confidence in our company's operations. Regarding your inquiry into how customers are approaching these decisions, it’s clear that everyone is taking great care to consider all implications before proceeding, which is slightly lengthening the sales cycles. We are navigating through it, and as circumstances improve, I believe that the demand environment will also enhance.

Tom Roderick, Analyst

Yeah. That's really helpful. Thanks. Jeff, a quick follow-up for you. We've heard from, again, a number of software companies with customers kind of pushing back on payment terms, and you're not exactly in the most troubled of industries with customers that can't pay or have to push out payment terms, but any issues that we should sort of be aware of in terms of payment deferrals or customers asking for concessions at this point?

Jeff Cooper, CFO

It really hasn't been material. A couple of our smaller insurers have asked for some concessions, but we haven't seen anything material on that front.

Tom Roderick, Analyst

Fantastic. Thank you both. Appreciate it.

Jeff Cooper, CFO

Thanks a lot.

Operator, Operator

Thank you. Our next questions come from the line of Ken Wong of Guggenheim Securities. Please proceed with your question.

Ken Wong, Analyst

Great. Thanks for taking my questions. The first one for you, Mike. When thinking about the slight pushouts, the delays, just wondering if you're seeing anything different in regards to a cloud transaction versus a traditional on-premise? Is there any – is one longer than the other? Are they both seeing similar type delays from customers?

Mike Rosenbaum, CEO

Yeah. I'm trying to think if there is like a distinction. I would say, no. The biggest thing you guys got to keep in mind with respect to cloud transactions for us is when they are an existing customer, what we're working through with that customer is the timing around an upgrade, a timing around work related to making sure that that implementation is ready to be run on the Guidewire Cloud. And the timing and how exactly we – they budget for that expense is really more of the issue than anything specifically COVID or non-COVID. I think about the business being a lot of the distinction between the upgrade of our installed base to the Guidewire Cloud and the benefits that we're able to achieve from adding functionality and capabilities around digital transformation and agility with a product release like Aspen, and it's slightly different for a customer that's going from a legacy system and going directly to a modern system. It's those kinds of – each one of those scenarios has unique dynamics. And so, I don't think there's a distinction between those two things as it relates to COVID-related uncertainty. I just think, like I said, these insurance companies are just by nature and by design very careful and very thoughtful about the way they approach these decisions. And these systems decisions are incredibly strategic and important for them. And so it's – this situation is just going to create a little bit of extra work for us all in working through it, and that creates a little bit more uncertainty than in the normal quarter about our ability to project what closes and doesn't close. But I'm very, very confident that we'll get through this.

Ken Wong, Analyst

Got it. Got it. And then, Jeff, one for you. I guess, I was a little surprised to see you guys had sort of a nice surge from multi-year activity driving term, I guess how should we think about customer appetite for longer duration deals going forward? Is that a trend you continue to expect to persist into 4Q and perhaps beyond?

Jeff Cooper, CFO

Yeah. Yeah. I mean, we've always had customer appetite for signing longer-term deals. And as you know, as we migrated into ASC 606, we put that limiter on our customers in order to try and preserve a revenue recognition pattern. Our view now is that we have ARR as a metric that normalizes through a lot of that complexity. We can do the right thing by Guidewire and the customer and start considering some of these longer-term arrangements again. So we are expecting to see some more of them. Our standard 2 plus 1 framework still is our kind of standard contract framework that we are engaging with customers, but my expectation is you may see more of these. It only really impacts the revenue on the on-prem term license deals.

Ken Wong, Analyst

Got it. Thanks a lot guys.

Jeff Cooper, CFO

Thank you.

Operator, Operator

Our next questions come from Bhavan Suri of William Blair. Please proceed with your question.

Bhavan Suri, Analyst

Hey guys, thanks for taking my question. And to piggyback on Tom’s third question, but it was a different twist. So hopefully not beating this dead horse here. But Tom, we talked about the slowing sales cycle but I'd like to set that a little bit and think about RFP. So talking to some of your bigger partners say, some of the big 4, they've seen an uptick in RFPs, which, again that could be 6 months out, 8 months out. So let's think of that multiyear sort of engagement with the customer. Has that – how those RFPs trickle down to you? Are you seeing an uptick in RFPs and request for proposals across your customers? And then a quick follow-up.

Mike Rosenbaum, CEO

Short answer is no. I would say, it's pretty aligned to the normal – our normal demand cycle. Like I said before, I think that there's 2 levels around which people think about these digital transformation projects because we might think, what can we do sort of immediately and sort of maybe a quicker approach. Guidewire's approach is really to address the issue from a core system perspective. And to be honest with you, the first phase of COVID, we saw a drop-off in that activity. That has started to pick up and get back to normal. But I wouldn't say that we've seen an uptick in RFP activity for core system modernization. But we – like I said, it hasn't changed dramatically one way or the other.

Jeff Cooper, CFO

Just one thing that I would add, and Mike referenced this in his script was just the activity we've seen in our partner community around getting cloud certifications, and we've seen a really interesting tick up there, which is, I think, an exciting leading indicator and may correlate to some of the reference checks you're doing.

Bhavan Suri, Analyst

Yes. Now either it's interesting the RFP affinity from like some of the big 4 was picking up. And again, maybe hasn't trickled down to you yet because it's early, they're going to start filling that up, but that seems interesting, but those are taken out over multiple quarters. I guess a quick follow-up, slightly more longer-term here. Obviously on the consumer side, this disruption and the digital transformation been critical to consumers want responses real-time and the legacy systems aren't doing it. And you think about the SMB business. And today, it's still very much agent based. You guys sort of disrupted obviously, the consumer business, but given the fact that with COVID, with all of this, no one really wants to go see someone, has the agent-based model, are you having more conversations on the business side of the insurance world to say, hey, we need to revamp some of the systems to make more real time or COG enabled? Have you seen any traction or interest or discussions on that side at all, given that model is still heavily agent-based in many cases?

Mike Rosenbaum, CEO

Yes, that's a great question. I would say this isn't necessarily related to COVID, but I have had numerous discussions about the relationship and value chain involved in how insurance for small businesses is sold, produced, and managed. There is a clear opportunity to enhance the efficiency of that value chain. Guidewire can play a significant role for carriers in addressing this. This type of conversation is quite common with our customers on the demand side, so it's an insightful point.

Bhavan Suri, Analyst

Helpful. Thank you, guys. Appreciate. Thanks for taking my question.

Operator, Operator

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

Michael Turrin, Analyst

Great. Thanks. Good afternoon. I just want to look at some of the recurring metrics. Subscription revenue remained strong, grew more than 100%, but the ARR target for the year coming back a bit. I mean, it sounds like most of that change just comes down to Q4 in the current environment. Is that right? And then on the ramped ARR comment, are you saying as some of that new business potentially elongates here that next year, you wouldn't expect to see a similar shape or step-up as compared to what you're seeing this year? Is that the right way to capture that?

Mike Rosenbaum, CEO

Yeah. So absolutely, our adjustment to our ARR outlook is reflective of just the difficult selling environment in Q4, and that's a context there. With respect to fully ramped, fully ramped ARR is a concept that will be a pretty potentially volatile metric, and it correlates to large cloud deal activity with significant ramps. And we just saw a lot of that in Q4 of last year. And as we were moving into this year, our expectation was that that trend would continue. It's a little bit more challenging environment this year that has caused for a difficult compare in Q4, in particular. And so we just wanted to highlight that for investors.

Michael Turrin, Analyst

Okay. That makes sense. And then maybe just sticking with you, Jeff, on margin. Can you just expand on some of the key sources of margin upside here, is there any way for us to think about how much of that is related to the new environment? I know you mentioned some cost offsets related to just the initial work-from-home phase. But I guess, I'm wondering if margins are troughing here or if there's some temporary changes in the model just given the way the work’s being done is changing that we should just be aware of in thinking about forecast here?

Jeff Cooper, CFO

We are continuing to invest in our platform, which we believe will be the foundation for our monetization efforts over the next 10 to 20 years. We are currently navigating a complex transition, and the current environment is affecting some of our short-term expenses, including travel and other minor costs. The key point is that we are still investing. We are at the core of this business model transition, which is when the impacts on margins are most significant. We will provide updates as we conclude Q4 regarding our expectations for the next year. At this time, we cannot confirm whether this year or next year will mark the low point for our operating margins, but that is our perspective.

Michael Turrin, Analyst

Okay. Appreciate the color. Thanks.

Jeff Cooper, CFO

Thank you.

Operator, Operator

Our next questions come from the line of Matt VanVliet of BTIG. Please proceed with your questions.

Matt VanVliet, Analyst

Hi, everyone. I appreciate you taking my question. Looking at the business activity throughout the quarter and in the first month of the current quarter, I'm interested in whether you're experiencing an increase in business activity, particularly in Asia or in European markets that seem to be reopening more quickly than the U.S. at this time. Could you share your observations regarding the timeline in these major regions, especially considering the delayed impact of COVID in those areas?

Mike Rosenbaum, CEO

Yes, it's an interesting question. I would say that I haven't seen any real relationship with the timing of economies opening up. I don't know whether or not that has to do with the dynamics of our insurance customers, but I haven't noticed a pattern with respect to that. If anything, I'm thinking about how it relates to our travel and our ability to work, and how it impacts our multinational operations rather than a change in the demand environment for our products. However, we are functioning so effectively in this current environment that it's not something we're particularly concerned about. So, the short answer is no. I haven't seen anything related to how this is evolving regionally. I don't know, Jeff, if you have anything to add.

Jeff Cooper, CFO

No, I mean, obviously, our sales cycles are so long that these decisions take a significant amount of time. So, I think it's harder for us to maybe see some of those shorter term geographic macro impacts than others.

Matt VanVliet, Analyst

Great. Thanks. As a follow-up, Jeff, I'm curious about the long-term investments in the cloud. Are you seeing any cost savings from reduced travel or the longer-term effects of remote work and the tools you've been using to lower costs? How are you planning to allocate those resources as you look ahead to next year?

Jeff Cooper, CFO

No, there are opportunities that we're currently evaluating in depth as part of our planning for next year. This has led to some interesting outcomes and insights regarding our efficiency that we will incorporate into our strategy. I want to emphasize that we are not viewing this as a chance to cut back or reconsider our cost structure simply because we are in the early stages of what we believe to be a significant shift in the industry. We are not slowing down or easing our efforts; there are indeed opportunities in some of the areas you mentioned.

Matt VanVliet, Analyst

Understood. Great. Thank you.

Mike Rosenbaum, CEO

Thank you.

Operator, Operator

Our next questions come from Mayank Tandon of Needham. Please proceed with your questions.

Kyle Peterson, Analyst

Good afternoon, everyone. This is Kyle Peterson speaking on behalf of Mayank. I appreciate the opportunity to ask a question. I'd like to get your thoughts on the recent media coverage regarding property and casualty carriers issuing policy rebates to customers and the effects of reduced driving in a more remote environment. Has this influenced your discussions about increased interest in subscription-based cloud services or any potential shifts in IT budgets? I'm interested in understanding how the impacts on the P&C industry are affecting your conversations, particularly if some sales cycles are experiencing delays.

Mike Rosenbaum, CEO

Yeah. So, this was one of the real early things that we recognized and our customers recognized once these lockdowns got turned on worldwide, was this dramatic drop in the amount of miles driven, claims volume, et cetera. And the insurance industry, in my opinion, has done something phenomenal in these rebates and premium reductions to align to that just as effectively a stimulus that the insurance industry has provided to these people who are, in many cases, need those funds a lot. I really see that as a one-time event, and I think that they're looking at it like that, that we're going to get back to a normal state eventually. And so, in terms of the recurring nature of projects and software IT projects, I haven't seen anybody think about that structurally. I would say, there's a lot of discussion about whether or not this pushes the industry more towards pay-per-mile utilization-based insurance. We've got a great Guidewire customer example of somebody who's using PolicyCenter to do that. With the modern system, you can execute projects like that, and it's really interesting and there's been a lot of discussion about whether or not, that's something that structurally changes has now come from this. But as it relates to IT budgets and projects, the answer is no.

Kyle Peterson, Analyst

That's helpful. I have a quick follow-up on margin cash flow. Can you share your thoughts on how to balance protecting profitability and cash flow with long-term investments for the cloud, especially if sales cycles continue to be prolonged or if we experience a second wave? I’d like to understand how you are considering the balance between near-term impacts and long-term investments.

Mike Rosenbaum, CEO

It's a great question, and we’re currently having an active discussion about it internally. We are very excited about the opportunity to expand our total addressable market and strengthen our leading position in the industry. Our focus is on properly investing in our product and cloud operations to prepare for what we anticipate will be a significant wave of cloud migrations in the future. As we review our performance and bookings over specific periods, we may make adjustments, but we are committed to keeping our focus on the long term.

Kyle Peterson, Analyst

All right. Great. That’s helpful. Thanks guys.

Mike Rosenbaum, CEO

Thanks very much.

Operator, Operator

Our next questions come from the line of Rishi Jaluria with D.A. Davidson. Please proceed with your questions.

Rishi Jaluria, Analyst

Hey, Mike and Jeff, thanks for answering my questions. Jeff, congratulations on your full-time promotion, it's truly well deserved. To start, I have an industry-related question. It's clear that property and casualty insurance is holding up better than many other sectors that are facing challenges. I’m curious about the budget aspect, given that interest rates are at an historic low and appear to be stable. Is this putting any pressure on budgets, or is it not really a topic in your discussions? I also have a quick follow-up.

Mike Rosenbaum, CEO

The short answer is that this isn't a topic that frequently arises. However, various factors are influencing each insurance company. This complexity likely plays a role in their decision-making regarding investments in green light projects with us. They are contending with savings, higher expenses, different risks, and a range of other considerations across various regions and business lines. This complexity shapes their ability to determine the right timing for starting a project. While we do consider interest rate dynamics, it is not the primary focus of our discussions. There are numerous other factors also at work.

Rishi Jaluria, Analyst

That's helpful. And then just quickly, with Guidewire connections going virtual, how are you thinking about the potential impact on pipeline building, on customer networking, on the partner side? Just want to get a sense for what you're thinking about that? Thanks.

Mike Rosenbaum, CEO

It's a really important event for us, and I find it disappointing that we won't be able to attend in person. I look forward to returning to these events and engaging in enterprise sales as soon as it's safe. However, I have been very impressed by the creativity our teams have shown in creating new digital content and connecting with customers. It's also much easier for me to conduct phone calls with customers now. A 30-minute call with a customer or prospect is significantly simpler in this environment, and I hope this trend continues. People seem more willing to take a few minutes to watch a video or read the collateral we've shared about our latest release. I had two conversations this week where customers mentioned they watched the video we sent and enjoyed it. This gives me confidence in our ability to leverage digital methods to replace some of what we miss from in-person interactions.

Rishi Jaluria, Analyst

All right, really helpful. Thank you so much.

Operator, Operator

Our next question come from the line of Pat Walravens of JMP Securities. Please proceed with your question.

Joe Marincek, Analyst

This is Joe, on for Pat. Thank you for taking the question. Can you just give us a quick update on the competitive landscape and any changes that you're seeing there?

Mike Rosenbaum, CEO

Thanks for the question. Short answer is, we haven't seen any change in the competitive landscape. We've talked about this before. It remains a competitive market, but the dynamics as we see it, in terms of win rates and competitive deals haven't really changed. It remains pretty steady.

Operator, Operator

We have no further questions at this time. I'll now turn the call back over to Mike Rosenbaum for any closing comments.

Mike Rosenbaum, CEO

All right. Thanks all for participating in the call today. We delivered solid quarter during a very dynamic macro environment. Despite the near-term challenge, we're all excited about the demand we see in technology and advancement of our cloud strategy. We're as optimistic as ever about the long-term vision and the opportunity that we see in front of us, and I hope you're all safe and well, and look forward to connecting again in Q4, so thanks very much and goodbye, everybody.

Operator, Operator

This does conclude tonight's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great evening.