Guidewire Software, Inc. (NYSE:GWRE) Q1 2021 Results Earnings Conference Call December 8, 2020 5:00 PM ET
Alex Hughes – Vice President, Investor Relations
Mike Rosenbaum – Chief Executive Officer
Jeff Cooper – Chief Financial Officer
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Conference Call Participants
Sterling Auty – JP Morgan
Bhavan Suri – William Blair
Chris Merwin – Goldman Sachs
Matt VanVliet – BTIG
Rishi Jaluria – D.A. Davidson
Ken Wong – Guggenheim Securities
Tom Roderick – Stifel
Brad Sills – Bank of America
Joe Vruwink – Baird
Michael Turrin – Wells Fargo Securities
Ji Cheong – Citi
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. [Operator Instructions]
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 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 jointing us today. We are all very excited with our start to the fiscal year and feel great about the momentum we have established in our business. Q1 is typically acquired 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 insurer’s trusts 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 a number of 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 API’s 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 a number of partner apps for InsuranceNow customers and it’s 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 claim 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 realize that to grow efficiently they needed analytics capabilities that are integrated with their core platform and with Guidewire achieved double-digit improvements in their last 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.
And 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 position 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 went 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 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 Guidewire Cloud Platform via Aspen with a Greenfield deployment that is part of a much larger Guidewire Cloud modernization. And 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 cloud. In addition, Buckle Insurance, a startup ensure offering policies specifically built for rideshare drivers adopted Guidewire ClaimCenter.
Notable expansions in the quarter include a Tier 1 specialty insurer broadening its use a 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, seeing 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, who has developed a smartphone app, which actually accurately produces 3D exterior property models and is used to dramatically improved the homeowners claim experience and Denver based Flyreel, who 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 in our growth.
In addition, for the sixth time in a row, Gartner has named InsuranceSuite as 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 a key to this.
By combining the deep end-to-end capability 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. Jeff?
Thanks, Mike. We were pleased with our first quarter financial performance, ARR, total revenue, operating — and 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 we’re 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 projects 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 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 margin.
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.
Operator, you may now open the call for questions.
Thank you. [Operator Instructions] 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?
Yeah. It’s a good question. So and I’m glad you asked that because — as I have been thinking about what’s the most important thing that we can be doing as a company in order to accelerate sales and accelerate adoption in the cloud. It’s really just getting these customer go lives, these proof points established. And the quarter are — the first quarter was a very, very important milestone for us, because we now have live production customers on the Guidewire Cloud Platform, as I mentioned.
The project with USAA is going very well and I would encourage you to take a look at the Connections materials that we were able to publish post the event where you can — there’s a couple of those that just haven’t really, really positive comments about the partnership and the momentum that we’ve been able to establish there.
Getting to your specific question, what we’ve seen so far with Guidewire Cloud Platform and it’s sort of testament to how flexible and agile you can be with the system. Are that new lines have gone live, right? So the production implementations are new lines. The next thing to expect is that some of our existing cloud customers will be making the jump over to the Guidewire Cloud Platform and that sort of ski resort based approach to the to the actual version number.
And that will be where you should expect the first sort of major existing book of business sort of implementations going live on that platform. I expect those will be coming in the next couple months or quarters and we’ll continue to build on the proof points, we need 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?
Well, so there’s a variety of compelling events associated with particular version of Java, customers running particular database versions, the customers running Version 8. All of those events, I would say, you should think about occurring over the course of, say, this year, maybe a year and a half.
And I also want to stress that, we work — these project decisions, very complicated for customers and we work with them to structure the upgrade around what makes the most sense for them. But all of those sort of compelling events are taking place over the next year, year and a half.
In terms of, we called out in this — in the prepared remarks, the vast majority of our customers being on Version 8, Version 9 or Version 10. I don’t have off the top of my head the exact percentage that is Version 8. But we’re — you should model greater than 50% of our customer base falls into that category.
And so our ability to sequence the proof points associated with live customers on Guidewire Cloud Platform with the compelling events associated with these version upgrades and these core infrastructure upgrades, I think, is really important for us, like I said, in order to be able to accelerate cloud adoption in the customer base.
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 comforts, 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 to 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?
Yeah. I’ll take the first half of the question and I’ll let Jeff comments on the gross margin question. I don’t think of it as exactly a count of customers. When I look at the our existing cloud customer base, I think we have — especially when you consider USAA, we have enough of a large Tier 1, Tier 2, Tier 3, sort of customer base in order to effectively prove out the system, such that we can prove to our customer base that this is vetted and this is reliable and this is something that they can trust.
And so that, unfortunately, I think, just turns into a series of project timelines associated with go lives and upgrades, and establishing those proof points and we are well on our way towards achieving the sort of critical mass that’s necessary to convince everyone that this is something that they can trust, right?
So we have the spectrum of customers and now it’s just a question of executing on those projects. And that’s why I was so excited about the milestones that we’ve been able to achieve in the last six months, announcing that we’re…
… going to ship Guidewire Cloud Platform, delivering Aspen, announcing that we were going to go to this six-month cycle and then delivering Banff and then getting the customers live on Guidewire Cloud Platform, that is just so important.
And so if you can imagine the way I’m operating the company, we’re just looking at a pipeline of project activity that is all sort of sequence and will all result in more and more Guidewire Cloud Platform cloud customers and that kind of leading to Jeff is what drives the improvement in the margin, right, that the more customers we have shifted over the more cloud customers, we have shifted over to this new approach to more efficiently delivering the cloud and delivering these upgrades, the more of the margin improvements are going to kick in. So, Jeff, anything do you want to add on the margin side?
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 operation 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 that Analysts Day, with respect 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 will say that there’s been any delays or anything like that. I mean, well, I wouldn’t say, like, excuse me, I want to be clear that — I wouldn’t say, that there’s any hesitation.
COVID doesn’t help us, as I was talking to our Head of Sales the other day. We’re working through it and we’re making it work. And we’ve been able to sell deals, which is a testament to all the hard work that goes on in our sales organization and on our customer sites to get these projects sort of coordinated and kicked off and get these deals completed.
But you got to imagine, this is a very, very complex enterprise sale and typically we would be on site with customers for big workshops and large meetings. And that — getting back into that sort of approach to coordinating these multiyear efforts is something we’re very much looking forward to, as we think about the light at the end of the COVID tunnel. But, I wouldn’t say that there’s any hesitation at all about our ability to execute. That’s not what’s behind that change.
Yeah. And to be — in the COVID and I want to be clear, the COVID commentary related to services is more on the year-over-year compare, as we look kind of the — 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, our willingness to invest a bit and helping our customers overcome what is a common objection to go 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. Here is one of the things I highlighted in the keynote at Connections. We have three customers live on Guidewire Cloud Platform right now in production and like I couldn’t be happier with that milestone and achieving that objective in the first quarter, because like I keep saying, that’s what is going to drive the confidence in the approach going forward and that’s what’s — that confidence is what sort of unlocks, I’d say, our ability to sell this more effectively.
And in terms of the work necessary, I think, you mentioned v9. It’s not exactly the way I think about it, right? What most — for the most part, what we’re doing is we’re making — we’re taking customers from v10 to the Guidewire Cloud Platform and Aspen, and now Banff. And whatever the latest version of the of the ski resort release is at the time that it makes sense to move them to that version of the product.
The — that’s obviously one of the things that we’re paying close attention to is what did that effort. I would say that it’s gone very, very well in terms of measuring that effort and estimating the complexity of the — of slotting that into the customer projects and such that it gives us a lot of confidence that we’re going to be able to continue this pace going forward.
And so, outside of like, providing some sort of objective measure of that expense, who was — it was sort of less than we thought it would be and very much in line with our hopes for how easy — easily we could make that transition. So that is going very, very well.
Great. And then maybe just for — I think you mentioned CloudDirect was part of the Banff release. Are you able to talk — give a little bit more detail about how you’re able to reduce these costs for customers looking to migrate to the cloud? What’s been done differently? Yeah, again, any way to quantify the savings just as we think about that being added incentive or something that can facilitate these migrations? Thanks.
Well, sure, I mean, in the past, we were saying that this was really a two-step process that customers needed to upgrade to Version 10 of InsuranceSuite product, and then subsequently, we would upgrade them to Guidewire Cloud. And after working through all of the details of the hundreds and hundreds of project steps associated with that program, we were, like, we were able to define a way to do it in one step, right?
And that makes it faster, it makes it easier, I think, really, more importantly, it makes it less complicated in terms of sequencing the various teams associated with checking the various steps and the overall complexity of a project. It’s just a less complicated undertaking for a customer to think about.
And I think more importantly, for me and for you, it makes it such that the customer can think about that step as one thing, right, because, I think, when I started at the company a little over a year ago, effectively we’re telling everybody in the customer base to think about just getting to Version 10 of InsuranceSuite and then subsequent to that, we would have a conversation about, okay, now you’re ready to move to the Cloud.
But now, because we can do this in one direct step, we can go out to the Version 8, the Version 9 and the Version 10 customers obviously and just talk about what the project looks like to get them directly to the cloud.
And that’s a really positive message. Like I said, just to the customers in terms of reducing the complexity and the time necessary, but it also creates a better — it just creates a better dynamic for us to be having the conversation about cloud in the first place.
Great. Thanks so much.
Thank you. Our next question comes from Matt VanVliet with BTIG. Please proceed with your question.
Guys, thanks for taking the question. Maybe building on the last one, I think, the customer example, you mentioned on the call earlier, about CloudDirect was someone buying and going live in four months on PolicyCenter and BillingCenter. Maybe just help us out thinking about kind of how typical that could be, what — maybe what that specific situation might have looked like under the typical InsuranceSuite realm and how that’s changing with CloudDirect and maybe what from an absolute timeframe, this could speed up additional customers moving forward?
Yeah. Thanks for the question. So I think you’re touching on — your question touches on something that’s important to understand about the market opportunity and Guidewire and Guidewire Cloud in general.
These initial implementations on Guidewire Cloud have been net new lines of business for customers. There’s one of the things I was talking about in terms of understanding the insurance business dynamic that’s driving a lot of this activity and the potential delivering value to our customer base.
So these insurance companies they want to grow or they want to bring new insurance products to market. They want to expand with existing products to new geographies. When they want to bring a new product to market, they’re seeing Guidewire Cloud as a mechanism to do that quickly. They’re seeing that in instantiating that a new insurance product on a Guidewire Cloud PolicyCenter, BillingCenter, ClaimCenter instance, is the fastest way to get that product to market.
And then that approach — that project that we can complete, like I said, in just four months, that’s very different than taking an existing system, an existing book of business, that in many cases has been running for decades and transitioning that over to a new instance. The project necessary to make sure that Guidewire is configured such that it can receive all of that existing book of business and the various complexities associated with the premiums and the customers and the claims that are running on that legacy system, that’s a much, much more complicated project.
That has to do with — we can — you could have the best possible core system in the world, which we do, but it still requires a degree of study and testing, and planning, that is very complicated, and that’s what is behind these multiyear projects that we talk so much about. So we have many of — we have done, as I said, 1000s of these implementations in our history. But we have — that is not something that you can do in four months.
That is something that we do with our customers based on the schedules associated with their business and how fast they want to run those projects and our job there is to provide a cloud infrastructure and a cloud product that’s capable of handling the scale and complexity of those types of implementations.
But it’s definitely something that we’re seeing in our customer base and in the market is that there is more and more interest in these new innovative lines and getting those lines up and running quickly and doing it on the same platform that you can run the whole book of business at your — at a P&C enterprise on. Does that make sense?
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 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 in, I guess, 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?
Yeah. I’ll answer the second part first. So, competitive dynamic hasn’t changed. We’ve touched on it in previous quarterly calls. We have not seen the competitive dynamic change at all. Q1 was no exception to that.
With respect to insurtech, I think, what we’re seeing is that it — the — especially the CIOs who are responsible for integrating these systems into their existing enterprise. They — it is much, much more logical for them to do this on a platform that is going to end up being the same platform, that is running their overall book of business. I don’t have a visual for you guys, because we haven’t opened up these calls yet on Zoom.
But the architecture diagrams that our customers operate with Guidewire in the center are very, very complicated. And so a policy system is not implemented as a satellite in an enterprise architecture. It’s right there in the middle of the enterprise architecture and it’s connected to almost any other system that you can think of.
There’s some — there’s 50, sometimes 100 integration points necessary to execute on a policy and a billing and a claim system implementation. And so when you think about it, what you really want is a platform that’s capable of providing the fast agile innovation on the product side, but at the same time can support all the robustness you need for your core book of business and being able to do that on one platform from Guidewire is a real, real selling point of our solution.
And so this is why when people say insurtechs, I actually — I don’t see insurtech as a potential vector of competition. I see it mostly as a positive. I see these companies coming up with mobile solutions, like the couple that I talked about previously in the prepared remarks that are just going to enhance the value that our customers are going to be able to get out of running Guidewire.
Not so much that they’re there to — that they’re thinking about or capable of competing with us from a core system perspective, but just that they want to help augment the value that we’re providing as their core system provider.
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 a 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.
Yeah. And I — look, I think, as we’ve noted in the past, that this is largely the big investment we’re seeing on the cloud operation side, as we start to see the newer releases and gain efficiencies out of the kind of headcount driven impacts to margins that we’re seeing now, that starts to have a more meaningful impact, but it’s not going to have an impact in this year. So this is very much in line with how we kind of were thinking about it and talking about things at Analyst Day.
The one — there are a variety of things that go into this. But the one kind of more technical component that we’ve talked a bit about in the past is, is a lot of our early cloud deals are large cloud migration deals, where we end up allocating a portion of the overall total contract value to term license and away from subscription revenue.
And so, we think about those as — those are all — we’re making big investments in those customers as cloud customers and that does have an impact on the kind of margin profile for those customers as we work through the initial term of the contract and then once it renews, there will no longer be that allocation towards term license, and as you know, they have to kind of use both systems as they work through that migration period.
That has a small — that does have an impact. We talked about I think 3 percentage points last quarter and that’s going to continue to have an impact as we’re migrating customers. But the big impact here is, is really that an investment that we’re making throughout this year that we expect to leverage for all of our customers going forward in the cloud operations function.
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.
Yeah. Thanks for the question. And I completely agree. I kind of never want to be selling cloud for cloud sake. I want to be selling cloud because it accelerates initiatives that our customers and makes them more successful. And I think data and analytics is part of the conversation whenever I talk to any customer about their technology initiatives going forward.
And I think what we have delivered now with the Guidewire Cloud Data Platform is very, very unique. That — if you think about on day one, a customer in production has access to every transaction that is flowing through Guidewire in a very modern Data Platform and the use cases for that are vast and the opportunities, like we say, to sort of improve the way that you’re making decisions at every step of an insurance like lifecycle are very real.
I think the other side of that is that we also think that Guidewire will be deployed with digital in every single circumstance, that there isn’t going to be an implementation to Guidewire that doesn’t have a consumer facing or agent facing digital interface. And so that being built into the cloud product just makes the overall value prop of a Guidewire InsuranceSuite implementation much stronger.
And I think we’ve given — we’re — you’re hearing from us how excited we are about that. But I think it’s going to start to really kick in as customers start to think about and talk about the value that they’re deriving from the transition to cloud, because it’s much, much more than just where the software runs and who upgrades it.
But it’s the key capabilities that we’re able to deliver, because it’s a cloud service, because it’s a cloud service we’re running. We can run that cloud data platform and we can give them access to that data and that’s a key value proposition.
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 and 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 help you understand kind of 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 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 process, 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?
Hey, Tom. Thanks for the question. Yeah. It’s — I think it’s really exciting that we are part of these growth initiatives for these companies. And those growth initiatives, I think, you should carter — you should think about them and like sort of one or two ways.
One is, we’re going to create a better digital interface, a better smoother mechanism for agents or for consumers to quote — get insurance quoted to actually complete transactions. That’s a phenomenal driver for Guidewire projects.
The other side of it is just bringing completely new products to market through completely new channels. There’s a very significant amount of conversations I have with customers that are looking to experiment with new channels to bring innovative products to market and you just need flexible IT systems in order to be able to do that.
Or I would — I should say, in order to be able to do that quickly and effectively and cheaply enough to be able to do the types of experiments that are sort of necessary to validate that a channel or a product is viable.
One of the things that I think a lot about, just because — just as an approach to building software is that, you want to sort of get the cost to try something as low as you possibly can, because that gives you an ability to try more things and because you never know that you’re going to get it right or that the channel you pick or the product that you pick or the unique set of circumstances that you choose are going to work and so you want to get that cost to try down as much as you possibly can, because that gives you an ability to try more things, experiment more and find the thing that’s going to actually work.
So to the extent that Guidewire Cloud can be a partner with these insurers in bringing these new products to market quickly and quickly enough to have meaningful impact on their business. That’s an — that’s a really, really exciting proof point for us.
One of the quotes that I saw sort of floated around the company was one of the executives at one of our customers just said, this is the new way that we launch products at our company is through this approach.
And look, I — there — the fact that you can do this with a platform as robust and proven as Guidewire is really, really important. Because they — these companies don’t want a sort of Frankenstein approach to all of these different systems, because they all ultimately has to be integrated back into the financial systems and the reporting systems and the analytics systems and the on and on and on, list goes on and on.
And if they’re doing that all that work anyway for their legacy modernization with Guidewire, for us to be able to bring something to market that enables them to do that quickly. It’s a phenomenal value proposition, something I’m really excited about. So, yeah, I don’t know, hopefully, that helps you give you a little more flavor as to what we’re seeing in the conversations we’re 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?
Sure. And I’d be remiss not to say that how proud I am of everybody in our product development organization for being able to pull it off. I think it’s one thing to say, hey, we have an intention to do a six-month release cycle. It’s a completely different thing to actually do it with Aspen and then follow it up six months later with Banff. And as one customer told me at Connections, you did it in the middle of a pandemic. And that is truly remarkable.
That — and the feedback had been very positive. I think most people think, your first glance, you think of Guidewire is hard to upgrade. So if we provide a release every six months, does that mean that it’s going to be hard to –is it more difficult to take these releases.
What actually ends up happening is the releases are easier to take. Because our mindset about what we’re putting into these new innovations, new characteristics of the solution, take into account the fact that we have the customers running on Aspen. And so Banff becomes easier to take than it otherwise would, had we waited for two years.
And so the initial feedback is mostly based off of this the transition from cloud to Aspen, and that’s been very positive. Those projects have gone very well. Those upgrade projects resulted in, like I said before, three customers going live on Aspen is a very, very positive sign.
And we just released Banff. So we’re right in the very, very early stages of getting that release out to customers and getting that worked into the projects and we’ll have an update for you on the next quarterly call. But the whole system is really coming together in a very positive way for us. That’s really truly exciting.
Really helpful. Thank you, Mike. Appreciate it.
Thanks very much.
Thank you. Our next question comes from Brad Sills with Bank of America. Please proceed with your question.
Oh! Great. Hey, guys. Thanks for taking my question. I just wanted to ask about the higher outlook on term license. What are you hearing from customers with regard to their plans for kind of running their roadmap with Guidewire along — for term license on-prem, alongside their plans to migrate to the cloud? You’re obviously seeing traction in both. I think it’s the first time in a while we’ve seen upside in term license. So, I guess, what’s driving that and how are customers — how’s the conversation with customers with regard to maintaining their existing term license on-prem system, while thinking about the longer term move more gradually towards the cloud?
Let me touch on it real quick and see if Jeff has anything to add. For the — I’d say, for the most part, customers are either deciding to make that decision to move to Guidewire Cloud, which would effectively replace their term license with a cloud subscription or they’re looking at these, as I keep talking about in especially on this call these sort of net new lines of business, that they can spin up more quickly as a way to experiment with and get used to the approach necessary to be successful with a cloud implementation.
Always in mind, always keeping in mind that experience and those proof points will help them make the decision about when if it makes sense to move to Guidewire Cloud with 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, guys. And then one more, if I may, at the Analyst Day, you guys mentioned, more investment moving towards — R&D investment moving towards the cloud. Could we see a point where the — there are more features in InsuranceSuite Cloud versus the on-premise solutions and there’s a feature advantage or incentive, if you will, to move more closely, 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. Our next 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 by 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?
Well, yeah, I don’t know, if there’s one thing. It just certainly feels like a combination of shipping and delivering the Guidewire Cloud Platform. These services that support it and then getting customers live with that — with real production use cases that people — that we can point to and customers can reference such that they feel confident that this is a viable alternative for them.
I’ve — again, I’ve said this previously on calls like this, I have had so many conversations with customers that basically summarize as, we understand what you’re doing. We applaud you for doing it. We’re your biggest fans and we want you to succeed and we’re right there with you.
But we’re really conservative organization and we want to see XYZ proof points established in order for us to make this decision for our company. And so, I’m sort of an execution guy and that’s why I think it’s I kind of love this job is because executing on this plan, as I said, sort of deal with a determined and diligent and steady approach is the right thing for our customer base and I think we’re on the right track.
And so, if you forced — if you pinned me down and said, what’s the one thing that really matters? It’s those production proof points. It’s establishing those production proof points that enable us to say to the customer base here, look, here’s the customers that are doing it and that’s starting to happen right now. And Q1 was such an important quarter for us in that regard.
Great. Thank you.
Thank you. Our next 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 your 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 is you hinted on 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. It’s 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 is in early, like towards the end of the year? And then given margin guidance was unchanged, could you kind of help us understand the put 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 over performance 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 were 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 model.
Okay. And the years like you give any expectation for T&E returning actually came with that?
Oh! For T&E returning.
This is — for T&E, there’s a couple different components of T&E. T&E is obviously a big expense within our sales organization and other parts of the organization. We have modeled in that that will return some in this fiscal year. So we do have some of that built into our models.
And then billable T&E with respect to our services organization, traveling to customer site, I believe we have a little bit of that modeled into Q4. But that’s really — there isn’t — that we’re not expecting a lot on that side. I would note that in prior years that billable T&E has been kind of close to $15 million or $16 million. So that is a pretty big shift this year compared to prior years.
Great. Thanks for fitting me in.
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.