Guidewire Software Inc (GWRE) 2016 Q1 法說會逐字稿

Good day, and welcome to the Guidewire first quarter FY16 earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Richard Hart, Chief Financial Officer. Please go ahead, sir.

Good afternoon, and welcome to Guidewire Software's earnings call for the first quarter of FY16, which ended on October 31, 2015. My name is Richard Hart. I am the Chief Financial Officer of Guidewire. And with me on the call is Marcus Ryu, Guidewire's Chief Executive Officer. A complete disclosure of our results can be found in our press release issued today, as well as in our related Form 8-K furnished to the SEC. To access the press release and the financial details therein, please see the Investor Relations section of our website at www.guidewire.com.

As a reminder, today's call is being recorded, and the replay will be available following the conclusion of the call. During today's call, we will make statements related to our business that may be considered forward-looking under Federal Securities Laws. These statements reflect our views only as of today, and should not be reflected upon as representing our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations.

These risks are summarized in the press release that we issued today. For a further discussion of the material risks, and other important factors that could affect our actual results, please refer to our annual report, on Form 10-K, for the period ended July 31, 2015, which is on file with the SEC. Also, during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in our press release, issued after the close of market today. Additionally, we are providing detailed reconciliation data, as well as recurring revenue calculations, in the supplement provided on our IR website at IR.Guidewire.com.

Finally, at times in our prepared comments or responses to your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business and our quarterly results. Please be advised that this additional detail may be one-time in nature, and we may or may not provide an update in the future.

With that, let me turn the call over to Marcus for his prepared remarks, and then I will provide details on our first-quarter results and our outlook for Q2 and FY16.

Thanks, Richard.

We're off to a solid start in FY16, with license revenue above the high end of our guidance range, at $32.3 million, and first-quarter revenue of $82.3 million, at the upper end of our range. Non-GAAP net income of $0.07 per share was also higher than our guidance range. Trailing 12 month term license and maintenance revenue was $225 million, up 15% from a year ago. On our last call, we mentioned that our trailing 12 month metric would fall below 20% in the beginning of FY16 due to the effect of one-time revenue events in Q1 and Q2 of FY15, and recover to 20% by year end. We continue to target term license revenue growth of 20% or higher for the year.

Right after the close of the quarter, we hosted over 1,500 attendees at our 11th annual Connections user conference. One of the major themes that we highlighted at Connections was the increasing importance of digital engagement with policyholders, agents, and vendor partners in an on-demand, mobile and 24x7 world. Our digital and data portfolios fit squarely into these themes, and growing interest in these capabilities was reflected in multiple customer-led sessions describing their place in the property/casualty lifecycle. Our digital portals enable our customers to offer policyholders self-service policy changes, claims tracking and billing, and enable agents to submit new business and service their customers while maintaining their distinctive brand attributes. Native integration to InsuranceSuite of course allows them to leverage all of the critical data and business logic therein, as well as to be implemented and managed far more cost-effectively than custom developing a digital presence from scratch.

The principle of reducing total cost of ownership was another major theme at Connections. Recognizing that implementation duration and direct cost are the primary drivers of TCO, we have embarked on a multi-pronged initiative to accelerate and streamline implementation. Measures include developing better tooling to ease configuration; offering prepackaged configurations, accelerators and templates; pre-integrating essential third-party software; and generally coaching customers on the benefits of project decisiveness and eschewing non-differentiating product configuration.

We're also taking advantage of new deployment models, including Guidewire's InsuranceCloud, for insurers who are ready to deploy in the cloud through our partners. While we still see major opportunities for improvement, and while legacy core system replacement is intrinsically extremely demanding, we were pleased with some proof points of rapid implementation in the recent quarter, in which 7 of 12 product go-lives were completed in under a year.

Sales-wise, we continued winning new customer for InsuranceSuite during the first quarter. We were honored to license our software to our sixth new Tier 1 customer in the past two quarters, MS&AD Group, which is comprised of Mitsui Sumitomo Insurance and Aioi Nissay Dowa Insurance. In one of their first departures from custom development for a major core system, they selected ClaimCenter for all of their commercial and personal lines. Together with Tokyo Marine Group (one of our very first large customers), and Sompo Japan Nipponkoa (which we announced last quarter), we are gratified to serve the three largest Japanese insurers.

We also expanded our geographic reach with AXA Asia selecting ClaimCenter for commercial and personal lines in Hong Kong, India, Indonesia, Malaysia, Singapore and Thailand, all of which represent new countries for Guidewire. AXA Asia builds on our global relationships with AXA, adding to their existing implementations of our products in Belgium, China, France, Germany, Mexico, and Poland.

Here in the US, Island Insurance Group, a PolicyCenter customer, selected BillingCenter in the quarter. And Seibels Bruce Company, a claims administration provider for numerous insurers, selected ClaimCenter to handle the claims processing of their customers writing both personal and commercial lines. Working through BPOs such as Seibels Bruce in the US and FDC in Europe, we are able to leverage their reach to a segment of small insurers that we do not have relationships with directly. Continental Western Insurance Company also selected ClaimCenter for a wide variety of commercial lines, and joins four other subsidiaries of W.R. Berkeley that are deploying Guidewire products.

As I mentioned on last quarter's call, we continue to gain momentum with our digital and data products. In the first quarter, Texas Windstorm Insurance Association selected DataHub, and Texas Fair Plan Association selected both DataHub and InfoCenter. Further, we significantly increased the total number of customers for our digital portals, with new licenses to Tier 1 insurers Direct Line Group, Erie Indemnity, and Nationwide, as well as Island Insurance, SSQ, Wawanesa and Western Reserve Group. Encouragingly, these customers represent a wide cross-section of InsuranceSuite customers of all sizes, across four different continents, signifying the relevance of digital enablement to the global industry.

Indeed, market results and feedback from Connections provides us with clear validation that our "Core-Data-Digital" product strategy aligns with the needs and ambitions of the P&C industry as a whole. To be clear, we still have a lot of software engineering work ahead to fulfill those ambitions. To support these efforts, during the quarter, we opened a new R&D center in Krakow, Poland, and have hired our initial team, which over the next year we expect to include R&D professionals for product management, development and quality assurance.

Finally, in the first quarter, we engaged with our first customer to work on a fully cloud-based deployment of InsuranceSuite, combined with our next generation digital offering, called DEX for now. The scope will be a greenfield effort they wish to launch in the homeowner personal lines business, and we are currently exploring similar arrangements with other early adopter customers in other lines of business. Notably, we expect to have to defer the recognition of any revenue related to these early cloud adopter wins, until we deliver and go-live with their respective deployments.

In summary, we have started FY16 with momentum across multiple fronts. We're encouraged to see customer demand for legacy core system replacement further catalyzed by our customers' data-driven and digital ambitions to compete in a rapidly changing marketplace. Our investments in both our new and existing core products have been fruitful, and we are encouraged by the adoption rates we are seeing for our newer offerings. At the same time, we continue to cultivate the industry's largest systems integrator ecosystem to broaden our reach and deployment capability. We remain optimistic about our prospects, in the years to come, to ultimately earn the mantle of industry standard for the market that we serve.

I will now turn the call back over to Richard, to provide details on our first-quarter financial results and our outlook for Q2 and FY16.

Thank you, Marcus.

We delivered a solid performance in the first quarter, outperforming our licensed revenue and earnings guidance, and coming in near the high end of our total revenue guidance. Total revenue in the quarter was $82.3 million, of which licensed revenue was $32.3 million, above our guidance range of $30 million to $32 million. Within license revenue, term license was $32.7 million for the quarter, an increase of 13% from a year ago. Recall that last year term license revenue benefited by $1.4 million from long-term deferred revenue that had reached recognition milestones. Excluding this impact, term license revenue growth from a year ago would have been closer to 20%.

Perpetual license revenue was negative $0.3 million in the quarter, due to a contractual disagreement relating to the appropriate application of foreign exchange rates with a South American customer to which we licensed our software in the fourth quarter. While this disagreement may ultimately get settled in our favor, we thought it prudent to reserve this amount in question, and not collect it in this quarter.

Maintenance revenue was $14 million for the first quarter, up 12% from a year ago. As we noted in our last call, in FY16 maintenance revenue growth will be impacted by last year's negative currency effect on bookings, as maintenance is recognized ratably over the year. Services revenue was $35.9 million in the quarter, down 6% from a year ago, reflecting planned increased participation of our SI partners in customer implementations. Geographically, the US represented 52% of revenue for the first quarter, with 48% of revenue coming from outside the US.

Turning to our profitability metrics, we will discuss these on a non-GAAP basis, and we have provided a reconciliation to GAAP in our earnings press release issued today, with the primary difference being stock-based compensation expenses.

Non-GAAP gross profit in the first quarter was $52.3 million, an increase of 9% on a year-over-year basis, and representing 63.5% non-GAAP gross margin, compared to 60.4% in the year-ago quarter. Breaking that down, in the first quarter of FY16, non-GAAP gross margin for license was 97.8%, maintenance was 84.8%, and services was 24.4%. Keep in mind that on a quarter-to-quarter basis we could see variations in services gross margin levels due to shifts in timing of revenue and expenses over the course of the year.

Total non-GAAP operating expenses were $45.7 million in the first quarter, an increase of 16% compared to a year ago. This resulted in non-GAAP operating income of $6.5 million, above our guidance of $2 million to $5 million, and represented a non-GAAP operating margin of 8%.

Out-performance on our profitability metrics was primarily due to out-performance on license and maintenance revenues, and due to the fact that hiring was below plan in the quarter. We do, however, expect to accelerate hiring in the next several quarters to meet our annual targets. Non-GAAP net income was $4.8 million, or $0.07 per fully diluted share, and was above expectations of net income of $0.02 to $0.05 per share.

Turning now to our balance sheet. We ended the first quarter with $663.6 million in cash, cash equivalents and investments, down from $677.8 million at the end of the fourth quarter, reflecting normal seasonal patterns of operating cash outflows, as annual employee bonus payments and commission payments for fourth-quarter bookings are remitted in the quarter. Total deferred revenue was $49.6 million at the end of the first quarter, compared to $52.6 million at the end of the fourth quarter.

As a reminder, our deferred revenue balance can vary widely from quarter to quarter, and is not a meaningful indicator of business activity, since we typically bill term license contracts annually, and recognize the full annual payment upon the due date. Further, long-term deferred revenue does not reflect our multi-year contracts. We believe that the combination of this contracted business and our best-in-class renewal rates provides us with a high level of visibility towards FY16 revenue.

Now, I'd like to turn to our outlook. We are still early in the year, but are modestly increasing our expectations for license revenue and profitability, based on our strong start and continued optimism for the year.

Looking at the second quarter of FY16, we anticipate total revenue to be in the range of $94.5 million to $98.5 million. Recall that on our second quarter 2015 call, we commented that $2.9 million in revenue in that quarter was from a customer that requested alignment of invoicing of an existing software with a new license purchase, skewing year-over-year revenue comparisons. Within revenue, we expect license revenue to be in the range of $48 million to $50 million, maintenance revenue of $13 million to $14 million, and services revenue of $33 million to $35 million.

For the second quarter, we anticipate non-GAAP operating income of between $14 million and $18 million, and non-GAAP net income of between $9.4 million and $12.1 million, or $0.13 to $0.16 per share, based on an estimated weighted average diluted share count of 73.4 million shares. On a GAAP basis, we anticipate net income to be between a loss of $0.5 million and income of $0.2 million, or an EPS loss of $0.01 per share to breakeven, based on an estimated weighted average basic and diluted share counts of 71.7 million shares and 73.4 million shares, respectively. (We expect to use cash during our second quarter, as we typically do in the first half of the fiscal year, and to rebuild cash balances from operations in the second half of the fiscal year.) [This statement was corrected by the company in the Q&A portion of the call]

For FY16, we anticipate total revenue to be in the range of $406 million to $416 million, representing an increase of $1 million at the midpoint from prior guidance, and an increase of 8% over FY15 at the midpoint. Within revenue, we anticipate that license revenue will be in the range of $204 million to $212 million, an increase of 14% to 18% from FY15. This guidance reflects our current assumption that perpetual license revenue will decline as a percentage of total license revenue.

We continue to expect maintenance revenue to be in the range of $56 million to $58 million, an increase of 14% at the midpoint, reflecting license revenue growth trends. As I previously mentioned, maintenance growth expectations are negatively impacted from the delayed effects of foreign exchange rates on FY15 maintenance renewals that will be recognized in 2016.

We continue to expect services revenue to be in the range of $144 million to $148 million, down approximately 4% from FY15, and representing approximately 36% of total revenue. This decrease remains consistent with our strategy to transition an increasing portion of implementation services to our system integrator partners. While on a quarterly basis the percentage of services revenue may fluctuate depending on the timing of project completions and project starts, we do expect the overall trend of a lower percentage of services revenue to persist over the year.

Non-GAAP operating income is expected to be in the range of $63 million to $73 million, resulting in full-year non-GAAP margins of 15% to 18%, slightly higher than prior expectations. Nevertheless, we continue to anticipate that the costs of hiring during the year -- during FY15, and the continued hiring in research and development in FY16, will more than offset gross margin improvements we are realizing from the revenue mix shift away from services, albeit to a lesser amount than previously anticipated. We are also slightly increasing expectations for non-GAAP net income, to a range of $41.6 million to $48.3 million, or $0.57 to $0.66 per share, based on an estimated weighted average diluted share count of 72.9 million shares.

On a GAAP basis, we anticipate FY16 operating income to be between a loss of $1.5 million and income of $8.5 million. We anticipate a net loss of $0.4 million to a net income of $1.4 million, or an EPS loss of $0.01 to a gain of $0.02, based on estimated weighted average basic and diluted share counts of 71.3 million and 72.9 million shares, respectively. We anticipate an effective non-GAAP tax rate of 33%, and a GAAP tax rate of approximately 82% for the second quarter and the full year.

In summary, we're off to a solid start for FY16. We continue our successful track record of gaining new customers and capturing opportunities for additional sales within our installed base. At our 11th annual Connections user conference last month, we introduced new versions of our data & analytics and digital experience products, and detailed our re-invigorated commitment to reducing total cost of ownership by utilizing an array of strategies to reduce the cost and time required to implement our software. We believe that relying on the approaches that have served us so well - focusing on successful implementations, investing in our products, and enabling our customers to adapt and succeed in a changing environment - is a recipe that will continue to generate solid returns.

Operator, you may now open the call for questions.

Thank you, sir.

(Operator Instructions)

First question comes from Ken Wong from Citi. Please go ahead.

Hi, Marcus. Earlier, you mentioned a -- working on a fully cloud product with a customer. Should we think of this as something similar to what your partners are doing, where it's simply a hosted version of the existing Guidewire product suite? Or is this more of a SaaS type of a product, as we typically know it?

You should think of it as SaaS product, though there's a number of important caveats. We don't believe that a multi-tenant model will be appropriate for this category of software, for a number of intrinsic reasons that aren't specific to our technology, but because of customer preferences. And we think that will probably be the case for, really, the foreseeable future, years into the future. So it's very much a single-tenant, private-cloud kind of approach that we expect customers to want. And that's -- we got a pretty clear signal on the demand, in that respect.

Secondly, we -- there's a great deal of content in the product that has to be developed before a product can be at the level of completion and readiness to go live that would be appropriate for a cloud-delivered modality. And that will take time to deliver across different lines of business. And so you will see us be selected and limited release in our approach towards those segments of the market that we think are most important to target early on, and that will expand over a multi-year horizon.

So with those limitations, it is indeed a transition of InsuranceSuite into the cloud, though we fully expect that there will be large segments of our customer base, and indeed the market, that will want most or even all of InsuranceSuite to be resident in their data centers.

Got you. And then for Richard, so this particular product, you said, could be -- it's going to be more ratable. Could you remind us, in terms of the cloud offerings that your partners are selling, is that ratable, as well? And then how has the mix of that particular line of business been relative to past quarters?

So if you think of our engagements with our partners right now, in the cloud space, those are very -- at very early stages. And we only have a couple of customers that have actually come in that way. While we are recognizing them ratably right now, and we anticipate doing that, they don't really have a significant effect on our P&L, and we don't anticipate that they will do so for quite some time.

This is a slightly larger company, and therefore, larger revenues will be involved here. And the fact that we're delaying those revenues, as well as delaying the costs, are having a small effect on our P&L. But again, even with this larger Company, those effects will not be in any way material, and we don't anticipate them to be for some time.

Got it. And then one -- just one quick follow-up on the current -- on maintenance. I'm not sure if you guys mentioned it, I might have missed it. But what was the -- are you able to quantify what the impact is for the full year?

It's actually hard to quantify the impact for the full year, because we're still going to be managing some of that. But think of it as somewhere between 1.5% to 2%.

Okay. Fantastic. Thanks a lot, guys.

And from Deutsche Bank, we have Nandan Amladi. Please go ahead, sir.

Hi. Thank you for taking my question. So this is a question that I have received a lot, on the ramped deals. You shared a slide at the Analyst Day that showed, by year five, your term licenses are about 2.2 times what they were in the year one, based on a cohort of Tier 1 customers that you had selected for that particular information set. So the question is, as you launch many of these new products, like DataCenter and DataHub and so on, does the cadence of that 1 going to 2.2 change somewhat?

I believe the cohort analysis you are referring to was really not tied to up-sells or additional sales. That was the second analysis that we provided, the second cohort analysis that we provided, which is much more reflective of Tier 1's buying more over a period of time, and how the rate of that change happens. So does that answer your question, Nandan?

Yes, I think so. I'm just trying to get a sense of what this ramp stuff looks like, or the customers that you're now signing. Because you just -- I expect that the cadence will -- or [really] should look a little bit different.

So Nandan, I think that I wouldn't want to conflate two very different dynamics, right? One is our land and expand strategy, and how it's executed over time, and how it then shows up in our revenue line. As opposed to ramp deals, which have no additional sales associated with them, but they really only reflect an accreting payment cycle over time. That is, an escalating set of payments that hit every year. Those are two very different constructs. Now --

Right.

One of the things (multiple speakers) that we've stressed, the ramp payments, while they were somewhat more significant in FY15, have always been a very small minority of our contracts. And in this particular quarter, for example, we had very little ramp activity.

Okay. Fair enough. And then one other question on FX. The euro appears to continue to weaken, so heading into next calendar year, how hedged are you? Do you have contracts that are US dollar denominated? You talked about how some of the maintenance that's sitting on deferred revenue will be impacted by currency rates. So can you talk a little bit about what your FX exposure is, overall?

Sure. So our FX exposure is naturally hedged, for the most part. The last year, about 80% of it was naturally hedged, because so much of our operations tend to also reside in those jurisdictions in which we sell our [products]. Now, I will say that, think of FX exposure in two ways, right? One is, how -- what impact does it have on our top line? And how much can it change our top line from that which we projected or anticipated? Those are slightly different calculations.

So for example, if you look at the FX effect on our top line this quarter, by comparing it to the FX rates in existence last quarter, it actually dampened revenue by about $1.3 million. So saying that in a different way, if exchange rates had been the same last year to this year, our revenue would have increased by about that amount. We anticipate a slightly larger impact next quarter, primarily due to the fact that the dollar continues to strengthen, especially in some of our larger offshore jurisdictions and sales locations, like Australia. Now --

And your ability to hedge --

One thing I would --

On the revenue side?

Nandan, just one final thought. We anticipated most of this, this year, as we gave guidance. So the one thing that I do not want to claim is that my guidance has been affected by currency swings, in this quarter, that I already knew were extant at the beginning of the guiding cycle. Does that make sense?

Yes. Thank you.

And we'll move on to Brendan Barnicle from Pacific Crest Securities.

Thanks so much. Marcus, you mentioned DEX in your prepared comments, and you guys have given us a few hints at that. When do you think we'll get a fuller view of that? Or you'll have something more fully to share with us, and with customers?

We're -- yes, it is a little bit early to be talking about it. And in fact, we don't even have the final branded name for it to share. We're in a code name version of it. And the fact that we're with the early adopter customer, I think, is further indication. Before we go to a broader availability of it, we'd like to do it in the context of a customer success story, which we anticipate happening in about a year's time from now.

That won't prevent us from having lots of other selective dialogue, and hopefully enlisting other -- or fully expecting to enlist a number of other early adopter customers. But the broader reveal of it to the market, and presumably to the investor community, will -- is about a year off.

Terrific. Thanks. And Richard, over on the cash flow statement, there are two things that stood out to us. Deferred tax liability looked bigger than we expected, and deferred compensation. Can you remind us of what's going on in those two items?

Hard for me to tell without having some more guidance there, Brendan. So on deferred compensation, what you should have seen, deferred compensation declined as a significant amount of the corporate [bonus] that have been claimed over the year was paid and therefore expensed. But that is always seasonally at about this level. So we haven't noticed any particular flux analysis that would cause us to call that particular line out. And on the deferred taxes, I actually don't know of any particular event or dynamic that is notable.

Okay. Great. That helps. And then lastly, Richard, on hiring plans, you guys were a little bit [light], which has happened in the past before. Any thoughts on how to resolve this?

I'm sorry, Brendan, could you repeat that question?

Sure. It was related to the hiring you called out, some of the weakness in hiring. And we've had that -- I think that comes up at least one quarter every year. Is this just the fact of the labor markets? Or anything you guys can do, a little more proactively, to not have this continue?

So I think it's fair to say that we have to work harder to meet our hiring targets, and have been working harder. I would say, if you de-constructed, Poland and Dublin have been doing very, very well, as we have explained. In the US, I think where we found our most challenging hiring market is in the Bay area. And there, we have seen, simply, a number of offers made and not accepted, that have been much higher than we've experienced in the past.

So we are working harder, on a number of different fronts, to try to make up for that lag. This is not something that I think is -- I think this is a little bit outside of the standard dynamic that we've seen in this particular market, at least for us. That is, things have gotten notably more difficult in Foster City.

Terrific. Thanks for the clarity. Thanks, guys.

And from Stifel, we have Tom Roderick. Please go ahead, sir.

Yes, hi, Matt VanVliet on for Tom this afternoon. Thanks for taking my question. You talked about speeding up some of the implementations, and in line with that, trying to lower the total cost of ownership for several of your customers. And in the quarter, you had 7 of your 12 go-lives completed in less than a year. Is that in line with the new push there? How much of -- how many of those contracts were in this new bucket? How much more improvement do you have that you can make on that progress?

So, I appreciate the question. The -- it's important to have a foundational understanding that our customers, and their projects, are tremendously heterogeneous. They write many different lines of business; they're very different in size. Our largest customer can write literally 100 times the number of transactions per year that our smallest customers can. And things vary by geography, and by IT capability, and -- as well as choice of project approach. Whether to deploy a project, over multiple phases or fewer phases, can obviously drive the timeline.

What we're aspiring to do is, across that entire portfolio of projects, to bring them all down in total duration, and in aggregate financial cost. And that's not -- there's no silver bullet to do that. These are very complex programs. But the combination of things we have to do on the product side, in terms of our methodology, pre-integrations with partner components that go into the final solution that a customer wants to deploy, many of these different elements all go into it.

Some of those things have been -- we've been at work at for a while, and probably contributed to somewhat faster deployments in this recent batch that happened to go live this quarter. Others are ongoing, and some are completely new efforts that we're really actively investing in. But it is a top-level corporate priority, for the Company, to reduce cost of ownership. And that's primarily about implementation, though it covers the entire customer life cycle, by a very material amount, over the coming years. And we have, really for the first time in our history, elevated that to a top-level priority at the same level as any new product capability, as such.

And then, just quickly following up on that, how many of these go-lives were ahead of or in line with the original plans? And maybe how many still continue to drag on, as these complex projects run over a little bit?

The large majority of our projects go live within a quarter of expectation of -- from the original project. Sometimes, the customer makes a rational, informed choice to add additional scope, or combine multiple phases into a single phase, and we don't really count that as a delay.

That can be a rational choice, as things come up during the course of the program. But we pride ourselves in the large majority goes live within one quarter of expectation. And it's a very small minority that drag on meaningfully beyond that. And usually, there's a combination of causes that just go along with a very complex program affecting, more or less, the entire IT organization, and a huge swathe of the user -- of the business constituency, as well.

And then one last one on the -- some of the newer products. DataHub is one that you continue to highlight. But even Guidewire Live, how are you seeing attach rates trending with new deals? And if there's any difference between that and land and expand deals? If you're seeing a higher attach rate of any of the newer, or at least non-InsuranceSuite, products?

I'd say across the board, we're seeing an increase in attach rates for all of the products outside of InsuranceSuite. But -- and that's true across the other two product families, namely digital, where the main set of products are -- that will be called digital portals. And then in data, where it's primarily about DataHub, and then secondarily, InfoCenter. So for both net new names, as well as the longstanding customer relationships, we're seeing strong and improving attach rates from quarter to quarter, at least for the last -- call it the last five fiscal quarters or so.

There's obviously, a natural ceiling to that, but we're not sure we're at that yet. And the -- [I think] sales force is well informed about positioning the totality of the offering, the whole platform, in all of their customer conversations. And we believe that pretty much all of the products are applicable to the vast majority of the market. And that's a good place to be, in terms of having a lot of different topics to engage customers with.

All right. Thank you.

And next, we have Justin Furby from William Blair & Company. Please go ahead, sir.

Hi, guys. Thanks, nice quarter, and thank you for your execution again. I wanted to ask about, first off, the early developments, the deployments with the Tier 1s that you signed in Q4. Marcus, any anecdotal thoughts that you could provide, in terms of customer feedback, would be certainly helpful. And I'm curious if any of these, or all of these, are actively looking at additional products like now? And would love your latest view on whether you think one of them might come back and buy incremental product this fiscal year.

Yes, so all of those projects are on track, and we feel good about them. And as you'd expect, given the scale and visibility of some of those projects, they have an even heightened degree of attention, as we make sure that their programs get off to good starts. We're encouraged by the fact that several, not all, but several of them, are seriously engaging in early discussions about other projects. So it could be the same product for a different portion of their business. It could be a separate application within InsuranceSuite or the other -- any other ancillary products in data or digital.

And we have plenty of those active ones going along. I'd say, even though our normal expectation is that the first major core system project has to get well settled in, and we no longer think that it has to go live and be in production and showing concrete business value before we can make that next sale. We're pretty -- we're more bullish than that, in thinking that we can get those dialogues to happen -- to mature faster, and potentially close even before that first project has gone live. We think that's the case for the recent set that we signed in Q4, in particular.

Got it. That's helpful. And then, does it -- I'm just curious, just given that commentary, what's embedded from a guidance standpoint? Or how it impacts guidance?

You should think of all of our Tier 1 relationship as, they're just part of the whole mix, the whole portfolio, that we're pursuing. And that's always been the case. What we take care not to do is bank on one or more really large, outsize transactions with them. And even to the degree that we're very hopeful of a large Tier 1 transaction, we tend to handicap the size of that transaction. Because as we've talked about many times before, there's a lot of variance in just how much they will license, and the schedule of that rollout of that license. So we take a very cautious view of that, but it would be inaccurate to say that we discount them entirely there. We do expect progress with the Tier 1 segment, both new names and existing names, and those are factored into our guidance.

Got it, that's helpful. And then Marcus, I was just curious, just coming out of Connections last month, you no doubt saw a lot of your customers and prospective customers. What you thought -- was curious to see what you thought was the most surprising, or maybe the most incremental theme, versus maybe last year? And then I've got one more follow-up for Richard. Thanks.

Yes, so the event is always a real high point for us. And this year, we had a particularly strong quotient of customer-delivered content. And it was a combination of exciting and a little bit daunting, the scale of the ambition that many of them have for full-blown transformation. We had multiple of our customers saying that they expect to look completely different in the way that they sell, go to market, service their policyholders, within the next three or four years.

So pretty urgent and intense language, especially when you consider it by the normal standards of sobriety that prevail in the insurance industry. So that was exciting. A little bit -- a little daunting, as well, because of course, as a core technology provider to them, we have to pull our weight to make that happen. But we had a lot of that testimony coming, if anything, with greater urgency and stridency from our customers than from us.

Got it. That's helpful. And then Richard, for you, on the cash flow, the last couple of quarters, I think cash flow has been down year over year, and DSOs have stepped up a little bit. I thought you made a comment, maybe, about the first half of the year being down, but I missed that. Was that free cash flow, operating cash flow? What was that comment? And then I guess for the full year, for FY16, what do you expect, from an operating cash flow standpoint, versus FY15? And that's it for me. Thanks, guys.

So I think that I -- on our last call, I suggested that free cash flow for FY16 would be in the area of $60 million to $70 million, and we're still comfortable with that analysis. With regard -- I'm sorry, Justin, you had a second question. And what we were talking about on the call was actually just use of cash in operations. So that is, where we ended up with cash on the balance sheet was lower than Q4, simply because we used cash in the quarter.

We actually anticipate cash increasing on our balance sheet every quarter for the rest of the year. That is, I think on the call, I suggested that we would use cash in operations in Q2, but I actually think that was a mistake. We will be generating cash from operations for each of the next three quarters.

Got it. Thanks very much. Appreciate it.

And we'll take our next question from Brent Thill from UBS. Please go ahead.

Thanks. Marcus, just a follow-up on the cloud. It seems like a number of the mid-tier companies makes a lot of sense. Are you seeing the same demand pull on the Tier 1s, for cloud at this point? Or is it more downstream?

We're seeing it in the sense that even the largest insurer tends to have different greenfield ambitions. New startup ideas that may be under a different brand, and may be in a different segment or -- other market than they normally target. But other growth opportunities, initiatives, and they may think of themselves in that way, or have a unit of people who think of themselves as a startup within a larger, more mature enterprise. And those would be very -- they would behave very similarly to a very small insurer.

But where we don't hear it is for the big mother ship, massive, multi-billion dollar book of business core systems. I think there are many reasons, which would be too involved to go into now, about why fully cloud-based deployment of those is far off, if ever to happen. And I think even if there may be a few who over, call it, the next five years would make -- might make that transition, I think the very large majority of the industry, at that Tier 1 and probably even Tier 2 level, will not be making that transition, for a host of reasons.

So for -- really, for the foreseeable future, probably indefinitely, we will have on-premise versions of our software, as well as, increasingly, cloud-based versions. And, to some degree, hybridized versions, as different aspects of the total platform get delivered as cloud-based services. And that was a big theme of the Connections conference, as well.

If it did tip faster than you think, Marcus, is there any economic downside, if your whole customer base said, we're ready to go cloud?

It's actually economic upside, in many ways. I think there's some evidence, both in our industry, and I think in other verticals, as well, that cloud-based software providers get -- actually get -- enjoy a somewhat higher capture rate on license as a share of customer revenues. And I think we have some evidence that that would be true in our industry, as well. And we actually look forward to participating in that.

But we think that that will definitely happen at the lower end of the -- I shouldn't say lower -- at the smaller carrier end of the market first. If it were to happen more aggressively, I think it would be predicated on a track record of success of that happening. And I would be hard-pressed to see which other technology provider would be there, serving the very biggest insurers with that kind of initiative, if it were not Guidewire. So taking your thought experiment to its logical extension, that would be a scenario in which we were leading that acceleration, and then we would be gratified to have it happen.

Okay. Great. Quick one for Richard. Richard, you've been pretty clear, this year is another year of investment. Seems like R&D as a percent of revenue, you had one of the higher levels I think we've seen for a while. Can you just give us a sense of, is the goal still, this year, continue that on the margin side, in terms of stabilizing the margin here? And then next year is the year that we should still think about some leverage returning to the model?

Yes, so what we've talked about is 16% operating margin being the trough for us, and then we're going to start seeing leverage in the operating margins start to become clearer and clearer in the P&L. And as we go forward, and we try to hit that long-term operating plan of 28% to 30% operating margin by year 5.

My sense is that that trough of 16%, even though that's still within the range of possibilities, has actually become slightly less likely, as we've been unable to hit hiring goals in Q1. And therefore, my sense is, operating margins will likely be a little bit higher than that this year. But they will still be, and represent, the trough of operating margins, for our plan, for the next four or five years.

Thank you.

And next, from Stephens, we have Alex Zukin. Please go ahead, sir.

Hi, guys, thanks for taking my questions. Marcus, maybe just one or two for you, and then one for Richard. What does the Tier 1 pipeline look like for this year? And I guess how much effort is being spent, to Justin's earlier question, to uptick the existing Tier 1s, the clustering of Tier 1s, that signed at the end of -- or during 4Q, get those customers to pick up more solutions, versus new Tier 1 relationships like the one you signed in 1Q?

Yes, I think we don't make a massive distinction between whether a Tier 1 customer is -- when a Tier 1 customer is thinking about a new core system project, a new major transformation, whether or not they're an existing customer doesn't really enter into the calculus much. I think we have other sales assets to leverage, when they've been successful with one core project. Some other executive relationships, a track record to point to. But in terms of the paces that we will be put through, as a sales organization, they're very similar, and it's an all-out effort.

And so we have some of those going with existing customers, and we have those going with net new names for us. And as far as the sales team is concerned, that's all new opportunity that they're pursuing with equal energy. That's how I'd characterize it. I think it would be -- I think it will be very encouraging if we can continue to show that larger carriers feel comfortable doing more than parallelizing, doing more than one of these core projects at the same time in different parts of their enterprise.

I would say five-plus years ago, we would say that would never happen, would be very unlikely to happen. And now, I think we feel that could very well happen. And that we have a good case to make that it's rational for some big companies to undertake that kind of parallel effort, because it's just too slow to serialize it.

Got it. And maybe one more. As you come back from Connections, any macro thoughts around trends and non-life insurance premiums for your customer base? And how, if it all, this is impacting sales cycles for you this year, maybe, versus last year?

Yes, I think the overall macro environment for P&C insurers is -- and I think, broadly speaking, similar to the way it's been for the last number of years. There's discussion about there being too much capacity in the market. But that's -- there's just a lot of capital in insurance, as there is in, I think, many other sectors. And that makes it a little bit harder to command the optimal premium that you might like as an insurer. I think there's been discussion of that for some time. There's talk about nontraditional entrance into insurers.

So some of those are macro factors that are swimming around. They're more in a theoretical way, or not in a way that has affected our business in any meaningful sense. For us, really, our growth, we see tied to, not so much the secular growth of the industry, as these catalysts of digital transformation and long-delayed legacy core system replacement and the like. And we see those trends being as robust as ever.

Got it, thanks. And maybe Richard, again, I had a question about the sales hiring. How would you characterize the plan for sales hiring this year, as it stands now? Do you expect to be caught up? And if you don't, I guess, does that potentially affect the ability to grow term license at that 20% plus level, maybe next year?

So I think where we've had trouble hiring has not been in sales, but mostly in R&D, and mostly in the Bay Area. So Alex, I think we'll be fine with sales hiring, and we're on target right now. So we don't anticipate any lack of successful sales talent being attracted to working for Guidewire during the year. I don't think that there's any risk that a failure to hire effectively will cause our 20% growth target to fail.

Perfect. Thank you, guys.

Thank you.

And next we'll take Sterling Auty from JPMorgan.

Yes, thanks. Hi, guys. I jumped in a couple of minutes late, but I thought, Richard, in your prepared remarks, you said perpetual licenses were a negative $3 million. Can you go on and give us a little bit more color about what the dispute is? Would -- so you're basically saying that reported license revenue would have been $3 million higher if that did not exist? And any time frame to resolution?

So Sterling, I apologize. That was $300,000. That was the hit to perpetual license, and you'll see that in our filings. It was not $3 million. If I said $3 million, I apologize. That was a complete misspeak. And that -- all that had to do with was a dispute with a customer that we engaged with in Q4 of last year. And when we received payment for that this quarter, that payment was $300,000 light.

When we investigated with the client, and asked them to remediate the payment, it turned out that there was a fundamental disagreement as to how to calculate the effects of foreign exchange fluctuations, during the period of invoicing and payment, that we simply have a disagreement on. And so we're working through that right now. But in light of the fact that there's a disagreement on the table, we just decided to reverse that revenue recognition in Q4 in Q1.

That makes perfect sense. Thank you. And then secondly, the gross margins, specifically in services, saw a tremendous improvement sequentially, even though revenue was basically, for that line item, in line with most people's expectations. What in particular gave you the extra leverage, in the quarter, on the gross margins for services?

There's been a couple of things that we've been doing that have been coming to fruition. One is, we've been ramping down what we call our global mobility core, which is effectively a number of expatriates, or people that have to work in different jurisdictions. It's very expensive to manage that effort. And so what we've been doing over the last 12 months is actually decreasing the size of that population.

Secondly, I think that, as the services organization looked at the revenue road map, they decided that they could be a little bit more disciplined on hiring. And therefore, our hiring in professional services was below plan, but not -- below plan at the outset of the year, but was done for good, rational reasons. And therefore, the fact that the headcount was lower and the fact that we had less expensive assets in the services organization naturally caused that margin to grow.

Now, I will say, and I will warn you, that that margin will come back down in the next quarter as we have the holidays in the quarter. And I do believe that that margin over the year should stay in line with where we've been in the past. (multiple speakers) Not mid-20s. I think we're running just a little high right now. The other thing we're looking at is hiring specialty services folks for our new portal and data initiatives.

And obviously, as we bring those people on and they ramp that will cause costs to go up a little bit and not necessarily be reflected in revenues immediately. So those are going to be the levers that will affect gross margins for services.

Okay. Sounds good. Sorry, I almost cut you off twice there. I apologize. Last question. Marcus, in terms of this cloud initiative, what have your discussions been like with partners such as Capgemini, that had been offering cloud versions of your solution for a little while now? They've obviously put some investment and money into that infrastructure. How is their reaction to you guys now, coming in and saying, okay, you're going to offer a cloud version. Are they excited because they can sell it? Or do they feel like there's a bit of [competition] that's going to evolve?

We've had, I think, very forthright discussions with all of our partners. We have extremely successful and mutually dependent relationships going with all of our leading partners. And so we're in constant dialogue with them about everything, at an account-specific level. The short answer to your question is, there's just a ton of work to go around, no matter what. And I think they are enthusiastic to see us catalyze more demand in that segment of the market that wants things that are more, quote-unquote, insurance in a box.

And there will be plenty of work for them to do in -- around the edges of that. And then also, all the other follow-on SI work that tends to follow that. And there's help that they can do, to help adapt any solution that we bring to market, to be more specific to different sub-segments of the market and the like. So it would not be competitive. It's going to be wholly collaborative, and I think we're very much arm-in-arm in everything we're doing.

Got it. Thank you, guys.

And following, from JMP Securities, we have Peter Lowry. Please go ahead, sir.

Two quick questions, both of which may have partially been answered. But I think last quarter, you mentioned that you had added services capacity ahead of expected implementations. So can you just talk about where you are now, in terms of services capacity?

We've seen utilizations pick up -- utilization rates pick up over the quarter, just like we expected, and some of these projects have come online. So much like we presaged in the past, we hired ahead of schedule, as some of these big projects were coming on board, and we had visibility to that. And now, we're utilizing that bench. And I think we're doing -- we're coming in very much to plan.

Okay. Great. And then, are you seeing any acceleration in SI's interest in Guidewire practices?

Acceleration. We have -- maybe you can qualify that a little bit more specifically, what you mean by acceleration.

I'll put it this way. We've had -- some of our companies have missed on the services line, because the SIs are actually already at customers by the time the services team gets there. They may have selected an SI. In other words, there's some competition, in some of our companies, with SIs for services.

Right. So there is a vigorously competitive marketplace now, among our SIs, for Guidewire projects, as well. I think any one of our partners would love to have the entire pie for themselves, but I think they also recognize that there's more than enough market for any one practice. And that -- and our customers certainly appreciate that they have a diversity of choices. I would say that the amount of activity in the space has attracted attention from basically every significant systems integrator that either serves or aspires to serve the P&C industry.

And every name that you would think of, they want to be -- that serves the industry wants to be involved in these large transformation programs. So it's definitely acceleration, in that sense. As quantitatively, how many consultants have we enabled, and what's the rate of that, I do know that at the end of last year, when we last disclosed the number, that we've seen a very meaningful uptick in the total size of the ecosystem. I believe to some 5,500 trained consultants, which was a 25% plus increase in the total size. And it seems like that trend, to us, qualitatively speaking, is continuing into this year.

But Peter, let me answer another question that I think was embedded in your first comment. And that is, we don't necessarily compete with our own SIs for business at our customers. We have a very collaborative approach to that -- to those customers, in which they take a lion's share of the work, but we still have a significant presence there, to make sure that the implementation success that the customer experiences is undiluted.

Okay. Great. Thank you.

Ladies and gentlemen, this does conclude our question-and-answer session for today. I'd like to turn the conference back over to Marcus Ryu for any closing and additional remarks.

No additional commentary. Thank you all for participating.

Ladies and gentlemen, that does conclude today's presentation, and we appreciate everyone's participation.