Guidewire Software Inc (GWRE) 2016 Q2 法說會逐字稿

Good day, and welcome to Guidewire's second quarter FY16 earnings call.

Today's conference is being recorded.

At this time, I would 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 conference call for the second quarter FY16 which ended on January 31, 2016.

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, please see the Investor Relations section of our website at IR.

Guidewire.com.

As a reminder, today's call is being recorded and a replay will be available following the conclusion of the call.

During the call, we will make forward-looking statements pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 regarding trends, strategies and anticipated performance of the business.

These forward-looking statements are based on management's current views and expectations as of today, and should not be relied upon as representing our views as of any subsequent date.

We disclaim any obligation to update any forward-looking statements or outlook.

Actual results may differ materially.

Please refer to the Risk Factors section in our most recent Form 10-K and 10-Qs filed with the SEC.

We will also refer to certain non-GAAP financial measures to provide additional information to investors.

A reconciliation of non-GAAP to GAAP measures is provided in our press release.

The reconciliations and additional data are also posted in a supplement on our IR website.

During the call, we may offer incremental metrics to provide greater insight into the dynamics of our business.

These details may be one-time in nature, and we may or may not provide updates 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 second quarter financial results and our outlook for Q3 and the rest of FY16.

Thanks, Richard.

Our second-quarter results exceeded our guidance for revenue at $102.1 million, as well as for profitability, with a non-GAAP operating margin of 24% and non-GAAP net income of $0.24 per share.

This result is attributable both to better than anticipated sales of our new products, and earlier sales of some licenses that we expected to close later in the year.

The early conversion of these licenses reinforces our optimism about our ability to achieve our goals for the fiscal year.

Term license revenue was $52.7 million in the quarter, representing 28% year-over-year growth.

Term life as a maintenance revenue for the trailing 12 months was $238 million, an increase of 16% from a year ago.

As we anticipated, the growth of this metric in the first half of the year was below our historical range due to one-time events benefiting revenue a year ago, and slower growth in maintenance revenues due to the delayed impact of negative currency rates.

However, we continue to expect for the full year term license revenue growth will be 20% or higher, an expectation bolstered by our positive sales results in this quarter.

Those results featured both growth dimensions that we care about, inaugurating relationships with new customers of all sizes, and expanding relationships with existing customers with additional products.

In the past, I've focused on our relationships with tier 1 companies.

This quarter featured progress and developing relationships with several smaller insurers in an important validation of our appeal to all segments of our target market.

For example, front line insurance, a tier 3 insurer specializing in coastal, commercial and residential property in the southeast US selected InsuranceSuite, our rating, Client Data Management and reinsurance modules and our data management and digital portals to enhance customer engagement.

In a similarly wide-ranging deal, Mountain West Farm Bureau selected InsuranceSuite in our rating, Client Data Management and reinsurance modules, as well as our full data management product line and digital portals.

Mountain West, a $200 million farm and ranch insurer in Montana and Wyoming will implement these products across its personal, commercial, worker's comp and reinsurance lines of business.

Safety National, a $600 million subsidiary of Tokyo Marine offering commercial lines in worker's compensation, selected PolicyCenter, ClaimCenter, a rating and business intelligence for InsuranceSuite.

And finally, AAA of Carolinas, a $60 million personal auto and homeowners insurer, licensed InsuranceSuite, DataHub and InfoCenter, digital portals and several add-on modules.

Notably, AAA of Carolina intends to implement our products in a hosted cloud offering managed by one of our insurance cloud solution partners.

Meanwhile, and in keeping with our experience of the last several years, several long-standing ClaimCenter customers expanded their relationships to encompass other core applications in the suite.

Middle Oak Insurance added BillingCenter, Southern Farm Bureau added PolicyCenter, and Accident Fund Insurance added PolicyCenter and our digital portals.

Turning to international, AXA UK, one of the largest subsidiaries in the major multinational AXA group, writing both personal and commercial lines selected ClaimCenter.

With the UK, we now serve AXA in 12 countries in Europe, the Americas and Asia.

Additionally, [Conte IT] a $350 million auto and motorcycle direct insurer in Italy, selected PolicyCenter and BillingCenter.

Conte is a subsidiary of Admiral, a leading UK direct insurer and a long-standing Guidewire PolicyCenter customer.

In South America, we initiated a new relationship with Seguros Generales Suramericana, a $700 million multi-line insurer based in Colombia, who will be implementing InsuranceSuite, our rating, Client Data Management and reinsurance modules and digital portals.

Along with [Kaisha] in Brazil, which we announced in Q1, Suramericana represents our second recent significant recent win in Latin America, a geography in which we anticipate multiple large insurers to undertake modernization programs over the next few years.

Overall then, our sales momentum is very healthy, as measured by results.

I would add to that a qualitative observation.

That our engagement at the CEO and even Board level with insurers of all sizes is stronger than ever, reflecting the urgency of adapting to technology-driven changes in the P&C industry as a whole.

The themes of data management, predictive analytics, sophisticated customer segmentation and digital engagement are catalysts for IT investments at a heightened level from several years ago.

We believe the investments we have and continue to make in our core data digital platform strategy position us particularly well to serve this demand.

For example, since the end of FY15, we have almost doubled the number of customers who have selected our digital products.

As I mentioned, Suramericana, Front Line, Mountain West, AAA Carolinas and Accident Fund all selected digital portals in conjunction with our core offerings.

During the second quarter, digital portals was also selected by Southern Farm Bureau, Texas Fair Plan and the Seibels Bruce Group.

Most meaningfully, we signed an enterprise-wide license for all of our digital portals with Nationwide, a $20 billion insurer and one of our largest and most sophisticated customers.

We are gratified that our customers perceive significant value in our newer products, and we will continue to invest in the data and digital frontiers so important to their strategic agendas.

Implementation-wise, our go lives in the quarter included AXA Tianping in China with ClaimCenter, and an Insurance and Data Management go live at the largest insurer in Australia, QBE.

Also noteworthy was an initial go live at State Farm, who was able to complete their implementation of PolicyCenter for the first of their commercial lines on schedule in seven months.

Our track record of successful delivery, shoulder to shoulder with our customers, remains fundamental to our identity and differentiation.

Track record notwithstanding, we aspire to continuous improvement.

As we mentioned during our analyst day presentation, we are focused on reducing the total cost of ownership of our software.

To date, InsuranceSuite has led in the marketplace due to its functional sophistication, extreme flexibility, and its ability to lower operating costs as compared to customer legacy systems.

We believe we can further facilitate adoption of our suite and thereby our other offerings by reducing the costs of implementation.

We are pursuing this objective energetically on multiple vectors, namely promoting more standard configuration, enhancing our market segment specific content and creating deeper integrations with technologies that are prevalent in our customers' environments.

As one proof point of the latter, we recently announced a reseller arrangement for our cloud-based document production technology offered by Thunderhead.

Thunderhead Solutions is broadly adopted in our market, including by many of our customers.

While we anticipate a modest contribution to revenues in FY17, this relationship is primarily intended to reduce the TCO of InsuranceSuite through a product type integration and pre-built document templates.

We see multiple similar other opportunities, which we will pursue to further streamline and standardize our customers' implementations.

Among our most significant initiatives is the facilitation of cloud deployment, as in the case of AAA Carolinas, which I mentioned earlier.

Notably, our launch of InsuranceSuite 9 later this year will introduce native support for deployments on AWS and Azure and integration with next generation digital features.

This development work will continue in InsuranceSuite 10 and later releases, as we continue to enhance business user configuration, micro service enablement of system function, and other architectural enhancements to support cloud native or hybrid deployments.

Our ongoing investments in InsuranceSuite are being recognized by customers and industry analysts.

For the second year in a row, Gartner positioned Guidewire as a leader in its magic quadrant for North American P&C policy management systems.

In addition, research firm Cylance named Guidewire as a top solution out of 43 for both advanced technology and customer base in their recently issued report on North American policy solutions.

During the quarter, we also made our first venture investment.

Trove is a bay area technology company providing an app for tracking and insuring individual valuable items.

Engaging with emerging technology companies will help us identify and leverage new ideas that we can bring to our customers and prospects in the industry we serve.

We intend to selectively use capital to engage with new market entrants that are incubating great ideas.

In summary, we had a strong second quarter, with results exceeding our expectations.

We're encouraged by our sales momentum, especially for our newer offerings, a conducive demand environment as P&C insurers invests to adapt.

And the positive feedback we're hearing from our customer community about our long-term investments in data, digital and lower TCO, as befits an aspiring industry standard.

I will now turn the call over to Richard to provide details on our second-quarter financial results, and our outlook for Q3 and FY16.

Thank you, Marcus.

As Marcus mentioned, we delivered a strong quarter, with revenue and earnings that came in above the high end of our guidance ranges.

Total revenue in the quarter was $102.1 million, of which license revenue was $53.4 million.

Within license revenue, term license was $52.7 million for the quarter, an increase of 28% from a year ago.

The petrol license revenue was $0.7 million.

We are justifiably proud of our term license growth, driven both by an increase in our InsuranceSuite business and fueled by the continued growth in our new product sales, which continue to increase as a percentage of bookings and revenue.

This growth is even more noteworthy, considering the currency headwinds reduced term license growth by approximately 5 percentage points in the quarter, a substantial majority of which was already considered in our guidance.

However, as Marcus mentioned, such growth did benefit from the earlier than anticipated closing of certain license transactions that we had not expected to close until later in the year.

Obviously, the timing of the license transactions, especially large ones, can create volatility in our period-to-period growth, as can the effects of currency rate movements and the timing of customer payments.

On an annual basis, however, we continue to be optimistic that we can achieve our 20% or better term license growth.

In the first half, perpetual license revenues contributed a much smaller portion of our license revenue in the same period last year.

This is in line with our focus on increasing term license revenues.

However, as we look forward to the second half, potential licenses with emerging market customers and with customers which have already transacted under a perpetual license will likely cause the contribution of perpetual licenses to be more significant than in the first half.

Although we are not in a position to offer specific guidance at this time.

Maintenance revenue was $14.3 million for the second quarter, up 17% from a year ago, and slightly above our guidance range.

Maintenance revenue growth continued to modestly lag license revenue growth, as historical perpetual licenses still make up a material portion of maintenance revenue and as perpetual transactions have declined as a percentage of total revenue over the past several fiscal years.

Additionally, as we have noted, maintenance revenue growth in FY16 has and will continue to be impacted by foreign exchange rate effects that impacted license revenue last year, but that are having a delayed impact on maintenance revenue due to the rateable nature of their revenue recognition.

Services revenue was $34.5 million, up 3% from a year ago, consistent with our goals of increasing SI participation in our customer implementations.

Geographically, the US represented 61% of revenue for the second quarter, with 39% coming from outside of the US.

Before turning to profitability, I wanted to address a topic of changes to accounting rules and the potential impact of these changes on our revenue recognition in the future that I have been asked about several times.

As a reminder, we will begin reporting under a new revenue standard in our 2019 fiscal year, which begins August 1, 2018.

As a caveat, we note there are elements of the new standard for which guidance is evolving, and therefore the application of the standard is not clear in all cases.

Having said that, we believe that revenue recognized under our typical term licenses as currently constructed will vary greatly.

Under the new standard, total term license amounts payable, even from multi-year deals, would be recognized in year one.

As an example, if under one of our five-year term licenses payments totaled an assumed $5 million, or $1 million per year, we would recognize the $5 million in year one as opposed to $1 million in each year of the term license.

And we would not recognize any term license revenue in subsequent years.

To maintain our current levels of revenue visibility, we have begun shortening the non-cancelable period of the initial term by offering our customers a contract that will have automatic annual renewal periods after the shorter non-cancelable term.

We do not anticipate that the introduction of this new licensing structure will have an impact on our seller retention rates, and obviously this change will be very gradual, as we have more than two years to implement this new model.

But we have begun organizing this effort so that we can capitalize on any intervening customer engagements in a way that minimizes customer inconvenience.

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 second quarter was $72.7 million, an increase of 21% on a year-over-year basis, and represents a non-GAAP gross margin of 71.2%, an increase from 67.0% in the year-ago quarter.

Breaking that down, in the second quarter of FY16, non-GAAP gross margin for license was 97.9%, maintenance was 84.2% and services was 24.6%.

Keep in mind that on a quarter-to-quarter basis, we will continue to see variations in services gross margin levels due to shifts in capacity utilization and the timing of revenue and expenses over the course of the year.

Moreover, looking to the second half of the fiscal year, we anticipate service margins to decline modestly as we increase hiring to meet demand generally.

And specifically, as we hire specialized consultants to support deployments of our new products, especially our Data Management products.

As with new product introductions in the past, we anticipate relying more on Guidewire services staff for new product deployments in the near term, as we work to increase the number of SI partner consultants trained on these new products.

Total non-GAAP operating expenses were $48.1 million in the second quarter, an increase of 13% compared to a year ago.

This resulted in non-GAAP operating income of $24.6 million above our guidance of $14 million to $18 million, and represented a non-GAAP operating margin of 24.1%.

A significant contribution to the operating income outperformance was the result of higher than projected license revenues, stronger than anticipated services gross margins.

And to a lesser extent, lower than forecast research and development expenses also had a beneficial impact on profitability.

We were able to hire close to plan in the quarter, unlike in the first quarter where we saw significant delays.

However, the effect of additional recruiting resources was evident most in a higher pace of hiring in the back half of the quarter.

We are working hard to meet our original hiring goals by maintaining our current pace of hiring through the end of the year.

As we gain experience in promoting Guidewire as a great place to work in Europe, we are making progress towards that goal.

Indeed, such progress was evident as we expanded our development organization in areas outside of the United States, with strong hiring both in Dublin and in Poland.

We finished an expansion of the Dublin office this quarter, and expect to move into our permanent facility in Krakow early in the next fiscal year.

We fully expect the development organization to grow more quickly in these geographies than in the United States for the remainder of the year.

As a result of this combination of factors, non-GAAP net income was also above our guidance range at $17.8 million, or $0.24 per diluted share.

Turning now to our balance sheet.

We ended the second quarter with $700.8 million in cash, cash equivalents and investments, up from $663 million at the end of the first quarter, as cash generated from operations in the second quarter was $37.9 million.

The $700.8 million figure includes the impact of our $5 million investment in Trove that Marcus mentioned, which is classified as a long-term investment.

Total deferred revenue was $62 million at the end of the second quarter compared to $49.6 million at the end of the first quarter.

As a reminder, our deferred revenue balance can vary widely from quarter to quarter, and is not a meaningful indicator of the business activity, since we typically build term license contracts annually and recognize the full payment upon the due date.

Further, long-term deferred revenue does not reflect our multi-year contracts.

And we believe that the combination of this contracted business and our investment class renewal rates provides us with a high level of visibility towards our FY16 revenue.

Now I would like to turn to our outlook.

While our revenue upside in the second quarter benefited from licenses that closed earlier in the year than anticipated, our overall momentum gives us confidence to slightly increase our full-year revenue guidance.

At the same time, it is important to note that we do not believe the currency headwinds we experienced this quarter will persist in the second half, as we anticipate fewer term license payments from customers in the affected areas.

With respect to profitability, even though we expect to see an increased pace of hiring in the third and fourth quarter, we are increasing our third-quarter and full-year profitability guidance.

Due to better than expected margins in the first half of the year, modestly higher revenues and lower than anticipated expenses as the impact of delayed hiring on operating expenses continues to be felt for the rest of the year.

Looking at the third quarter of FY16 which has historically experienced a seasonal revenue decline, we anticipate total revenue to be in the range of $90.3 million to $94.3 million.

Within revenue, we expect license revenue to be in the range of $40 million to $42 million.

Maintenance revenue of $14 million to $14.5 million, and services revenue of $36 million to $38 million.

For the third quarter, we anticipate non-GAAP operating income of between $4.5 million and $8.5 million.

And non-GAAP net income of between $3.1 million and $5.8 million, or $0.04 to $0.08 per share based on an estimated diluted average share count of 73.8 million shares.

For FY16, we now anticipate total revenue to be in the range of $408.5 million to $416.5 million, representing an increase of $1.5 million at the midpoint from prior guidance.

Within revenue, we anticipate license revenue to be in the range of $206 million to $212 million, an increase of $1 million at the midpoint.

We expect maintenance revenue to be in the range of $56.5 million to $58.5 million, representing an increase of $0.5 million at the midpoint.

As I previously mentioned, maintenance revenue growth expectations are negatively impacted by the delayed effects of foreign exchange rates on maintenance renewals in FY15 as we recognize that revenue in this fiscal year.

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 35% of total revenue.

This decrease remains consistent with our stated strategy to transition an increasing potion of implementation services to our systems integrator Partners.

While on a quarterly basis, the percentage of services revenue may fluctuate depending on the timing of project completions or project starts, we expect the overall trend of a lower percentage of services revenues to persist over the year.

We are increasing non-GAAP operating income guidance to a range of $69 million to $77 million, resulting in full-year non-GAAP operating margins of 18% at the midpoint of guidance.

As the increased profitability in the first half of the year and the continued push to grow our Dublin and Poland organizations more rapidly than our organization in the US will further moderate expense growth in the second half.

We are also increasing expectations for non-GAAP net income to a range of $46.3 million to $51.7 million, or $0.64 to $0.71 per share, based on an estimated weighted average diluted share count of 72.8 million shares.

We anticipate an effective non-GAAP tax rate of 32% and a GAAP tax rate of approximately 44% for the third quarter and the full year.

In summary, our strong second-quarter results reflect continued momentum in enabling insurers to adapt and succeed in a changing world.

Transform their businesses with our modern core systems software, improve their decision making with our data products and enhance their agent and customer interaction with our digital products.

At the same time, we continue to make progress in reducing the total cost of ownership of our products through product innovation and content development, the introduction of streamlined delivery methodologies, and partnerships with other technology providers such as Thunderhead.

Our strong business momentum and leadership position are reinforced by our advancing solutions, and make us confident that we can drive continued growth and profitability as we transform the marketplace.

Operator, can you now open the call for questions?

(Operator Instructions)

We'll take our first question today from Tom Roderick with Stifel.

Yes, hello.

Matt VanVliet on for Tom.

Thanks for taking my question.

I guess first on it looked like a very good quarter for cross selling to existing customers.

I was wondering if you could just give us some updates on where that process is in terms of revenue mix and maybe some updates, I know you talked about State Farm, but some of the big projects and where they are in their lifecycle.

We appreciate the question.

To the first part about the mix of new deals, we care equally about both getting new logos, new customers, starting new relationships on the one hand, and then developing the existing relationships that we have.

Both are very important to our growth aspirations, and this was quite a good quarter on both of those fronts.

Our bookings were very evenly balanced between both of those categories, completely new customer relationships, as well as expansions of existing relationships.

As you noted and as we called out in the prepared remarks, the newer products were very important in both as stand-alone sales to existing customers, as well as being part of an initial purchase by our newer customers.

And we like seeing both of those trends.

The latter part of your question was about some of the big deployments that are underway.

Nothing in particular to report there.

It's more or less business as usual.

These are all large scale, big transformation programs.

We called out a few that went live that were significant.

Each of those was important in its own way, AXA Tianping is our first customer in China, so going live is clearly an important proof point, State Farm is who they are and so forth.

But nothing special to announce in terms of that pattern.

But as we've underscored in this call and multiple others, driving down the amount of effort, the degree of configuration, the extra effort in integration, all of those are very important to reducing the cost of ownership, and therefore, to our value proposition.

And then following up, digging a little deeper on the newer products.

You talked about the digital enterprise-wide license at Nationwide.

Can you just give us a sense for how big those deals are, whether it's relative to some of the InsuranceSuite products, or just how we can think about that in terms of maybe direct written premium cost there?

We have to be careful about getting specific on the pricing by individual product, in part because we think that that -- we're dealing with still small numbers at this stage.

The pricing has evolved, and we expect to continue to evolve it as the products mature.

And we're still developing proof points in different market segments that will be important to motivating a higher capture rate on the value created.

But as we commented, the newer products, both portals and the data products, are now in aggregate contributing a meaningful portion of our bookings, and helping our growth rate, which is exactly as planned.

And the deals with some of our larger customers, among them Nationwide, are comparing meaningfully to licenses of InsuranceSuite applications.

Great.

Thank you.

One thing I would add is that the Nationwide transaction is a little bit unique in that Nationwide will be licensing all of our portals as they develop.

And therefore, we will be recognizing that license rateably.

So you're not seeing a significant impact from that license in this quarter on a revenue basis.

All right.

Got it.

Thank you.

Next we'll hear from Ken Wong with Citi.

Sorry, guys.

Looked like I was on mute.

Marcus, you talked about the State Farm deal going live, and that seems like a lot quicker than -- Marcus, you talked about the State Farm deal going live and that seemed like a lot quicker than I would have expected for such a big customer.

Was this due to the simplification of processes that you talked about?

Or is it just something specific to this particular project?

It's important to note that our relationship with State Farm to date is confined to their business lines insurance, which is pretty meaningful at about $4 billion in premiums.

But still, obviously, that's a very small fraction of the entire State Farm premium base, which is many multiples of that.

So we're dealing with a relatively small segment percentage wise of the total State Farm book of business.

It was a rapid project.

And I think that that reflects both strong program execution on the customer side and our side, as well as a heightened emphasis that you're going to see from us across all projects to drive to a very highly conformed project.

Namely an implementation that hues quite closely to the base capabilities of the system, and that becomes more and more possible and appealing as the applications now are quite mature and are getting more mature and have more and more base content already built into them.

But it is important to note also that this is only the first of their commercial lines that have gone live right now, and there are multiple lines still to go, as well as a deployment to their very significant nationwide operation.

So we have a long way to go before it's mission accomplished, even on the current scope of the project that we have with them.

Got you.

That's super helpful.

Richard, earlier you mentioned you've got some license transactions in terms of from timing-wise that came forward into this quarter.

That sounds like it was specific to this particular year, so some back half deals.

But anything that perhaps was pulled forward from next year?

No, nothing that far out.

I will say that in any particular quarter, we're going to see a little bit of flux between deals that are appearing in the pipeline in the quarter that we have to delay, or the deals that come in a little bit faster than we anticipate.

I think in this quarter, we had both phenomena happening at the same time.

But I will say that the net advantage to us in this quarter was that more dollar of deals came in this quarter than we anticipated, but nothing as far out as next year.

And then anything specific that you might call out that caused that?

Was it just customers trying to get ahead of perhaps the budgets being closed off, or anything of that nature?

Is it just this happens from time to time?

No systematic pattern that I would call out.

I think -- well, I would like to believe that we become steadily more competent at motivating an efficient sales cycle, but I may be retracting that in another future quarter when things don't go that way.

But it was a quarter of good sales execution.

Not just in the overall result, but I think in the efficiency of close and the accuracy of forecast.

So I feel -- we feel quite positive about that.

Got you.

And the last thing for me, in terms of the hiring pace that you guys are seeing, a couple quarters now where you guys haven't quite I guess filled the pipe like you guys would hope.

Is that something that you guys worry about in terms of trying to acquire the necessary talent to grow like you guys want?

Is that something that you feel like you can ramp up on later?

No concerns on that front.

With any hiring engine, there's a little bit of a warmup period and then a lag effect between when you want to hire and when you have the recruiting engine humming.

In our case also, we've been directing more of the development hiring, or as much as possible really to our new international location in the ones we've talked about in Dublin and in Krakow, Poland.

But we feel very confident that we're going to converge closely on the exit rate that we had hoped for, or the exit head count.

Maybe down a little bit from it, but pretty close to it.

No concerns on that.

And you did see a significant improvement between Q1 and Q2, where we actually came very close to planning Q2.

Okay.

Fantastic.

Thanks.

That's it for me, guys.

Thank you.

Next we'll hear from Justin Furby with William Blair & Company.

Thanks for taking the questions, and than you for another stunning quarter.

Marcus, can you just give us an update on the macro as you see it today?

Are you seeing any signs out there that insurers are getting nervous at all about the market [tickering] the year up?

And what kind of downturn would we need to see where you think your view of 20% type term license growth over the medium term could be meaningfully at risk?

Or do you think that the secular shifts that you're seeing out there would outweigh any potential incremental macros?

Then we've got a couple follow-ups.

Thanks.

Sure.

As we've always emphasized and as you know, Justin, our growth rate isn't pegged to the growth of the industry as a whole, but to this pent-up demand for technology-driven transformation and so forth.

And that's only loosely coupled with the overall macro environment.

One of the strengths or I guess or weaknesses of the industry is that it is not in lock step with the rest of the macro world.

And that's -- we've taken some comfort from that, especially during the global financial crisis and so forth, which were relatively modest events from our perspective.

So it has not made a difference in any way, and the dialogue that we have with our customers really at every level is about their strategic imperatives, and these other tectonic changes that are happening in the industry that we've talked about at analyst day and elsewhere.

The digital engagement, the potential impact of sophisticated predictive analytics and the like, and these are really the catalysts for investment.

Sometimes there can be an exogenous event like a big catastrophe that really distracts an organization or imposes a big hit.

That could make a difference.

But it's actually been a pretty benign year, catastrophe and weather-wise, and hasn't been anything like that we've seen on the horizon either.

Europe is a somewhat different matter.

It's a sluggish macro environment, as you know well.

And there's certain geographies, like France, like the [pedoc] region overall that don't feel that energetic or that optimistic about their -- the prospects for growth, and therefore, are more reticent to invest in their platform, even though they generally agree with our thesis that that's a necessity.

It's just harder to get it motivated.

So if there's a place where we're seeing a macro impact, it's in Europe.

But that's a multi-year story, not something that's happened in the last few months.

Okay.

So nothing really incrementally changing quarter over quarter, it sounds like then.

Certainly not.

Okay.

That's helpful.

And then it seems like you continue to see really nice traction with digital and data and newer initiatives.

Can you just give a sense for how meaningful this is in terms of a percentage from new bookings, is it 10%, 15%, 20%, just somewhere in there?

Marcus, does that potentially change your view as you start to see more success here of the 20% term license growth?

Could it be something higher, or is it just increased confidence into that number?

Without getting too precise about it, the newer products are contributed in the quarter something like 20% to 25% of bookings, which was outstanding.

We were pleased by that.

But it's important that every system in the engine fires here so that we're winning new customers, that we're selling ClaimCenter, we're selling PolicyCenter, and that we're showing that we put the newer products are compelling to existing customers, to new customers.

All of those are important because our ambition is pretty straightforward.

We just want to be the total operating platform for every insurer, and every component is important.

In terms of accelerating our growth rate, we expect newer products are a component of that.

It would be premature to say that the strong uptick that we've seen in the last two, three quarters for newer products changes our view on the longer-term growth rate.

That would be definitely premature.

But one place that it's definitely bolstered our confidence is the ability to bring new products to bear, and cross sell compellingly to our customers.

Because if you have your core operating system running on Guidewire, it becomes a very logical, natural choice to do a lot of other things that are ancillary to that.

And if we can provide a compelling value proposition, native integration, increasingly rapid implementation for all those, I think we'll be very well situated to serve our customers on a much broader platform than we do even today.

Got it.

And then lastly, just, Richard, going back to the upcoming rev rec changes.

As you go through and you shorten duration and assuming you're able to work through your base over the next few years and we go into FY18, do the revenue and the cash flow dynamics then still effectively look like they do today in that environment?

Or what effectively changes?

As we look at our models right now and we look at the kind of work we anticipate being able to accomplish over the next couple of years, you will actually see very little difference in terms of our top line growth rate or the contribution between the different line items on the top line, if that's your question.

So we don't foresee a significant difference both in the visibility of our revenue and in the growth of our revenue.

Yes, and I was referring specifically once you get to FY18 and beyond.

Right.

No, and that's exactly right.

Okay.

I think one of the reasons we're starting so early is because by the time we get there, we will have remediated anything we need to remediate in order to ensure that you don't see any big hiccups in how we recognize revenue.

Got it.

The main consequence, Justin, just to make sure this isn't lost, is that we will have shorter contract terms than has been our historical norm.

And that we should think that that's in a sense a non event.

Because as you well know, you know about our renewal rates and our expectations and our customers' expectation to use the software for a very long time, really indefinitely.

But the underlying contract form will entail a shorter license term.

And in a way, that's an unfortunate consequence of the accounting standard, but it's the only sensible thing to do.

That makes sense.

I'm not at all worried about short duration.

You renew everything in sight, it's more does the revenue change and it sounds like it doesn't.

So thank you.

And thank you for doing that early so it doesn't become a nightmare over time.

Thanks, Justin.

Next we'll hear from Alex Zukin with Stephens.

Hey, guys.

Thanks for taking my questions, and congratulations on the quarter.

Marcus, you mentioned the solid pace of sales cycles.

I guess one of my questions is do you think it is being influenced by the amount of the tier 1 wins that you had over the last couple of quarters?

Are you starting to see those flood gates open?

Are those conversations becoming a little bit easier to have?

Then I've got a couple of follow ups for Richard.

Yes, I think that certainly having certain household names as recent customer wins is very helpful in that it elevates the stature of the Company.

I imagine this is true of every industry, but CEOs and decision makers within insurers are intensely curious about what their peers are doing, and they look to their example as really positive indicators of technology is ready for prime time potentially in their own environments.

So yes, that's helpful.

But it's also important to note that the industry we serve is really heterogeneous.

And different segments, different sizes, different lines of business, and obviously different geographies have different peer groups.

And winning a very significant name like a State Farm or Farmers or The Hartford or Nationwide is extremely meaningful to one important segment of the market, and almost irrelevant to other segments that we aspire to serve.

So it's -- and nothing would be worse than arrogantly assuming that well we've earned these customers selection, therefore we're entitled to yours.

We really find that we have to earn it each time in every segment, and there are many segments that we serve.

So we care about all of them, and some of the, particularly some of the smaller insurers with less DWP, have a different set of strategic goals and it's important to establish proof points in those segments -- as important there as with the more recognizable household names.

Got it.

And then one more question about sales cycles.

Are you seeing that you're starting more and more conversations now with the digital front office products from the prior year?

And is that, in some cases, actually starting to pull the rest of the InsuranceSuite forward for you?

Yes, that's an astute question.

Digital transformation, digital engagement is a major catalyst for IT investment in the industry.

As I mentioned, it is for other industries.

And in many cases, the underlying motivation for core system replacement is to have an operational platform that will support a digital ambition.

It's not to say that the core system replacement is incidental or just a necessary evil.

It's just that the digital imperative is the activator finally for institutional action.

And that's very helpful.

So it's -- digital is a word that probably never came up in our sales cycle five years ago, and now it's very rare to have a meeting with any customer or prospect in which we're not talking a lot about digital.

Got it.

That's helpful.

Then, Richard, when I look at the term license beat, it's I think one of the biggest that you guys have had in the last couple years.

Is there any way to quantify the magnitude of that early recognition of some of the license revenue from later in the year in the quarter, in terms of just the quarterly benefit that you got?

It's actually hard to do so, Alex, simply because there are a lot of moving pieces, and that would require me to make some judgments on the fly which I'm uncomfortable making.

But I would say that at least half of the upside was driven by that kind of dynamic.

Perfect.

And then just squeeze one more in here for Richard.

You mentioned that the incremental perpetual revenue, perpetual licenses in second half was going to be higher than the first half.

I'm trying to figure out what kind of impact, without specifically guiding for it, what kind of impact are you baking in in the guidance for license revenue from that incremental uptick in perpetual in the second half?

So when I say I have no ability to guide you at the moment, I mean that.

And what I mean by that is when I look at the pipeline and I look at the number of transactions that are coming from areas of the world or from customers that we've already engaged with on a perpetual license basis, I have to probability weight those.

I don't know how those will ultimately end up.

And we are always pushing to even drive current customers that are under a perpetual scheme to transition to term, right.

So I don't want to handicap that.

All I know is that in the first half, I've only had effectively $400,000 worth of perpetual license.

And I know for a fact that that is simply not a rate that I can sustain over the next two quarters.

So does that mean that it's upside to the guide, or is that baked in?

So I think we always think about a range of perpetual that we think is within the ambit of the probable as we look out for our guidance during the year.

But we are not so scientific as to say, well if that comes in perpetual, I'm going to be able do this with my term.

All we are willing to do, all we can do, is simply suggest that we have a goal that we think we can meet, which is to improve our term license by 20% or more.

Obviously, that becomes more difficult if some of those term licenses transition to perpetual, but we don't think that that's going to happen.

So we continue to maintain that 20% goal.

Perfect.

Thank you, guys, for taking my questions.

Thanks, Alex.

Next we'll hear from Nandan Amladi with Deutsche Bank.

Hello, good afternoon.

Thanks for taking my question.

So this is kind of a big picture financial model question that relates back to the analyst day.

Marcus, you mentioned that maybe 20%, 25% of your new bookings came from these digital products and data products, which are sold on a rateable basis.

And then of course some of the hosting options may have an impact on your margins, as some of your Partners maybe host in AWS or Azure or what have you.

So assuming that much of this was already factored into your long-term operating model that you gave us back in October, have any of the vectors changed meaningfully since then?

So may I jump in here, Nandan?

I know the question was addressed to Marcus, but I want to clarify something.

When we sell a Data Management license or when we complete a portal license, those licenses are treated the way we treat our InsuranceSuite sales.

That is, we have a term license and we recognize that revenue up front on an annual basis, or in some cases on a quarterly basis.

The product that we sell that is recognized on a rateable basis is live.

And we also have some transactions that are of a nature like the Nationwide portal transaction in which we will recognize that rateably.

We have those in the base.

So I just wanted to clarify that the new products are not necessarily rateable per se.

And in terms of the big picture you're asking about, Nandan.

I would say that the newer products -- the main impact they have on our big picture thinking is about really TAM extension, the opportunity to have a higher basis points on premium capture with our customers.

Because we are more relevant to a broader swath of what they are trying to achieve strategically.

And then possibly there's an impact on sales efficiency, because what we're finding is -- and this is totally intuitive, that once you have a well established customer relationship and some real proof points of delivery under your belt, that the next sale becomes a lot more straightforward and efficient than that first sale was.

And so as a larger proportion of our bookings can come from newer products, then perhaps it's reasonable to expect a more sales efficient and more rapid rate of distribution on those.

But in terms of the underlying margin characteristics of that software, Richard is right.

It's very much the same kind of model so far, and it's still quite a few years away before a large enough percentage of our customer base and even new customers will be coming in a rateable cloud native SaaS form that will really change our model.

And obviously we'll give you lots of -- there will be lots of opportunity for discussion with you and the investment community about how that will look.

Okay.

Thank you.

That's all for me.

Thanks, Nandan.

We'll now hear from Brent Thill with UBS.

Thanks.

Marcus, it's pretty clear the success you're having in tier 1, tier 2. When you look at tier 3, tier 4, I think you've been pretty clear the economic opportunity there is big in each of the categories.

I'm just curious what you're seeing as you go downstream, and from an economic perspective, is the downstream in your opinion just as profitable as what you're seeing upstream?

Yes, it's potentially more profitable if we get it right.

Yes, there is a material investment in sales for ultimately a smaller ticket, but if we can get that repeatable and have highly standardized implementations, which those segments of the market absolutely want, then we can serve it very efficiently and profitably indeed.

It is a segment that we have the most work to do in, the smaller the insurer, the more work we have to do.

It's one of the reasons in our prepared remarks, we called out the fact that we had quite a few tier 3 and tier 4 customers, new names this quarter, which is very encouraging.

For us, it's not all about just the big household names.

We're here to serve the whole industry.

And they are a substantial part of our TAM, as we've talked about before.

But we have more homework to do.

We have to build more base content.

We have to continue to pull in our deployment time lines, lower the cost of implementation, have many more pre-built integrations.

There's a pretty clear agenda that we have to achieve to drive down that cost of ownership, so that we're an industry standard for the hundreds and hundreds of smaller insurers out there.

We know that on a per name basis that we can get substantially more basis points on premiums in that segment, but we have to earn it.

There's more work to be done here.

Thanks.

And Richard, the operating margin was obviously well ahead of what anyone had expected.

When you look at your long-term target of high 20%s, it sounds like you don't expect this to carry forward.

There were some anomalies maybe in this quarter, but maybe just walk through how you're still framing that high 20% op margin versus what you posted here this quarter, which was close to the mid-20%s.

So if you look at our operating margins on a quarter-by-quarter basis, you're going to see a lot of volatility, simply because of the seasonal nature of our top line.

Obviously, we had a very good quarter from a profitability perspective, and that was really caused by two things.

One is the license beat, which flows all the way down to that bottom line.

And two, we had a little bit of delayed hiring and delayed project starts that didn't hit the expense lines on the operating side, which caused operating margins and operating profitability to grow.

Now, one of the things we've done as we kind of started the year and we've looked at how the year has progressed, we have raised our operating margin and now we're sitting somewhere in the middle of the range at around 18%.

So 2 points higher than we thought we would be at the beginning of the year.

My sense is that that's a good place to think about both operating income and cash flow during the year.

And as we look forward after this year, it is our goal not to come down from wherever we end up and to continue to straight line that path as closely as we can to that high 20%s in year five that I suggested at the analyst day is well within our reach.

Great.

Thank you.

Thanks.

Next we'll hear from Brendan Barnicle with Pacific Crest Securities.

Thanks so much.

Marcus, as we look at the increased adoption that you guys are seeing amongst tier 1s and throughout the other tiers as well, where is the point at which companies are at a competitive disadvantage if they have not upgraded their systems to a system like yours or started to incorporate digital and have that digital strategy?

Well, we think every insurer has to have a digital strategy.

That's not a novel concept on our part.

We don't have to evangelize that notion, it's the industry that's telling us that.

Now, it matters a lot what segment of insurance you're operating in.

Some are more exposed to those winds of change than others.

If you're selling highly specialized commercial insurance, maritime insurance, et cetera, then the digital dimension doesn't matter so much.

If you're selling largely commoditized personalized insurance to millennials, well then it's nonsensical to think that you'll succeed without a very sophisticated digital strategy.

So insurers are differently situated on that spectrum.

But in terms of their competitiveness, it's not only about digital.

It's the underlying economic fitness matters a lot.

And even though it's a more prosaic value proposition than the one we started the Company with, I think it's as relevant as ever that pulling a few points or a few hundred basis points of operating profitability out of a more efficient underwriting and claims operation is massively important to an insurer.

Because that means you can plow that back into more competitive pricing.

It's better customer service, and therefore higher retention, et cetera.

So it's been our argument for a very long time that any insurer that's still stuck on a legacy core system platform, no matter how well managed they are, that is running a race with carrying a rock.

And it's a question of how heavy that rock is, it's heavier in some market segments than others.

And then I guess as a follow-up to that, is you've penetrated more and more of the property and casualty.

Are you at a point now where you're starting to explore maybe life or some of the other categories that you've not been in historically?

Yes.

We have aspirations, but it would -- we're pretty careful about not mentioning anything to the market until we're in a place -- at least ready to start engaging customers in an early adopter mode, and let alone in any kind of more general market appeal.

And we're pretty far from that point.

We have a lot of unfinished work here to get to the completeness of our products so that we can serve all of the P&C segments that we serve.

But at a technology level, at a go-to-market level, I think there are very compelling reasons why we ought to explore the most adjacent markets, and by far the most adjacent one to us would be life and annuities.

But it would be very premature to talk about anything we're doing there yet.

Terrific.

Then lastly for Richard, Richard, how should we be thinking about CapEx for 2016 or for the remainder of the year and into next year?

I think as we look at our capital investments this year, driven in part by new a data center that we have been working on bringing live, you should think about $6 million to $8 million of CapEx, and maybe trending a little bit on the higher end of that.

That's what we see.

And if you think free cash flow for the year, I think when I think free cash flow, I'm thinking somewhere between $65 million to $75 million is the right target for us to reach.

Great.

Thank you both.

Thank you.

Sterling Auty with JPMorgan has our next question.

Sterling, you're on mute, I believe.

Hello?

Hello?

Hello.

This is Mena Comsur in for Sterling.

Sorry.

Just a quick question regarding the system integrators.

How long do you think it will be before the system integrators are ramped up to do the services on new products so that you guys will not have to keep up hiring to support that?

Right.

So we're already engaged with our primary systems integrator partners to train them on the newer products.

So we don't anticipate a prolonged period of elevated services involvement on our part.

It will probably be a shorter interval than, and a more modest increments than what we had to do with PolicyCenter.

But we're still relatively early in the product lifecycle for the newer offerings.

We have our own services team that has to become competent in those implementations, let alone our Partners.

And so it's definitely a heightened pressure on a -- or it's a source of heightened demand for Guidewire services for a little while.

But we expect it to be again, more modest and shorter lived than what we had to do with PolicyCenter, which was thematically what we had to talk a lot about soon after our IPO.

Thank you.

That will conclude our question-and-answer session.

I'll turn the conference over to Mr. Ryu for any additional closing comments.

No other comments.

Thank you for joining our call.

That does conclude today's conference.

Thank you for your participation.