Guidewire Software Inc (GWRE) 2016 Q4 法說會逐字稿

Good day and welcome to Guidewire's fourth-quarter and FY16 financial results 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.

Good afternoon and welcome to Guidewire Software's earnings conference call for the fourth quarter of FY16, which ended on July 31 of this year. My name is Richard Hart and I am the Chief Financial Officer of Guidewire. And with me on the call today 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, both of which are available on 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 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. 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. I will provide details on the fourth quarter of FY16 and for the full year and our outlook for Q1 and FY17.

Thanks, Richard. Revenue and profitability were above the high end of our outlook for the fourth quarter, with total revenue of $141.2 million and non-GAAP net income of $61.9 million. License revenue was $88.2 million, which -- with both term license and total license revenue increasing 20% from a year ago. Term license and maintenance revenue for the trailing 12 months totaled $268 million, an increase of 22% from a year ago and above our target growth of 20%.

This performance caps an important year for Guidewire, as we gained momentum in the marketplace, with the growing adoption of Guidewire's insurance platform. We introduced new versions of all our products, including the first cloud-ready release of our core product InsuranceSuite 9, and as of last week, welcomed new colleagues from two acquired companies who will help us expand our value position to P&C insurers.

This is a period of dramatic change for the industry, filled with both new threats and new opportunities. We talk to insurers aiming to develop and compete with disruptive new business models, to design new products to address emerging risks, to better leverage their existing data and incorporate new data to price risks more effectively, and to engage with our customers digitally, with intuitive applications matching today's ' expectations.

Guidewire's mission and opportunity is to provide the industry-standard operating platform for insurers to compete effectively in this dynamic landscape. Our continuing investments in research and development reflect this commitment.

In the fourth quarter, we began new relationships or expanded existing ones with insurers of all sizes in multiple countries. These insurers adopted components from across Guidewire's insurance platform, our transactional core systems, our data and analytics products, and our Digital Portals.

Our activity in the tier 1 segment of our market was noteworthy. We completed a follow-on license in the quarter to Farmers Insurance, who licensed ClaimCenter for their primary personal lines business, complementing their license of PolicyCenter for the same scope in the fourth quarter of last year.

We also expanded our relationship with additional PolicyCenter and data management licenses, for Insurance Australia Group, a tier 1 insurer and the largest domestic insurer in Australia, also active in New Zealand and Southeast Asia.

Finally, we initiated a relationship with Mapfre Insurance, a multinational tier 1 insurer domiciled in Spain, which selected InsuranceSuite and Digital Portals for a new US subsidiary called Cube Insurance. These transactions, when combined with enterprise sales to Nationwide of our digital and data products, and the license at the start of the year to MS&AD of Japan, continue to validate the confidence that very large insurers place in our software and our services personnel.

As we always emphasize, however, our mission is to enable insurers of all sizes to adapt and succeed. In the quarter, we welcomed two get new regional insurers to the InsuranceSuite family. Alberta Motor Association Insurance selected InsuranceSuite, DataHub, and InfoCenter for its personal and commercial lines. And Western National Mutual Group selected ClaimCenter for its personal, commercial, and workers' comp lines.

Outside of North America, we earned mandates from three new customers. Grupo Sancor Seguros, which operates in four countries in South America, selected InsuranceSuite, Digital Portals and data management. And [Ansi Contio] of Finland selected PolicyCenter, BillingCenter and Digital Portals. And in Japan, Nissan Fire and Marine selected ClaimCenter and Digital Portals.

As we noted in previous conference calls, sales of our data and digital projects grew faster than expected, accounting for approximately 25% of bookings in the fiscal year, excluding the impact of an enterprise-wide relationship that we have with Nationwide, which covers data and digital products. This growth confirmed the market's strong appetite for solutions that improve how they make decisions and how they interact with their channels and policyholders. It also represented the satisfying validation for our platform thesis and our multi-year development efforts.

Twelve customers chose Digital Portals and seven customers licensed one or more of our data products during the quarter. By the end of FY16, 59 customers licensed one or more of our data products, up from 31 at the end of 2015, and 53 customers licensed one or more of our Digital Portals, up from 27 at the end of FY15.

Of course, we continue to see sustained adoption of our core applications. We ended FY16 with 115 PolicyCenter customers, up from 95 a year ago; 200 ClaimCenter customers, up from 170; and 122 BillingCenter customers, up from 102 a year ago.

Net of acquisitions, we increased our customer counts in FY16 by more than in each of the last few years, and including the impact of EagleEye, we ended the year with 260 customers. Of these, 228 were Guidewire insurance platform customers, a net increase of 30 from FY15. EagleEye contributed an additional 23 customers. Not included in this figure are 14 customers into the acquisition of FirstBest, which closed last week. In the future, we will report customers of EagleEye and FirstBest on a combined basis with Guidewire insurance platform customers.

We also continued our track record of successful go lives in the quarter, with 10 core implementations completed in eight different countries. Of these 10, one is rather noteworthy, Metromile, a relatively new entrant, offering pay-per-mile car insurance, went live with a cloud deployment of ClaimCenter in under five months.

We don't expect most implementations to be nearly this fast, and Metromile likely benefited from not having a legacy system. But it's encouraging to see the early results from some of our efforts to reduce cost of ownership and implementation time. In total, we ended the year with 162 customers live on core InsuranceSuite products, or 71% of our customer base.

We also gauge our progress by the total direct written premiums we have under license for at least one of our core applications. This figure was up 18% to $342 billion from $289 billion at the end of FY15. We are encouraged by this progress and the considerable runway ahead of us to serve the $2 trillion industry.

This fiscal year was also characterized by an increase in strategic activity, motivated by the success of our digital and data products and our discussions with many insurers, in that we focused our efforts on new technologies that are industry specialized and directly address core competitiveness.

When we announced our combination with EagleEye, we discussed how embedding predictive analytics and transactional workflows can sharpen underwriting and claims positions. FirstBest directly improves the most important of these workflows for complex commercial insurers. Their underwriting management system applications is a collaborative environment that unifies many sources of risk-related information and standardizes and streamlines decision-making. While it naturally complements Guidewire PolicyCenter, it can operate with multiple third-party policy systems to improve the speed and profitability of their underwriting process.

Unlike the software we acquired with Millbrook in 2013, which required significant investment to bring to market effectively, the offerings of FirstBest and EagleEye are market-ready and can be licensed to insurers that have not yet licensed InsuranceSuite. Indeed, Texas Farm Bureau, a regional provider of personal and commercial lines, inaugurated its relationship with Guidewire through its license of Predictive Analytics this quarter.

Nevertheless, it's important to note that the full value and durability of these products will only be realized with the additional investments necessary to enhance their functionality and to integrate them into our platform. We expect to see greater sales traction once these milestones have been achieved, and we're confident that the returns generated from these investments will readily justify the increased near-term costs.

Our strategic initiatives are not limited to acquisitions. We have mentioned our work with a national branding insurer to develop and deploy for a significant greenfield effort: a cloud-based and digitally focused implementation of the Guidewire insurance platform. With this digital greenfield engagement, we are bringing to market a new and enhanced digital offering, developing competencies in cloud deployment, and for the first time as a Company, taking responsibility for post go-live production. We were mindful of the economic benefits to us of this high-growth greenfield initiative, given that the fees agreed to under this arrangement grow with our customers' direct written premium.

During the quarter, we agreed to expand the scope of this project by adding another line of business. While our primary motivation was to accommodate our clients' desire to accelerate its time to market, the addition of a new line of business will likely accelerate the growth in DWP.

This decision required careful consideration, however, in light of the increased resources required. Unlike our traditional implementations, which are staffed primary by our SI partners, with a modest complement of our personnel, Guidewire is leading this effort. Allocating our services personnel to this project created modest capacity constraints in the fourth quarter and we hired aggressively in the second half of the year to avoid capacity issues and to meet future demands.

We anticipate going live with the first line of business during the latter part of FY17. This date is important because, as Richard will explain, recognition of all revenues, licensed, maintenance, and services, for this project, will be deferred until we have delivered the first line of business and recognized ratably thereafter.

Turning to development, I want to underscore that the latest release of the Guidewire insurance platform in June represents a major advancement with new capabilities, including our core InsuranceSuite 9, DataHub 9, InfoCenter 9 and Digital Portals 5. Perhaps most significant is that our latest release is architected to offer insurers a choice of deployment options, both on premises and in the cloud on public infrastructure. We believe this hybrid architecture will enable those insurers who wish to migrate to the cloud to do so at their own pace.

Our development efforts continue to receive distinctive recognition. For instance, we're gratified in June that Gartner positioned Guidewire as the sole leader in their Magic Quadrant report for P&C claims systems.

To reiterate, we serve a very large global industry that's in the early days of a major transition to a more digitally competitive future. Our ambition and commitment is to deliver an industry standard operating platform that fully replaces the legacy generation of core systems, enables deeper analytic insights from data, and provides compelling digital experiences for agents and policyholders.

Of the many tasks that Guidewire must undertake to earn that industry standard in premature, three come to the [floor] for FY17. First, achieving stronger market adoption in EMEA, especially in the large markets of continental Europe, which are underrepresented for both Guidewire and ensuring software overall. Second, achieving state-of-the-art breadth and technical quality for our product platform, which now includes the offerings of two acquisitions to be integrated. And third, after a year of approximately 10% gains in project efficiency, to make further strides in our long-term quest to drive down customer TCO.

This entails both work on product completeness and in developing strong competencies in deploying and managing production customers in the cloud. These all require investment and considerable effort motivated by the rewards of accelerating market adoption and industry standard stature. I now turn the call over to Richard to review our results and to provide our financial outlook for FY17.

Thank you, Marcus. As Marcus indicated, we exceeded our guidance for fourth-quarter revenue and earnings. Total revenue in the quarter was $141.2 million, with license revenue of $88.2 million. Within license revenue for the quarter, term license revenue was $82.5 million, an increase of 20% from a year ago.

Our quarterly results benefited from an early payment of approximately $2.7 million, which contributed to revenue and earnings upside. Under our model, we recognize revenue under the earlier of due date or payment receipt. Sometimes, customers remit payments early and these payments cannot be anticipated. A sizable payment of this kind can modestly increase growth and profitability metrics in the current period and lower them in subsequent periods, to which the guidance I will review for the first quarter and for FY17 is impacted by this lack of revenue.

Perpetual license revenue was $5.7 million in the quarter, reflecting anticipated increase in perpetual licenses in the second half of the year. As we have noted, a limited number of transactions in any quarter or year can result in this level of perpetual license. Nevertheless, the term license model remains the predominant way we license our software.

Maintenance revenue was $17 million for the fourth quarter, up 29% from a year ago and above our guidance range. Maintenance revenue benefited in part from the recognition of approximately $0.9 million of revenue that we had not being able to recognize previously in FY16 due to certain contractual provisions.

Service revenue was $36 million, a decrease of 9% from a year ago. The result was slightly below our guidance range due to the delay of several projects, and to a lesser degree, capacity constraints in the Americas regions which developed and the second half of the year with the increasing scope of the digital greenfield effort that Marcus noted and for which no revenue was recognized. We anticipate that services revenue will return to growth in the next fiscal year.

For the fiscal year, total revenue was $424.4 million, of which license revenue totaled $219.8 million, above our guidance range of $211 million to $215 million. Within license revenue, term license revenue was $208.4 million, up 23% from FY15, and perpetual license revenue increased 15% to $11.3 million. Adjusted for the effect of the early payment I've described, term licenses grew 21% year over year.

Maintenance revenue grew to $59.9 million in FY16, up 20% year over year, above our original expectations largely due to the benefits of a more front-end weighted year than we typically experience. Recurring revenue comprising term license and maintenance revenue totaled $268.4 million in FY16, up 22% from a year ago.

Service revenue was $144.8 million in FY16, down 4% from FY15. The year-on-year decline is the natural result of the partner engagement model we adopted approximately three years ago, that has increasingly levered our SI partners for customer implementations.

As a result, service revenues declined from 45% of total revenue in FY14 to 40% of revenue in FY15 and further to 34% of total revenue in FY16. The rate of this decline will moderate this year and will likely maintain a more moderate rate going forward, particularly as we begin to recognize in FY18 a sizable portion of previously deferred services revenues. Geographically, the US represented 55% and 54% of revenue in the fourth quarter and for the full year, substantially similar to FY15.

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

Non-GAAP gross profit in the fourth quarter was $104.1 million, an increase of 14% on a year-over-year basis, and represented a non-GAAP gross margin of 73.7%, an increase from 72.3% in the year-ago quarter. Breaking that down, non-GAAP gross margin for license was 98.4%, maintenance was 82.2%, and services was 9.2%.

Services margin in the fourth quarter is typically impacted by the attainment of bonus targets. Services margins in this quarter was additionally impacted by the significant hiring and training in the third and fourth quarters, as we mitigated capacity constraints to prepare for the expansion of work for our digital greenfield customer, as well as lower utilization due to the delay of certain projects.

Total non-GAAP operating expenses were $61.4 million in the fourth quarter, an increase of 14% compared to a year ago. This resulted in non-GAAP operating income of $42.7 million, above the high end of our guidance range, and represented a non-GAAP operating margin of 30.3%.

This strong margin performance was primarily the result of higher-than-expected revenue, including the $2.7 million early payment, which carried no associated costs, which I previously mentioned. With non-GAAP operating income above expectations, non-GAAP net income of $28.7 million, or $0.39 per diluted share, was also above the top end of our guidance range.

Looking at profitability for the year, non-GAAP gross margin was 69.4%, up from 66% in FY15, primarily due to the increase in license and maintenance as a percentage of total revenue, offset modestly by lower services and maintenance margins. Non-GAAP operating income was $84.9 million, up 22% from a year ago, resulting in non-GAAP operating margin of 20%, considerably better than our expectations at the beginning of the 15% to 17% we enunciated at the beginning of the year.

During the year, we added 195 employees, of which 58 were in research and development, 29 in sales and marketing, and 73 associated with our professional services organization. Growth in our R&D organization was lower than we forecast, as hiring the sluggish in the first half. A substantial portion of the growth in our services organization is driven by hires in the second half, as 64 service professionals were added out of total of 73 in the year, to ease capacity issues which began to emerge in the Americas, and to a lesser degree, which we anticipated in APAC.

This does not represent the change in our partnership strategy. Indeed, we look forward to continuing our mutually beneficial activities as our SI partners are trained in our newer products and establish a greater presence in certain international markets.

Our increased pace of hiring in the second half was also due to our decision to expand our work with our digital greenfield customer to a second line of business. We anticipate this new work stream to start this quarter.

Turning now to our balance sheet, we ended the year with $735.8 million in cash, cash equivalents, and investments, up from $680.8 million at the end of the third quarter, primarily due to $49.3 million in operating cash flow in the quarter. In FY16, we generated free cash flow of $92.8 million, an increase of 62% from FY15 and above the high end of expectations that we outlined last quarter. This increase was primarily attributable to high collections in the period.

Total deferred revenue was $70 million at the end of the fourth quarter, increasing from $68.3 million of the end of the third 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.

In FY17, however, there will be a new and notable element to deferred revenue as a result of the significant activities we mentioned with our digital greenfield customer. We currently estimate that deferred revenues attributable to this engagement will improve to $20 million to $25 million prior to commencing the recognition of these revenues.

This estimate is based on our assumptions regarding when the project is complete and the time frame over which these deferred amounts will be ratably recognized. These estimates may change.

Now, I'd like to turn to our outlook. As you may expect, we have refined and updated our expectations for FY17 from the general guidance we offered during our last call. For FY17, we anticipate total revenue to be in a range of $471.5 million to $483.5 million, representing an increase of 11% to 14% over FY16 at the midpoint. We expect FY17 to return to more typical seasonality patterns, with the first quarter and third quarter being low compared to the second and fourth quarters.

Within revenue we anticipate that license revenue will be in the range of $252 million to $262 million, an increase of 15% to 19% from FY16. Revenue from our two recent acquisitions are only expected to contribute $4 million to $6 million in aggregate license revenue due to purchase accounting reductions in deferred revenue balances and the fact that revenue from new sales will either be deferred until contract completion or recognized ratably or a combination thereof.

As we look at the year, we note that our pipeline is biased toward larger transactions. The size, timing, and structure of large transactions is somewhat harder to predict, which recommends a slightly more conservative approach to developing our expectations. Nevertheless, we continue to target term license growth of 20%.

We currently anticipate perpetual license revenue for FY17 to be roughly in line with FY16 on a dollar basis. We expect maintenance revenue to be in the range of $65 million to $68 million, representing an increase of 8% to 13%. The more modest growth of maintenance revenues reflects the benefit of a more front-loaded FY16 and the return to more normal back-end weighted seasonality which we expect this year.

We expect services revenue to be in the range of $150 million to $158 million, an increase of 4% to 9% from FY16. This estimate only includes the recognition of a small portion of the services we will deliver to our digital greenfield customer over the year. We continue to expect services revenue to grow more modestly than license revenues over time.

The impact of several decisions we've made since our last call will have the effect of lowering our gross margins, and consequently, our operating margins this year. As Marcus mentioned, we carefully deliberated before expanding the scope of our digital greenfield engagement to a second line of business. In part, our caution was due to the margin impact of this engagement.

While we are invoicing and receiving payment for this work, the deferral of associated revenues will be accompanied only by the deferral of direct costs. When combined with the additional costs needed to hire and train the personnel that must be added to accommodate this increased need, services margins will decline.

This engagement has also required an investment in scalable cloud and production services operations, which will impact our license and services margins. Notably, our outlook does not currently anticipate adding additional customers under this engagement model. We further anticipate that our two recent acquisitions will be moderately dilutive in the fiscal year, negative impacting gross and operating margins with a cumulative operating margin decline of up to 2% based on our current outlook, as the purchase accounting impact on deferred revenue, delayed revenue recognition on new sales in incremental R&D investments burden our operating margins.

Finally, in FY16, we instituted a program whereby employees outside the United States will see an increasing portion of long-term compensation in cash and not stock. While this will reduce the growth of our overall stock-based compensation expenses, we expect it to negatively impact our non-GAAP operating margins by approximately 0.5 of a percentage point in FY17.

While we don't normally provide a view of gross margin, we thought it would be helpful in this instance to provide perspective on the cumulative effect on these factors. Based on our current outlook, relative to FY16, license margins will decline by approximately 1 percentage point, maintenance margin trends already visible during the latter half of FY16 will also decline approximately 1 percentage point as we increase staffing to support additional products. Services margin is the most affected, and we expect services margins to decrease by approximately 6 percentage points. When combined, gross margin is impacted by approximately 2 percentage points.

As a result, we are estimating non-GAAP operating income to be in a range of $76 million to $88 million, resulting in full-year non-GAAP operating margin of approximately 17% at the midpoint. Though a decline from our FY16 out performance, we expect the recognition of deferred revenue and anticipated accretion from our two acquisitions to positively impact operating margins beyond FY17. We anticipate non-GAAP net income in the range of $52.2 million to $60.1 million, or $0.69 to $0.79 per diluted share, based on approximately 75.6 million diluted shares.

In addition to guidance metrics we are providing, we also believe it is worthwhile to share our views on cash flow for the fiscal year, while we may not anticipate -- though we do not anticipate providing cash-flow expectations on a quarterly basis. In FY17, we expect to generate free cash flow of between $70 million to $85 million. This is composed of anticipated operating cash flow of $78 million to $93 million less anticipated capital expenditures of approximately $8 million.

Looking at the first quarter of FY17, we anticipate total revenue to be in the range of $84.5 million to $88.5 million. Within revenue, we expect license revenue to be in the range of $35 million to $37 million, with more challenging compares due to early payments of approximately $2.7 million in the fourth quarter, which I have already mentioned. We anticipate maintenance revenue of $15 million to $16 million and services revenue of $34 million to $36 million.

For the first quarter, we anticipate non-GAAP operating loss of between $4 million to $8 million and a non-GAAP net loss of between $2.6 million and $5.3 million, or $0.04 to $0.07 per basic share, based on approximately 73.3 million basic shares. Note that operating results in the first quarter will be impacted by a change in the timing of our annual Connections conference, which occurred in the second quarter of FY16, and which adds approximately $2 million in cost to the first quarter.

Expenses associated with closing and operating FirstBest add approximately $3 million to the first quarter, and finally, it is important to note that the effect of the early payment I've discussed deprives us of that same amount in profitability in the quarter. We anticipate a GAAP tax rate of approximately 36% and an effective non-GAAP tax rate of 34% for both the first quarter and the fiscal year.

In summary, our strong performance during FY16 reflects the continued transformation of the industry that our platform facilitates. We believe the hybrid deployment capabilities of our latest release will help drive continued demand for InsuranceSuite, growing traction of our data and Digital Portal products, and opportunities for our new Predictive Analytics and underwriting management applications, the division that will enable insurers to thrive in this rapid kind of change. We are confident that we can extend our track record for profitable growth and extend our leadership position in FY17 and beyond. Operator, can you now open the call for questions?

Thank you.

(Operator Instructions)

Sterling Auty, JPMorgan.

Thanks, hi, guys. I actually got disconnected for a couple minutes there, so hopefully this wasn't already covered. But when you look at the pure public cloud implementation or version of the core platform, where is the interest level in the customer base coming from at the moment? Are you seeing it's the smaller customers that are interested in it or is it for smaller lines among some of your bigger customers? Or is it up and down the customer size list that you are seeing that interest level?

Sterling, I would say that there is a broad cross-section of interest. It's a topic that the CIO of any size insurance company wants to have a discussion about. And sometimes the discussion is not only about our software but our view on how they should think about their overall enterprise IT environment. So it's -- I think there's a broad level of interest across the industry, and I suspect you'd find the same in other industries.

In terms of the segment of the market that we expect the most rapid adoption or those who we expect to deploy InsuranceSuite 9 on public infrastructure, very early and we haven't even released all the aspects of IS 9 yet, but I think we would expect it to be probably smaller insurers or the greenfield subsidiaries of large insurers. But we could be surprised in that respect, and if so, we'll adapt accordingly.

And then my one follow-up, in terms of the investments that you're making here for this coming fiscal year, how should we characterize -- how much of that incremental investments (inaudible) other investments, whether be it be marketing, advertising, et cetera? And within the headcount, how should we think about the split of how much that is going to go into R&D versus other functions?

Sterling, it's Richard. I think as we look out to FY17, I think we're going to see more adds to R&D. In fact, this year, R&D adds were quite light because we delayed hiring primarily until the second half when the market was a little bit more ready. So I think we're going to continue to see hiring in R&D, and maybe in fact increase the actual headcount as we deploy more of those resources to our new polling center. Although, we will continue to hire in all of our locations.

We will continue to hire in services during the year as we seek to address -- continue to address some capacity constraints that crept into the system because of this large digital greenfield project that we've undertaken. And so you should expect to see hiring and services commensurate with the hiring that we made this year. We are also adding about 20 to 30 people in the sales and marketing organization [primarily to]p handle sales of new products. So we will be increasing quota-carrying capacity modestly, and we will also be adding our presales and sales consulting organizations.

Got it. Thank you.

Ken Wong, Citigroup

Hey guys, touching on this capacity greenfield project, so you mentioned $20 million to $25 million in deferred revenue. Any rough sense for how much of that would hit in Q4 when you said that this project probably goes live?

Yes, since we're looking up the project starting towards the latter half of FY17 and maybe in the fourth quarter, I think we're only currently modeling in the low single digits.

Sorry, a clarification there: the project has started. When the project will be going live. The initial go-live will be -- is expected in the second half of the year, probably closer to the fourth quarter. So it will be only a few months of ratable recognition of those deferred revenues.

Got you. And then on the gross margin impact, you mentioned -- just trying to circle back there, around 6 points on the services side. But should we expect that in Q1 that's going to hit meaningfully more so than in the back half of the year? And if so, can you give us some sense of what the margin might be in Q1?

I think you should expect it to hit linearly throughout the year. And unfortunately, the margin impact in any particular quarter can vary quite a bit, in part because of seasonality in the services line, whether due to holidays or due to summer vacation. So it's a little bit difficult for us to give you guidance on services margins for the quarter right now. But I think if you guide yourself through with the seasonal patterns that we've established, that will give you a sense as to where the impact will be felt. But the 6% applies to the total year.

Got it. And then, Marcus, it sounds like for FY17, you guys mentioned it's going to be maybe more big deal loaded. Would you say that -- again, it sounds like it's definitely more tier one. Is that just more a result of just customers finding their way onto the platform, just getting close to actually deploying on the platform, or is it just that you guys have engaged with more of these customers and we should be expecting longer sales cycles and things that could potentially fall to the back half of the year?

No. We wouldn't want to suggest there's a shift in the pace of deals getting done. I think you've heard from us over a whole series of calls the importance of the tier-one segment or the individual accounts within the tier-one segment the fact, that we have long-term -- in some cases, multi-year conversations going with them. And the way that it has affected our outlook for this current year is an overall pipeline that is, I would -- I think we'd say modestly tilted towards larger accounts, both net new and existing relationships.

And given that fact and our -- the traditional conservatism that we apply to the forecast in building a financial outlook for the year, there has definitely been a modest effect of that, given how early we are in the year right now.

Got it, and I forgot a follow-on, on that earlier greenfield project line of questioning. But you mentioned no other customers currently that you guys are working with. Is it fair to assume once you guys have that go live in the back half of the year that it's something that you could bring more people into? Basically, is that the threshold or can you guys introduce new customers right now into that particular project?

The first half of what you said, Ken, is absolutely the intention. We're building, as in all things we do, a standard product that we intend to license with as standard as possible commercial terms to as many insurers as possible.

There is a bit more collaboration with this particular customer and the accounting treatment of that evaluated some of the things that we are intending to do here as undelivered elements for this first project. But precisely the point is to build a market-leading offering that we can license repeatedly, and that is absolutely what our customer wants as well.

Okay. Fantastic. Thanks a lot, guys.

Justin Furby, William Blair & Company.

Thanks, guys. I wanted to first ask on seasonality. Marcus or Richard, can you remind us why last year was more balanced across quarters and why you expect more normal seasonality to return this year? I'm curious how you're guiding to the digital and data products this year. It seems like that probably was a positive surprise at 25% of bookings. If it comes in again at that level in FY17, would that be more upside or what is the guidance factor on those products? Then I've got a couple follow-ups.

Sure appreciate the question, Justin. So on the first question was about the linearity or seasonality of the year. I would love to understand why the year that we had -- that we just finished was more linear than usual. I think it was a modest statistical fluke, because certainly every other year we've had, including the ones when we were a private Company, had the classic enterprise software sales pattern of deal shifting toward the back half of the year no matter where in the calendar we had rotated our fiscal year. Last year was a bit anomalous in that respect, just because of a couple transactions.

Our outlook right now, here we are in the first month of -- or the second month of the fiscal year is that it's probably going to be more like the standard seasonal pattern, though there's always the chance of being surprised. Again, it only takes a few deals to make a big difference in that shape.

The second part of your question was about the competence -- the contribution of newer products to the bookings expectation for the year. We were positively surprised last year. I think that's because, well, first, there is a tailwind of demand for the themes that our newer products address, mainly data in digital.

Also our sales team, I think, found some real targets of opportunity on existing customers that were very satisfied with their platform or the InsuranceSuite investment they made, and saw a very logical expansion of the scope of their programs to include data and digital. And then we added a bit to that with some modest sales incentives that, in hindsight, were probably a bit more than necessary, all of which motivated more success in the newer products than we had originally expected.

Looking into this year, we don't think -- we don't expect any acceleration there. It could be something quite close to what we experienced last year. But it's important to keep in mind that the newer products are combined with an InsuranceSuite sale or are bundled with that. And so in a sense, it is a subset of the total addressable market that we have where we are aspiring to sell InsuranceSuite to lots of net new customers as well, and that's obviously not the case with the newer products.

Got it, that's helpful. And then, Richard, there were a lot of moving parts with guidance. Could you go back to the cash flow guidance? I thought you said high 60s, low 70s operating cash flow, and if I heard that right, that's a pretty big disconnect between your operating or your EBITDA guidance for FY17. So what -- did I hear that right and what drives the disconnect there?

Justin, please correct me, are you referring to my cash flow guidance for -- or perspective for FY17? If that's the case, I think you're understating that perspective. Because I think, as I was trying to find it again. I apologize, I had a lot to say today.

I was referring to FY17, Richard, just the operating cash flow guidance. I think I must --

So what I said was $70 million to $85.

$70 million to $85 million.

Right.

Okay. Sorry, is there anything to think about in terms of that versus your margin guidance and from a cash flow perspective versus last year and how it played out?

I think last year we did very, very well on collections, which led to an outsized performance on cash flow, operating and free cash flow. I think this year as we give guidance for the year, or give our perspective for the year, which is something we have not done in the past, we wanted to take a slightly more conservative view, simply because we can be whipsawed a little bit by the effects of working capital on that perspective.

Okay, got it. And then last question on the margins for this year, when you think out to what you laid out last year at your analyst day, the high 20% to 30% margin, five-year framework. It's now -- we're now four years from that, is there any change to that view? It would seem like you'd need a pretty big ramp exiting FY17 to get there. Are you rethinking that view as you start to get into some of these newer cloud investments? Thanks.

So the timing of those -- of any potential transition part of our licensing model can have an impact on margin. So that is difficult for us to control over a long period of time.

Having said that, I think if you look at the -- what we hope to be able to achieve from a pricing perspective for that particular type of engagement, I think the margin impact is actually quite modest when those projects actually come to full realization. So -- and when we can amortize the investments we've made in cloud operations and production services over multiple customers as opposed to just one.

And indeed, the margin impact this year naturally reverses a significant portion of itself, simply from the operation of the deferred revenue that comes in next year. So that deferred revenue actually carries with it a very healthy margin, and so as that deferred revenue flows through the year next year, you will simply see margins accreting almost to the same of it that they impacted this year for that particular engagement. So we are not moving away from our current commitment, and we will update the Street if we ever decide to do so.

Got it. Thanks very much, guys.

Nandan Amladi, Deutsche Bank.

Thank you. Good afternoon. The first question is on the mix of new versus upsell. You've launched a whole bunch of new products this past year. Version 9 now has different configurations you're going to deploy. And so has that changed, at least early indications on the mix between [you and upsell]?

Nandan, at Analyst Day, we were planning on talking a little bit about the mix between our land and expand strategies. Last year, is if you'll recall, we were slightly weighted towards land. This year, you will see the reverse, as a result of the fact that we were selling a lot of the new products to our installed base, as well as the fact that we were able to convert a couple of existing large clients with additional sales.

So I think the preliminary view of that kind of land-and-expand statistic is that we were 60% expand this year versus 40% land. So you need more in line with where we were in 2012 when we -- in 2013 when we expanded our licenses to Nationwide and The Hartford.

Great. And my second question, you probably have answered this already. The ramped deals, obviously those would count as upsell. So if you're shift -- seeing that shift, is that [explained] largely?

Yes, we haven't talked about it, but I think this year as we look through -- pass through the year, we note that the ramped transactions represent, on a percentage basis, about the same as they did last year as a percentage of sales. So we think that escalating payments and our license agreements, or at least a significant minority of those licenses, seem to be here to stay.

Great. Thank you.

Alex Zukin, Piper Jaffray.

Hi guys. Thanks for taking my question. So maybe I missed this in the prepared remarks or maybe just step back for a second, Marcus. Is there any chance you can maybe simplify or just introduce this digital greenfield product? What is the strategy? Is the domestic or international customer? Ultimately, why are you engaged in this arrangement in the first place and what is the payoff behind some of these investments that you've made? Then I have got a follow-up.

Sure, I am happy to give it a little more context. Out of respect for the customer and their own business intentions, you'll understand that we don't want to share their name specifically, but I think I can tell you it is a US customer, it's a large P&C player with -- that writes many different standard lines of P&C insurance.

Like other insurers, they feel both the pressures and the opportunities of this change in end-market behavior for new digital technologies, for new approaches to predictive analytics and the like. And they have the notion they can go to market, they want to go to market as rapidly and vigorously as possible with a new offering as unburdened as possible from their current state business with some other marketing approaches wrapped around that to try to make a splash in the market.

And that's -- we see that kind of innovation or that kind of intention expressed both by very long-standing, well-established insurers, as well as new entrants. It's very thematic for what we're seeing in the industry overall. And it's a trend that we think not only is inevitable but one we want to have a central role in enabling.

Everything that they are doing will be based on our platform. Some of the capabilities that they want are net new functionality to what we offer today, and there was an opportunity to collaborate with them in a really high-stakes market live context to get their advice and their input and prioritization as we put those features into the platform.

There was another very important dimension here in that they want to deploy as cloud-based as possible, and that is a -- it's a significant difference from really all of our other customers, with the exception of a few things on the margin that we've done with Guidewire Live and the like, in that we will be taking responsibility for their production. The production operations of their use of our software. And that involves new competencies that we really haven't developed in the Company up to this point, but are very much part of future that we expect.

So it was a combination of the opportunity to work with a significant brand-name insurer, doing some very innovatives on the Vanguard go-to market -- digitally native go-to-market approach, a chance to build our own cloud and application management capabilities alongside a really live and important customer. And then to do so with potential growth expansion potential under the right kind commercial framework that we hope to become more representative of how we serve customers in the future.

So there were many attractive aspects, and the only unfortunate aspect that gave us a lot of pause in figuring out how to do this was that the accounting treatment of it required a substantial deferral of really all the revenues associated with the deal. And we decided that given that substantively, we were getting all of the other things that we wanted, that we would -- it was worth taking on a deferral of revenues really within a one-year timeframe. Unfortunately, it spans the boundary of the fiscal year, as you see reflected in the guidance we've just given, to undertake this project and that's what we've done.

Marcus, was this an existing customer that was a policy customer with Guidewire that you extended the relationship with? Or was this a net new customer that engaged in -- that you've engaged in a completely new way?

It's the former. We had a relationship with their current state business, which is a more conventional-style project involving data conversion and integration into an existing enterprise IT environment and the like. This customer also, at the same time that that business will continue, wanted to take a greenfield approach to different market segments with a completely digital strategy. It's the same enterprise but, in a sense two different projects under that rubric. But there's a longer-term path of convergence. But at this stage of the project, it's really two different distinct efforts underway.

Got it, and then separately, last Q4 you guys signed a record I think five tier ones. Can you update -- you mentioned Farmers, I think, in the script as one where you expanded into ClaimCenter, in addition to the PolicyCenter that you signed at the time. Can you update us on the current penetration of the total potential licensing opportunities of those and how you're thinking about that in terms of the guidance for the next year?

Sure, just to reiterate what I said in the prepared remarks, there was also the International Australia Group, or IAG, which is the largest domestic insurer in Australia. They are a tier one by our definition. We had served them really with an acquired subsidiary out of New Zealand, and this relationship that we're starting with them is much more enterprise-wide for their core domestic business.

And then the other one I mentioned was Mapfre, which is a net new customer, new logo for us. Quite a large multinational and a continental Europe one, they're based in Spain, as well, and that's a new relationship.

To the other part of your question about expansion within some of the new tier ones that we signed, that absolutely happening, not exactly at the same pace in every relationship as you'd expect. But we've advanced dialogue with multiple of them and they comprise a meaningful portion of our outlook for this current fiscal year.

And then maybe, Richard, just a quick one on -- and you may have addressed this in the Q&A already, but the maintenance revenue, the sequential decline in maintenance revenue in Q1, that looks a little bit different. Is that because of some of the pull-in that you mentioned or is there some other dynamic we should take note of?

Yes, no, that's right. Unfortunately, every once in a while, we have catch-ups and true-ups that can modestly influence any particular quarter. In this particular case, in Q4, we benefited by about $900,000 of that kind of recognized maintenance set of payments that were being, in some cases were being made, in some cases the contract required us not to invoice until acceptance. But that those amounts were accruing. That is the primary effect from quarter to quarter.

On a year-over-year basis, the thing to be understood is that last year we benefited simply by a front-end loaded calendar of new deals. Therefore, we had more time to generate more maintenance revenue during the year, where as this year, we're going back to our more traditional seasonal pattern. In fact, if you look at Q1 and you actually adjust for the effect of the prepayment, Q1 is growing 11% year over year, which is much more in line with our traditional Q1 dynamic.

Thanks, guys. I'll jump back in the queue.

Tom Roderick, Stifel.

Hi gentlemen, good afternoon, thanks for taking my question. Marcus, can you just talk a little bit more about your current thinking about the go-to-market for your cloud-based offering, the version 9? And particularly, love to hear a little bit more about any incremental CapEx plans that has to be rolled into the model. And then beyond that, what kind of role can your global services partners take in deploying cloud as well? Thanks.

Sure. First, an important clarification that what we are releasing with InsuranceSuite 9 is a cloud deployment option. It's the -- you can take our software and run it in a production environment on public infrastructure, most obviously Amazon Web Services or Azure.

That does not permit us, in those deployments, for us to be the one taking production responsibility for the deployment. And it does not fundamentally change the nature or the division of labor that we have with our systems integrator partners. As you would expect, those partners are very enthusiastic to be involved in any project, whether it is deployed on promise or on public infrastructure, and we expect that will continue pretty much along the same trend that we've had before.

In terms of the capital requirements for InsuranceSuite 9, there really are none that attach to that specifically. Over time, as part of our functional roadmap, as we offer services that will be cloud native, we'd hope some aspects of the functionality that we intend to develop will be delivered as a cloud native service form. And there may be some modest CapEx that's associated with that development and how we characterize the investments to build those services versus our traditional software approach. But those are modest and don't really materially affect our outlook certainly for this year.

Got it, that's a helpful clarification. And then with all the success you've had in the last year around the digital portal business and seems like that will be set to continue going forward, can you provide a little bit of an update just around the ongoing traction with the Guidewire Live apps, this suite of apps you've got there and what existing partners are doing to continue to put some of their own data into Guidewire Live and how they've thinking about that these days?

We've evolved our go-to-market approach with Guidewire Live and the whole thesis about the way that predictive analytics and data visualization will be used by the industry. So it's been an immensely useful period of working with customers with it.

But I think we've concluded that with the initial hypothesis of how we would go to market with that functionality as a standalone almost separately branded category of products isn't the most effective. And that really what ensures [monetization] and that's and any kind of analytic insight that comes out of that data to be embedded with the core applications.

So we've taken the approach of incorporating that into the future sets of what we're doing with really InsuranceSuite itself. It's a good early example of what I just mentioned in response to your the question, Tom, about a cloud-native service that is delivered in hybrid form to a customer. And from the end users perspective, it's all the same, whether some aspects of the functionality are delivered on premise and some come from calling a cloud-based service.

So that's the approach that we're taking with live. The big push that we're making overall with our data initiative is a combination of the business -- conventional business intelligence but in a very insurance-specific form. And then the -- getting the most out of the predictive analytics acquisition that we made just a few months ago and applying predictive analytic intelligence to all the decisions and the insurance lifecycle.

We think there's enormous potential for that, and it's actually a catalyst even for core systems sales. And insurers recognize that that's -- it's essential to their competitiveness in the future.

That's great, thanks very much. Appreciate it.

(Operator Instructions)

Rishi Jaluria, JMP Securities.

Thank you for taking my questions. Just a quick one for you, Richard, on the cash flow guidance, coming back to that. With -- the cash flow guidance you gave was roughly in line with what you were giving in terms of guidance for non-GAAP operating income for the year. I was just trying to understand, because I know that dynamics affecting operating income include the deferrals of revenue related to this digital greenfield project, as well as the investment. I'm just wondering how that's -- why the cash flow would still be in line and still be declining, because it wouldn't be impacted as much by the deferral of revenues?

You're absolutely right in understanding that deferral of revenues will actually create a little bit of a schism between reported operating income and reported cash flows. If my cash flow guidance is modest, it's because I have seen over the last two years a very big swing in accounts receivable significantly affecting that line. If we are able to maintain DSOs where we are able to finish this year, I believe cash flows will be higher than what I have indicated. But I want to just take a conservative position on that.

Okay. Thank you very much.

Brent Thill, UBS.

Thanks. Richard, it has been four years historically where you were at 18% margins. You came in higher this year, broke the trend. Now you're guiding margins below what you've done in the last five years. I think everyone has -- I'm trying to make sure we digest this correctly. And if I -- I just want to make sure I got this correct.

The result of this is because of the new in the business. Secondarily, the return of larger deals which are lumpier; and then third, they increase in sales and marketing. Is there anything else to take into account, why that should trend down after it 's been starting to at least to trend back up after this year?

I think what I would suggest is this should be viewed as a somewhat temporary decline. That, as we've suggested, margins will come back into line next year as some of the accounting-related effects of our work with this digital greenfield customer hit us this year. But then, if as we hope, we start recognizing that deferred revenue next year, which brings along with it quite a healthy margin, you will see the benefits of that transition clearly in the next fiscal year.

In addition to that, one of the realities of our industry is that anybody that we acquire will likely not have the requisite ability to account for revenues in the way we account for revenues because they will miss one of the key important elements of having ESOE or standalone value or be able to recognize revenue as we do when we sell the software. So as a result, one of the challenges we face is that we are funding a set of sales opportunities for the two new acquired transactions in a way that we don't benefit from until we establish the SOE or until the deferred revenue write-downs that we experience in the first year for those revenues that are ratable come back in year two.

Those are the two big things you're going to see impacting margins. What you will not see impacting margins is any significant increase as a percentage of revenue of expense in sales and marketing or R&D. Those expenses will be in line pretty much from year-over-year, on a year-over-year basis.

Thank you.

Brad Sills, Bank of America Merrill Lynch.

Hey guys, thanks. Not to beat a dead horse too much, but on the digital greenfield investment that you're making, it's a new line of business but it's commissioned by a single customer. How do you envision the long term for that business? Is this potentially the size of your data business over time? Is it applicable to the broader install base, given that it's commissioned by a single customer, what gives you the confidence that this is something that you view as applicable to the wider market in your install base? Thank you.

Yes, Brad. I think I may have contributed to a misunderstanding in my prepared remarks about the line of business. This is not a new line of business for Guidewire; these are new capabilities for our core platform that we intend to sell to the entirety of our market.

What -- the new line of business we refer to is for our customer who expanded the business scope of the project. And that decision was finalized in the quarter, which resulted to some of the change in our outlook, at least as far as the GAAP numbers are concerned.

It's really about working with a specific customer to advance the vanguard of our core products' capabilities that led to an accounting deferral of the work we're doing with that one customer. But the products that we will have, the product that we have today and what they are deploying will be something applicable to the entirety of our market.

Got it.

What is new is the production services that we will be ultimately accountable for in this engagement post go live, and we are building that capability and that skill set, so that should other customers want to engage with us in that way, we'll be able to scale that operation going forward.

Richard, makes a good point: it's -- this is not additional products. That capability is a different model of how we can serve customers that have -- that really want a more extensive division of labor with a technology provider. And in this particular case, we are taking on the entirety of that work, but going forward, we expect that even projects that have that deployment model will be ones with the -- a standard, small amount of Guidewire personnel complemented by mostly systems integrator staff.

Great, thanks for the clarification, guys.

Thank you. That does conclude today's question-and-answer session. I'd like to turn the conference back to our presenters for any additional or closing remarks.

No additional comments. Thanks for joining us in today's call.

Thank you.

Thank you. This does conclude today's presentation. We thank you for your participation.