Guidewire Software Inc (GWRE) 2023 Q1 法說會逐字稿

Greetings. Welcome to the Guidewire First Quarter and Fiscal 2023 Financial Results Conference Call.

(Operator Instructions)

Please note, this conference is being recorded. I will now turn the conference over to your host, Alex Hughes. You may begin.

Thank you, operator. I'm Alex Hughes, Vice President of Investor Relations. And with me today is Mike Rosenbaum, Chief Executive Officer; and Jeff Cooper, Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today as well as in our related Form 8-K furnished to the SEC, both of which are available on our Investor Relations section of our website.

Today's call is being recorded, and a replay will be available following the call. Statements made on the call today include forward-looking ones regarding our financial results, products, customer demand, operations, the impact of local, national and geopolitical events and our business and other matters.

These statements are subject to risks, uncertainties and assumptions that are based on management's current expectations as of today, which should not be relied upon as representing our views as of any subsequent date.

Please refer to the press release and the risk factors and documents we file with the SEC, including our most recent annual report on Form 10-K in our quarterly report on Form 10-Q to be filed with the SEC for information on risks, uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements.

We also will refer to certain non-GAAP financial measures to provide additional information to investors. All commentary on margins, profitability and expenses are on a non-GAAP basis, unless stated otherwise. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are also posted to the supplement on our IR website. And with that, I'll now turn the call over to Mike.

Thank you, Alex. Good afternoon, everyone, and thanks very much for joining us today. We're off to a solid start in the fiscal year with steady and consistent execution towards our goal to modernize the technology platforms supporting the global property and casualty insurance industry. ARR and subscription revenue both finished ahead of our expectations and notably, subscription and support gross margin came in better than our expectations. You have heard me say before that we feel privileged to serve a critical and essential industry, one that helps families and businesses manage risks so that they can better plan and grow, insurers need an agile core platform that effectively engages, consumers that supports faster innovation with new products and distribution channels and that enables them to grow efficiently.

Guidewire Cloud Platform delivers this agility, and I'm pleased to share the progress we continue to make in expanding its depth, adoption and deployment. The momentum around Guidewire, our ecosystem and our cloud platform was on full display at our recent connections conference held in October in Las Vegas.

With nearly 2,800 people attending in person, we saw record attendance more than doubling from the prior year and representing broad participation across customer segments, partners and regions of the world. At Connections, we announced Flaine, our sixth platform release. Flaine built on our previous releases to deliver improved self-service tooling for faster production deployments and introduces a new approach to release updates.

Cloud customers can now update their implementations to new releases far more easily, which will structurally change how customers approach upgrades allowing them to stay on the latest Guidewire version and take advantage of platform and application innovation more continuously.

We also released our digital framework Jutro, which enables customers to launch new digital experiences built on InsuranceSuite quickly and easily. Together, these product capabilities provide much greater speed and agility to our customers, and help us manage our customers' cloud deployments far more efficiently. But the real highlight of Connections was hearing customers share their cloud visions, journeys and outcomes with Guidewire. USAA, which has served U.S. veterans and their families for 100 years and has over 13 million members, is halfway through a multiyear modernization journey to increase engagement, innovation and efficient growth. Guidewire Cloud Platform is a key foundation of this journey and already USAA has been able to introduce a touchless claims experience for members and launched its new small business insurance line of business in less than 9 months.

Tryg, the largest property and casualty insurer in Scandinavia with over 5 million customers move to Guidewire Cloud platform with the goal of fully automating the claims process to further drive efficiency and customer satisfaction. Tryg has already been able to reduce the amount of time spent per claim by 26% and the percentage of claims leakage by 58%, while also significantly increasing customer satisfaction. Aioi Insurance, part of Nissay Dowa Insurance, the eighth largest insurer in the world was able to replace its core system with Guidewire Cloud platform in 12 months, and attribute greater flexibility, security and optimization.

They were able to double their new business capacity by reducing manual steps and cutting claims acceptance time and half. As we continue to increase platform maturity with each release, we are driving healthy adoption across existing and new customers. Over 20% of our core InsuranceSuite customer base has already adopted Guidewire Cloud Platform and we added another 4 cloud wins in the first quarter. [Budva] group, a Swiss Tier 2 insurer, founded over 125 years ago, chose to upgrade to InsuranceSuite on Guidewire Cloud Platform for a major part of its book of business to achieve greater operational excellence. Budva Group initially adopted InsuranceSuite self-managed, but before deploying, elected to upgrade to Guidewire Cloud.

Santa Lucia, S.A. a Tier 2 insurer in Spain, selected InsuranceSuite on Guidewire Cloud Platform for their largest line of business, funeral insurance and end-of-life support. Santa Lucia decided to modernize policy, claims and billing on GWCP because of our market-leading presence, combined with our platform adaptability and flexibility. This is our first InsuranceSuite cloud customer in Spain, and we're excited about the future potential in this market.

Builders, a midsized mutual insurer specializing in workers' compensation and construction operating in 22 states, selected full InsuranceSuite on Guidewire Cloud platform to replace their legacy mainframe-based system and to establish a new technology framework that improves their customers' experience, increases productivity and supports future growth. Finally, RVOS Farm Mutual Insurance based in Texas adopted InsuranceNow for its functionality, configuration, upgradability and self-service capabilities.

In addition to these cloud decisions, we also saw 3 insurers including 1 in Japan and 1 in South Africa, ought to begin a modernization with Guidewire on-prem. While the vast majority of sales activity over the past few years has been cloud, we do see cases where an insurer decides it makes sense to begin on-prem. Our technical approach facilitates this path and our perspective is that as long as the customers understand the strategic direction we are following and acknowledge that an eventual transition to cloud will come, we can support this approach.

In one of the deals in existing Tier 1 on-prem ClaimCenter customer selected PolicyCenter for a new modernization project, to support specialty lines. In another, the selection was based on the native integration of data and analytics into ClaimCenter, which will enable the creation of a better claims experience through real-time modeling and targeted straight-through processing. This example supports our strategy to deliver a fully modernized score platform with data and analytics embedded throughout the insurance life cycle.

We also saw HazardHub continued to accelerate in the quarter. This was highlighted by a meaningful deal at Frontline insurance company, a large home and commercial property insurer operating in Florida, Alabama, Georgia and the Carolinas. Frontline will use HazardHub's granular risk scoring for their direct-to-consumer business, Open House, to inform customer acquisition and core underwriting strategies. We are very pleased with the continued success of this product as it offers us a new faster sales cycle and a more flow-based business that might in the future, complement our core system sales dynamic.

Turning to operations. At Analyst Day, we talked about our focus on driving improved platform efficiency as we expand breadth and adoption. In the first quarter, this translated into progress in subscription and support gross margins. This is an area we will continue to stay focused on and expect to improve steadily as we deploy more customers in the cloud, roll out new self-service capabilities and generally improve the efficiency of our cloud platform, while at the same time, always continuing to ensure that our customer implementations are resources managed to ensure that the greatest possible degree of success.

In the first quarter, we executed a number of new InsuranceSuite production deployments on Guidewire Cloud Platform, including Definity Insurance, a Tier 2 insurer in Canada known for industry-leading innovation, a 2-time winner of Guidewire's Innovation Awards, migrated to Guidewire Cloud platform with over $2.5 billion in personal lines and production.

Already, it is seeing 40% faster consumer transactions, 12% faster broker transactions and an 8% increase in quote volume. We also saw a Tier 2 insurer with over 90 years of history, offering auto, homeowners and other personal lines to members in 23 states go live with ClaimCenter on Guidewire Cloud Platform. This deployment lays a strong foundation to build on as this customer embarks on further transformation.

In addition, a large farm mutual insurer in Texas went live with InsuranceSuite on Guidewire Cloud Platform. This is a company with over 100 years in operation and Guidewire Cloud platform will help them maximize operational efficiency as they pursue further growth.

And finally, let me just close by discussing our partner community and ecosystem. Our system integrator community has been and will remain critical to our differentiation and long-term success. SIs are currently involved in over 60 Guidewire Cloud projects and growing this total will remain a strategic focus for us.

The number of Guidewire consultants at systems integrators grew to over 20,000 at the end of Q1, up by 28% year-over-year. We also continue to see cloud momentum build in this community with a number of cloud certified consultants, sustaining growth of over 100% year-over-year and passing 5,800 at the end of Q1. This gives our customers a valuable bench of cloud trained professionals to draw on as they start down the path of modernization or embark on cloud upgrades. We are also seeing momentum in our solution partner community.

In the first quarter, 19 more solution partners joined Guidewire's Marketplace, bringing the total to nearly 180. We also announced a few important new strategic partnerships at Connections. We partnered with One Inc., a digital payment solution for P&C insurers that offers comprehensive digital payment options and automated inbound and outbound payments. Our collaboration will make it possible for our cloud customers to deploy these solutions significantly faster than they were able to in the past.

We've also partnered with Appian, a leading workflow automation platform, to enable our cloud customers to rapidly create and manage cloud-based digital experiences and business process automation. And we partnered with Earnix, a leading dynamic pricing engine, to accelerate insurers' speed to market in defining, updating and optimizing insurance products that are already in market.

In summary, Q1 was a great quarter and a solid start to the fiscal year. We continue to expand our platform in critical areas. We continue to sell new modernizations and cloud upgrades. We continue to expand our ecosystem and deliver successful production go-lives and continue to make steady progress on cloud operating efficiency. All of these critical elements of our plan that reinforce each other and demonstrate steady progress towards strategic cloud leadership in our market.

With that, I'll turn it over to Jeff.

Thanks, Mike. First quarter ARR ended at $673 million ahead of our expectations. Q1 is always our slowest quarter, but we are pleased to see some exciting cloud wins, most notably meaningful progress in EMEA. Total revenue was $195.3 million, just above the high end of our outlook. Filed strength continues to be visible on subscription revenue, which was $79 million, up 38% year-over-year. Subscription and support revenue was $99.1 million, up 25% year-over-year.

License revenue was $41 million, up 2% when compared to Q1 last year. Services revenue was $55.3 million, up 18%. Services revenue benefited from ongoing increases in the number of cloud implementation programs.

Turning to profitability for the first quarter, which we will discuss on a non-GAAP basis, gross profit was $83 million. Overall gross margin was 42%. All of our margin disclosure for the quarter and for the comparison periods reflect our updated allocation methodology for headcount-related costs for IT, payroll and procurement.

As a reminder, and as we discussed on our Q4 earnings call in September, we moved headcount-related costs of IT payroll procurement to G&A expense. Previously, we allocated these headcount costs out to other expense lines. Subscription and support gross margin was 49% compared to 45% a year ago. This was ahead of our expectations due to increased cloud infrastructure efficiency and slower-than-expected hiring. And services gross margin was negative 9% compared to positive 10% a year ago.

As discussed in prior quarters, we are working through some complex early cloud projects and have been leveraging subcontractors at higher than normal levels. We are making steady progress through these programs and expect services to return to positive margin in the second half of the fiscal year.

Operating loss was $35.9 million. This included $2.9 million of severance expense, half of which impacted sales and marketing expense. Also, as previously mentioned, G&A expenses were negatively impacted by the reallocation adjustment. This had an $11.3 million impact on G&A expenses in the quarter. Overall stock-based compensation was $35.1 million, up 9% from Q1 of last year, which is generally in line with our growth in overall compensation expense. We ended the year with $868.5 million in cash, cash equivalents and investments.

In Q1, our Board authorized a $400 million share repurchase program. And as part of that, we initiated a $200 million accelerated share repurchase program that we expect to complete in Q3.

Turning to our outlook for the fiscal year 2023, we are maintaining our ARR outlook of $745 million to $760 million. For our usual approach, our ARR outlook assumes foreign currency exchange rates as of the end of our last fiscal year. We are adjusting our outlook on total revenue now expect to be between $886 million and $896 million. The only change, we now expect subscription revenue to be $342 million, an adjustment of $2 million. All other components of revenue are largely unchanged.

Turning to margins and profitability, which we will discuss on a non-GAAP basis, we expect subscription and support gross margins to be 49% for the year, an increase of 3 percentage points when compared to our outlook last quarter. We now anticipate lower cloud infrastructure costs, and we redeployed some headcount from COGS to R&D as their work transitioned from supporting specific customers to building platform capabilities that will benefit all of our customers.

This adjustment reflects increasing confidence in our margin trajectory as we execute toward our mid- and longer-term margin targets. We expect services margins in the mid-single digits for the year with significantly better services margins in the second half of the year. This improvement reflects the successful completion of ongoing arrangements with investments from Guidewire, the ramp of new services hires replacing subcontractors and the redeployment of some Guidewire services resources from nonbillable to billable roles.

As a result, we now expect overall gross margins to be just under 52% for the full year. With respect to operating income, we expect an operating loss of between $28 million and $18 million for the fiscal year. We now expect stock-based compensation to be approximately $138 million, representing a 1% growth rate year-over-year. We expect stock-based compensation expense growth to slow as we temper overall hiring. There is no change to our cash flow from operations expectations.

Turning to our outlook for Q2. We expect ARR to finish between $695 million and $700 million, which represents 16% growth at the midpoint on a constant currency basis.

We expect total revenue of between $221 million and $226 million. We expect subscription revenue of approximately $83 million and services revenue of approximately $52 million. We expect subscription and support gross margins of approximately 50%, and we expect services margins of approximately negative 2%. We expect an operating income of between negative $4 million and breakeven in Q2.

Operator, you can now open the call for questions.

(Operator Instructions)

And our first question comes from the line of Dylan Becker with William Blair.

Maybe Mike, double-clicking on the Connections conference about a month-or-so ago. The cloud messaging there was very apparent and you guys emphasized the plans of getting 100% of that customer base to the cloud over time. So I guess how is the initial feedback been from a customer perspective following that event? And how important are those conferences being in person as you think about building out that pipeline progression with some of those initial reference points?

Yes. Dylan, thanks for the question. I would say -- let me take the second half of it first. I think these in-person events are critical for us. There's just nothing that you can do to replace the ability to connect with customers and the ability to connect customers with other customers, to be able to hear firsthand their experience, the things to do, the things not to do. That event is just invaluable just both for us and the community. When you add to that the opportunity to connect with the different partners, different application partners, the new fresh innovation that you're seeing in the ecosystem, it's just great to be able to get people back in person, and we were really excited, so like I said in the prepared remarks, a set a record in terms of in-person attendance.

So really, really great to see. I think -- I was pretty direct, I guess, in terms of our intention to get 100% of the customer base to the cloud. I think at first, people saw that as a sort of a more direct statement of that strategy. But I think as it sunk in over maybe a couple of hours or 24 hours and then certainly over the past few months as we've engaged with customers following the event.

I think everybody understands and appreciates why it's important for us to be so clear about where we're taking the company and where we intend to take 100% of our customers. These implementations in these projects have to last for 20, 30 years, the decision time frame that people have when they're thinking about how to approach it is not measured in months, it's certainly measured in years. And it's not to say that we're going to abandon anyone. That's not the intention. But I thought it was necessary to be crystal clear that there's just so much more of the innovation, the thrust of the creativity and the physical investment in the product going into cloud that I really wanted to make sure that every single one of our customers sees that and thinks about it and thinks about how they can take the appropriate steps right now to ensure that they're aligned with that eventual outcome.

And so the initial feedback was a bit of, "wow, that was interesting that you said that." But I quickly got the follow-up that, "yes, thank you very much." We actually had 1 customer who, as I said in the prepared remarks today, we do occasionally sell even today, even in this quarter, an on-prem deal but we had a customer had a long conversation. They had done an on-prem deal previously in the year. And they said after connections in my keynote and the sessions that they were able to participate in, they were sitting down to make a more concerted effort about making a plan to get to cloud. And so it was, I'd say, received on the whole very constructively, is the summary way to answer your question. So hopefully, that helps. And thanks for the question.

Yes. Yes. No, absolutely. Great to hear. And maybe piggybacking off of that as well, too. I think there was a an important implementation in the quarter at [Massif] and maybe one of the largest ones you guys have done to date, particularly in Europe and some where you guys called out strength from an ARR perspective, so I guess wondering, first, how important is that implementation relative to kind of a market validation perspective and then also driving kind of some nice initial margin leverage here. Maybe how are you thinking about some learnings of moving that complex book of business as some of those other customers are kind of thinking about their own migration road maps.

Yes. So thanks for that. Thanks for the question about them. One thing I would say is our attitude is every single one of our customer implementations is just as important as every other. I'm 100% committed to ensuring that we're doing everything we can to make sure that every single implementation is a success. This was an important -- it's funny like when I first was talking to the Board and talking to Marcus about joining Guidewire, this was one of the most memorable parts of the way that they talked about the company is that there -- because of the nature of these projects, we have to make such a huge commitment to ensuring that they are successful.

And that's sounds emotional, but it's really strategic, right? Because if you think about what do you want from a core system vendor, you want somebody who's completely committed to ensuring that the project is successful. And for them and for us, if these implementations last 20, 30 years, and this is going to, in the end, be sort of economically positive for both of us. But we are committed to everybody being successful.

So you talked about [Massif]. That project is going well. It's critical to us that we have a success in Europe at scale. It's critical to us that we have a success in the market in France. And so we are very focused on that just like we are many of our other customers. So I wouldn't call out anything in specific there, but it is certainly one of the programs that we pay close attention to, maybe not so much because we care about it being successful more, but just because it's big and complicated and requires that level of focus.

Our next question comes from the line of Ken Wong with Oppenheimer Company.

Mike, I wanted to maybe just check in with you on what you're hearing from customers in terms of -- how they're thinking about macro last quarter? Obviously, how deal composition maybe changed a little bit. Any sense from your conversations with customers on any incremental caution? Or what were you hearing from them as far as how they're thinking about core systems and IT budgets?

I would say the answer to that question has not changed over the past few quarters. I'd say that the insurance industry is a very stable industry relative to maybe the other, I don't know, buying behavior you see from other tech companies that are more horizontally focused. We consider that to be a sort of lucky characteristic of Guidewire's focus. That said, there still is the concerns associated with tracking inflation closely and making sure that the system, the rate changes, the claims expense, all those tons of things are balanced.

There's a deal that we're working on in the pipeline right now, where there's some changes to the operating model associated with inflation that's having an impact on when exactly the Guidewire deal will flow through the system. But I wouldn't characterize these things as macro headwinds, but more just normal course of business and selling core systems to the insurance industry.

So summary is thing doesn't seem to be helping things, but it isn't hurting things for us. And I really feel like our destiny is in our own hands if we execute effectively and we provide the value that we think we need to provide, we're going to be able to hit the targets and grow the company based on the forecast that we've laid out.

Got it. Fantastic. And Jeff, just one quick one for you. Really nice uptake on that subscription and support gross margin line. How much of that is kind of seasonal? I think typically, Q1 does see kind of a bit of an uptick versus actually getting some solid progress on the efficiency front.

Yes. That's one of the highlights from my perspective of the quarter. I wouldn't categorize it as seasonal. There can be some quarterly fluctuations, but that was a result of some real hard work that we've done over the last year and in collaboration with the finance team, the cloud operations team, the product development team to drive much more efficiencies through how we manage our cloud infrastructure. So a real positive element there that we've been working on for some period of time.

And there's still a lot of -- we're still learning a lot in terms of how customers consume our products and what this will look like, but some positive signs there that we all felt really confident in. As we look ahead, we were able to kind of adjust our target for subscription and support gross margins up a few percentage points, which was positive as well. Some of that benefit was a result of, as we saw some of the efficiencies of the platform, we were able to repurpose some headcount and move them back into product development where they were doing more platform-specific work rather than customer-specific work. And so that also was a benefit that's flowing through our guide as we look for the full year.

Our next question comes from the line of [William McNamara] with BTIG.

Wanted to just follow up. You mentioned hiring plans and how they've slowed down a bit. Just curious to know if there are certain areas you're aggressively trying to hire in to kind of fill potential like implementation needs things of that nature?

There's no specific area. We -- the pace of hiring has definitely slowed down. And I think that there was a period of time over maybe the last year, I'd say, maybe a little bit further out where we were concerned about attrition. And so when you're concerned about attrition, you try to make sure you get all the appropriate roles filled you're really focused on gearing up hiring and recruiting to make sure you can compensate for any attrition that you do see. That didn't materialize as significantly as we thought it might. And at this point, there's -- we're not really seeing any gaps or strategic gaps or anything like that. It's just sort of a slow and steady approach to managing the company and ensuring that we're making, as Jeff and I have said, steady improvement on the margins. So nothing out of the ordinary.

And our next question comes from the line of Rishi Jaluria with RBC.

Wonderful. I wanted to maybe start out with coming out of Guidewire Connections. One of the pieces of feedback we got from the partners is cloud demand is definitely really strong and customers are very much interested in migrating to the cloud. But one of the things that some partners told me that is maybe holding them back, is that they've built so much customization and custom apps on-premise and that makes it harder to kind of migrate to the cloud version. Can you talk to what kind of steps you can take to make that migration path a little bit more painless? And then I've got a follow-up.

Super question. So this is something we spend a lot of time thinking about, obviously. These things end up being super, super complicated. And so somewhat the answer to your question is 1,000 little details. But I'll give you some examples.

Number one, I think when we started the journey, we had a sort of view for the types of customizations, types of configurations, characteristics of the implementation that we thought were acceptable and not acceptable when those implementations landed on our cloud platform. As we've gained experience, we've been able to hone those requirements. And so maybe a lot more of those things that we thought at first were inappropriate or not something we could support that maybe they could be things that we could support them in certain ways. And sort of that experience enables us to really hone what the requirements are for things like integrations or customizations that are running on the platform.

The other thing that we could do is facilitate the conversion of those customizations to something that will work more effectively on cloud. An example here is we have something called Advanced Product Designer, which is sort of a new way to build out an insurance product on our platform. And when you use Advanced Product Designer to build out that product on our platform. You just get a whole bunch of features for free, right? We're able to build APIs, to be able to integrate that product into different applications.

We're able to make a digital interface for that product. much more efficiently. But for a customer that's already built their products in the on-prem version of Guidewire, they were looking at having to rebuild that product using Advanced Product Designer, so we built something called APD retrofit, which is a mechanism for us to take most of the product definition that exists on-prem and convert it efficiently to an APD based product, which enables that customer to more smoothly transition to the cloud and take advantage more of the benefits of the cloud version of the product.

And so that's one example that is relatively important and strategic, but you want to think about lots and lots of these things that relates to the various components of an implementation. And those things will just build and build and build over time as we get more and more experience, and we do more and more of these migration projects. So hopefully, that helps give you a little bit of color. But to the -- what the partners are telling you is real. There is a difference between the on-prem implementations and what we really want to see and what the customers want to get out of the cloud implementation. And that, I would say, is just something that needs to be accounted for in the planning through each one of these migrations.

Got it. No, that's super helpful. I appreciate that example. And then, Jeff, just a quick follow-up to continue on the margin question. So we saw a continued improvement on the subscription gross margin side, right? If we did the kind of back-of-the-envelope math, above 40% for the first time in a while. Anything just onetime to call out? I know you said not seasonality, but accounting or anything like that? Or is there any reason we can't kind of straight line the sort of margin improvement we've been seeing for the past couple of quarters and kind of get it from that glide path from 40% to, call it, 60% over the next several years?

Yes, nothing really onetime in nature. Sometimes it can take a little bit longer for -- Q4 is our largest deal, those customers to get provisioned up and running and start using some of the product infrastructure resources. So if you look at our guide for the year, our guide for the year is consistent with what we delivered in Q1, but in terms of onetime in nature, nothing in particular to call out, this has just been a lot of progress that we made over the last 12 months, you may remember, it was about a year ago when we -- in Q1 last year, where we had a little bit of surprise in some of our cloud infrastructure costs, and we've done a lot of work to get that in a much healthier place. So yes, in general, as you look over the longer term, and if you look at our long-term models, it is implied that there will be steady progression as we track towards those targets.

Our next question comes from the line of Parker Lane with Stifel.

Mike, I was hoping you could dive in a little bit more on the decision to use Guidewire on-prem as a stepping stone of the cloud. I think it was 3 insurers that opted for that during the quarter. Why is that the right approach today? And then two, when they talk about the modernization side of it and the eventual migration to cloud, when a customer has made that decision today, are they still thinking about this as a maybe multiple years down the road? Or does it accelerate the time line to perhaps the next 12 to 18 months?

Yes. Thanks for the question. So first of all, I want to make sure everybody understands that. I think that this is a sort of a positive attribute of the choices we've made about the technical architecture Obviously, in a perfect world, you would want everybody that goes straight to cloud. But every single customer is different, the circumstances around their overall enterprise environment are all very, very unique, and there's a lot of different variables that are at play in terms of a customer making this sort of decision. And now in 1 case, you could say like a customer has just got the rest of the enterprise all on-prem, Guidewire is on-prem, and they want to add a core component of the insurance suite to that implementation. And that just makes sense for them to do that modernization on a Guidewire core, but without making the overall lease to cloud, and that may be driven by the overall strategy -- the cloud -- overall cloud strategy of that customer.

Other circumstances, there's going to be some regional differences around people's proclivity to accept cloud as a safe and secure place and we're constantly working on that and we're constantly making progress, but like I've said a couple of times, I mean, these decisions are 20-, 30-year decisions. And if we can get ourselves established and we can make sure that the customers are crystal clear about the real strategic direction of the company and acknowledge clearly that eventually these implementations will move to our cloud. I see it as a positive characteristic.

I'll also refer to you to [Budva] that we called out in the prepared remarks. This is a customer that made a decision to go on-prem and in the process of that implementation made the decision to move to cloud. And so this happens. And so even though we are doing these deals, and it probably seems -- and even to me, sometimes seems like as a bit of a head scratcher, there is real logic behind this, and I do think that it's a positive characteristic of the architecture and the strategy of our company, especially as you think about Guidewire. I know it's tough sometimes, but if you think about Guidewire over a 10- or a 20-year time horizon, this makes a lot of sense.

Our next question comes from the line of Michael Turrin with Wells Fargo Securities.

Just in terms of capital allocation, I mean you announced the buyback. You've clearly been active around. Can you just provide us with an update on how you're assessing the trade-offs and uses of cash in the current environment? And then just the second part, I'll ask upfront. On the free cash flow side, negative for Q1, but you're holding on to the cash flow from operations guide for the fiscal year. Can you just remind us anything we should be mindful of in updating models around seasonality on the free cash flow side?

Yes, yes. So on the capital allocation side, we're obviously executing on our $200 million accelerated repurchase program once we complete that, which we expect to complete in Q3, we'll revisit the authorization for the other $200 million. We continue to think that where Guidewire is trading today that there's no greater use of our cash at this point in time than buying back some of our shares. But it's important for us to maintain flexibility to allow for inorganic activities should those arise in this environment. So we think that the $400 million share repurchase program that we have authorized allows us to kind of walk that line and do both.

So we feel that, that's the right posture for us. With respect to cash flow, we obviously guide on an annual basis. There can be a lot of movements on a quarter-to-quarter basis. The results in Q1 were very much in line with our internal expectations and how we thought this year would play out. And in fact, some of the -- we slightly adjusted our operating income expectations, and that has an impact on cash flow. So slightly more confident into the range. There can be a lot of movements in terms of collections at the end of the year that causes us to provide a somewhat wide range there, but no adjustments to how we think about the full year.

And our next question comes from the line of Joe Vruwink with Baird.

Going back to the subscription gross margin topic. Given the updated guidance for the year and again, the backlog -- back-of-the-envelope math just on the subscription line. I think it implies an incremental margin pretty close to 60%, and last year was also pretty close to 60%. So obviously, you just hold (inaudible) proven over time, but I also think the midterm framework implies reaching a next tire level. What are some of the elements that are going to inflect that? Or is it not even necessarily discrete elements, but maybe just more a function of how your business evolves over time given some of the installed base and kind of vintage dynamics you highlighted at the Investor Day.

Yes. I'm not sure I followed completely your analysis. I'm not sure that I've looked at it the exact same way. But in terms of the key levers that we're focused on, you've heard us talk repeatedly about building our cloud operations team in advance of the demand to ensure that every one of these early cloud programs are ultimately successful. This is critical to our long-term strategy. And as we think about the build-out of that particular function, we've indicated at Analyst Day that largely, we've built out the team to support $1 billion of ARR and now we need to grow into that profile without necessarily expanding significantly the existing cloud operations team.

We saw in this quarter -- towards the end of this quarter, we were able to repurpose or reallocate heads and employees that were working on customer-specific things and so impacting cost of goods sold. And now they are focused where they should have -- where they were originally focused on building more platform capabilities that will address all of our customers. There's other things like that, that we can do specifically as we continue to march through migrating the customers that went live on Guidewire Cloud Classic to GWCP and recognizing the efficiency uplift associated with that. So those are the things we're focused on. And we think we have all the levers in place to execute to the margin targets that we set forth at the Analyst Day.

And our next question comes from the line of Michael Funk with Bank of America.

So I appreciate the comments about the resiliency of your customer base in terms of spending in earlier comments about the efficiencies that your customers see when they adopt your platform. Maybe just stepping back and trying to quantify the value proposition that you sell to your clients. And how you quantify that for them in terms of payback and maybe where there are differences in that conversation when talking about new deployments versus some of the customers are electing to remain on-prem because they have substantial investments in legacy bespoke systems. That would be helpful if you could walk us through that math how you talk to customers about the payback and the value proposition.

Sure thing. I don't know whether or not I'm going to give you the math behind it. I'll give you this objective explanation. Maybe we could connect later to talk about the math of this in a micro sense. When we do a new deal, as you heard me describe a deal where we're replacing a mainframe system, the value proposition associated with that has a lot to do with the risks that the company faces in operating a system that, in some cases, is like greater than 30 years old and has a very small number of people who are able to configure it and support it. And so when you talk to these companies, there's not really a math behind that as much as it is just an overall risk calculation that they think about in terms of the ongoing operations of their company.

Certainly, there's a lot of value that an insurance company can gain from just simply being able to create engaging digital experiences on top of core systems for doing things like quoting policies, with agents, with consumers, if it's personal lines or commercial lines, it's like being able to connect with buyers with convenient digital processing flows is basically necessary in order to be able to compete in the modern insurance market. And we see this all the time. And so you could basically do the math of saying, we're going to be able to implement Guidewire create a digital experience and grow this much, but you can also do the negative math, say that if we're -- we don't get up the mainframe system, we don't do a digital experience, we don't create an API to connect into the broker system. We're not going to get any more business at all. And so you just have to do something in order to connect in a modern way to these new channels.

On the claims side, being able to create an efficient claims operation to be able to manage claims efficiently, just as direct benefit to operating expenses at an insurance company, trade is probably one of the best examples in our customer base and maybe the industry of the kinds of impacts that you can gain from really effectively automating claims experiences. These are real structural costs for insurance companies, and you cannot do that on these legacy systems. And so that's sort of the category of net new business. That's great.

Now you talk about the Guidewire installed base. Some of the Guidewire installed base is challenging for them to run Guidewire, right? Everybody in the world really is looking at data center expense, IT operations expense. It's just complicated to manage and run these systems to keep them updated. All this kind of expense and effort, it doesn't contribute to the strategic thrust of an organization. And so by moving something to cloud, by transferring the burden of IT, of the servers, of the database, of the updates, if you transfer all that to Guidewire, there's an economy of scale that we can deliver to our customer base and managing all of that for them and there is a value proposition there.

And then there are a small number of Guidewire customers that are doing this super, super efficiently. And so for us, with that cohort of customer, we're really talking about, what's the incremental benefits that we're able to add to the application and the platform beyond. These are things that we just can't do in an on-prem modality, but we can do as a cloud service. And so those characteristics create value both in terms of agility, but also operating efficiency for that carrier.

So anyway, without giving you all the numbers of that because it probably changes for each insurance company and each line of business and each sort of segment of the core systems, that's how we generally think about the overall value proposition for Guidewire Cloud. Sorry, does that help you?

It did. I think that's a good overview of thinking about the kind of consistency of the transition of the growth and the drivers relative to other software companies. And one more quickly, if I could. As we think about growth this year versus the last couple of years, if you have it top of head, how should we think about the contribution from NRR versus net new? Are you seeing any shift there?

Yes. I mean I'd say we've, over time, built up a pipeline of ARR that flows in from what we call our backlog from ramp deals. And so that's a pretty meaningful part. We are starting to see some -- a bit more new RFPs or new modernization programs for a little while, that was sitting on the sidelines because those folks were making the decision to kick the can down the road while they sat on the sidelines and waited for a bit more cloud maturity.

So we're starting to see that come back to market, which is exciting for us. But no material shift in terms of the overall model. I mean I think we're still going to get a lot coming from our installed base and our customers. A significant amount coming from deals that we sold in prior periods as those ramps flow through the model. And then we're always very focused on new modernization programs.

And our next question comes from the line of Alexei Gogolev with JPMorgan.

I had a quick question on cybersecurity because the standardized multi-tenant nature of Guidewire Cloud allow you to invest more into security compared to some of your peers. And I was wondering if you disclosed any of those investments in the past? Or maybe you can give us some examples that highlight your security superiority versus peers.

Yes. I think the way we think about this is that the centralization of the management of a system facilitates a greater degree of security for that system. And that's simply because we can patch Guidewire and the various implementations that are running on Guidewire Cloud more efficiently than we are able to patch and maintain the systems that each of our customers are individually running. That -- your comment about multi-tenancy is sort of exactly right. It's like the changes that we can make once can be applied to many customers. And so therefore, the effort that we put in to securing that system can be sort of leveraged by a greater number of customers, the greater number of tenants. And so the system overall can be more secure than what any of the individual customers are able to achieve on their own.

There's been a few conditions that have come up and examples of this where we were able to ensure that the Guidewire Cloud implementations were quickly patched for vulnerabilities in a way that it was just a lot more cumbersome for us to get those patches, those updates pushed out to all of the on-prem customers that were impacted by this. And I think in the end, you see this throughout enterprise software is that the centralized systems just get this benefit of a central focus on security, a sort of idea of a limited number of code lines in order to patch and secure.

And you just, over time, you create something that's a lot more secure than the variability that exists within all of the individual implementations. This is certainly something that we talk about with our customers as a benefit of the cloud model and they understand that. I think that there's also a degree of risk that they're thinking about in terms of making sure that we are as at least as secure in our approach to managing the system as they are with their individual implementations.

And so depending on the size and scope of the customer that we're talking about, that conversation will either be quick and easy for a small insurance company where what we can apply with the resources of Guidewire far outstrips what they're able to do on their own. But we have some of the largest, most sophisticated customers in the world from an enterprise software perspective.

And so those conversations are pretty in-depth and we work very, very closely with those customers to ensure we're creating the most secure, reliable services we possibly can. So I hope that gives you a flavor for how we think about this and why I think it's certainly a benefit of the model here at Guidewire.

And we have reached the end of our question-and-answer session. And I'll now turn the call back over to Mike Rosenbaum for closing remarks.

I just wanted to say thanks, everybody, for participating on the call today. We're thrilled with the continued momentum in the cloud and new and existing customers. We see that as a great validation of the strategy and it's given us increasing confidence in the long-term opportunity at Guidewire. And look forward to catching up with everybody throughout the quarter. So thanks very much.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.