Guidewire Software Inc (GWRE) 2022 Q1 法說會逐字稿

Greetings and welcome to the Guidewire First Quarter 2022 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Alex Hughes, Vice President of Investor Relations. Thank you, Alex. You may begin.

Thank you, operator.

Good afternoon, and welcome to Guidewire earnings conference call for the first quarter of fiscal year 2022, which ended on October 31. My name is Alex Hughes. I'm Vice President of Investor Relations, and with me on the call is: Mike Rosenbaum, Guidewire's Chief Executive Officer; and Jeff Cooper, Guidewire's 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 the Investor Relations section of our website.

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

Statements made on this call include forward-looking ones regarding our financial results, products, customer demand, operations and the impact of COVID-19 on our business and other matters. These statements are subject to risks, uncertainties and assumptions and are based on management's current expectations as of today and should not be relied upon as representing our views as of any subsequent date. Please refer to the press release and the risk factors included within the documents we file with the SEC, including our most recent annual report on Form 10-K as 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. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are also posted in the supplement on our IR website.

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.

On the heels of a strong finish to last fiscal year, we had a record Q1 sales activity and continued to build momentum for Guidewire Cloud. Cloud bookings were over 90% of deal activity for the first time ever and helped drive Q1 ARR, above the high end of our guidance range. It was a great start to our fiscal year and points to continued strength in our cloud business and strategy.

In the quarter, we signed 5 more InsuranceSuite cloud deals on top of 17 last quarter and saw another 6 successful cloud customer deployments. This is a great illustration of success leading to success. As we close more deals and demonstrate more go-lives, we will see increasing confidence in demand from our customer base. With a growing number of commitments and successful deployments, more insurers will decide that the time to move to the cloud is now.

Interest in Guidewire and the overall insurtech market was on full display at our recent Connections customer conference which was held as a hybrid event in Las Vegas last month. We had over 1,300 people in physical attendance, which I think is phenomenal, considering the current environment and international travel restrictions. We saw a broad participation from across our customer base and partner community, and it was great to see a heightened focus on cloud and insurance innovation from everyone in our ecosystem.

Connections was a great platform to show the Guidewire community the exciting new developments and innovations in Dobson, our fourth release of the Guidewire Cloud platform. I'll talk more about Dobson in a minute, but I think it is getting clearer and clearer to our customers that the 6-month release cycle of Guidewire Cloud Platform offers a superior track to the faster and continuous innovation needed to advance their objectives.

As I mentioned, cloud deal activity in the quarter was phenomenal, with 5 new InsuranceSuite cloud upgrades in the first quarter spanning both Americas and EMEA. In the Americas, I was pleased to see a deal with a Tier 1 insurer and activity across both commercial and personal lines. A Tier 1 insurer elected to upgrade ClaimCenter to the cloud as part of its strategic vision to provide industry-leading claims services while balancing superior satisfaction, indemnity accuracy and cost of service management.

Franklin Mutual, based in New Jersey and dating back to 1879, elected to migrate to the Guidewire Cloud Platform to take advantage of our Autopilot road map, data strategy and the combination of our deep R&D and innovation cadence delivered to the cloud through our fast 6-month release cycle. Franklin Mutual came to Guidewire through our acquisition of ISCS, decided to migrate to InsuranceSuite v10 from InsuranceNow in 2018. And we are now excited to take them to our cloud as they look to further expand.

A Tier 2 insurer based in Canada chose to migrate ClaimCenter in order to simplify its technical ecosystem and to accelerate speed to market. This builds on their adoption earlier in the year of PolicyCenter and BillingCenter for the Guidewire Cloud.

In EMEA, it was great to see 2 exciting cloud deals. Tryg, the largest non-life insurance company in Scandinavia with significant market share across Denmark, Sweden and Norway, adopted ClaimCenter on Guidewire Cloud for its platform sophistication, Autopilot and analytics technologies. P&V Assurances, founded in 1907 and now one of Belgium's largest insurers, elected to migrate InsuranceSuite to the cloud because of our platform's strong fit with its strategic imperatives.

We also saw continued success in analytics in the first quarter. S&P, as I briefly mentioned last earnings call, expanded their relationship with us in a very significant and strategic way. We will work with S&P to use Cyence to develop the first cyber risk impact quantification of credit and financial health. This is an outstanding validation of what we already know, that cyber risk is an important consideration when evaluating credit risk. And it's exciting to partner with S&P on this initiative. Additionally, Markel Corporation, a global insurance and reinsurance carrier based in Virginia, has selected Cyence.

In addition to deal activity, we continue to drive strong cloud deployments with 6 more cloud go-lives in the quarter. These deployments are a critical element of our cloud strategy because they enable us to show the industry that customers just like them are successfully executing cloud strategies on the Guidewire Cloud Platform. A large Tier 1 insurer went live with ClaimCenter on Guidewire Cloud and began its business rollout. This speaks to our ability to support an important Tier 1 customer in the cloud, and we look forward to continuing our work together.

Amica, the oldest mutual insurer of automobiles in the United States, achieved the second of its 3 major cloud milestones with the launch of PolicyCenter on Guidewire Cloud. This joins BillingCenter and will next be joined by ClaimCenter and speaks to our ability to successfully transition a large, long-standing and highly configured customer to Guidewire Cloud. We also saw a private mutual insurer with over 120 years of experience serving individuals, families and businesses in multiple states throughout the United States deploy PolicyCenter, BillingCenter, ProducerEngage and Cloud Data Access in Guidewire Cloud. This sets the foundation for multistate expansion and additional lines of business on Guidewire Cloud.

In addition, a fast-moving commercial insurer targeting the evolving mobility market successfully launched ClaimCenter on Guidewire Cloud in less than 10 weeks, which speaks to the fast time-to-market advantage that Guidewire Cloud brings to greenfield initiatives. This follows the PolicyCenter and BillingCenter go-lives a year ago, meaning they're now in production with all 3 core InsuranceSuite Cloud products. At the same time, we also deployed InsuranceNow at 2 more insurers, Bowhead Specialty and Innovative Holdings.

Customers adopting and deploying Guidewire Cloud are doing so in large part to take advantage of the superior speed and innovation it delivers every release. The release adoption last month demonstrates these advantages and delivers exciting new enhancements that accelerate innovation, integration, design and insights. Innovation is made faster by enabling customers to launch and deliver products more quickly with Guidewire GO.

Innovation is also amplified and accelerated by making it easier for developers to integrate external applications with their core systems through our cloud integration framework. It's also now much faster and easier to design front-end digital experiences with Jutro, which delivers an expanding library of pre-configured building blocks, reusable components and metadata-driven UI configurations for our customers' digital experiences. At Connections, we also launched Guidewire Live, a suite of analytics applications designed to allow insurers to be brilliant in every stage of the insurance life cycle. This all makes me very proud of our team and excited for our future.

I'm equally excited about the excellent progress we continue to make with our expanding partner community, which is a critical component to our strategy and an important element of our success. Our SI partners remain a force multiplier for us since they play a critical role in helping customers plan and execute their deployment on Guidewire Cloud. We continue to see strong growth in this area. We now have 15,800 Guidewire consultants from 32 SI partners, up 38% year-over-year. And we now have 14 SI partners involved across 35 cloud projects. With Guidewire Cloud momentum increasing, we are seeing this community move quickly to become Guidewire Cloud certified. Guidewire Cloud certified consultants grew 287% year-over-year to over 2,800.

At the same time, our solution partners in the Guidewire marketplace continue to be important drivers powering P&C insurance innovation for our customers. We continue to see strong growth in our marketplace, and I'm even more excited about the long-term potential here as cloud deployments make it easier and easier to integrate and deploy on Guidewire This ecosystem will unlock tremendous value on top of and alongside Guidewire, and developments such as our new cloud integration framework and Jutro are important components facilitating this.

We finished the first quarter with over 140 solution partners, up 50% year-over-year. We understand the strategic importance of the insurtech ecosystem to our customers looking to build competitive advantage. So we're investing in this area further to identify and incubate the next-generation insurtechs as potential solution partners through our new Insurtech Vanguard program.

We're also investing directly in leading insurtech solutions. And last month, we invested in 2 exciting innovators: FRISS, an AI-powered end-to-end fraud prevention and detection solution for global P&C insurers; and Shift, a provider of AI-driven automation and optimization solutions for global -- for the global insurance industry.

In summary, we had a fantastic first quarter on the heels of a strong finish to last year. I feel good about how the fiscal year is shaping up with our strategy and execution coming along nicely. We are optimizing and investing for product velocity, and more importantly, customer success in the cloud. These projects are very challenging and complicated, and we'll continue to invest to help ensure successful outcomes. It's hard but rewarding work that we're proud to tackle as we work arm in arm with our customers and partners to transform.

With that, I'll turn it over to Jeff to talk about our financial results and our full year outlook.

Thanks, Mike.

Let me jump right into our Q1 results, our strongest first quarter ever from a bookings perspective, which fueled our ARR outperformance. And over 90% of our bookings activity came from our cloud products. ARR ended the quarter at $594 million, ahead of our expectations and up 16% year-over-year. We were thrilled with the activity we experienced, which continues to be highlighted by InsuranceSuite cloud momentum. Our ongoing cloud strength is also visible in our subscription revenue, which was $57.1 million, up 53% year-over-year. Subscription and support revenue was $79 million, up 36% year-over-year. License revenue was $40.2 million, down $25 million or 38% when compared to Q1 last year.

While we expect term license to decline as we successfully upgrade on-premise customers to our cloud, the decline in Q1 was also due to $15 million of incremental revenue from term license deals that deviated from our standard contract terms in Q1 last year. We discussed this at length last year, and much of this incremental revenue was due to a multiyear contract consolidation at one of our largest customers. As a reminder, term license revenue is recognized upfront for multiyear contracts.

Services revenue was $46.8 million. This was lower than our expectations due to 3 complex customer engagements, 2 of which are cloud migrations where revenue recognition is tied to project percent complete assumptions rather than our typical time and materials arrangements. Given project complexities, we adjusted our percent complete assessment, which impacts the timing of revenue recognition. Even with this adjustment, total revenue in the quarter was $165.9 million, at the high end of our guidance as strength in subscription revenue largely offset lower-than-expected services revenue.

Turning to profitability, which we will discuss on a non-GAAP basis. Gross profit was $73.9 million. Overall gross margin was 45%, down from 54% last year. Subscription and support gross margin was 43%, down from 48% a year ago. This decline was due to large investments we have made to support our current and future cloud customers. Additionally, accelerating cloud activity in Q1 led to higher-than-expected cloud infrastructure costs.

Services gross margin was 4%, up from 2% a year ago.

Operating loss was $28.7 million. This was below our guidance range due to a few factors.

First, moving into fiscal 2022, we updated our employee attrition assumptions. During the pandemic, our overall employee attrition was at historically low levels. And looking ahead, we modeled in higher employee turnover to reflect what is commonly being referred to as the Great Resignation. Thankfully, we have not seen a spike in attrition at this point, and we are recalibrating our models. Over the long term, retaining our existing outstanding employees is a much better outcome for Guidewire, but this does have an impact on our assumptions for the year.

Second, as I previously mentioned, cloud infrastructure costs in Q1 were a bit higher than expectations. This impacted both our cost of subscription and support revenue, but also operating expenses as our engineering teams are utilizing public cloud services more in product development, and our presales teams are building out demos and POCs utilizing public cloud services.

Finally, we did see a bit higher commission expense as well in Q1 as we had strong bookings activity. And much of this activity occurred early in the quarter.

We ended the quarter with $1.1 billion in cash, cash equivalents and investments. The combination of bonus payout, vacation accrual payouts as we moved to an unlimited vacation policy in the U.S., our acquisition of HazardHub, and our investments in FRISS and Shift all had an impact on cash balances. Additionally, we invested $26 million on the repurchase of 226,000 shares in the quarter.

Now turning to our outlook for the fiscal year and the second quarter. For the year, we are increasing our ARR guidance to $569 million to $566 million, (sic) [$659 million to $669 million] representing 14% constant currency growth at the midpoint. There is no change in our total revenue expectations. We now expect our subscription revenue to be a couple of million higher than our prior expectations and services revenue to be a couple of million lower than our prior expectations. We now expect total gross margin for the year to be closer to 50%, but this gross margin percentage will ultimately depend on our final revenue mix. Overall subscription and support gross margins for the year should be flat to up 1 point as the subscription margin improvement to approximately 30% is offset by the mix shift between subscription and support revenue. We expect services margins to be in the low single digits.

With respect to operating income, we expect an operating loss of between $58 million and $48 million for the fiscal year. This adjustment to our operating loss is due to the recalibration of our employee attrition assumption built into our forecast model and due to higher public cloud infrastructure costs.

On the cloud infrastructure side, we have been optimizing for speed and customer success as we build and deliver cloud-first products, which include new capabilities such as Cloud Data Access and data studio. We are building out more controls and constantly optimizing our architecture to ensure efficient management of our public cloud spend. We still feel confident that improved controls and cloud maturity will support our long-term margin expectations, but higher-than-expected Q1 costs, combined with accelerating demand and adoption of our cloud products resulted in a revision of our expectations for fiscal 2022.

Cash flow is expected to be impacted by these factors as well. As such, we now expect cash flow from operations in fiscal 2022 to be between $10 million and $20 million.

Turning to our outlook for Q2. We expect ARR to finish between $613 million and $616 million, which represents 18% growth at the midpoint or just under 17% on a constant currency basis. We are managing the much better linearity in bookings activity this year, which is really positive. And Q2 benefits from the realization of ramps sold in prior periods.

We expect total revenue of between $195 million and $199 million. We expect subscription revenue of approximately $60.5 million and services revenue of approximately $49 million. We expect an operating loss of between $15 million and $11 million in Q2.

In summary, we are thrilled to see strong momentum in Q4 continue into Q1. ARR and subscription revenue continues to track nicely to our near-term and longer-term targets. This validates our investment thesis as we bring insurer core systems to the cloud. While we are now seeing a bit higher expense in fiscal 2022, we do not think these increased costs pose a challenge to our longer-term margin expectations.

Operator, you can now open the call to questions.

(Operator Instructions) Our first question is from Jackson Ader with JPMorgan.

I guess the first one is maybe on the expenses, Jeff. So I guess can we just dig into it a little bit more? I would have thought that better build for ARR and more cloud deals would have ultimately helped the operating expense -- or I'm sorry, the operating income line. So just curious what happened there. And then also on the ARR build, is any kind of strength in the first or second quarter coming from pulling forward the third and fourth quarter pipeline?

Yes. So first of all, I just wanted to clarify. I think I misspoke on the call. I mentioned an ARR guidance of $559 million to $569 million. That should have been $659 million to $669 million. So I just wanted to clarify the record there.

And then Jackson, on the expense side, I think one of the things, as we're working through this transition to the cloud, there are a couple of things going on. These are obviously very complex engagements that we're working on hand in hand with our customers. And some of these projects have -- are taking a little bit more effort to get to -- get them to where we need them to get to. And we're certainly committed to customer success. We know we're at a critical part of this overall journey towards this industry adopting cloud systems, and these early cohorts of customers are absolutely critical. So we are investing a bit on the services side to ensure that these projects are successful. And that's part of what's going on in the overall expense arena.

I do think that some of this was a bit of a modeling artifact. As we were exiting the pandemic operating at historically low levels of attrition on the employee side, recognizing that everybody has been talking about the Great Resignation, we did embed a little bit more attrition into our forecast model. And we gave a license to the business to continue to hire aggressively because we are concerned -- we want to -- this is a real critical time for us, and we want to make sure that these projects and the PD velocity that we have going on right now continues. And so we wanted to be prepared for an acceleration of employee attrition and we haven't seen that yet. So that played into the numbers a bit on the cost side.

And then finally, we did see a bit of spike in usage with respect to some of our public cloud spend. We have teams digging into that to make sure that we are optimizing our spend and being thoughtful about how we architect certain things.

There were certainly some decisions that were made on the architecture side that were more focused on making sure we can move in a fast cadence and with products that will meet the needs of our customers. And then as we evolve those products, we will make them more efficient over time. But that caught us a bit off guard in the quarter, and you see that reflected in the guide.

And then finally on pulling forward deals, we are seeing better linearity this year than prior years, and that's a positive thing. If you think the last couple of years have been extremely back-end weighted, and there's been actions that we've taken as a company, but it's something we really want to start to see better linearity.

So I wouldn't say we're pulling forward any deals into Q2. We're just seeing what should be more consistent linearity moving forward. And the last couple of years were much more extreme on the back-end weighted side. And that does make for some easier compares, and there is an easier compare in Q2.

Okay. Great. And then a quick follow-up, you mentioned employee attrition, which reminds me, so Frank, your Chief Sales Officer departure I guess early last month, any update on that search? And yes, just any additional color you can give on Frank's departure would be great.

Yes, let me take it. I guess first thing I'd say is I've been just delighted with how the teams responded and how Priscilla has stepped in to lead the organization and continue driving success. We miss Frank and -- but the company is moving forward. And we're just really, really excited about -- you can see it in the results of the quarter, how we're executing and the view that we have into Q2 and the pipeline and the perspective on the year.

So we are engaged with folks about talking about that role. But I don't feel -- I personally don't feel like this is something that I need to rush just because I feel like we've got a very, very good team, and I feel great about the leadership that Priscilla is providing right now. And I think that's what you -- that's reflected in the confidence that we have about the sort of top line outlook for the company right now.

Okay, all right.

Our next question comes from Bhavan Suri with William Blair.

This is Dylan on for Bhavan. I guess maybe first, the potential benefit of being able to kind of host the Connections Conference in person, right. So given these systems are so mission-critical, can you talk about maybe how that's helped benefit pipeline activity, interaction, being able to showcase the value here? Especially since kind of the rollout of GCP -- GWCP, excuse me, had fully kind of happened in a virtual environment. So maybe any color or commentary to support kind of that reference selling motion, having the event in person.

Sure, great question. I am just right now so happy that we decided to proceed with doing the event in person. The feedback that we got across the board from customers that were able to attend, partners on the -- on both sides of the aisle, so to speak, the systems integrators as well as the applications that are on our marketplace, the feedback was just incredibly positive. Just to have the opportunity to get together and talk to customers about projects and about initiatives and about the progress that we've been able to make over the last 18 months or so about the cloud product, it was all together a positive event.

And you do an event like that and it certainly has a positive influence on the deals that we can touch and influence, the pipeline that we can connect with at the event. It also provides a super, super forcing function for us to be able to put together the enablement sort of presentations that are going to enable the teams to be able to execute on programs more effectively. So across the board, very, very positive.

I think that the biggest -- the one -- if I could give you one takeaway that I had from the event was just simply consistent feedback from customers about how the Guidewire cloud product story is really coming through consistently across teams. And the consistent ability to deliver the releases and to deliver the new functionality in the release and follow through on the road map, I think, was the major takeaway that I had from the event. But overall, very positive.

I mean on the downside, it's still frustrating that we're living in a world that's constantly dealing with this -- with COVID. And the international audience was some -- was a lot -- pretty limited in terms of their ability to attend the event. So it's also very positive that we were able to run the thing as a hybrid event and broadcast it and make it available for people to watch asynchronously. And I think that will be a positive pattern for us going forward. So hopefully, that gives you a little bit more color and -- the outcome of the event.

Yes, that's really helpful. And then I guess maybe one other one, too. So you've announced some recent marketplace partnerships here around kind of digital claims payments. So I would like to kind of maybe get a sense of how you're thinking about the broader opportunity around digital payments. Kind of where maybe this sits with adoption within kind of insurance carriers and their end customers today. And how this also kind of ties into the broader claims automation initiative that we're seeing with carriers.

Yes. Okay, sure. Let me touch on the second half of that first. So you heard me talk about Autopilot a couple of times in terms of the color behind some of the implementations and the transactions that we've done. We think in our -- and a significant number of our customers think that there's a very, very significant, I would call, efficiency opportunity that exists in claims automation. And there's a lot of excitement about the Autopilot road map, and that's a big part of a lot of the cloud upgrade and new sales activity around ClaimCenter.

Specifically, we're excited to talk about Tryg as one of the deals that we closed in the quarter. They just have a phenomenally aggressive and innovative view about how automated the interaction model ought to be with claimants and with customers. And we're excited to partner with them as they sort of push us and push the industry forward. So that's really exciting.

With respect to payments, my perspective is that again, it's an opportunity for you to not only improve the efficiency of an insurance organization but also improve the convenience and the customer satisfaction associated with making a claim or making a payment. And our view, I'd point you back to the work we've done around our integration gateway and the cloud APIs in the marketplace. And just making it easier for these partners to plug into a Guidewire core system, makes it -- just reduces the barrier to try and implement these types of solutions because they're just almost obviously a smart thing to do for most insurance companies. And so if we can make that easier and easier and easier, it's going to drive innovation in the industry. It's going to drive demand for cloud -- for our cloud platform.

So there's a couple marketplace solutions that we are excited to work with in this area and expect it, like a lot of other areas in the marketplace, to just help us grow.

Very helpful. Really nice job in the quarter.

Our next question comes from Matt VanVliet with BTIG.

Maybe following up a little bit, Jeff, on the comment you made to one of the questions earlier about continuing to be very focused on the execution of deployments and having a very customer-centric approach. How is that pressuring the capacity of the services staff that you have now? Do you need to add headcount there? Or should we think about the rapid growth in Guidewire Cloud-certified systems integrator partners, that you can now start offloading more and more of those deals, especially as you've built up some sort of muscle memory, I think, in the best way to roll out the Guidewire Cloud deals?

Let me take that. I think that's exact -- your question sort of describes exactly how we're looking at it. It's definitely something we watch very closely because the work required, the people necessary to do these -- to execute on these programs is something we pay very close attention to. And it's -- as we sell more and get into more of these programs, that's a potential limiter on our ability to grow. And so getting the partners involved, either directly or indirectly, having the people trained up with the experience necessary to be able to successfully implement and upgrade the systems to the cloud, is critically important and something we're very, very focused on.

It's not something that I would call out now as a limiter, but it's something that we're closely following and managing closely. And it's working as hard as we can to keep up with the demand and ensure that the projects are delivered successfully.

Like I said in the prepared remarks, these are very, very complicated programs that we work through with our customers. And it's not just the core system upgrade, but it's the downstream systems that they need to be integrated to. And it's the data and analytics services that they power and the digital interfaces that go alongside them. And each time we do one of these upgrades, each time we successfully get one of these customers live, we're learning a little bit that gives us an ability to be a little bit more efficient on the next one. And also transitioning that information, that learning out to the broader ecosystem and working hard to increase the capacity for us to meet this demand.

So it's a great question, and I think you're -- the way you pose it lines up very well to the way we're managing it.

Great. And then I guess as you continue to have the discussions with a number of -- especially your largest Tier 1 customers about their path to the cloud, what it might take and when it might happen, are you still getting any pushback of, "Oh, I don't see any reference customers that sort of look like us or operate in the markets we operate in." Or do you feel like you're kind of over the hump now, where you've gotten enough of a sample across your entire customer base that that's no longer a limiter? And instead you really are on the when, not if, for virtually every customer in your portfolio?

I would say it tends towards the when, not if, okay? But that still doesn't mean that they're not asking us for more proof points and more experience and more examples. That's still definitely part of the evaluation process. And the more successful implementations and go-lives that we have, the more experience that we have, the more releases under our belt on the Guidewire Cloud platform, the more functionally ready we are to support them.

So that experience just continues to build and kind of whittles away at the questions and the concerns. But for sure, the tone of the interaction with our top customers is -- has shifted, as I've said before, to a -- more of a question of when they plan to do it and when they feel like they're ready and we are ready as opposed to a more sort of existential question about if it's the right approach. I am completely confident now that we are on the right technical approach for our customer base.

But like we constantly say, these decisions and implementations are so complicated that it may take multiple years for that sort of decision to sort of proceed makes logical sense for them. And so the trend is very positive, but it -- there's nothing sort of magical about any particular moment. It's just positively working through these implementations and the experience we gain from them and continuing to execute on the road map and continuing to improve our readiness. So hopefully, that helps answer the question.

That's great.

Our next question is from Ken Wong with Guggenheim Securities.

Mike, I wanted to maybe build on that Tier 1 theme. It sounds like you guys had pretty good traction this quarter. I think a peer of yours indicated some -- maybe some uncertainty with Tier 1 deal activity. Just wanted to check to see, if anything, you're seeing as far as sales cycles have changed or just customer interest from some of your largest customers.

I wouldn't say anything's changed quarter to quarter. We continue to see interest build. The innovation agenda, the automation agenda, the efficiency agenda at customers continues to build, I would say, over the course of the last 6 months or so. And I think we touched on this a bit in Q4 is the COVID concerns about the economy, et cetera, seem to be past. The working model associated with work from home or hybrid project work is past. And so people feel comfortable about taking on these programs now.

And that, we see that across the board. So I wouldn't call out anything with respect to Tier 1s. Like I said, we had some good activity in the quarter, and we continue to make positive progress, especially in our customer base about building that confidence.

Got it, perfect. And Jeff, just one for you on the ARR increase. Looks like Q1, Q2, you guys are getting better than what we're used to seeing from a sequential increase. And you mentioned some of the ramp deals starting to flow through. How should we think about the contribution from ramp deals versus maybe net new ARR as far as keeping those ARR numbers elevated?

Yes, I mean -- and we've talked about this a bit in the past. We don't get too explicit on breaking that out. But I will note that Q2, in particular, has a fair amount of activity coming in from prior deals sold, which is great to see, but that is a bit of a tailwind that we're seeing in Q2. And as we think about the full year, the context we've provided in the past is, is that we expect a little bit more from the backlog coming in from ramp deals this year when you compare that to what we need to go out and get net new.

Our next question comes from Peter Heckmann with D.A. Davidson.

After reviewing the Gartner reports for both North America and Europe, it seems as if a number of marginal players continue to get squeezed out as more and more carriers decide to upgrade their technology with one of a handful of leaders. Do you feel that's the case? And do you see there's an opportunity for either yourself or someone else to consolidate some of those smaller players over time?

Okay, interesting question. I would say there -- certainly, I think the investment necessary to instantiate a cloud platform to serve core systems in property and casualty insurance requires a pretty significant investment. And so the idea that there won't be 25 vendors successfully competing in this space over the course of the next 10 years is a good conclusion. And certainly, I'm biased, being the leader, but we see that. And I see that just based on my experience and the view into what it takes to really do this well and the long-term investment necessary and the specificity necessary to win in this market and serve this customer base and these needs specifically. Size is going to play a big positive factor in the success of those kind of companies.

Whether or not it creates an opportunity to consolidate, I would say I'm not sure. I think when you do think -- these systems are implemented for a long time. And the expectations customers have about the duration of that investment is pretty significant. And so it's not the same as other SaaS industries where the implementation might be turned over once every year, once every 2 years. When the implementation is only turned over, in the best case, once every 10, then you got to be careful, I think, about the assumptions associated with consolidation.

But I feel great about our position and the investments that we've made over the past 20 years and over the past 3 to take that expertise and turn it into a winning cloud platform. And so hopefully, that gives you a little bit of color in terms of how I see it.

Yes. No, thank you for the thoughtful answer. And just as a follow-up, Jeff, did you say about $49 million of services revenue in the second quarter? And if so, could you just review that issue around time and materials versus the other accounting method that you mentioned? I think, I missed that.

Yes. So we said $49 million in Q2. That's approximately $49 million is our expectation at this point in time. And essentially, we typically do services arrangements on a time and materials basis. Some of our customers have invested significant amounts to put in place the on-prem system, and we are now asking and working with those customers to shift them over to the cloud.

And we have done some of these projects on a more fixed-bid type of arrangement. And the accounting around a fixed-bid arrangement is as you have to constantly assess how complete -- how much work to be done and what percent of the overall project is that. And we had -- in Q1, there were some reassessments of the effort required in order to complete projects. And so that had an impact, and you saw that how we ended -- how we executed in the year on the services revenue line vis-a-vis the expectations we set last quarter.

Our next question comes from Joe Vruwink with Baird.

I wanted to go back to claims automation. That was obviously a big focus at Connection a year ago and within biannual release now claims is where you're having a lot of deal momentum.

Is it fair to make the association between the 2 and think about kind of this 12-month time frame between the biannual release and starting to get some pipeline conversion with -- I guess the obvious implication is you're now on 4 releases, and over time, it's only going to increase more so that this kind of broadens the potential opportunity, if this kind of connection and 12-month time frame makes sense?

Yes, sure. I think it's a great insight. There's a lot of -- as I mentioned, there's a lot of very, very positive feedback and interest from our customer base around the Autopilot product. And it just -- it takes a bit of time for us to launch something, explain it to everybody what our vision is. We're getting used to launching things based on the idea of what we call early access. That enables us to work with a couple of customers directly and limit that interaction, so that we can learn from the implementation and the feedback and then factor that into the next couple of versions of the product.

Having that cadence facilitates us building better software. And so yes, I think it is absolutely valid to say that hey, it was about a year ago we launched it, and then we went through a cycle and found some interest. And now it's driving some deals in a more active way.

I think the other way to think about this more broadly is that we are more clearly now, release after release after release, differentiating the service and the value we can provide to customers through the cloud beyond just the -- where it runs and who runs it and how it's upgraded, but actually what it does and how quickly you can build new products using it with Advanced Product Designer or roll out a new digital interface using Jutro or use Guidewire Go, like I talked about, to instantiate a new product line.

And so there's a variety of things specifically related to operating a core system and innovating an insurance company that are now enhanced and accelerated via Guidewire Cloud. And that's just going to keep building. As much as we can pack into each release, it's going to keep building and building and building. And I hope to see that sort of story play out across the various product lines. So thanks for the question.

Okay. Good. And then just one more on the SI partners. One thing we heard at Connections was this idea that, "Actually I'd like to grow my Guidewire practice faster. But I need to hire and then I need to get that higher cloud certified." And that becomes the inhibitor. Since partners seem to be handling a decent amount of your cloud activity, do you think this factors in at all on kind of your forward outlook for cloud deal signings?

Well, I don't know if it factors in the cloud deal signings, but I would say -- and this is, I think, not just true in this industry. It's true in a lot of industries is, the capacity of the technical experts who are available to do an implementation and run an implementation, the amount of those people in the world, it dictates to some degree the cost and the expense of doing those sorts of implementations. And so when there's a constraint and there's a limited resource pool, the expense of doing these implementations kind of goes up. And so the more people we can bring into the system, into the ecosystem and train them up and get them certified, the more opportunity there is for them to be put on to projects and those projects to deliver innovation to the customer base.

I look at it like this is a -- there's just almost an unlimited amount of technology-driven innovation potential in the P&C insurance industry, that improving convenience and digital interactions with customers and automating claims. And like we talked about here a couple of great examples. Detecting fraud proactively, predicting things with analytics more effectively, like all that stuff is enhanced and accelerated by how many technical experts there are out in the world that can drive these projects. And so that's a big part. The education and the enablement of resources in our ecosystem and at Guidewire is a big part of our strategy. And the more we can do that, the faster this whole system will grow.

So I kind of see it as, yes, is it a potential limiter? Yes, it certainly is. But is it something that people are stepping into and learning and growing? Yes, that's also true because there's a huge demand out there.

Our next question comes from Parker Lane with Stifel.

This is Matt [Kicker] on for Parker. Congrats on the quarter.

My question revolves around Dobson and some of its new functionality. And first building off a previous question on Tier 1s, are you seeing more interest with the platform from those Tier 1s kind of the higher end of the market or instead from the lower end of the market? Or is the interest about equally distributed between the 2?

And then secondly, when these customers do choose to expand their deployment, what are the most common tools you're seeing that they're adopting on Dobson?

Okay, great question. So let me touch -- I'll touch on the demand, okay?

So with respect to our customer base, there is a lot of interest in Guidewire Cloud and getting updates about what's going on and what's the latest and how have things evolved since the last time we talked, regardless of whether they're on cloud because that's obviously important to the program. But then if they're not yet made that decision, it's important to that decision and how they think about when and if to go. That's equally distributed across all the customers.

What they're specifically interested in changes depending on the size of the customer and the complexity of the implementation. That really is what drives their specific interests. If they're running ClaimCenter across a whole complex implementation and there's a lot of integrations, they're going to be more interested in the integration framework in ClaimCenter and Autopilot. But if they're a PolicyCenter customer and launching new lines and rolling out to new states, they're going to be wanting to talk to us about Advanced Product Designer. So I would say it's not so much tier based, but it has to do with the use case that we're supporting in their company and how that lines up to their innovation objectives that they have for their departments and their corporate strategy.

With respect to Dobson and what people are most interested in, first, it's pretty early, right? So it's just launched, just released, and so we're in the early stages of working with customers around it. But I would say my take of the feedback -- and maybe I'm going to give you an answer that's across the board. The changes that we've made to the way our Advanced Product Designer and the Jutro digital platform, the way that, that works together is very interesting to customers. Because like we're starting -- we're able to do things a lot more seamlessly and a lot faster with that approach. And I think that is something that I saw a lot of interest in, especially at Connections and in the conversations that I had.

The other side of it just because it's such a big part of -- or the other side of the answer is just because it's such a big part of every implementation of Guidewire is the integration framework. And being able to extract logic out of the core system and put it into this integration framework and create the ability for people to build and roll out these integrations faster to other cloud services is a real change, I think, to the way that Guidewire has been implemented and is very interesting to customers. Hopefully, that helps.

Okay, yes, that's really great. That's all for me.

Our next question comes from Michael Turrin with Wells Fargo.

This is David on the line for Michael Turrin. Just one from us. Can you just talk about the appetite you're seeing for purchases that include data and analytics and perhaps any flexibility you may have on pricing when you sell into that customer base?

Sure. I'll take that. So one of the things that we've been able to do with cloud is that we've been able to incorporate a little bit of data and analytics into the implementations. And there's a lot of interest in that. One of the highlights of the last couple of quarters has been looking at the business plans that justify the investment in Guidewire Cloud and how often the data and analytics components of that cloud implementation incorporate the value proposition driven by smarter decisions.

But the analytics business at Guidewire is also healthy independently, right? So it's not just reliant on our core customer base. It's selling independently. Highlighted, obviously, the deal that we did in Q1 at S&P and also Markel for Cyence and cyber. But also, we're seeing positive feedback -- very positive feedback, actually, about HazardHub and the acquisition and the momentum that we're seeing there. So that's been pretty strong. And obviously that's mostly driven so far in the customer base, just because those are the first folks that we've been able to talk to about it and the reasons behind incorporating it into Guidewire. But that also has gone very, very well since we did the acquisition.

So hopefully, that gives you a little bit of color about how we're seeing it. It's like -- it's successful in the cloud deals and also independently.

That's excellent color.

Our next question comes from Tyler Radke with Citi.

I wanted to ask you just about the on-premise customers. I think in years past, you talked about a fair amount of customers still on older versions, version 8 and 9. How have those kind of migrations progressed? And to what extent is the significant partner growth kind of helping in accelerating those migrations from some of the older on-prem versions?

I can try to give you color on it. I think that the upgrade cycle, as we've talked about before, continues to be a great forcing function for us and customers to have a conversation about what the plan is for them and what version they're going to target and whether or not cloud makes sense. So that is still healthy and still ongoing. We do still see some customers making the decision to move to the version 10 of Guidewire on-prem just for a variety of different reasons. And I suppose, like the ecosystem and the consultants are -- facilitate those kinds of programs effectively.

But I wouldn't say it's -- it helps or hurts really. It's just kind of the normal operating procedure, normal operating mode of how the overall Guidewire ecosystem works. But the overall takeaway with respect to -- the opportunity that exists for us in our customer base that is driven by the upgrade cycle is still a very important driver for cloud transitions. That behind each one of these stories about a decision to move to cloud is partially at least factored in there the necessity to make to move from whatever version they're on to the latest, and therefore cloud. So that dynamic is still happening and still playing out in our customer base and an important driver for cloud momentum.

Great. And then if I could sneak in a follow-up, maybe this one is for Jeff. But can you just give us an update on how you're thinking about kind of the moving pieces in cloud or subscription gross margins? I know with some of the new cloud releases you have here with Dobson and one coming up in the first part of 2022 and some of the automation you're building, just help us understand kind of what your baseline assumptions are around the factors that's underpinning your gross margin outlook for cloud.

Yes, sure. We talked briefly in the call that if you think about the subscription margin that underpins the subscription and support margin, that kind of should grow from around 23% last year into around 30% this year. So we are starting to see a little bit of leverage on that line. We feel very confident in how durable the overall subscription revenue growth will be as we execute against this opportunity in front of us and start moving our on-prem customers to the cloud, in addition to seeing more modernization activities in general in the industry as the industry gets more comfortable with buying cloud. So those are driving the top line.

And then as we think about the margins, we've invested a lot to ensure that we have the right cloud operations team in place today to allow us to successfully execute the current customers that we have and the future customers that we expect to add. So we've invested quite a bit in building out that team. It is our expectation that we can start to leverage that investment quite significantly moving forward.

We, obviously, in Q1 saw a little bit more cloud infrastructure expense than we were expecting. I noted that we've been optimizing for speed and customer success in that particular area, but we certainly have our eye on the ball in terms of how we can optimize and make that much more efficient moving forward.

And as we inspected our forward-looking plans, we still feel confident with the longer-term margin profile that we put out there. What's driving that is, is these investments that we're making in products that will allow us to deliver the product in a much more efficient way, both from a headcount attach perspective but also just in terms of how it's architected. And as we add more customers to the platform and gain that scale, that's where we get confidence that we'll see that margin expansion.

There are no further questions at this time. I would like to turn the floor back over to Mike Rosenbaum for any closing comments.

I just wanted to say we had a -- we felt like it was a very solid start to the year and look forward to continuing to execute effectively throughout the rest of the fiscal.

I want to thank everybody for joining us today, and have a great day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.