Guidewire Software Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
June 1, 2023

There are 10 speakers on the call.

Operator

And welcome to the Guidewire Third Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alex Hughes, Vice President of Investor Relations.

Operator

Thank you, Mr. Hughes. You may begin.

Speaker 1

Thanks, Kamala. I'm Alex Hughes, Vice President of Investor Relations. 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 ks 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.

Speaker 1

Statements made on this call include forward looking ones regarding our financial results, Products, customer demand, operations, impact of local, national and geopolitical events 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 representatives 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 ks and our quarterly reports on Form 10 Q filed and to be filed with the SEC for information on risks, uncertainties and We will also 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 in the supplemental on our IR website.

Speaker 1

And with that, I'll now turn the call over to Mike.

Speaker 2

Thank you, Alex. Good afternoon and thanks for joining us today. We had a strong Q3 highlighted by sustained demand for InsuranceSuite Cloud and ARR and profitability both exceeding guidance. Services revenue was below expectations, primarily due to the timing of revenue from a few complex engagements, which we will address later in the call. We were thrilled to see continued improvement in subscription and support gross margins, which more than offset the services shortfall.

Speaker 2

Our cloud gross margin trajectory drove operating income out Objectives were that we closed 8 cloud deals and sales momentum remained solid ahead of our seasonally strong 4th quarter. Cloud deployments were also strong with 8 go lives in the quarter across both commercial and personal lines. And we continued to drive improved cloud efficiency with subscription and support gross margins Demonstrated execution with Guidewire Cloud Platform and the growth of our ecosystem have clearly established us As the cloud leader in our market and have positioned us well to serve the top insurance carriers in the world. From this position, we will continue to expand the breadth and depth of our solutions and ecosystem to help insurers drive innovation and improved decisions at scale. The second point I would like to make is about the macroeconomic environment and its impact On our P and C customers, the industry is generally resilient to economic cycles, but it is not immune.

Speaker 2

The inflation driven increase in claims expense has had an impact on the profitability of many insurance companies And is causing scrutiny on near term investments and budgets. Given this backdrop, we are pleased to see our momentum Our strategic deals and projects continue to progress and we remain confident in our sales outlook. With that said, let me turn to discussing our Q3 results in a little more detail before handing it over to Jeff to cover the financials. As I said earlier, it was a strong quarter with 8 cloud deals, 7 of which were for InsuranceSuite. In addition to insurers seeking to modernize legacy mainframe systems, We are starting to see an increased interest in replacing previously modernized on prem systems, which is a very positive market development for us and a great validation of the investment we've made In the Guidewire cloud platform, deal volume in Q3 was well balanced with 3 new logos, 3 migrations and 2 expansions.

Speaker 2

First, let me walk through our new customer wins. Texas Farm Bureau, A Tier 2 insurer headquartered in Waco, Texas selected full InsuranceSuite Cloud to modernize their existing portfolio of Legacy and On Prem Core Systems. We look forward to helping them achieve improved system performance and operational excellence, Staying current on functional and technical capabilities via Guidewire cloud updates. Taking advantage of Guidewire's extensive market This commercial insurer selected Guidewire as their long term partner and will use InsuranceSuite Cloud to retire legacy systems and transform core operations across policy, billing, claims, digital and data. Predictive Analytics was a key differentiator in this Hard fought competitive deal and it represents a key mid market win for us as this progressive carrier has substantial growth aspirations.

Speaker 2

And the insurance company of Prince Edward Island, a growing Canadian property and casualty carrier selected Guidewire Cloud Platform Turning to cloud migrations. We saw Country Mutual, a Tier 2 carrier focused on personal and commercial lines across 19 states, Elected to upgrade their on prem ClaimCenter system to the cloud. And they also expanded their Guidewire footprint, selecting PolicyCenter Cloud for its commercial and agricultural lines of business. A Tier 2 provider of reinsurance and insurance PolicyCenter Cloud was a key differentiator to increase agility and support their growth strategy. And the Home Building Compensation Fund, a provider of Safety Net Insurance for homeowners in Australia who are faced with incomplete or defective building work will migrate to InsuranceSuite Cloud.

Speaker 2

Finally, looking at expansions, CNA, a top 12 commercial lines carrier based in Chicago, expanded their investment in ClaimCenter Cloud to additional commercial lines and a Tier 4 insurer expanded their InsuranceNow investment to include additional lines. This brings the total number of wins for the Guidewire cloud platform to 20 for the year. Over 70% of this total was with Tier 1 and as well as provide a system suited to the success of the Tier 3 through 5 customers that make up a significant proportion of our customer The improving maturity of our platform is also reflected in the increased cadence of cloud production go lives. In Q3, we added another 8 cloud deployments, bringing the total number of customers live on Guidewire cloud platform to nearly 40 with healthy activity in both personal and commercial lines. In personal lines, some of the deployments included Auto Club of Southern California, The largest member of the AAA Federation with 16,000,000 members and a Guidewire customer since 2004 went live with InsuranceSuite In addition, a large insurer with over 2,000,000 customers across the Nordics Policy Center, Claims Center and Billing Center on GWCP.

Speaker 2

With respect to commercial lines, some of the deployments included Went live with ClaimCenter on Guidewire Cloud Platform to further reduce claims processing times and automate claims adjustments and costs. All of these deployments represent incredible work by our customers' project teams, Our Guidewire service teams and our ecosystem partners. As I mentioned earlier, this is a community that is increasingly leading cloud deployments And I'm pleased to see it continue to expand. SIs now have over 22,000 Guidewire Consultants as of the end of April, up 27% year over year. Moreover, the number of cloud certified consultants Increased 67% year over year to approximately 7,300.

Speaker 2

These are important stats Because a healthy partner ecosystem helps to drive customer success, but also because it is critical to providing as the prime integrator on cloud projects. This will inevitably lead to Guidewire Services revenue growth slowing Relative to the growth of the total services ecosystem and allows us to focus on a more scaled services model that drives expert services in coordination with the SIs and retains the scale required for delivery of new products and strategically important projects. This approach will provide us with a more durable and profitable service model. The services revenue shortfall we saw in the quarter speaks to the importance of this. Earlier in our cloud journey, We took on complex fixed fee arrangements where we leveraged SI's as subcontractors.

Speaker 2

This was both to actually deliver the work, As this portfolio of early projects are completed and the services margin burden associated with these early cloud customers will lessen. Turning to our solution partner ecosystem. We also continue to grow the number of partners on the Guidewire marketplace. This collection of integrated applications And we have added 6 new solution partners in areas such as providing more granular and accurate property data for better risk scoring and enabling greater workflow automation and speed. We are building a powerful cloud platform where greater innovation will layer on over time and where customers can platform is the one with 1, Inc.

Speaker 2

Where we are seeing strong interest from insurers to incorporate its technology to enable a more frictionless payment experience for their customers. I would also like to briefly discuss generative AI and large language models and their exciting potential for Guidewire and the insurance industry. First, and I think the most important consideration as it relates to Guidewire is that insurers begin to look at their systems and processes To evaluate if they are equipped to take advantage of this technology shift, they will realize that modernization is a key first step. We believe that insurers who have already modernized their core systems will be dramatically better positioned to take advantage of the efforts to justify modernization initiatives. 2nd, generative AI has the potential to make developers more productive, which in turn will drive more efficient implementation projects and improved product innovation.

Speaker 2

I think it's likely that in the course of 12 3rd, like a lot of software companies and many of the companies in our solution partner ecosystem, We are working on incorporating large language model driven product enhancements into our cloud product suite that will enhance the value of the products we offer to our customers. Broad based productivity gains should be a logical outcome of embracing generative AI and we expect that our cloud based product suite We'll be an enabler of this. Overall, generative AI has tremendous potential to have a positive impact on our mission We look forward to taking a leadership position in how the industry adopts generative AI in the months years to come. Finally, let me spend a minute on leadership in the organization.

Speaker 3

I was

Speaker 2

very happy to announce the addition of Michael Hau to the Guidewire team as Chief Product Officer. Michael is a longtime veteran of the insurance technology industry, having led product at Applied Systems for over a decade. He will lead product strategy and product marketing here at Guidewire. We are now in a position to build on the tremendous progress Diego de Valle And the engineering team have made in establishing our cloud platform and InsuranceSuite product releases. Michael will help us increase And optimize our focus on product innovation and the alignment of our data and analytics solutions with our core.

Speaker 2

While Diego continues to lead platform growth, performance and scale, which is all foundational to everything else we do. With that, I'll turn it over to Jeff to discuss the financials.

Speaker 4

Thanks, Mike. I want to highlight a few topics as I walk through the financial results in the quarter. First, as Mike noted, sales momentum continues to be strong and notably we are seeing more new customer wins and new modernization programs. We are also seeing some insurers looking to replace core systems put in place over the last decade or 2 as they evaluate their cloud strategies and want to ensure they have Partner that is investing to grow and innovate with them. This is an exciting development for us.

Speaker 4

At the same time, we are seeing steeper ramps than last year, Which means the initial ARR impact of new sales activity is lower in the 1st year, but fully ramped ARR is preserved. This combined with the macro backdrop are the primary reasons healthy sales activity is not translating into a higher ARR outlook for the year. 2nd, continued sales momentum combined with better than planned execution on cost controls and efficiency initiatives are driving cloud margins ahead of our FY2023 expectations. Our subscription and support gross margin trajectory gives us increased confidence in the long term earnings 3rd, in the services portion of our business, we are working through a number of very complex core system modernization programs. A handful of these are fixed bid arrangements where changes in the project plan can impact the timing of services revenue.

Speaker 4

A couple of programs had an adverse Finally, turning to cash flow. We are seeing slower collections than we expected in our model. Accounts receivable grew by $43,000,000 over Q3 last year Which did have a brief disruption to our collections cadence, but this is now resolved. Given slower collections, combined with the fact that we have the end of the quarter, we have adjusted our cash flow expectations for the year. This adjustment to timing of collections has no impact on the long term cash generation assumptions we have discussed with you all at our Analyst Day.

Speaker 4

Now turning to results for the quarter. 3rd quarter ARR ended at $722,000,000 ahead of our expectations. This represents 17% year over year growth on a constant currency basis. Total revenue was $207,500,000 This finished below our outlook due to Services revenue results. All product components of revenue were either better than or in line with our expectations.

Speaker 4

Cloud strength continues to be visible with subscription revenue within subscription revenue, which grew 34% year over year to $89,100,000 Subscription and support revenue was $107,500,000 up 24% year over year. License revenue was $50,500,000 down 6% year over year. Services revenue was $49,400,000 down 13% year over year. As I mentioned previously, we had 2 guide Wire led programs where project replanning resulted in an adjustment to the time lines and as a result an adjustment to the revenue recognition timing. This was an approximately $4,000,000 impact when compared with our outlook last quarter.

Speaker 4

Additionally, there has been increased scrutiny on Services' statements of work That has caused some streamlining of scope or pushing more services work to lower cost partners, which resulted in lower than expected billings in the quarter, and this accounted for approximately $2,000,000 to 3,000,000 Turning to profitability for the quarter, which we will discuss on a non GAAP basis. Gross profit was 107,700,000 Overall gross margin was 52%. Subscription and support gross margin was 55% compared to 47% a year ago. We are thrilled with the progress we're making on subscription and support gross margin, which continues to track ahead of our expectations. Services gross margin finished at negative 2% compared with positive 4% a year ago.

Speaker 4

We have been expecting positive margin in Q3, Revenue headwinds impacted margins in the quarter. We continue to be confident in our services strategy to return to profitability in the Q4 and beyond. Operating loss was $12,200,000 better than our expectations due to strong subscription and support gross profit and lower than expected operating costs. These factors more than offset the impact of Services margin shortfall in the quarter. Overall, stock based compensation was $35,000,000 Stock based compensation expense was up 6% year over year in Q3 and up 3% year over year through the 1st 3 quarters of 2023.

Speaker 4

We ended the quarter with $807,000,000 in cash, cash equivalents and investments. As of the end of Q3, the accelerated share repurchase program was settled in full with the delivery of an additional 6 148,000 shares of common stock, which resulted in total repurchases under the ASR of 3,200,000 shares at an average purchase price of $61.93 per share. Also in Q3, we repurchased an additional 207,000 shares at an average price of $77.19 per share. Turning to our outlook for the full fiscal year 2023, We are adjusting our ARR outlook to $745,000,000 to $755,000,000 As I previously mentioned, we are seeing healthy sales activity and expect this to continue in Q4, but we are seeing steeper ramps this year. This results in less ARR in the 1st year of new sales arrangements.

Speaker 4

However, we are still preserving attractive fully ramped ARR terms in these arrangements. So while ARR growth this year is expected to be approximately 13% at the midpoint, I expect fully ramped ARR to grow at 14% to 15%. We will also provide more detail on fully ramped ARR at year end as this is a metric we discuss on an annual basis. As a reminder, our ARR outlook assumes foreign currency exchange rates as of the end of the last fiscal year And then we update exchange rates at year end. Last year, the year end exchange rate adjustments to ARR were negative $19,000,000 If exchange rates stay the same as current rates, then we would expect a negative $5,000,000 adjustment at year end, largely driven by the dollar strengthening versus the Canadian dollar.

Speaker 4

With respect to revenue, we are increasing our expectations for subscription, Subscription and support and license revenue. We are adjusting subscription revenue to approximately $349,000,000 a positive adjustment of $1,000,000 We We are adjusting subscription and support revenue to approximately $426,000,000 a positive adjustment of $1,000,000 and we are adjusting license revenue to approximately $261,000,000 a positive adjustment of approximately $5,000,000 to 6,000,000 We are lowering our services revenue expectations by $10,000,000 to $12,000,000 As a result, our outlook for total revenue Turning to margins and profitability, which we will discuss on a non GAAP basis, we expect subscription and support gross margins to be between 54% and 55% for the year, an increase of 3 percentage points when compared to our outlook last quarter and 8 to 9 percentage points from the Q4 call. We expect services gross margins to be around breakeven for the year. This implies a Q4 improvement that assumes the successful completion of ongoing fixed bid arrangements. As a result, we now expect overall gross margins of approximately 54% for the year.

Speaker 4

With respect to operating income, we expect Between a $4,000,000 operating loss and a $6,000,000 operating profit for the fiscal year. We expect stock based compensation to be approximately $140,000,000 representing 2% growth year over year. Given this, Combined with the impact of our accelerated share repurchase program and our active repurchase program, we expect fully diluted shares to decline by approximately 1,000,000 shares this fiscal year. As mentioned above, we are adjusting our cash flow from operations expectations to between $10,000,000 $40,000,000 Finally, as we look ahead to fiscal year 2024, We feel it is prudent to wait until after our Q4 before discussing ARR growth expectations. With respect to profitability, We are committed to demonstrate non GAAP operating margins of 6% or higher and GAAP operating margins of negative 10% or better.

Speaker 4

We will continue to monitor both GAAP and non GAAP operating income metrics, but we expect to ultimately measure our success in hitting targets that

Operator

Thank you. Our first question comes from Dylan Decker with William Blair. Please proceed with your question. Hey,

Speaker 3

I appreciate the question and certainly get the product versus services side here. Maybe Mike for you, I think you noted Some of those existing on prem customers seeing accelerated migration activity. I wonder how much of that's a function of kind of the updated Garmish Release here and that the shift to, I think, 3 product releases annually versus 2, maybe widening the functional gap of kind of the on prem And from a go live perspective, now maybe having more of those customers that are that can validate that update versus upgrade kind of type of framework you guys have talked about?

Speaker 2

Thanks for the question, Dylan. I appreciate the insight. It certainly helps. I'd say in addition to those, I don't know topics, which I'll discuss briefly, I think The most important thing is just our experience and our track record running these programs at scale going live over the special go live weekends repeatedly now, something that we're getting better and better at. And So just building the overall confidence in the ecosystem, in the community of P and C customers, I think it is helping us.

Speaker 2

The shift to 3 releases a year, I think is also it's great and it helps. I think the most important thing is what you should read into that is more and more confidence that we have and that we can execute these updates seamlessly. Now we're still working through that with our cloud customer base and with the new customers. This is a different approach that this whole P and C ecosystem, the entirety of the way that this all operates throughout the world It is changing and we are changing it. But I think customers, especially those that have been on the journey with for a couple of years now and are seeing it and are experiencing it, are very excited about the potential that it offers.

Speaker 2

Just personally, I know I commented a little bit on generative AI. I am very much looking forward to the idea that we have production customers where we can put these changes into updates and then get them shipped out to customers seamlessly and they can Hopefully, just literally turn them on. It's just a very, very different operating model than Guidewire has been operating under and the industry has been operating under for the 20 years, and I think it is that is helping us drive the continued sales activity that we're seeing. So thanks for the question.

Speaker 3

Makes total sense. And then I think you made a comment as well around kind of obviously some of the carrier pressures around elevated claims. I think again core modernization can help address this and there's a lot of optionality on the data side. But wondering what kind of role Maybe digital twins could play in the future evolution of insurance and real time data connectivity to help carriers Predict with a more holistic view, maybe risk analysis and then maybe even preventative risk mitigation.

Speaker 2

Yes, that's a deep strategic question and I think it is top of mind as carriers think about modernization And getting to a core platform that provides sort of an agile ability to roll out New innovative products that take advantage of some of the connectivity and IoT like IoT enabled characteristics that you're describing. I'm not sure I'd go so far as to say those things would have prevented the cycle that we're in right now. I think Inflation jumped up and caught lots of industries by surprise and Has this impact that just has to be worked through. It's just sort of a normal cycle. I guess normal in the sense If there is inflation, there will be a disconnect between, you're feeling that you're feeling the impact of that inflation in claims versus being to adjust premiums and readjust the policies that support to support the risk actually in the replacement costs.

Speaker 2

But certainly, there is a lot of excitement in the overall industry about modernization in general and the ability for it to reposition Insurance companies somewhat around providing risk mitigation services and actually just controlling the risk as opposed to Sort of paying for things that break, actually using the industry and the relationship to prevent that risk, prevent that breakage, reduce the expense Of mishaps and perils. And so that is an exciting part of what we do and I think tied to this just this general idea of bringing agility To the core system equation, to the data and analytics equation, which makes these models more possible. So I love the question and it's definitely part of the story What we're selling to customers.

Speaker 3

Got it. Thanks, Mike. Appreciate it.

Speaker 2

Yes. Thank you, Dylan.

Operator

Thank you. Our next question is from Peter Heckmann with D. A. Davidson. Please proceed with your question.

Speaker 5

Good afternoon. Thanks for the question. With the 8 go lives this quarter, can you talk about how many live modules you have and what Percentage of ARR is now either live or committed to migrate to the cloud?

Speaker 2

Say again the last clause in your sentence, I missed it.

Speaker 5

Sure, sure. So just I'm just trying to think about what percentage of ARR is now either live or committed to migrate to the cloud? I mean, is this something in the range of See, it's 55%.

Speaker 2

Okay. So let me pivot to Jeff in a second. I just want to say like Just a couple of things that are included in the statistics. We talk about the number of customers that are alive. Within each customer, they're going to sometimes have one instance, Oftentimes, we'll have many instances.

Speaker 2

So when you dig into the actual number of instances of say ClaimCenter or Policy Center or Policy Center for a particular line of business, there might be and often is multiple instances that are live in production. And then each of those depending on whether or not it's an established line of business or a new line of business for that carrier We'll carry with it a certain amount of DWP, right? So very the biggest go lives for us in terms of scale When you have like a fully deployed claim center or a policy center billing center implementation on prem and we move that to our cloud And then immediately you have all that DWP operating on the cloud instance on the cloud on the production instance. In terms of factory, Jeff can give you a sense of this. Cloud ARR is now larger than non cloud ARR at Guidewire and that has to do with the price point As much as it is the momentum in the count, but certainly the predominance Of the majority of the ARR at the company now is associated with cloud.

Speaker 4

And Pete, the way we measure cloud ARR is that once a We count them in our cloud ARR calculation. So as of the end of last year, we were just over 50% Our ARR was coming from cloud ARR. And our expectation that we set at Analyst Day is that we'd be in the 58% to 62% range of Total ARR coming from cloud this fiscal year. I think that's still in line with our overall expectations, but we'll update on that particular metric that you're in.

Speaker 2

Yes. I would just ask, like, we obviously know this. We obviously track this very closely internally, like the percentage of that ARR that is live or is still in a project To go live, right, but we don't that's not in my script or in my head because it's not something we talk about publicly, but it's obviously something that we pay very, very close attention to. And look, the culture at the company and we have a very, very good track record of this is that 100% of that will It's been complicated and hard. We are standing shoulder to shoulder with these customers and partners and making sure 100% of that is eventually live in production.

Speaker 2

Sometimes it takes longer than a year because the projects are going to be complicated, but it all does At least the intention is and the commitment is culturally that we will get it all live.

Speaker 5

All right. That makes sense. And then to your point on the Underwriting losses nationwide for insurance carriers, something like $30,000,000,000 of Undering losses the last 2 years, but won't that lead then to further price increases for premium that could potentially lead to higher growth in DWP over the next couple of years?

Speaker 2

Yes, that's the expectation. It should. The system, when in balance, is equal on both sides of that equation and the overall system can operate profitably. Over time, based on the variety of ways we contract for our core systems That DWP will flow into Guidewire and then complicated growth bands and barriers and thresholds that need to be crossed In order to trigger those increases, but generally, yes.

Speaker 6

Like I

Speaker 2

said, this is a bit of a Headache, let's say, or maybe issue for us in the short term working through this and causing, like I said in the script, a little bit of scrutiny around short term expenditures. But in the long run, the industry is equipped to deal with this. And I think Guidewire as System Providing Innovation and Agility facilitates carriers being better able to absorb this. And one of the reasons why we think Sales activity continues to be solid heading into the Q4.

Speaker 3

Helpful. Thank you. Thank

Operator

you. Our next question is from Kevin Kumar with Goldman Sachs. Please proceed with your question.

Speaker 7

Hi, thanks for taking my question. I wanted to double click on the ramp deal activity. Jeff, can you help us frame the types of multiyear ramp Deal structures you're closing and maybe how that compares to prior years? And how much of a headwind is it in the initial year or years? And kind of how steep is that ramp Compared to kind of maybe historical levels.

Speaker 4

Yes, it's a good question. And it's interesting because last Q4, We saw a little bit less ramp activity and a bit more kind of smaller starts that would grow in a more organic fashion. So a little bit surprised this year to see a bit higher ramp activity. And interestingly, we're also seeing our deal portfolio a bit more than we expected towards new modernization programs and new customer wins versus migrations. And migrations always had fairly Kind of steep ramp elements attached to them because we count a booking as the incremental ARR that's being added to Guidewire And sometimes they're already paying ARR and a term license fee and it takes a little while to get up and running and live in the cloud.

Speaker 4

And so Oftentimes, there's not a big uplift associated with ARR, associated with migration. So seeing higher ramps this year is both A little bit of an interesting fact pattern, but a positive fact pattern. It means that customers and prospects are willing to make big multiyear commitments To Guidewire in this path with Guidewire. So we are seeing a little bit, we use the phrase steeper ramps, which means The starting point to the end point, that the growth is bigger in those committed ramps than what we saw The prior year and the prior year was notably a little bit shallower in terms of the overall alt ramp activity as we saw Some smaller starts rather than big commitments. So it's a mix.

Speaker 4

I was a little bit surprised to see that. But in general, we are Pleased to see especially new customer wins and even some competitive displacements, which is very exciting for us to see. And we're seeing healthy fully ramped ARR events. But I do think some of the near term Cost conscious pressures that are existing in the insurer install base is having a little bit of impact on kind of their

Speaker 7

That's helpful context. And then maybe just on the subscription and support gross margin, obviously, Nice outperformance there, higher than the guide you gave. Is that just a function of kind of continued cost discipline? Anything else you'd call out there? And then how are you feeling about cloud and infrastructure investments and the ability to reach $1,000,000,000 in ARR with minimal kind of incremental Thank you.

Speaker 7

Yes.

Speaker 4

So we are very pleased with the efficiency gains we're seeing in the platform. The engineering team has done a lot of work to help us manage our overall cloud infrastructure costs. And so that is continuing to exceed our expectations, which is a big positive. Another area of our cloud COGS at this point in the cloud journey is cloud updates and upgrade costs. And we did see a little bit of those costs push out.

Speaker 4

So when I think about the outperformance in the quarter, if you think about 5 percentage points, about 2.5 We tend to model this work very conservatively, so we're not surprised by a lot of work coming into a quarter that was unforecasted, But that was the primary drivers of the outperformance in the quarter. That's helpful. Thanks.

Operator

Thank you. Our next question is from Ken Wong with Oppenheimer. Please proceed with your question.

Speaker 2

Thank you

Speaker 6

for the question. Maybe the first one for Mike. Just in terms of the scrutiny of IT budgets, I guess, How has that materialized for Guidewire versus just broad IT spend pullback? And if that has hit Sales conversation, is that more on the edges of your products or is that actually impacting Core Systems, we'd love to get a sense for kind of how that may or may not materialize.

Speaker 2

Yes. Okay. Thanks for the question. I would say this. I would say My sense is Guidewire is more immune to this than most, okay?

Speaker 2

I think people think about Guidewire Our investment in the Guidewire projects very strategically, 5 year duration, 10 year duration is a very legitimate conversation, One of which I had this quarter, right? That company is not thinking about as much the day to day quarter to quarter Cash flows, they are thinking about what are we doing for the next 10 years. So in general, Guidewire is more immune to this than probably most IT spend, But it does exist, right? And so you bring it up I bring it up because it's like the ability for us to manufacture deals, the ability for us to Accelerate things in a climate where the general mindset is conservatism as it relates It just makes it a little bit harder. The things that were already in flight and the plans that were already in place are continuing to And it does give us confidence in the outlook we've provided for Q4.

Speaker 2

But it is a bit of a headwind and it is coming up Much more in the last few months than it has in the past. And so I thought it was worth mentioning. That said, I do want to stress and this was we touched on this in one of the earlier answers to one of the earlier questions. This is a cycle. There is an adjustment period that we believe the industry will process through.

Speaker 2

And then I think things will get a bit back to normal and it will open up and the budgets will loosen a bit and we'll be able to Create a bit more acceleration, even beyond what we've got right now. So hopefully that helps to give you a sense of things.

Speaker 6

Yes, super helpful. Really appreciate all the thoughtful color there. And then Jeff, just wanted to maybe dig into the cash flow reduction. How much of that is maybe a byproduct of the lower top line, kind of trimming the ARR a little bit on the services side Versus what was just pushed out because of timing, collection, things of that nature, which hopefully you guys can recapture in future quarters?

Speaker 4

Yes. The majority of it was just given the environment that we're seeing in Some of the dynamics that Mike just talked to, putting a bit more conservatism into our collections assumptions Vis a vis what's going to be billed and invoiced in Q4. So that is a big part of it. We have the services the overall service Billing also had an impact. But if you think about that's probably a pretty small percentage of the adjustment Cash flow, most of it is just the timing of collections and making sure we build some more conservatism.

Speaker 4

We are seeing a bit more Process and bureaucracy that, insurers are putting in place before they make large vendor payments and we're having to jump through those hoops. And, certainly, the shift And our operating bank account in the quarter didn't help as we had to kind of go through a lot of revalidation to make sure that everything was in order. So that created a bit more process. That's behind us now. But as we look ahead, we just felt it was prudent to build more conservatism into our collections forecast.

Speaker 6

Got it. Okay, perfect. Thank you very much.

Speaker 2

Thanks, Ken.

Operator

Thank you. Our next question is from Rishi Jaluria with RBC. Please proceed with your question.

Speaker 8

Wonderful. Thanks so much for taking my questions. Mike, I wanted to go back to the generative AI theme. I'm really glad to hear kind The way you're talking about it and some of the transformational effects for Guidewire, I want to think about the impact on the industry itself, right? Not only does it For some of the peak draggers to modernize and kind of catch up and migrate to the cloud, but what's the potential for PMC insurers to actually Change the way that they view the business and maybe even more importantly, the way that they interact with customers.

Speaker 8

And what sort of impact do you think that can have on the overall Spending environment as it pertains to budget for Guidewire. And then I've got a quick follow-up.

Speaker 2

Yes. Thanks for the question. I spoke recently at a Guidewire event and kind of talked about how you can think of these things on a spectrum sort of near term to long term and you can get a little bit wrapped up in how Dramatically impactful it can be to systems like insurance in the long run. But I think you're making a bit of a mistake if you do that and missing out on The potential for us to just generally improve process efficiency and operational efficiency and all the little things that we do every day. And I think there's it's not just Guidewire thinking this, there's plenty of industry analysts who are Looking at this and looking at the insurance industry and you just see some potential or maybe a lot of potential Better to operationalize these models and use them with human beings in the loop, not to replace human beings, but to augment Human beings and make people more productive in managing sales processes, managing customer service, managing Claims, making sure all of those processes are more and more efficient.

Speaker 2

It's like hundreds and hundreds of little tiny details that Can be managed more effectively through systems like Guidewire. I think that there is a very important A story to be told and granted this stuff needs to be built and fleshed out and rolled out and proven, but it's exciting to see something with this much Potential and very accessible. The other thing that I was saying to the audience there was that One of the things I really, really like about these generative AI and large language model solutions is They don't necessitate a replacement of a system like Guidewire. You can just augment what you're already using Guidewire for. Now, I think If you're running a legacy mainframe system, it will be much more difficult for you to augment that system and that workflow with generative AI and I think that that might drive these transformations.

Speaker 2

But a system like Guidewire with a cloud API, you can call out you can grab information call out to a model and get an answer back and that helps the person who's on the phone with agents or a customer and it makes the process More efficient. So I'm very excited about this. I think a lot of people in the industry are very excited about it. We're excited to over the next few months I'll start to roll this out and start to think about how do we productize it. And I just talked for 5 whole minutes maybe and I haven't even touched on the implementation side of it.

Speaker 2

As I said, I think that the developer productivity component of this technology is very, very exciting. And I also expect it will improve. We're not yet at the point where we can give you estimates for objective measures of the productivity improvements, But there's a lot of engineers who are super excited about this. And so hopefully that gives you a little bit of color about You know where we are, how we're thinking about it and how we think it will have an impact on the industry.

Speaker 8

Yes, got it. Thanks. So that's really helpful. Appreciate all the thoughts there. And then I wanted to go back to some of the dynamics around ramped ARR.

Speaker 8

And maybe, I know you talked about this kind of a little bit of a surprise seeing that versus the smaller lands with Potential upside that we saw last year, but what's driving in your opinion that change in behavior? And maybe as we see some of those shallower lands or whatever you want to call it, the smaller lands from last year, as those kind of come up for renewal, Should that be kind of a driver as we put it think about our models that might lead to a little bit of an uptick in ARR and potential ARR acceleration? Thanks.

Speaker 2

Yes. I mean, as I said,

Speaker 4

I think it's an exciting pattern The insurers in this environment are tackling large strategic programs and making big commitments and investments with Guidewire, and we're seeing that in the total Contract values that support these ramped agreements. In terms of the shift over last year, It was a bit interesting. Last year, we saw a bit slower starts kind of dipping their toe in the water type of dynamic and There was a thought that maybe that would persist and that could have a pretty big impact on how we think about our model if that was the way that The industry chose to adopt and buy. I think it's a positive fact pattern that we're seeing some of these bigger commitments this fiscal year, but It is driving the way we were just to give you a glimpse into how we think about this is so we measure a booking. A booking for Guidewire is the average ARR that's delivered over a 5 year period.

Speaker 4

And then we have certain metrics that we look at internally such as What is the ratio between the year 1 ARR to that average ARR over a 5 year period? And that ratio our model is quite sensitive to that ratio. And so if you see that ratio go down a little bit, it means that there's and the bookings levels are the same. It means you're adding really Fully ramped ARR, but the year one dynamics that are a little bit lower than what we had modeled. So it's just one of these multiple levers That we have to manage through and we try to provide some insights into that.

Speaker 4

For a period of time, I thought Fully ramped ARR may fade into the background of relevant metrics because if insurers are buying a bit smaller and growing in a more organic fashion, Then that metric would just be a little bit less relevant, but as we're executing through this year, we're seeing that metric outpace ARR growth once again, which is gives us confidence as we think about the long term, but does Create some dynamics that we have to manage through relating to health health expectations. What was the second was there another part of the

Speaker 2

question? No,

Speaker 8

no, you covered everything. Really appreciate it guys. Thank you so much.

Speaker 2

Thanks, Rich. Thank you.

Operator

Thank you. Our next question is from Matt VanVliet with BTIG. Please proceed with your question.

Speaker 9

Yeah. Thanks for taking the question. Good evening. I guess just one more on sort of the higher mix of fully ramped ARR or fully ramped deals. How I guess think about that over the next couple of years of, from both a backlog perspective on the implementation side and then Related to that, overall staffing needs for the services group, especially as you push more, to SIs in general.

Speaker 4

Yes. And I think what I don't want to do is make this out to be a bigger deal than it is. I mean, we saw Ramped activity look more akin to what we saw 2 years ago. And coming out of last year, we adjusted our models a little bit to make those ramps A little bit shallower. So I don't want to overplay this, but it is a dynamic that we wanted to call out in the business.

Speaker 4

And how it relates to the services engagements is pretty detached, right? So And what we're seeing in the services part of our business is a part of our longer term strategy to shift more and more of this work to Partner community and we had to go through a cycle of certifying and enabling the partners to lead these programs. And that's what we are starting to see more and more of today, which will allow us to build a more Scaled and durable services organization in support of the broader ecosystem who will take the lead in managing these programs.

Speaker 2

I just want to say, I don't expect the manpower in our services organization to go down. I just think as the overall economy of Guidewire implementations to grow, more of that growth will flow to the Essak Partners, then it will flow to Guidewire. I think there's a very important role that our team plays in with respect to this These expert services that we can provide, especially around new product introductions and strategic projects, and there's just going to be some percentage Of the prospect base, the potential customers that want to have Guidewire take a role in the implementation And it's important for us to maintain that manpower. So like I wouldn't be thinking that this is going to contract, just It will grow more slowly than the overall ecosystem as we shift to this more durable, more leveraged model.

Speaker 9

Yes, makes sense. And then I guess on a few of the answers, you've talked about a number of customers wanting to lean more into Data and really the analytics behind a lot of that, and it sounds like more projects are maybe going live with those Implemented originally, but curious on how that overall demand cycle is impacting kind of the upsellcross sell motion Versus now just being included from the start because of the value perceived by the customers?

Speaker 2

Yes, it's a great question. I think we're doing a much better job, sort of designing the product To work together, to be integrated from the beginning, to be pitched and sold and packaged and marketed and then the sales process Described as one unified solution that can solve a core system modernization problem, but also deliver business benefits And so it's exciting to see, very often the economic justification for The modernization is attached to efficiency gains that can be either significantly or partially produced with predictive analytics. There's been a lot of excitement for, not just the predictive analytics, but also the sort of operational machinery for, What I'd say deploying the prediction into a user experience that actually causes end users to change their behaviors. And I think the industry in general, and this is not just insurance, but sort of the industry overall, the world of IT is pretty good at making analytics Pretty good at making analytics predictions and not as good at activating those predictions and causing a business change. And so A part of what we're producing here and what customers are excited about is that we'll be able to take these algorithms and turn them into And our practical useful predictions that end users will be able to use either make better decisions about underwriting risks Make better decisions about processing claims and that's exciting and it's a bigger and bigger part of the Story and the reason that a customer makes the decision to go now with a Guidewire project.

Speaker 2

So that's exciting to see and I hope it will continue to improve And we'll see, but my expectation is generative AI, large language model supported capabilities Augment that and kind of fit right into the same story I just told you about our predictive analytics capabilities.

Speaker 9

All right. Thank you. Very helpful.

Operator

Thank you. Our next question is from Joe Bruehring with Robert W. Baird. Please proceed with your question.

Speaker 3

Great. Hi, everyone. Thanks for squeezing me in. A little bit on the last topic since you brought up analytics, but just on that new logo win with the Tier 3 carrier. The mid market does seem a bit more competitive of late.

Speaker 3

What are you finding to be the differentiator for Guidewire When you're winning in that segment or Tier 3 through 5 outside of Tier 1 through 2, is Something like analytics catching on or would you maybe point to some broader themes there?

Speaker 2

Yes, great question. Hilla, I'll give you the themes. I think number 1, it's important that it's valuable that we bring A complete solution that is consistent across claims policy billing, right? So I think the larger carriers Probably have more horsepower, maybe more capacity to be able to tolerate different systems for different use cases. But with these smaller companies, More limited to IT organizations, a consistent platform with one approach to integration, data, analytics, configuration, 1 vendor, the whole stack, the full suite, the whole insurance business process operating very cleanly, That's important.

Speaker 2

I think that one vendor being responsible for the predictive analytics and that The other thing that's coming up is just like and I kind of touched on this before, Just track record of success. We've got I think 40 some And customers in production, we've got multiple years now of track record and experience running this. We've got a vision for this 3 releases a year. And I think that customers see that momentum. And I think that that does factor into the decision making process in a significant way and helps us.

Speaker 2

And I wanted to say something because I'm surprised actually nobody asked this question yet. Jeff and I touched on this. Like in this quarter, we're seeing Conversations about competitive displacement that I have not seen in my 4 years at Guidewire It's like we mentally think of these systems as being the mainframe has been replaced and this package has been deployed and we started to think of That's like that TAM is removed. But now it's coming back up. And the systems that are now at this point maybe more than a decade old, These companies are talking to us about what's our potential for replacing them and that's a very, very exciting Development, it's a great conversation to have.

Speaker 2

And I think the reasoning behind that interest has a lot to do with all the reasons I just gave you about why That tier of the market is interested in Guidewire. So I think it all plays to our strengths right now.

Speaker 3

And I'll just quickly follow-up on that last point. I think in the past you said like 20% to 25% global BWP, You manage that of what remains, half of that remainder is on a mainframe system. You're really talking about like that half is maybe just unbounded at this point. I mean, it's all up for grabs?

Speaker 2

Yes. I think if you play it out, if you play that concept out, yes, you could say all of that is now up for grabs. Now it obviously depends on which vendor you're talking about and when the implementation was done and what are the unique circumstances associated with that implementation. It's probably too exaggerated to say that it is completely all up for grabs, but part of that segment of the market It's up for grabs. And in that like I said, that's a very exciting thing to see, and I think is Unlocked a bit just based on time, but also based on the momentum and the innovation that we've established and are proving through our execution.

Speaker 3

Great. Thank you very much.

Operator

Thank you. Our next question is from Michael Turrin with Wells Fargo. Please proceed with your question.

Speaker 4

Hey there. Thanks for squeezing me in. Just one for me. Going back to just some of the other comments. So 3Q ARR Came in ahead of the prior guide.

Speaker 4

The fiscal Q4 compared to the full year is more a tightening of the range. I appreciate you not wanting to turn this into a call around But is the second half impact you're characterizing last quarter there the difference between what was previously expected? And is that more what's driving the decision to wait Q4 before framing the prelim growth outlook as you historically have or is some of that also just macro fiscal Q4 being important and that's What's driving the decision process there? Any further context is helpful. I think you're thinking about it right.

Speaker 4

That's exactly Our thought process, I mean, I also think that in prior years when we assessed the analyst models and look What was out there, if there's something that we felt that was critical to get in front of that we had visibility into, we would try to do that. But Given kind of where we are and how critical Q4 is for establishing the right framework for the next fiscal year, we felt like it was prudent to kind of wait until that is completed.

Speaker 2

Thank you.

Speaker 4

Yes. Thanks.

Operator

Thank you. Our next question is from Parker Lane with Stifel. Please proceed with your question.

Speaker 5

I'll just ask one in the interest of time. Mike, I was wondering if you could talk about the share migrations that carry expansion As part of the project and the general appetite you see for customers that are embarking on the cloud journey to either hit the ground running and just make sure they have Successful cloud migration or widen the scope of what they're trying to achieve?

Speaker 2

Super question. This is a dynamic which we also have noticed and very often It is the let's call it the modernization projects to modernize something that causes the conversation about let's To the cloud upgrade of the existing implementation as well. Sometimes it's the other way around where we're talking about a cloud upgrade or a version upgrade and that causes the conversation about new lines of business or modernization around another Component of the core system. But what triggers these things are Deals like this, they need triggers. They need compelling events.

Speaker 2

They need business related objectives that can drive the projects and the deal for us. And so like I said, a lot of times Hey, we've got an initiative to do XYZ in our business. We need a modern system to do that. Okay, that We have Guidewire for claims already and we're happy and so let's talk about policy. And then while we're going to do policy on cloud, what how should we think about claims?

Speaker 2

We move that to cloud also and that's the way that the conversation goes and evolves and then results in a migration and an upgrade. And there's just a variety of different ways that those conversations can happen, but those compelling events are created and driven by these business objectives. And so that's a dynamic that we're absolutely seeing right now and are excited about just continuing it. And so it's like there It kind of relates also to this idea that we are a very good solution for a full suite offering where you can do everything in a very consistent way, 1 vendor, 1 approach to configuration, 1 approach to data and analytics and integration, 1 approach to the marketplace partners and Having a consistency across these core systems, claims policy and billing, really just facilitates a better and insurance process and it's a big part of the value prop that we've provided. And even it's like not to Not competitors, but just like Guidewire is pretty unique in the landscape for P&C Core Systems And that from the InsuranceSuite perspective, all of these products have been built organically At Guidewire, they haven't been acquired or kind of bolted together through acquisition.

Speaker 2

It's like this has been built and crafted Great engineers, great teams at Guidewire over the course of many, many years and hundreds and hundreds of implementations. And that's a big part of our success. So I appreciate the insight and the question and it's definitely one of the things driving a lot of these deals right now.

Speaker 5

Appreciate the feedback. Thanks again.

Speaker 2

Hey, thanks for the question.

Operator

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

Speaker 2

Thanks very much. So I just want to thank everybody for participating in the call today. We're obviously thrilled with the continued cloud momentum across new and existing customers, Tier 1 and Tier 2 insurers, while also driving margin improvement. I was particularly Happy to see the continued improvement in margins. There's been a huge effort here at the company to make that happen and this was a great validation And so we're very excited about the future, very excited to have a great Q4 and we look forward to talking to everybody Again, at the end of our Q4 at our next call.

Speaker 2

So thanks very much.

Operator

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

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Guidewire Software Q3 2023
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