Richard Hart – Chief Financial Officer Marcus Ryu – Chief Executive Officer.

Matthew VanVliet – Stifle Kenneth Wong – Citi Justin Furby – William Blair & Company Alex Zukin – Stephens Nandan Amladi – Deutsche Bank Brent Thill – UBS Brendan Barnicle – Pacific Crest Securities.

Good day, and welcome to the Guidewire's Second Quarter Fiscal 2016 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Richard Hart, Chief Financial Officer. Please go ahead, sir..

Good afternoon, and welcome to Guidewire Software's earnings conference call for the second quarter of fiscal year 2016, which ended on January 31, 2016. My name is Richard Hart. I'm the Chief Financial Officer of Guidewire and with me on the call is Marcus Ryu, Guidewire's Chief Executive Officer.

A complete disclosure of our results can be found in our press release issued today as well as in our related Form 8-K furnished to the SEC. To access the press release and the financial details, please see the Investor Relations section of our website at ir.guidewire.com.

As a reminder, today's call is being recorded and the replay will be available following the conclusion of the call. During today's call, we will make statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, regarding trends, strategies and anticipated performance of the business.

These forward-looking statements are based on management's current views and expectations as of today and should not be relied upon as representing our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. Actual results may differ materially.

Please refer to the Risk Factor section in our most recent Form 10-K and 10-Qs filed with the SEC. We will also referred to certain non-GAAP financial measures to provide additional information to investors. A reconciliation of non-GAAP to GAAP measures as provided in our press release.

Reconciliations and additional data are also posted in the supplement on our IR website. During the call, we may offer incremental metrics to provide greater insight into the dynamics of our business. These details maybe one-time in nature and we may or may not provide updates in the future.

With that, let me turn the call over to Marcus for his prepared remarks and then I will provide details on our second quarter financial results and our outlook for Q3 and the rest of fiscal year 2016..

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

This result is attributable, both to better than anticipated sales of our new products in earlier sales of some licenses that we expected to close later in the year. The early conversion of these licenses reinforces our optimism about our ability to achieve our goals for the fiscal year.

Term license revenue was $52.7 million in the quarter, representing 28% year-over-year growth. Term license and maintenance revenue for the trailing 12 month was $238 million, an increase of 16% from a year ago.

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

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

Those results featured both growth dimensions that we care about, inaugurating relationships with new customers of all sizes and expanding relationships with existing customers with additional products. In the past, I focused on our relationships with Tier 1 companies.

This quarter featured progress and developing relationships with several smaller insurers in an important validation of our appeal to all segments of our target market. For example, frontline insurance a Tier 3 insurers specializing in coastal commercial and residential property in the Southeast U.S.

selected InsuranceSuite, our rating, client data management in reinsurance modules and our data management in digital portals to enhance customer engagement.

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

Now in the left, a $200 million farm and ranch insurer in Montana and Wyoming will implement these products across it's personal, commercial, workers comp and the reinsurance lines of business.

Safety National a $600 million subsidiary of Tokio Marine offering commercial lines and workers compensation selected PolicyCenter, claim center, rating and business intelligence for InsuranceSuite.

And finally, AAA of Carolinas, a $60 million personal auto and homeowner’s insurer, licensed InsuranceSuite, DataHub and InfoCenter, Digital Portals and several add-on modules. Notably, AAA of Carolinas intends to implement our products in our hosted cloud offering, managed by one of our insurance cloud solution partners.

Meanwhile, and in keeping with our experience of the last several years, several long-standing claim center customers expand their relationships to encompass other core applications in the suite. MiddleOak insurance added BillingCenter, Southern Farm Bureau added PolicyCenter and Accident Fund Insurance added PolicyCenter and our Digital Portals.

Turning to international, AXA UK, one of the largest subsidiaries in the major multinational AXA Group, writing both personal and commercial lines, selected ClaimCenter. With the UK, we now serve AXA in 12 countries in Europe, the Americas and Asia.

Additionally, ConTe.it a $350 million auto and motorcycle direct insurer in Italy, selected PolicyCenter and BillingCenter. ConTe is a company is subsidiary of Admiral a leading UK direct insurer and a long-standing GuideWire PolicyCenter customer.

In South America, we initiated a new relationship with Seguros Generales Suramericana, a $700 million multi-line insurer based in Columbia, who will be implanting InsuranceSuite, our Rating, Client Data Management and Reinsurance modules and Digital Portals.

Along with [indiscernible] in Brazil which we announced in Q1, Suramericana represents our second significant recent win in Latin America, a geography in which we anticipate multiple large insurers to undertake modernization programs over the next few years. Overall then, our sales momentum is very healthy it's measured by results.

I would add to that a qualitative observation that our engagement of the CEO and even board level with insurers of all sizes it's stronger than ever, reflecting the urgency of adapting to technology-driven changes in the P&C industry as a whole.

The themes of data management, predictive analytics, sophisticated customer segmentation and digital engagement are catalysts for IT investments at a heightened level from several years ago. We believe the investments we have and continue to make in our core data digital platform strategy positioned us particularly well to serve this demand.

For example, since the end of fiscal 2015, we've almost doubled the number of customers who have selected our digital products. As I mentioned, Sudamericana, Frontline, Mountain West, AAA Carolinas and Accident Fund also like the Digital Portals in conjunction with our core offerings.

During the second quarter, Digital Portals was also selected by Southern Farm Bureau, Texas FAIR Plan, and Seibels Bruce Group. Most meaningfully, we signed an enterprise-wide license for all of our Digital Portals with Nationwide, a $20 billion insurer and one of our largest and most sophisticated customers.

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

Implementation-wise, our go-lives in the quarter included active campaigning in China with claim center, and in insurance and data management go-lives at the largest insurer in Australia, QBE.

Also noteworthy, with an initial go-live at State Farms, who was able to complete their implementation of PolicyCenter for the first of their commercial lines on schedule in seven months. Our track record of successful delivery, shoulder-to-shoulder with our customers remain fundamental to our identity and differentiation.

Track record notwithstanding, we aspire to continuous improvement. As we mentioned during our Analyst Day presentation, we are focused on reducing the total cost of ownership of our software.

To-date, InsuranceSuite has led in the marketplace due to its functional sophistication, extreme flexibility and its ability to lower operating cost, as compared to customer legacy systems. We believe, we can further facilitate adoption of our suite and thereby our other offerings by reducing the cost of implementation.

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

As one proof point of the latter, we've recently announced a reseller arrangement for our cloud-based document production technology offered by Thunderhead. Thunderhead solution is broadly adopted in our market, including by many of our customers.

While we anticipate a modest contribution to revenues in fiscal 2017, this relationship is primarily intended to reduce the TCO of InsuranceSuite through a product type integration and pre-built document templates. We see multiple similar other opportunities, which we will pursue to further streamline and standardize our customers' implementations.

Among our most significant initiative, is the facilitation for cloud deployment as in the case of AAA Carolinas, which I mentioned earlier. Notably, our launch of InsuranceSuite 9 later this year will introduce native support for deployments on AWS and 00:09:07 and integration with next-generation digital features.

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

Our ongoing investments in InsuranceSuite are being recognized by customers and industry analysts. For the second year in a row Gartner positioned Guidewire as a leader in its magic quadrants for North American P&C policy management systems.

In addition, research firm Celent named Guidewire as the top solution out of 43 for both advanced technology and customer base in their recently issued report on North American policy solutions. During the quarter, we also made our first venture investment.

Trove is the Bay Area technology company providing an app for tracking and insuring individual valuable items. Engaging with emergency technology – engaging with the emerging technology companies will help us identify and leverage new ideas that we can bring to our customers and prospects in the industry we serve.

We intend to selectively use capital to engage with new market entrants that are incubating great ideas. In summary, we had a strong second quarter with results exceeding our expectations. We are encouraged by our sales momentum, especially for our newer offerings.

A conducive demand environment as P&C insurers invest to adapt, and the positive feedback, we're hearing from our customer community about our long-term investments in data, digital at lower TCO, at visits and an aspiring industry standard.

I will now turn the call over to Richard, to provide details on our second quarter financial results and our outlook for Q3 and fiscal 2016..

Thank you, Marcus. As Marcus, mentioned we delivered a strong quarter with revenue and earnings that came in above the high end of our guidance ranges. Total revenue in the quarter was $102.1 million of which license revenue was $53.4 million. Within license revenue, term license was $52.7 million for the quarter, an increase of 28% from a year ago.

Perpetual license revenue was at $0.7 million. We are justifiably proud of our term license growth, driven both by an increase in our InsuranceSuite business, and fueled by the continued growth in our new product sales, which continue to increase as a percentage of bookings and revenue.

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

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

Obviously, the timing of the license transactions, especially large ones can create volatility in our period-to-period growth, as can the effects of currency rate movements and the timing of customer payments. On an annual basis however, we continue to be optimistic that we can still achieve our 20% or better term license growth.

In the first half, perpetual license revenues contributed a much smaller portion of our license revenue in the same period last year. This is in line with our focus on increasing term license revenues.

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

Although, we are not in a position to offer specific guidance at this time. Maintenance revenue was $14.3 million for the second quarter, up 17% from the year ago and slightly above our guidance range.

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

Additionally, as we've noted, maintenance revenue growth in fiscal 2016 has and will continue to be impacted by foreign exchange rate effects that impacted license revenue last year, but that are having a delayed impact on maintenance revenue, due to the ratable nature of their revenue recognition.

Services revenue was$34.5 million, up 3% from a year ago, consistent with our goals of increasing SI participation in our customer implementations. Geographically, the U.S. represented 61% of revenue for the second quarter with 39% coming from outside the U.S.

Before turning to profitability, I wanted to address the topic of changes to accounting rules and the potential impact of these changes on our revenue recognition in the future that I've been asked about several times. As a reminder, we will begin reporting under a new revenue standard in our 2019 fiscal year, which begins August 2018.

As a caveat, we note that there are elements of the new standard for which guidance is evolving and therefore the application of the standard is not clear in all cases. Having said that, we believe that revenue recognized under our typical term licenses has currently constructed will vary greatly.

Under the new standard total term license amounts payable even for multiyear deals would be recognized in year one.

As an example, if under one of our five-year term licenses, payments totaled and assumed $5 million or $1 million per year, we would recognize that $5 million in year one as opposed to $1 million each year of the term license and would not recognize any term license revenue in subsequent years.

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

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

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

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

Non-GAAP gross profit in the second quarter was $72.7 million, an increase of 21% on a year-over-year basis and represents a non-GAAP gross margin of 71.2% an increase from 67.0% in the year ago quarter. Breaking that down in the second quarter of fiscal 2016, non-GAAP gross margin for license was 97.9%, maintenance was 84.2% and services was 24.6%.

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

Moreover, looking to the second half of the fiscal year, we anticipate service margins to decline modestly as we increase hiring to meet demand generally and specifically as we hire specialized consultants to support deployments of our new products, especially our data management products.

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

Total non-GAAP operating expenses were $48.1 million in the second quarter, an increase of 13% compared to a year ago. This resulted in non-GAAP operating income of $24.6 million above our guidance of $14 million to $18 million and represented a non-GAAP operating margin of 24.1%.

A significant contribution to the operating income outperformance was the result of higher than projected license revenues, stronger than anticipated services gross margins into a lesser extent, lower than forecast research and development expenses also had a beneficial impact on profitability.

We were able to hire close to plan the quarter unlike in the first quarter where we saw a significant delays. However, with the effect of additional recruiting resources was evident most in a higher pace of hiring in the back half of the quarter.

We are working hard to meet our original hiring goals, by maintaining our current pace of hiring through the end of the year. As we gain experience in promoting Guidewire as a great place to work in Europe, we are making progress towards that goal.

Indeed, such progress was evident as we expanded our development organization in areas outside the United States with strong hiring both in Dublin and Poland. We finished an expansion of the Dublin office this quarter and expect to move into a permanent facility in Kraków early in the next fiscal year.

We fully expect the development organization to grow more quickly in these geographies, than in the United States for the remainder of the year. As a result of this combination of factors, non-GAAP net income was also above our guidance range of $17.8 million or $0.24 per diluted share.

Turning now to our balance sheet, we ended the second quarter with $700.8 million in cash, cash equivalents and investments up from $663 million at the end of the first quarter, as cash generated from operations in the second quarter was $37.9 million.

The $700.8 million figure includes the impact of our $5 million investment in Trove as Marcus mentioned, which is classified as a long-term investment. Total deferred revenue was $62 million at the end of the second quarter, compared to $49.6 million at the end of the first quarter.

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

So we believe that the combination of this contracted business and our best-in-class renewal rates, provides us with a high level of visibility towards our fiscal 2016 revenue. Now, I'd like to turn to our outlook.

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

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

With respect to profitability, even though, we expect to see an increase pace of hiring in the third quarter and fourth quarter, we are increasing our third quarter and full year profitability guidance due to better than expected margins in the first half of the year, modestly higher revenues and lower than anticipated expenses as the impact of delayed hiring on operating expenses continues to be felt for the rest of the year.

Looking at the third quarter fiscal 2016, which has experienced – has historically experienced the seasonal revenue decline, we anticipate total revenue to be in the range of $90.3 million to $94.3 million.

Within revenue, we expect license revenue to be in the range of $40 million to $42 million, maintenance revenue of $14 million to $14.5 million, and services revenue of $36 million to $38 million.

For the third quarter, we anticipate non-GAAP operating income of between $4.5 and $8.5 million, and non-GAAP net income of between $3.1 and $5.8 million or $0.48 per share based on an estimated weighted average diluted share count of 73.8 million shares.

For fiscal year 2016, we now anticipate total revenue to be in the range of $408.5 million to $416.5 million representing an increase of $1.5 million at the midpoint from prior guidance. Within revenue, we anticipate license revenue to be in the range of $2.06 million to $2.12 million an increase of $1 million at the midpoint.

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

As I previously mentioned maintenance revenue growth expectations are negatively impacted by the delayed effects of foreign exchange rates on maintenance renewals in fiscal year 2015, as we recognize that revenue in this fiscal year.

We continue to expect services revenue to be in the range of $144 million to $148 million, down approximately 4% from fiscal year 2015, and representing approximately 35% of total revenue. This decrease remains consistent with our stated strategy to transition and an increasing portion of implementation services to our systems integrator partners.

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

We are increasing non-GAAP operating income guidance to a range of $69 million to $77 million, resulting in full year non-GAAP operating margins of 18% at the midpoint of guidance as the increased profitability in the first half of the year and the continued push to grow our Dublin and Poland organizations more rapidly than our organization in the U.S.

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

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

In summary, our strong second quarter results reflect continued momentum and enabling insurers to adapt and succeed in a changing world, transform their businesses with our modern core system software, improve their decision making with our data products and enhance their agent and customer interaction with their digital product – with our digital products.

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

A strong business momentum and leadership position are reinforced by our advancing solutions and make us confident that we can drive continued growth and profitability as we transform the marketplace. Operator, can you now open the call for questions..

Thank you. [Operator Instructions] And we'll take our first question today from Tom Roderick with Stifle..

Yes. Hi, Matt, VanVliet on for Tom, thanks for taking my question. I guess first on it looked like a very good quarter for cross selling to existing customers.

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

We appreciate the question. The first part about the mix of new deals. We carry equally about both getting new logos, new customers starting new relationships on the one hand and then developing the existing relationships that we have. Both are very important to our growth aspirations and this was quite a good quarter on both of those fronts.

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

As you noted and as we called out in the prepared remarks the newer products were very important in both our standalone sales to existing customers as well as being part of an initial purchase by our newer customers and we like seeing both of those trends.

The latter part of your question was about some of the big deployments that are underway, nothing in particular to report there that it's more or less business as usual, there – these are all large-scale big transformation programs, we called out a few, that went live, that were significant, each of those is – was important in its own way.

AXA TianPing is our first customer in China, so going live is clearly an important proof point, state, farmers, who they are and so forth.

But there is nothing special to announce in terms of that pattern, but as we've underscored in this call and multiple others, driving down the amount of effort, the degree of configuration that the extra effort and integration, all of those are very important to reducing the cost of ownership, and therefore, to our value proposition..

And then following up, digging a little deeper on the newer products, you talked about the digital enterprise wide license at nationwide.

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

We have to be careful about, getting specific on the pricing by individual product in part because we think that, that it we are dealing with still a small numbers at this stage, the pricing has we, has evolved and we expect to continue to evolve as the products mature, we're still developing proof points in different market segments, that will be important to kind of getting – to motivating a higher capture rate on the value created.

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

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

Great. Thank you..

One thing, I would add....

I'm Sorry..

Yeah. I'm sorry the Nationwide transaction is a is a little bit unique in that Nationwide will be licensing all of our portals, as they developed and therefore we will be recognizing that license ratably, so you're not seeing a significant impact from that license in this quarter on a revenue basis..

All right. Got it. Thank you..

Next we'll hear from Ken Wong with Citi..

Sorry, guys it looks like I was on mute.

Hey, Marcus, you talked about the State Farm deal go in lot highest and that seems like a lot quicker than sorry – Marcus, you talked about the State Farm deal going live and that seems like a lot quicker than I would have expected for such a big customer, was this due to the simplification of processes that you talked about or is it just something specific to this particular project?.

Yeah, it's important to note that our relationship with State Farm date is confined to their business lines insurance, which is pretty meaningful at about $4 billion premiums but still obviously a very small fraction of the entire State Farm premium base, which is many multiples of that.

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

It was a rapid project and I think that, that reflects both strong program, execution on the customer side and our side as well as a heightened emphasis that you're going to see from us, across all projects to drive to a very highly conforming projects – namely implementation that hues quite closely to the base capabilities of the system, and that becomes more and more possible and appealing as the applications – now are quite mature and are getting more mature and have more and more base content already built into them.

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

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

Got you. That's super helpful. And Richard, earlier you mentioned that you've got some – some license transactions in terms of the – from timing wise that – that kind of came forward into this quarter.

That sounds like you're specific to this particular year or some back half deals that – but, anything that is – perhaps is pulled forward from next year?.

No, nothing that far out. I will say that in any particular quarter, we're going to see a little bit of flux, between deals that are appearing in the pipeline and in the quarter that we have to delay or the deals that come in a little bit faster than we anticipate.

I think in this quarter, we had both phenomena happening at the same time, but I will say that – the net advantage to us in this quarter was that – more dollar of deals came in this quarter than we anticipated. But, nothing is far out as next year..

And then anything specific that you might call out that caused that whether just customers trying to get ahead of – perhaps on the – budgets being closed off or anything of that nature or is it just – it's kind of just – this happens from time to time?.

No systematic pattern that I would call out. I think while I would like to believe that we become steadily more confident at motivating inefficient sales cycle, but I maybe retracting that in another future quarter when – we'll still go that way.

But it was a quarter of good sales execution, not just in the overall result, but I think in the efficiency at close and the accuracy of forecast. So I feel, we feel quite positive about that..

Got you.

And the last thing from me, in terms of the hiring pace that you guys are seeing, it's kind of four quarters now where you guys haven't quite, I guess, still the pipe like you guys would hope, is that something that you guys worry about in terms of trying to acquire – acquire the necessary talent to grow like you guys want, got nothing that you clearly can ramp up on later?.

Yeah. No concerns on that front. As with any hiring engine, there is a little bit of a warm up period and then kind of a lag effect between when you want to hire and when you have the recruiting engine humming.

In our case also we've been directing more of the development hiring or as much as possible really to our new international location the ones we talked about in Dublin and Kraków, Poland, but we feel very confident that we're going to converge closely on the exit rate that we had hoped for or the exit head count maybe down a little bit from it, but pretty close to it, no concerns on that..

And you did see a significant improvement between Q1 and Q2 where we actually came very close to plan in Q2?.

Okay. Fantastic. Thanks. That's it from me guys..

Thank you..

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

Hi, guys. Thanks for taking the questions and thank you for another stunning quarter.

Marcus, can you just give us update on the macro as you see it today? Are you seeing any signs out there that insurers are getting nervous at all about the market, particularly in Europe? And, what kind of downturn will we need to see where you think your view of 20% type term license growth over the medium-term could be meaningfully at risk? Or do you think of the secular shifts that you're seeing out there would outweigh any potential incremental macros? And then, I've got a couple of follow-ups.

Thanks..

Sure. Well, as we've always emphasized and as you know, Justin our we've – our growth rate is impact to the growth of the industry as a whole. But to this pent up demand for technology-driven transformation and so forth. And, that's when we loosely coupled with the overall macro environment.

The – one of the strengths I guess or weaknesses of the industry is that it is not in lockstep with the rest of the macro world. And, that's – we have taken some comfort from that especially during the global financial crisis and so forth, which were relatively modest events from our perspective.

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

You know the digital engagement, you know the potential impact of sophisticated, predictive analytics and the like. I mean these are really the catalysts for investment. Sometimes there are – that can be an exogenous event like a big catastrophe that really distracts an organization or imposes a big hit. That could make a difference.

But, it's actually been a pretty benign year, catastrophe and weather wise and then anything like that that's – that we've seen on the horizon either. Europe is a somewhat different matter. It's a sluggish macro environment as you know well.

And there are certain geographies like France, like the dark region overall that have not – they don't feel that energetic or that optimistic about their – the prospects of growth and therefore more reticent to invest in their platform, even though they generally agree with our thesis that, that's a necessity, which is harder to get it motivated.

So, if there is a place, where we are seeing a macro impact, it's in Europe, but that's a multi-year story, not something that's happened in the last few months..

Okay. So, nothing really incrementally changing quarter-over-quarter, it's sounds like then..

Certainly, not..

Okay. That's helpful. And then, it seems like you continue to see really nice traction, with digital and data and newer initiatives, can you just give us a sense how meaningful this is, in terms of a percentage of a new bookings, is at 10%, 15%, 20% just somewhere in there.

And market does that potentially change your view as you start to see more success here of the 20% term license growth, could it be something higher or is it just increased confidence into that number..

Yeah. Without getting too precise about it, the newer products are contributed in the quarter something like 20% to 25% of bookings, which was outstanding, we were pleased by that, but it's important that every piston in the engine fires here. So, that when a new customers, that we're selling claim center, we are selling PolicyCenter.

And that, we're showing that, we put the newer products are compelling to the existing customers, to new customers, all of those are important because our ambition is pretty straightforward, we just wanted to be the total operating platform for every insurer and every component is important.

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

Of that, it's – it would be premature to say that, that the uptick a strong uptick, that we've seen in the last two quarters, three quarters for newer products, changes our view in the longer-term growth rate that would be definitely premature, but we are at place that is definitely bolstered our confidence is the ability to bring new products to there and cross sell compellingly to our customers, because if you have your core operating system running on Guidewire it becomes a very logical, a natural choice to do a lot of other things that are ancillary to that.

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

Got it. And then, lastly just Richard, going back to the upcoming rev rec changes. As you go through and you shorten duration and assuming you're able to sort of work through your base over the next few years and we go into fiscal 2018.

Do the revenue and the cash flow dynamics and still effectively look like they do today in that environment or what affectively changes?.

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

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

Yeah.

And I was referring specifically once you get to fiscal 2018 and beyond?.

Fine. No, and that's exactly fine..

Okay..

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

Got it..

The main consequence just to make sure this is in last, is that we will have shorter contract terms than has been our historical norm and that we think in the sense of nonevent, because as you well know we – you know about our renewal rates and our expectations and our customers' expectation to use the software for a very long time, really definitely, but the underlying contract from may entail a shorter – or will entail license term and in a way that's sort of an unfortunate consequence of the accounting standard, but it's the only sensible thing to do..

No, that makes sense. I'm not all worried about – about short duration you renewed everything inside, it's more does the revenue change and it' sounds like it doesn't. So, thank you, and thank you for doing that earlier, so it doesn't become a nightmare over time..

Thanks, Justin..

Next we'll hear from Alex Zukin with Stephens..

Yeah, hey, guys. Thank you for taking my questions and congratulations on the – on the quarter.

Marcus, you mentioned the solid pace of sales cycle, and I guess one of my questions is, do you think it is being influenced by the amount of the tier 1 wins that you had over the last couple of quarters? Are you starting to see those floodgates open? Are those conversations become a little bit easier to have? And then I've got a couple of follow ups for Richard?.

Yeah, I think that certainly having certain hospitals named as recent customer wins is very helpful, and it elevates the stature of the company.

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

So, yes, that's helpful, but it's also important to note that the industry we serve is really heterogeneous, and different segments, different sizes, different lines of business, and obviously different geographies have different peer groups and winning a very significant name like a State Farm or Farmers or the Hartford and Nationwide is extremely meaningful to one important segment of the market, and all of the relevant to other segments that aspire to serve.

So, it's – and nothing would be worse than sort of arrogantly assuming that while we've earned these each customer's selection, therefore we're entitled to yours. We really find that we have to earn it each time in every segment and there are many segments that we serve.

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

Got it. And then one more question about the sales cycles.

Are you seeing that you're starting more and more conversations now with the digital front office products than the prior year and is that in some cases actually starting to pull the rest of the InsuranceSuite forward for you?.

Yeah. That's an interesting question. Digital transformation, digital engagement is a major catalyst for IT investment in the industry. As I imagine, it is for other industries. And in many cases, the underlying motivation for core system replacement is to have an operational platform that will support a digital ambition.

It's not to say that, that with the core system replacement is the incidental or just a necessary evil, it's just – that the digital imperative has – is the activator finally for institutional action. And that's very helpful.

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

Yeah. That's helpful. And then Richard, when I look at the term license be its I think one of the biggest that you guys have had in the last couple of years.

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

It's actually hard to do so Alex simply because there are a lot of moving pieces and that would require me to make some judgments on the fly which I'm uncomfortable making, but I would say that at least half of the upside was driven by that kind of dynamic..

Perfect. And then just to squeeze one more in here for Richard.

You mentioned that the incremental perpetual revenue – perpetual licenses in the second half is going to be higher than the first half, I'm trying to figure out what kind of impact without specifically guiding for, what kind of impact are you baking in in the guidance for license revenue from that incremental uptick in perpetual in the second half?.

So,0 when I say I have no ability to guide you at the moment, I mean that. And what I mean by that is when I look at the pipeline and I look at the number of transactions that are coming from areas of the world or from customers that we've already engaged with on a perpetual license basis, I have to probability wait those.

I don't know how those will ultimately end up and we are always pushing to even drive current customers that are under a perpetual scheme to transition to term. And so I don't want to handicap that.

All I know is that in the first half, I've only had effectively $400,000 worth of perpetual license, and I know for a fact, that that is simply not a rate that I can sustain over the next two quarters..

So, is that meaning you're – it's upside to the guide or is that baked in?.

So I mean, I think, we always, we always kind of think about kind of a range of perpetual that we think is within the ambit of the probable as we look out for our guidance during the year. But we are not so scientific as to say, well that comes in perpetual, I'm going to be able to do this with my term.

All we are willing to do, all we can do, is simply suggest that we have a goal that we think we can meet, which is to improve our term license by 20% or more. And obviously that becomes more difficult, if some of those term licenses transitioned to perpetual, but we don't think that's going to happen..

Perfect..

So, we continue to maintain that 20% goal..

Perfect. Thank you guys for taking my questions..

Thanks, Alex..

Next, we will hear from Nandan Amladi with Deutsche Bank..

Hey, Nandan..

Hi. Good afternoon. Thanks for taking my question. So, this is kind of a big picture, financial model question that relates back to the Analyst Day. Marcus, you mentioned that maybe a 20%, 25% of your new bookings came from these digital products and data products which are sold on a ratable basis.

And then off course, some of the hosting options may have an impact on your margins, as some of your partner’s maybe host in EWS or Azure or what have you.

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

So, may I jump in here Nandan, I know the question was addressed to Marcus. But, I want to clarify something.

When we sell a data management license or when we complete a portal license, those licenses are treated, the way we treat our InsuranceSuite sales, right? That as we have a term license and we recognize that revenue upfront on an annual basis or in some cases, on a quarterly basis.

The product that we sell, that is – that is recognized on a ratable basis is live and we also have some transactions that are of a nature like the nationwide portal transaction, in which we will recognize that ratably. We have those in the base, right. So, I just wanted to clarify that the new products are not necessarily ratable per say..

Yeah.

And in terms of the big picture you are asking about Nandan, I would say that the newer products, that the main impact they have on our big picture thinking is about really TAM expansion, the opportunity to have a higher basis points of un-premium capture with our customers because we are more relevant to a broader swap of what they are trying to achieve strategically and then possibly there is an impact on sales efficiency because what we are finding is and this is totally intuitive that once you have a well-established customer relationship and some real proof points of delivery under your belt, that the next sale becomes a lot more straightforward and efficient than that, that first thing it was.

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

But in terms of the underlying margin characteristics of that software Richard is right, with this the where it's very much the same kind of model so far and it still quite a few years away before a large enough percentage of our customer base and even new customers will be coming in a ratable cloud native platform that, that it will really change our model and obviously will give you lots of opportunity for discussion with you and the investment community about how that will look..

Okay. Thank you, that's all from me..

Thanks, Nandan..

We will now hear from Brent Thill with UBS..

Thanks.

Marcus, it's pretty clear, the success you're having in tier 1 and tier 2, when you look at tier 3, tier 4, I think you've been pretty clear the economic opportunity there is big in each of the categories and just curious what you're seeing as you go downstream – and from an economic perspective is the downstream in your opinion just is profitable is what you're seeing upstream?.

Yeah. It's potentially more profitable if we get it right. Yes, there is a material investment in sales for ultimately a smaller ticket, but if we can get that repeatable then and have highly standardized implementation, which this segment – those segments of the market absolutely want, then we can serve it very efficiently and profitably indeed.

It is a segment that we have the most work to do in, the smaller the insurer the more work we have to do. It's one of the reasons in our prepared remarks we called out the fact that we had quite a few Tier 3 and Tier 4 customers, the new names this quarter, which is very encouraging.

For us, it's not all about just a big household names, we're looking to serve the whole industry and that's very substantial part of our TAM as we've talked about before. But we have more homework to do. We have to build more base content.

We have to have our – we have to continue to pull in our deployment timelines, lower the cost of implementation and have many more pre-built integration.

There is a pretty clear agenda that we have to achieve to drive down that cost of ownership so that we're an industry standard for the hundreds and hundreds of smaller insurers out there, we know that on a per name basis that we can get substantially more basis points on premiums in that segment, but we have to earn it and there is more work to be done here..

Thanks.

And Richard, the operating margin was obviously well ahead of – more than anyone would have expected, when you look at your long-term target is still high 20s, it sounds like you don't expect this to carry forward, there are some anomalies maybe in this quarter but maybe just walk through kind of how you still framing that high 20% on margin versus what you posted the year this quarter which was close to a bit twice?.

So if you look at our operating margins on a quarter-by-quarter basis, you're going to see a lot of profitability simply because of the seasonal nature of our top line. Obviously we had a very good quarter from the profitability perspective and that was really caused by two things, right.

One is the license fee which kind of flows all the way down to that bottom line. And two, we had a little bit of delayed the hiring and delayed projects starts that didn't hit the expense lines on the operating side which caused operating margins and operating profitability to grow.

Now one other things we've done is -- as we kind of started the year and we looked at how the year has progressed, we have raised our operating margin and now we're sitting kind of somewhere in the middle of the range at around 18. So two points higher than we thought we'd be at the beginning of the year.

My sense is that's a good place to think about, both operating income and cash flow during the year and as we look forward after this year, it is our goal not to come from wherever we end up and to continue to kind of straight-line that path as closely as we can to that high 20s in your 5 that I suggested at the Analyst Day is well within our reach..

Great. Thank you..

Thanks..

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

Thanks so much. Marcus as we look at the increased adoption that you guys are seeing amongst Tier 1s and throughout the other tiers as well.

Where is the point at which companies are at competitive disadvantage if they have not upgraded their systems to a system like you're or I started to incorporate digital and have that sort of digital strategy?.

Well, we think every insurer has had a digital strategy that's it's – and that's not a novel concept on our part, we don't have to evangelize that notion, if the industry telling us that.

Now it matters a lot what segment of the insurance you're operating in, some are more exposed to those winds have change than others, if you're selling a highly specialized commercial insurance – Maritime Insurance et cetera than the digital dimension doesn't matter so much, if you're selling largely commoditized personalized insurance to Millennials, well then, it's nonsensical to think that you'll succeed without a very sophisticated digital strategy.

And so insurers are kind of differently situated on that spectrum, but in terms of their competitiveness, it's not only about digital, it's that underlying economic fitness matters a lot.

And even though it's a more prosaic value proposition and the one that we started with – we started the company with, I think it's relevant as ever that – that the pulling a few points or a few hundred basis points of operating profitability out of a more efficient underwriting and claims operation is massively important to an insurer because that means you can plough that back into a more competitive pricing, it's better customer service and therefore higher retention et cetera.

So, in our argument for a very long time that any insurer that's still stuck on the legacy core system platform, no matter how – how well-managed they are, is that – is running a race with a carrying a rock and it's the question of how heavy that rock is, it's heavier for some – in some market segments and others..

And then I guess as a follow-up to that as you've – you've penetrated more and more of the property and casualty, are you at a point now are you starting to explore or maybe life or some of the other categories that you've not been in historically?.

Yeah, and we have aspirations, but we are pretty careful about not mentioning anything to the market, until we are in a place to – at least ready to start engaging customers in an early adopter mode and net loan in any kind of more general market appeal and we are pretty far from that point.

It's – we have a lot of unfinished work here to get to the completeness of our products.

So, that we can serve all of the PMC segments that we served, but at a technology level at a go-to-market level, I think, there are very compelling reasons, why we – we ought to explore at the multi-adjacent markets and by far of the most adjacent one to us is would be life and annuities.

But it will be very premature to talk of anything we're doing there yet..

Terrific. And then lastly for Richard. Richard, how should we be thinking about CapEx for 2016, or for the remainder of the next year and into next year..

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

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

Great. Thank you, both..

Thank you..

Sterling Auty with JPMorgan has our next question..

Sterling, you are on mute, I believe..

Hello?.

Hello..

This is Mina [indiscernible] in for Sterling, sorry.

Just a quick question regarding the system integrators, how long do you think it will be before the system integrators are ramped up to do this services on new products, so that you guys will now have to keep up hiring to support that?.

Right.

So, we're already engaged with our primary systems integrator partners to train them on the newer products, so we don't anticipate a prolonged period of elevated services involvement on our part, it will probably be a shorter interval than in a more modest increments and what we have to do with PolicyCenter, but we're still relatively early in the product lifecycle for the newer offerings.

We have our own services team that have to become confident in those implementations, let alone our partners and so it's definitely a heightened pressure or it's a source of heightened the demand for Guidewire services for a little while, but we expected to be again more modest and shorter lived than what we had to do with PolicyCenter, which kind of thematically where we had to talk a lot about soon after our IPO..

Thank you..

That will conclude our question-and-answer session. I'll turn the conference over to Mr. Ryu for any additional or closing comment..

No other comments. Thank you for joining our call. Good afternoon..

That does conclude today's conference. Thank you for your participation..