Richard Hart - CFO Marcus Ryu - CEO.
Vinay Mohan - William Blair & Company Monika Garg - KeyBanc Nandan Amladi - Deutsche Bank Sterling Auty - JPMorgan Ken Wong - Citigroup Tom Roderick - Stifel Rishi Jaluria - JMP Securities Brad Sills - Bank of America Merrill Lynch Taylor Reiners - Piper Jaffray Devon Kumar - Goldman Sachs.
Please standby we're about to begin. Good day, and welcome to the Guidewire First Quarter Fiscal Year 2018 Conference Call. Today’s conference is being recorded. At this time, I would 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 first quarter of fiscal year 2018, which ended on October 31, 2017. My name is Richard Hart. I am 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, both of which are available on the Investor Relations section of our website at ir.guidewire.com.
As a reminder, today’s call is being recorded and a replay will be available following the conclusion of the call.
During the call, we will make forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 regarding trends, strategies, and anticipated performance of the business, including developments in connection with our recent acquisition activity.
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 and actual results may differ materially.
Please refer to the Risk Factors in our most recent Form 10-K and 10-Q filed with the SEC. We will also refer to certain non-GAAP financial measures to provide additional information to investors. A reconciliation of non-GAAP to GAAP measures is provided in our press release.
Reconciliations and additional data are also posted in a supplement on our IR site. During the call, we may offer incremental metrics to provide greater insight into the dynamics of our business. These details may be one-time in nature, and we may or may not provide updates in the future.
With that, let me turn over the call to Marcus for his prepared remarks. And then I will provide details on our first quarter results and our outlook for Q2 and the rest of fiscal '18..
Thank you, Richard. As anticipated by our announcement earlier in the month first quarter revenue of 108.2 million was above our guidance range moderately exceeding expectations on all revenue lines. That upside carried through to the bottom line and narrowed our non-GAAP net loss to 4.8 million. Q1 was a significant quarter for Guidewire.
We completed the next unified release of Guidewire -- platform which introduced numerous enhancements to our complete product set. We unveiled several new cloud based products and announced the strategic partnership with Salesforce.
We also won a second mandate for InsuranceSuite cloud to be deployed and wholly managed by Guidewire in the cloud and we made significant progress developing our InsuranceNow business with both new sales and customer goals.
Just after the end of the quarter, we closed our largest acquisition to date namely for the next generation Risk Analytics for coming Cyence and we recently held our Connection User Conference which grew by 25% in attendance and refreshed our perspective of our market's priorities.
This is a time of rapid change for both Guidewire and our end market and in this call, I'd like to elaborate on the most important of these trends to offer context in the moving parts of our business that impact our guidance for the fiscal year.
The dynamics most visible in our results and our current sales effort is the pace at which the P&C insurance industry appears to be moving towards cloud based solutions.
In addition to interest for our cloud only offerings such as InsuranceNow underwriting management and predictive analytics, we see a growing proportion of our prospects considering both cloud and on-premise options for InsuranceSuite.
This leads us to increase the estimate we shared last quarter of 20% of 30% of new sales coming in subscription form this year to a range of 30% to 40%. Our first quarter reflects this transition with a substantial majority of sales from cloud based solutions.
Indeed, our second InsuranceSuite cloud transaction also illustrates how current customers may participate in this transition. This customer whose name we cannot share at this stage in their project had already licensed claim center to revise their approach prior to implementation and offer to Guidewire that -- arrangements instead.
As a result, we were able to consummate the transaction and provision the software more rapidly than we would otherwise expect from our cloud transaction contributing modestly our outperformance in Q1. The appetite for cloud based delivery and the accompanying willingness to further standardize implementations are quite positive in the long-term.
They will drive more rapid upgrade cycles, reduce customer TCO, improve our understanding of how customers use our products and see the development and adoption of new Guidewire offerings.
Moreover, we continue to expect that InsuranceSuite cloud arrangements will increase the economic value to Guidewire of the customer relationships by 2X or more versus our current on-premise model albeit at a somewhat lower gross margin.
There are two adverse impacts on our reportable results however, first an increasing proportion of our license revenue come in [indiscernible] form will negatively impact our license revenue growth this year.
Second, perspective customers evaluating cloud based and on-premise delivery options may increase the complexity and duration of sales processes in the near term, which could offer us less time to recognize new ratable revenue streams in the current year.
These considerations combined with an anticipated decline in perpetual licenses have led us to reduce our license and other revenue outlook for the year. At the same time and for related reasons, we expect services revenue to accelerate in the near term.
As we noted previously, InsuranceNow implementations are led by Guidewire augmented by subcontractors. And we are in the early stages of developing an anti-ecosystem for that product. Similarly, our Go-for-Insurance suite cloud is to have our anti-partners responsible for significant portions of implementations in the future.
But for these early projects, we believe much heavier Guidewire involvement is necessary to minimize risk. Heavier Guidewire involvement is also motivated by the robust demand we are seeing in Continental Europe which has become meaningfully more active for us over the previous four quarters.
Our experience is that European insurers expect Guidewire to bring experts with local language skills and that they often prefer to have key software vendors lead their implementations to the degree that we may agree to act in prime capacity in select strategic cases.
Because of this increase in European demand and the overall transition of our market preferences, we believe it is important to avoid gating new sales win with capacity constraints and delivery.
Consequently, in the near term, we will experience an outside growth in services revenue, as we continue to hire aggressively to ensure that we can serve the new core system mandates we win. These adjustments in our resourcing strategy are part of a larger evolution for the company that we highlighted at our recent user conference, Connections.
A shift towards shouldering more complexity and risk on behalf of our customers and the global P&C industry overall. We believe that insurers are seeking this transfer to approve and partner in order to redirect focus on transformation initiative.
Catalyzed in part by the surge in ensure tech investment over the last several years, P&C insurers are responding to new competitive [indiscernible] for digital transformation of distribution and service and the leverage of new data sources and machine learning, to operational insight to automate underwriting and claims decisions and to grow by creating new insurance products to address emerging risk such as cyber.
In addition to cloud based delivery at the core we're also well positioned to serve these data and digital initiatives after the investments we've made and this year we're accelerating in product expansion, we're now sharpening the use of our organic developed digital products which have enjoyed rapid adoption on their own into a focused offering to support the drive of insurers for digitally distributed small commercial insurance which we call DSV.
We're also integrating our digital portfolio with Salesforces financial services cloud to provide a unified digital front office for captive agents and customer service reps. We're integrating our predictive analytics capabilities into InsuranceSuite to support decisions, a key point in the insurance lifecycle, enabling what we call smart core.
And we're evolving our BI solutions into a new cloud based offering called live analytics, which provides near real time data visualization and operational insights.
We're confident that the significant investments we've made to introduce these new products aligned as they are with the increasingly future service priorities of our customers will become engines of future growth even though they're contributing only modestly to revenue today. Our investments continue to gain as industry recognition.
We're doubly pleased that this year Gartner rated InsuranceSuite as a category leader and placed InsuranceNow in the challenger quadrant of their magic quadrant for P&C core platform in the inaugural year for this category. Finally, we fully welcomed our colleagues from Cyence on November 1st.
Cyence is internet scale data listening platform and its machine learning powered risk analytics will enable the insurers to grow by underwriting new categories of risk for which actuarial data is not available or is incomplete.
Longer term, we see unique opportunities to integrate Cyence's external data with the internal data gathered in real time by Live Analytics and to provide insurers the full life cycle from product design to transactional management to these new insurance products.
We were fortunate to retain the employees of Cyence and Arvind Parthasarathi, its founder and CEO. And he will continue to serve as the head of Cyence Risk Analytics. Arvind's Connections keynote is available on our investor relations website ir.guidewire.com, and it explains Cyence's unique value proportion.
In addition to Arvind joining my core team, I want to comment on previously announced organizational changes, I thank Scott Roza for his service to Guidewire since 2013 as he leaves for another opportunity at the end of the calendar year.
I was pleased to be able to promote two 12-year Guidewire veterans, Steve Sherry who was already responsible for worldwide sales and now reports to me and Eileen Maier who assumes Scott's title of Chief Business Officer and heads our product line business strategy pre-sales, product marketing and value consulting teams.
Recognizing the importance of the cloud to our growth ambition we also named 14-year Guidewire veteran Alex Naddaff as Chief Cloud Officer adding to his current title of Chief Customer Officer.
It is my great privilege to work with such a capable and long tenured leadership team at Guidewire and I believe that we’re well equipped to extend our collective success. With that I'll turn it over to Richard to detail the financial results of our first quarter and update our view for the fiscal year..
Thank you, Marcus. As Marcus indicated we've exceeded our revenue and earnings guidance for the first quarter, total revenue in the first quarter was 108.2 million increase of 15% from a year ago. Within revenue license and other revenue decreased by 22% from a year ago to 30.1 million.
As we previously noted any sequential quarterly comparison is taking to account the $6.1 million, which was recognize in the fourth quarter due to the early receipt of customer payments.
I also note that the first quarter of fiscal 2017 featured a perpetual license, and well this quarter was mark by substantial majority of sales coming in subscriptions. Adjusting for these factors license and other revenue would have grown year-over-year. Maintenance revenue was 18.9 million in the first quarter or 15% increase from a year ago.
As a reminder, maintenance services are included as part of subscriptions and as a result inclusive in subscription sales as a percentage of total sales, will reduce maintenance revenue growth in the future.
Our rolling fourth quarter recurring revenue comprising of recurring license and maintenance revenue totaled 324 million in first quarter of fiscal 2018, up 19% from a year ago even as its sequential growth was negatively impacted by the shifts in yield mix, which characterized the first quarter of 2018.
This shifting mix from licenses that are recognize upfront on an annual basis to subscriptions that are recognize ratably, will reduce the growth rate calculated by this metric while this shift is underway.
Services revenue was 59.1 million, a 52% increase from a year ago, and was above our guidance, primarily due to the higher than expected services revenue from InsuranceNow implementations. Turning to profitability.
We will discuss these metrics on a non-GAAP basis, and we’ve provided the comparable GAAP metrics and the reconciliation of GAAP to non-GAAP measures in our earnings press release issued today, with the primary difference being stock-based compensation expenses.
Non-GAAP gross profit in the first quarter was 55 million, compared to 58.3 million a year ago. This represented a non-GAAP gross margin in the quarter of 50.9%, compared to 62% a year ago due to the higher mix of lower margin services revenues and the decrease and license in other margins due to our investments in our cloud operations.
Total non-GAAP operating expenses were 63.3 million in the first quarter, an increase of 11% compared to a year ago.
This resulted in a non-GAAP operating loss 8.3 million, which was better than our guidance range, primarily due to higher than anticipated revenue and the non-GAAP net loss of 4.8 million or $0.06 per basic and diluted share, compared to our non-GAAP net income of 1.1 million a year ago.
Turning for our balance sheet, we ended the quarter with 653 million in cash, cash equivalents to investments down from 687.8 million at the end of the fourth quarter. Operating cash outflow in the first quarter was 31.2 million, primarily due to the seasonal use of cash for bonus payments in the first quarter.
Cash balances do not reflect the impact of our Cyence acquisition, which closed on November 1st after the end of our first quarter. Total consideration net of cash precise was 265 million consisting of net cash of approximately 130 million, as well as 1.6 million of new leadership shares of Guidewire common stock in options.
The impact of this acquisition will appear in our second quarter in fiscal year financial results. Total deferred revenue remained at 111.2 million at the end of the first quarter, compared to the end of the fourth quarter.
As a reminder, our deferred revenue balance can vary widely from quarter-to-quarter and has not been a meaningful indicator of business activities since we typically build term license contracts annually and recognize the full annual payment upon the due day.
However, in the future deferred revenue may continue to be variable, but may increase as we sustain higher levels of percentage of subscription based sales which as you know we recognize ratably.
Now, I'd like to turn to our updated outlook for clarity of presentation, our first detail, our revised outlook for Guidewire standalone and then combine that outlook with our view of Cyence's contribution to our revenue and operating income.
Today we're modestly increasing our standalone total revenue outlook for the year from 611.5 million to 623.5 million up to 631 million to 641 million for reasons Marcus elaborated we're anticipating a greater percentage of orders to be subscriptions leading us to moderate our license revenue outlook and increase our services revenue estimates for the year; this revision is atypical for us and underscores the uncertainty we face in estimating the pace of adoption of our cloud based solutions.
Our revised fiscal year outlook for license and other revenue now incorporates a 10% increase in the percentage of subscription orders raising prior expectations of 20% to 30% to 30% to 40% of software sales.
Term and perpetual licenses are expected to decline as a result with perpetual licenses declining to approximately half of last year's $13.1 million and well below the 5% of total revenue which perpetual licenses have represented in the last three fiscal years. We're monitoring two other dynamics that have emerged as market sentiment has evolved.
First as Marcus mentioned, we're experiencing an elongation of certain sales cycles where customers are considering both cloud based and on-premise deployment solutions, this is driving a more backend weighted year and they extend a few purchasing decisions into our next fiscal year.
Second, sales of the newer offerings which Marcus itemized could lead to a deferral of revenue if those offerings are combined with existing products; in these situations, we will defer revenues into our product delivery requirements have been met.
As a result of these factors we're revising our license and other revenue to 292 million to 302 million representing a decline of approximately 7 million at the midpoint of the range, together with the anticipated contribution of $9 million to $11 million of Cyence subscription revenues, we've reaffirmed -- which we reaffirm, we anticipate license and other revenue of 302 million to 312 million, an increase of 11% to 15% from fiscal 2017 on a reported basis and 16% to 20% after excluding the effect of the 6.1 million in early payments from the fourth quarter of fiscal 2017.
Conversely, we now anticipate higher services revenue for the year for two primary reasons, first the combination of aggressive hiring and an expansive use of sub-contractors to remediate capacity constraints in our InsuranceNow implementations.
Second, our intention to lead InsuranceSuite cloud implementations in the near term to ensure the effective transition of newly implemented systems to Guidewire production services.
We believe that after several InsuranceSuite cloud implementations, we will be better positioned to leverage our SI partners as we currently do in our on-premises business, and result increases in the number of InsuranceSuite cloud subscriptions will likely result in higher service revenue estimates for the fiscal year.
Consequently, we're increasing our outlook for services revenues from 235 million to 245 million to 250 million to 260 million representing a $50 million increase at the midpoint of the range. We're mindful that this services revenue increase is not constant with past expressions of our target revenue model.
Nevertheless, we believe this hands-on approach is necessary to manage this transition effectively and we intend to reduce services revenue growth as we leverage our SI partners as I described. We expect maintenance revenue to remain in range of $73 million to $75 million representing an increase of 6% to 9% from the year ago.
I again though that customers that subscribed for our cloud services obtaining and support as part of their subscription and no separate amounts are recognized as maintenance revenue.
Therefore, for fiscal year 2018, we now anticipate total revenue including Cyence to be in the range of $631 million to $641 million, representing an increase of 23% to 25% over fiscal 2017. Turning to expenses and profitability.
As we noted at our analyst day in September, fiscal 2018 will be one of the increased but necessary investments as we lay the foundation for future growth and we intend to return for our more historical case of expense growth starting in fiscal 2019.
Our hiring this year is focused primarily in research development and services, the tactical additions to sales to help grow our broad array of products including Cyence and to capitalize on European demand.
This year, we felt a greater sense of urgency in meeting our hiring goals and increased our recruiting efforts and as a result, unlike in past years, we have met our hiring goals for the first quarter and expect to meet our targets again in the second quarter.
We also expect to experience an increase in G&A this year in order to scale our business to meet new revenue standards and accommodate the increasing depth of products and variety of go-to-market models that we are deploying.
Our operational teams and finance IT, HR and sales implemented a new ERP system, and a new configured price quote system in the quarter. Our upgraded planning software application will be delivered into December and the implementation of the new ASE-606 complaint revenue module will be completed in February.
We estimate that these investments which will not regularly recur will cost approximately $8 million to $9 million over the year all of which will be expensed. Even with these additional expenses and gross profit compressions, we are maintaining our standalone non-GAAP operating income expectations.
-- we indicated that costs and assumed operating losses associated with that acquisition will dilute operating margin by approximately 3 percentage points. We are confirming that to you today, as we expect total transaction costs of approximately $5 million and anticipate operating losses in the fiscal year of $12 million to $13 million.
Including this impact, we anticipate non-GAAP net income in fiscal 2018 to range from approximately $90 million to $100 million or $0.82 to $0.90 per diluted shares based on approximately 77.5 million diluted shares.
We are raising our free cash flow guidance for the year from $94 million to $106 million to $105 million to $115 million, this revised range includes an anticipated use of cash by our newly acquired Cyence business unit which we currently estimate to be $15 million to $20 million for the year. And which was not included in our previous forecast.
For the second quarter of fiscal 2018, we anticipate total revenue to be in the range of $152 million to $156 million within revenue, we expect license revenue to be in the range of $76 million to $78 million with growth challenged by faster than anticipated shift to subscription licenses even in the second quarter.
We anticipate maintenance revenue of $18 million to $19 million and services revenue of $57.5 million to $59.5 million.
For the second quarter, we anticipate a non-GAAP operating income of between $18 million to $22 million and the non-GAAP net income of between $13.2 million to $15.8 million or $0.17 to $0.21 per share based on approximately 77.2 million diluted shares.
In summary we are excited by the dynamic changes in the industry by the opportunities that those changes are catalyzing and by our expanded line of the software and services which we hope to drive -- we will continue to drive our industry forward. Operator, we can now open the call for questions..
[Operator Instructions] And we will take our first question from Justin Furby with William Blair & Company..
This is actually Vinay on for Justin Furby. The first one is for Marcus or Richard.
With another quarter under the belt but just wanted to confirm are you still seeing that 2x up lift from moving to the cloud? And then I just want to confirm is that a comparison of in the old-world term plus maintenance versus subscription today?.
It's still very early days but we have the same reasons for confidence I think that we have had throughout, that they will be significantly greater economic value for Guidewire in these arrangements, and that customers will be enthusiastic I think to pay that additional amount to us because not only their cloud transfer but there is an absolute reduction in risk and complexity for them.
So, something like 2x or even a bit higher than that is what we use in our internal modeling, and is also the basis for the commercial discussions that we are having with variety different insurers right now.
But it is still early days and today we just talked about only our second arrangement under this new form for InsuranceSuite, so we will continue to update you as we have more experience on that account..
And to confirm it does include both the license and maintenance numbers of our on-premises sales..
The services is not in that, correct, just to be sure..
No, not at all..
Not at all..
And then Marcus just following up. You mentioned Europe, can you just a little bit about the pipeline that you are seeing in Europe. And then maybe add some color on the mix of cloud versus traditional license deals in that region.
And then perhaps how Accenture is helping in that at all?.
Sure, I think the most -- more exciting thing about what's happening in Europe is that we have sales activity in a number of geographies that have been pretty dormant for us despite years of trying, that have now gotten to be quite active. These are the major countries in continental Europe like Spain and France and Germany.
And that's -- we can't take full credit for that of course, I think their dynamic in each of those markets including the rise of the local ensure tech industry in each of these countries on its own that has helped catalyze some of the demand.
So, it's a very encouraging to be able to pursue a whole new set of opportunities including with some of the major insurers in those deals, as well as in the Nordics and parts of central Europe as well.
Accenture has -- as you know has been allied with us, outside of North America and I would describe the relationship as helpful but not transformative so far in those efforts. It's always good to have more systems integrator options in partners in helping insurers make these major capital investments.
I think you also had one of the dimensions to your question....
Cloud [indiscernible]..
And a bit surprise I would say that, that deliberation has pretty much the same character all around the world and I would include even Asia-Pac in that statement, ensures really everywhere are looking for the same thing namely transfer of risk and complexity and acceleration of the transformation initiatives in data and digital that we’ve been talking about.
.
We’ll take our next question from Monika Garg with KeyBanc..
So Cyence was supposed to add about 10 million as all of that revenue would have gone into license line, so now but you’re reducing license by almost 10 million.
So, is that all of that reduction is to the mostly subscription?.
So, yes. So, what we’ve said Monika is that we reduced license and other by about 7 million in the mid-point and a significant part of that is the mix, in the type of deal that we’re seeing in our pipeline. And also, the fact that we’re seen them push a little bit later in the fiscal year as these sales cycles take a little bit longer to conclude.
And if you recall, when we first started talking about the effects of this transition on our P&L, we suggested that every additional 10% of subscription revenue percentage would decline license growth by about 1, 1.5 and the same kind of impact for every quarter of delay, you see for the average deal hitting the fiscal year that is subscription, because we simply have less time to take on those ratable revenues.
The other very significant element to be fair, the reduction of perpetual license is by about half. I mean one of the things that a lot of these conversations are doing are actually pushing out some of the perpetual demand that we sometimes have to fight against in our sales process.
And so, we think that those perpetual numbers are going to be half and that also has an impact on our planning and our year. .
Got it. So, if I include Cyence and the negative impact of moving to subscription, you are increasing your total revenue bought somewhere 15-ish million.
So, is all of that is as people are coming for more cloud implementations and that’s why your service revenue is going up?.
Yes. So, service revenue is going up for two reasons.
One is that, right, we’re anticipating revenues more insurance sweet service representation on our engagements simply because, if they come in as an InsuranceSuite cloud engagement, will actually see a significance in the per engagement service revenue that we would generate, right, almost in order of magnitude.
But the big influence are especially in the beginning of the year is really a reassessment of the insurance in our customer base, their needs and our ability to actually staff, the services professionals that will help them get to their finish line on time and on budget..
Just the last one for housekeeping just to understand the model transition. As you move to customers to cloud you can get to 2x to 2.5x higher revenue that will all go to the license lines and the service revenue implementation costs or implementation revenue will go into service line.
Is that right understanding?.
That’s right..
We’ll take our next question from Nandan Amladi with Deutsche Bank..
So, Marcus with this transfer of cloud projects coming your way how ready do you feel to be able to execute, against the opportunity particularly on the hiring and training front as you bring more services people are?.
I think it’s a thoughtful question Nandan, it's something that we have a lot of discussion about as a management team, I think we're enthusiastic for this change, it's one that we've been discussing for years and anticipating, of course it's always hard to calibrate exactly the pace at which these changes come and we have to make some guesses, it's also quite sensitive to any individual relationship, a single major cloud relationship with a major tier 2 or tier 1 insurer, has a really meaningful impact on the servicing -- the services requirements from Guidewire, so there's a lot to try to forecasting and calibrate and making our resource plan and what you heard from us in the prepared remarks was a determination not to have new sales gated by not being able to service them, and to really err on the side of extra capacity if anything, to ensure that we can meet the demand for cloud deployments as well as some of the additional demand that we talked about in Europe.
So, I'd say that we're ready and enthusiastic but part of this journey has also been learning new skills in cloud production services, in cloud based security many other things as well; we've been able to develop those skills in tandem with the strategic customer, MetLife that we've talked about quite a bit on these calls, and that's been super helpful, but we think -- we'll be hefted again as we take on the next wave of customers which we expect to continue to grow into the future..
And a follow-up for Richard if I might, with all of these moving parts any view on what the new sort of leading indicators might be in terms of metrics or some additional metrics that you might be able to provide us, that help with visibility?.
Well I think there's a couple of things, we introduced a couple of new metrics at our Analyst Day and we'd like to like those seasoned a little bit, and settle in, and I will say that one of the things that we are really focused right now on and as opposed to figuring out what the metrics will be that can best describe our business is really trying to understand how the business is shaping up, the fact that after our -- setting our guidance for the fiscal year, we've had to shift both license and services lines which for us is a very significant change should indicate how much the variability of these lines may continue to impact our forecasting for the next year.
I would keep an eye out on the services line, I think there's a chance for that services line to grow a little bit more as the year moves on, and I think we feel very comfortable that we reset the shape of the license line now at least for the next couple of quarters..
We'll go for our next question to Sterling Auty with JPMorgan..
Richard, I hate to do this to you but I had the same question around metrics, is there a thought to maybe giving us ARR or the number of cloud or subscription customers just so we have something that we can tick off to see the growth of the health in the business that's it's going to be a while, this is I think a little bit more of a unique subscription transition then the 14 or 15 others that I've seen over the last 10-12 years?.
So, obviously I don't want to necessarily say anything that the Street or you would want me to update overtime because obviously this would not be a considered metric, but let me just give you a framing for what is driving some of our considerations.
So, we had begun the year thinking that there would be two new InsuranceSuite cloud customers, that's what we were thinking. I think as we look at the year now that number has crept up to four, and may go a little bit higher still.
Now the one thing that is a little bit of challenge for us is that a lot of these discussions are at very early stages, and so we have to try to into it from what our customers are telling us of their priorities which way they may lean, and it's almost like if your probability waiting a pipeline between cloud and on-prem.
And that is how we're kind of generating some of our new figures. With the InsuranceNow, customers I think we pretty much started from a standing start, the company had done very well at selling three or four transactions that they've been working on for a while before we acquired them.
And so, the pipeline which was still pretty good really required rebuilding and we've done a very good job at that.
And I think now as we kind of come into the second quarter I think we feel much more comfortable that we can double the InsuranceNow business in terms of number of customers from what they were able to do in our first year stewarding this group with the help of the former founder Andy Scurto and his Chief Engineer Doug Moore.
And those are the two kind of significant numbers that will kind of really pivot our P&L around the service and license line going forward. .
That makes sense. And then just is there any market sense as you look at the types of customers that are having conversations around InsuranceSuite in the cloud in particular.
Is there any commonality to them in terms of the type of P&C carrier or which insurance lines are looking to move first or anything else that you can really trend line?.
Well there is certainly a commonality in the motivation which we haven't talked about, mainly existing complexity transfer and a greater confidence in the stability and inevitability of using public infrastructure and having major core business applications delivered in services. So that's getting to be more and more universal across the industry.
And we are having conversations with both current and perspective customers across really all of our -- all of the applications and InsuranceSuite along those kinds of themes. As for the ones that will actually move forward.
I think it is more likely that smaller insurers they generally have fewer inhibitions about making that transition, but we are having new conversations also with very large and even tier 1 insurers as well.
I just think that they tend to have a longer list of reservations that they have to get over institutionally before they can make the big decision. But I think the motivations are really the same. So, we expect to see it across all segments, all peers of our markets.
So more rapidly at the lower end, the smaller end I should say and that's in fact was dealing with InsuranceNow which of course is only [indiscernible]..
We'll go now to Ken Wong with Citigroup. .
Hey thanks for taking my questions, guys. Marc as you mentioned earlier about elongation of sales cycles. Is that just purely due to as you just mentioned kind of institutional reservations, is it the kind of the cloud -- the actual concerns around cloud is it pricing.
Any thoughts there, and then you also mentioned being able to accelerate the deployment of the deal in this quarter that went cloud going from traditional claim center. I mean I guess should we expect that those two kinds of offset each other kind a longer sales cycle shorter deployment cycles. .
I appreciate the question. So, to the first part about what could drive the potential elongation.
I think it's not so much reservations as it is the need to evaluate two different options and contract them side by side to consider what it would mean to deploy this in our conventional data center or what it means to have Guidewire take on full responsibility.
So, it's almost -- it's not quite twice the set of questions but it’s a considerable expansion of the set of questions and topics that a perspective customer will go through, and that could include an existing customer.
I don’t think that that will always be the case, there is an element of novelty to it, that as we routinize things more and have more examples to look forward, more references just like any new offering those things should -- we would expect an acceleration.
And hopefully even the structural acceleration over time because a lot of the questions that you have to ask about on-premise implementation are actually simplified by the cloud. That’s really the longer-term hope.
Now on second part of your question about possible acceleration for existing or even long-standing InsuranceSuite customers, I think we are hopeful for that as well. So, these are companies that insurers that have been using one or more applications in InsuranceSuite for some time and now there is no real product evaluation to go forward.
It's just a matter of rethinking the service relationship that they have a Guidewire and the transfer of responsibility. That’s what happened in the second case, and we fully expect there to be more of these. And these will in general be faster than when a prospective customer or current customers considering completely new application implementation.
Now to the mix of those two effects that’s very, very hard for us to guess. I mean of course we have our whole pipeline knocked out with a guess of when they will all happen but there's no way I could right now digest it all and in cash it out into which effect dominate.
I think what you will hear from us overall and reflected in the guidance is the general caution about the pace at that which the transactions will close and then given this whole ratable element how much of the revenue will get to recognize within the current period..
And then Richard in terms of -- you mentioned the services mix could -- I mean that services number could continue to trend higher, in the past you guys have done as high as kind of mid-40s and on a quarterly basis as high into the 50s as a percent of total revenue.
Where do you think that that could potentially settle in or right now your guidance 40%? Is that kind of mid 40 is a good feeling or any help there would be great..
So, Ken I think, the answer is not one that I can give easily give right now, and let me tell you why.
We are right now embarking on a course of action that says we will help the industry transition as fast as it needs to be, so we need to absorb all the services demands for any cloud implementation whether InsuranceSuite now or insurance in cloud are frankly for any of our other products that tag along with those two core systems.
And in the meantime, we are -- and that is our first priority. Our first priority is simply to absorb that demand because we do not want to hold our companies back and our customers back from whatever transformation they want to progress with.
At the same time, we are instituting new processes and coming up with these skills to be able to hand that back off to be a size as soon as we feel comfortable that the risk is assessed and minimized. And trained -- we have trained those SIs appropriately in being able to help us with these exercises.
And if the speed of that transition that gives me a little bit pause of the too comfortable, knowing how high the services number can go.
I do believe right now that services will outpace license growth for at least two years and so you may see services revenue actually rise above 50%, if this transition accelerates or paces at the speed with which we are seeing right now. And then you’re going to see it come back down after 2019 that is my current gut.
Obviously, this is not a model that we are embracing in any way, this is simply the exigencies of the moment that are driving our decisions. And as soon as we can, you will see us replicate to model that was able to bring them services revenue down to 30% to 35% of total revenue. .
We’ll take our next question from Tom Roderick with Stifel..
I guess sort of building on the last question about the overall services mix. As that accelerates, does it help get to sort of the low point in margins and then build up moving forward that you sort of went through at the Analyst Day or is the acceleration -- okay, so the acceleration really sort of pulls forward some of that..
So, what will happen, if our crystal ball isn’t too cloudy, is you will see services increase as part of the mix for another 12 to 18 months and then start declining and that’s our current assumption.
Obviously, we want to improve services margins, but I think, right now with all the hiring we’re doing to make sure that we can engender this transition effectively we’re going to keep that margin at about 20% and try very hard to do so. And that will obviously have a gross margin effect that will then dropdown for the operating margin.
The other issue though is that right now our license margin is actually down to 91%, because we’ve invested in all these cloud teams and infrastructure. And now these teams have to start being able to absorb more InsuranceSuite cloud and InsuranceNow implementations.
And so, what you’ll see is, you’ll see hopefully that margin start to improve overtime as that line starts to increase, because the ratable revenue start being recognize. So that will also be the other improvement that you will see effecting the gross margin line sometime in end of 2019 starting 2020..
I have another comment, which I think speaks to your question as well as the previous one, which is that some of -- essentially all of the newer products that we have outside of InsuranceNow have almost no services attached with them, so predictive analytics, anything to do with Cyence, Live Analytics.
None of these products have really any services attached. And if whether all relatively modest in their adoption so far.
If they attach to our system customers at the pace that we’re aspiring to or even faster than that, that will have a positive effect with respect to the -- in light with the subscription to services next and that’s certainly a lever that we want to push on hard. .
And by the way to Marcus’s point and to further it, those products also have a higher license margin associated with them. Because they don’t necessarily share the infrastructure and production environment costs and InsuranceSuite cloud and InsuranceNow require.
And therefore, those margins will actually improve as the mix towards the new product increases, our gross margin will improve overtime as well..
Great. And then looking at, from a sales compensation and overall management perspective.
What are you doing to push or not push more cloud revenue? Is it still based on sort of total contract value or are you really pulling into recurring revenue basis driving higher upside for individual sales people?.
Well we've always had a recurring revenue basis for sales compensation, we try to keep it very simple, which is essentially an ARR target for each of our quota-carrying reps, and we wanted to apply that with a minimum modification to cloud based revenue as well; actually because of the economics of these InsuranceSuite cloud relationships where there is a transfer of cost as well, we apply a bit of a haircut to that ARR, the accompanying cloud form, but even taking that hair cut into account a rep has substantially more to gain in total quarter payment for consummating an InsuranceSuite cloud opportunity.
So, there's plenty of enthusiasm on the sales team because there's a chance to go for larger or even substantially larger transactions for which they have been working..
We'll go next to Rishi Jaluria with JMP Securities..
Marcus, I hate to keep going back to the commentary around the elongating sales cycles but just kind of want to get a sense where are you seeing this and this is with new customers, with expansions with potential conversions, help me understand where are you seeing this most often?.
Well let me try to characterize it this way, in every sales evaluation with the prospective customer or even an existing customer who is considering licensing a new product, there's a portion of the sales evaluation which is functional, they want to know, does it meet all of our business requirements, can we achieve the business benefits that we want, but then there is a substantial portion of the sales cycle which is planning the project and estimating the scale of the project and figuring out what we purchase what we need, what the integrated partner might we need, how long will it be, what is the leverage we have to bring this in to a certain envelope of expectations etc., and that's a distinct part of the sales cycle.
Now that part of the sales cycle is a bit complicated when a prospective customer has to think about two different approaches one where they are implementing on-premise which is pretty much how all of their applications -- their core applications certainly are running today or a new cloud model, and what we're seeing is that some customers -- well prospective customers are essentially modeling out both of those scenarios and comparing them to make a decision, and there're lots of quantitative and qualitative factors that go into making that choice.
And that takes a bit longer.
Now, again I don't believe that will always be the case, I -- we think that over time, we would -- we will probably start to lead much more aggressively and confidently with the cloud option being the right one and there'll be more references to attest to that, and the increasing preference that we see in the market for that simplification on risk transfer will motivate them to really opt maybe exclusively for evaluating the cloud option, so that’s our expectation and so I think that this temporary period where a greater analysis requirement will be a temporary phenomenon maybe on the order of the year something like that, that's our best guess right now.
I hope that clarifies..
And Marcus I wanted to go back to a comment you made earlier, can you just help me understand why you expect Cyence to have little to no services attached especially because it's in kind of a more emerging business than what your typical InsuranceSuite has?.
As a technical matter, there's essentially no implementation. It's entirely cognitive offering, what you do as a Cyence customer is access their universe of companies that they have modeled to cyber risk for and are keeping that data current. And then you look at set of scores dashboard tools to appraise the amount of cyber risk.
This is an underwriter we'd look at. And so, their current customers today have effectively zero integration and really zero implementation.
There is an oversimplification there because sometimes a customer may want to add additional data stream, of course there is a business change process change dimension to this that has to be involved and Cyence has a few folks who come from an industry background that help advice on that.
But when you contract that to the kind of services that are required for a full core legacy system replacement there is no comparison, not in absolute terms nor in relative terms. It's extremely light touch in terms of services presence compared to what's involved in the major legacy replacements that we do or have always done as a business. .
Okay, got it. And that's helpful. And last one from me, Richard, just want to looking into guidance. For Q2, I mean there is a really big sequential increase higher than we normally see going from Q1 to Q2 even controlling for the Q4 prepayment.
Can you help us understand the dynamic you're especially given that we're seeing increased subscription adoption and associated headwind with that?.
I don't think there is much that I can explain. I mean I think we're seeing a quarter firm up which will lead to a particular set of license revenue and subscription revenue dollars that come into the quarter. We also have Cyence that increases our quarterly revenue by about $2 million.
And don't forget right in Q1, we have that $6.1 million that simply disappeared and came into Q4 of the previous year and that's one of the things that’s showing and making that jump that much more visible. .
We'll take our next question from Brad Sills with Bank of America Merrill Lynch. .
Hey guys thanks for taking my question. Just one on Cyence, I know it's early and I know the deal just closed.
But to the extent you can provide some color on early risk section particularly in the tier 1 and tier 2 market? What type of use cases are being considered for deployment of Cyence and what kind of traction are you seeing there just in terms of interest at this point?.
In terms of interest it has been significantly ahead of my own expectations. And not only in the breadth of insurers that are interested, so these are ones -- these are -- some insurers who explicitly target these emerging risks like trying to write cyber product.
But also, very traditional mainline standard line insurers that are concerned about particularly as embedded cyber risk that they have even in their traditional lines of insurance. And there is tremendous interest across the board of all these categories customers of all sizes. So that's very encouraging.
Of course, we have to convert that early enthusiasm into actual commercial relationship deals. And we've just recruited a new sales leader, a veteran who will be fully dedicated to leading the sales team that focuses on Cyence. Being prior to the acquisition Cyence had really no sales organization at all.
It was entirely kind founder and executive level sales and we're hoping to implement a much broader outreach to the market.
And as for used cases, I talked about those insurers that are focused on new risks and those who are worried about embedded risks, we are also very interested in the possibility of using their data listening approach to standard line. And the more standard insurance use cases.
The conventional way the data is gathered in insurance industry is -- you ask the insured for a lot of information, and then on the basis of that you underwrite the risk, its supplemented with some other data but primarily from the insured.
Cyence's approach to data listening proposes the inversion of that where you build a profile of the insured even before they have applied for an insurance policy. And come to that insured very informed about the character of their business and their risk.
And that could have significant implications for both a much more satisfying digital distribution experience as well as making better underwriting judgment. That’s a much more provocative possibility but it's one that that could have a very big impact if we get it adopted more broadly..
And then one on InsuranceNow, any commentary on how performed amongst kind of the new market entrants with ensure tech companies coming in increasingly and how that offering is resonating with that end market?.
We are pleased with InsuranceNow I think we after a little period of complication I think we stabilized the customer relationship well, and even able to convert a number of deals in their pipeline and have been building the go forward pipeline pretty much according to plan.
So, I think where we enthusiastically ratified the decision we made to add that second-core to our product portfolio. With respect to ensure tech, there is huge wave of investment in ensure tech, almost none of it has gone to funding new core system providers that we will consider competitors.
And then a huge amount has gone towards funding competitors to our customers, new insurance companies that have some kind of new angle or value proposition. But as for software players that are trying to sell to the insurance industry a new core system essentially none.
Some of our competitors have been recapitalized but in terms of completely new entrant coming in out of the blue we really haven't seen any of that in the last few years despite the huge wave with ensure tech investment.
So, I think that's -- a lot interesting in competing with insurance as opposed to serving insurers and we are very much on the serving insurers side of the equation..
We will go next to Alex Zukin, Piper Jaffray..
This is Taylor Reiners on for Alex. I was wondering if you could maybe dig in a bit on what you're seeing with respect to attach rates on your data in digital products and then is that at all being impacted by the uptick in cloud that you have been seeing..
I think attach rates in data and digital continue to be very strong.
I don’t have exact numbers for you Taylor but they are at least as strong as they have been historically and we are confident that will continue or even increase as they just become part of this all different aspects of the same platform, that you heard that theme from -- at our analyst day and maybe at our user conference too if you heard those presentations.
And I think that will continue. So, we are very confident that they will be stronger attach rates so basically everything we are doing in data digital and that’s really the heart of our strategy. Cloud does not really intersect with that in any particularly novel way, i.e.
whether or not you have deployed InsuranceSuite in the cloud or in the traditional on-premise mode you would still want to access these other ancillary products which themselves are generally all cloud based and from a business user's perspective, it's all the same application, it's all the same environment.
So, it sort of and orthogonal dimension to the question. But it’s worth mentioning here that essentially all the new products that we expect to build or require in the future will be cloud based, it’s really a question of getting that huge core application adopted and implemented that gave the adoption of most of these products.
But we want to make it as easy as possible for them to adopt the data in digital products once you’ve made that core decision..
And Q1 is always our lightest quarter and therefore the data is not so revealing as those are looking at the full year. And at the end of the last full year, our attach rates for data and digital have been 50% or better. So, they have continued to strengthen over the last couple of years. .
We’ll take our next question from Devon Kumar, Goldman Sachs..
Regarding InsuranceSuite and InsuranceNow, is having high-end and low-end cloud offerings accelerating growth in the number of opportunities in the pipeline even if some of those opportunities elongated in some cases?.
Yes. That’s very much the strategy here. We want to cover the water front. So, any primary insurer, pretty much anywhere in the world that likes non-life insurance will want to have a core system offering for them and we want to give them.
If they are a very small insurer they will probably in system sales on having it be delivered in the cloud and that’s what InsuranceNow is for. And if there are medium and large insurer, we want to be sure they have the option now to deploy on-premise or in the cloud. We want to try to meet the customer on their own terms.
And I think now, with the choices we have, we’re really covering the waterfront..
One interesting fact to know is that, I would say at least half of the InsuranceNow prospects that are in the pipeline we would not even have gone after with only InsuranceSuite, because they’ll be too small for us have an effective solution for those customers..
It’s also worth adding, of course that we cannot, we are not selling InsuranceNow internationally yet. So, despite if we have couple of early conversations in English speaking geographies. But another dimension of market expansion for us is to ensure that we can sell it around the world the same way that we do with InsuranceSuite today. .
That concludes today’s question-and-answer session. At this time, I’ll turn the conference back to Marcus Ryu for any concluding remarks. .
No additional remarks. Thank you for joining. .
This does conclude today’s conference. Thank you for your participation. You may now disconnect..