Guidewire Software, Inc. (NYSE:GWRE) Q2 2023 Earnings Call Transcript

Guidewire Software, Inc. (NYSE:GWRE) Q2 2023 Earnings Call Transcript March 6, 2023

Operator: Greetings. Welcome to Guidewire’s Second Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I’ll turn the conference over to Alex Hughes, Vice President, Investor Relations. Alex, you may now begin.

Alex Hughes: Thanks, Rob. I’m Alex Hughes, Vice President of Investor Relations and with me today is Mike Rosenbaum, Chief Executive Officer; and Jeff Cooper, Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today as well as in our related Form 8-K furnished to the SEC, both of which are available on the Investor Relations section of our website. Today’s call is being recorded, and a replay will be available following the conclusion of this call. Statements made on this call include forward-looking ones regarding our financial results, products, customer demand, operations, the impact of local, national and geopolitical events on our business and other matters. These statements are subject to risks, uncertainties and assumptions and are based on management’s current expectations as of today and should not be relied upon as representing our views of any subsequent date.

Please refer to the press release and risk factors and documents we file with the SEC, including our most recent annual report on Form 10-K our quarterly reports on Form 10-Q filed to be — and to be filed with the SEC. For information on the risks, uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements. We also will refer to certain non-GAAP financial measures to provide additional information to investors. All commentary on margins, profitability and expenses are on a non-GAAP basis unless stated otherwise. A reconciliation of non-GAAP to GAAP measures is provided in our press release a reconciliation of additional data are also posted to please a supplemental on our IR website.

With that, I’ll turn the call over to Mike.

Mike Rosenbaum: Thank you, Alex. Good afternoon, and thanks for joining us today. I’m pleased to share the results of what was another great quarter by Guidewire. We continue to steadily execute and improve in all key of our business, and second quarter results were a good demonstration of this. We combined strong sales execution, great cloud adoption and improve cost discipline delivered than expected. We exceeded our targets for ARR, subscription and support gross margin operating margin products and our performance this quarter gives us a strong fundament to build on for the remainder of this fiscal year. As we continue to lead an industry transition to modern cloud-based core systems, we enable our P&C insurance customers to better engage with their customers, innovate with new products, channels and agile approaches to risk management and structurally grow more efficiently than is possible with the legacy core system.

We continue to make steady progress in the key pillars of our strategy, cloud adoption, cloud deployment, cloud efficiency also growing our ecosystem of partners by amplifying everything we do on sales. On the call today, I’ll talk about our quarterly progress in each of these areas. Starting with adoption; Q2 sales activity was strong with eight cloud deals including two new customer wins, three migrations, and three insurance suite expansions at existing customers. In the Americas, we had two new customer wins, including one for InsuranceSuite with a $2 billion DWP insurer and another for ClaimsCenter with a $1.4 billion DWP insurer. We also closed two cloud migration dealers, including one for ClaimsCenter with a Global Tier 1 insurer and another for InsuranceSuite with a long time Guidewire regional customer In addition, we continue to work with one of the largest insurers in the world to steadily expand on Guidewire Cloud with a new greenfield initiative.

In EMEA, we had three cloud wins, which is a strong quarter for us in this region. two of these deals were with one of the largest insurers who will be migrating an on-prem implementation of InsuranceSuite to Guidewire Cloud platform while also with InsuranceSuite to a new line of business. In addition major UK base insurer will adopt BillingCenter on Guidewire Cloud platform after adopting on the platform last year. All of these transactions repricing confidence in our platform and cloud capabilities and unique center partners can provide cloud-based modern core systems. Turning to cloud deployment, we continue to build momentum with nine more go-lives on the Guidewire in the quarter. The breadth and pace of deployment in Q2 was exciting and has kept us all very busy.

The go live activity this quarter was international with three departments in the United States, three in EMEA, three in Canada customers and it goes up market with one Tier 1 and five Tier 2 deployments. In the quarter, we saw a Tier 1 insurer and a Top 20 P&C insurer in the United States deploying ClaimsCenter on Guidewire Cloud illustrating new GWCP’s ability to scale with the largest insurers. At the same time, a startup insurer was able to deploy PolicyCenter and BillingCenter on Guidewire Cloud platform in just a few moments, demonstrating that GWCP can be deployed quickly. I was also pleased to see insurers successfully modernize and transform their core systems to GWCP . This Included AMA Insurance Company, one of Canada’s largest motor insurers, deploying InsuranceSuite on GWCP to deliver greater efficiency and better experience for its customers and its agent network.

We also saw a major U.K. insurer with over a 300-year history deploy ClaimsCenter on Guidewire Cloud platform to begin its transformation journey. 31 customers have gone live on Guidewire Cloud platform. This total includes migration and modernization in greenfield deployment and I believe this speaks to the capability, agility and stability of our cloud platform. We would obviously continue to increase this total in the quarter, and as we do, we continue to improve our operating capabilities and efficiencies with each new deployment and each new lead. We also still have a lot to learn. Every time we complete a go live, we learn something. We identify ways to improve both for our operating efficiency but more critically, we learn how to make these experiences and projects better for our customers.

We remain determined to relentless drive further improvement in our cloud operations liability performance security. So while we are thrilled to now have doubled our production with customers and proud of the work we have done to achieve it. We also recognize that eventually and I might say inevitably, this number will be in the hundreds or maybe even the thousands. So the work we are doing right now to improve the efficiency of our operations in the future is critical to our long-term success and is a key component of our intention to be a source of durable long term profitable growth. One of the assumptions we have made coming into this year was that we can hold our cloud operation head count flat while continuing to scale cloud adoption.

This was based on a significant investment we have made and continue to make in our cloud platform. In the past 6 months, we have nearly doubled the number of the production customers on Guidewire Cloud and have been able to effectively control the infrastructure and headcount expenses required to support that growth. The significantly improved subscription gross margins we saw this quarter were driven by these decisions and the determined execution of our team. We’ll continue to learn and improve as we grow and continue to leverage the experience and feedback we get from each project go-live so that we can confidently position Guidewire Cloud for every relevant insurer everywhere in the world. Turning to Guidewire Partner ecosystem, we continue to build momentum with both our SI partners and our agency partners.

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The number of Guidewire consultancy and system integrators grew to operating 21,000 at the end of Q2, up by 27% quarter-over-year platform. The number of cloud certified consultants increased year-over-year passing 6,300 at the end of Q2. It gives our customers a valuable bench of cloud trained professionals to draw on as they start down the path of modernization or embark cloud upgrade. The importance of this community is illustrated by the fact that SIs have participated in over 70% of our cloud projects to date and of these, 15% have been SI-led. Now before I hand it over to Jeff, let me just comment on what we see regarding our headquarters. Around 4 years ago, we moved into a beautiful new building in San Mateo, California with approximately 180,000 square feet of cases.

But shortly after this move, the COVID pandemic changed the world. Post-COVID, our teams have become more distributed and our hiring strategy has become more global. This move allows us to realize significant savings while rightsizing and aligning our office footprint with needs of a more distributed, flexible and global workforce. Jeff will comment in more detail about the financial impact of this move but basically it will save us $10 million to $12 million a year starting next fiscal year. And I want to congratulate our real estate team on executing this transaction in a very challenging environment for these sorts of activities and I look forward to discussing this move further through Guidewire policies this coming weeks. With that, I’ll turn it over to Jeff.

Jeff Cooper: Thanks, Mike. We are thrilled with our second quarter cloud momentum with improved operational efficiency and cost discipline, all of which resulted in a great outcome in Q2 and a strong foundation to build upon as we execute forward our fiscal ’23 and longer-term financial targets. Second quarter ARR ended at $707 million ahead of our expectation. This represents 17% year-over-year growth on a constant currency basis. The first half of fiscal ’23 benefited from minimal ARR attrition and healthy growth in ARR coming from deals years sold in prior years with escalating fees, which we refer to as a ramp deal. Total revenue was $232.6 million, above the high end of our outlook. Cloud strength continues to be visible within subscription revenue, which grew 37% year-over-year to $86 million.

Subscription and support revenue was $105.8 million up 25% year-over-year. License revenue was $73 million, up 5% year-over-year. Services revenue was $53.7 million, up 6% year-over-year. Turning to profitability for the second quarter, which we will discuss on a non-GAAP, gross profit was $131.9 million. Overall gross margin was 57%. Subscription and support gross margin was also 57%, compared to 49% a year ago. This was significantly ahead of our expectations. Strong subscription revenue growth, combined with our focus on cloud infrastructure efficiency, is having a positive impact. We are also recognizing benefits associated with our new agreement with our cloud provider including some onetime savings that positively impacted Q2. We are expecting some higher costs in the back half of the year related to cloud customer upgrades to the latest release and healthy go-live activity.

Collectively, we were pleased with our margins in the quarter and with how subscription and support margins are tracking for the year. And services gross margins in Q2 was just below breakeven compared to positive 8% a year ago. We continue to make steady progress working through complex early cloud programs and other programs that have been leveraging subcontractors at higher-than-normal levels, and we still expect services to return to positive margin in the second half of the fiscal year. Operating income was $15.1 million. This was significantly higher than our expectations due to better-than-expected subscription and support gross profit and lower-than-expected operating costs. Overall stock-based compensation was $36.2 million. expense was down year-over-year in Q2 and up 2% year-over-year in the first half of ’23.

We expect unit growth in BC in the back half of this year. This is consistent with our slowdown in hiring as we scale our business without adding additional headcount. We ended the quarter with $870 million in cash, cash equivalents and investments. In Q1, we announced a $400 million share repurchase program. As part of that program, we executed a $200 million accelerated share repurchase program, which was finalized in February 2023, an aggregate share delivery of 3.2 million shares at an average price of $61.93 per share. The initial tranche of 2.6 million shares were delivered in Q1. The remaining approximately 600,000 shares were delivered in February which is in our Q3. Outlook for fiscal year 2023. We are maintaining our ARR outlook of $745 million to $760 million.

We are pleased with our progress in the first half and feel confident in our pipeline for the back half of the year, but feel it is prudent to maintain our outlook at this point in the fiscal year. As I previously noted, the first half benefited from a strong ARR coming from ramp deals and very low ARR attrition. The second half of this year has more difficult year-over-year compares in these two areas, which was already embedded into our guidance. We are excited by the pace of new modernization this year, whereas in the early part of the cloud transition, much of the bookings activity was focused on customer cloud migrations. This momentum is exciting for two reasons. One, it indicates increasing confidence in the maturity of our cloud platform; and two, it is demonstrating our ability to compete and win at a high level since most of these deals are competitive.

We are raising our outlook for total revenue, which we now expect to be between $894 million and $904 million, representing 11% growth at the midpoint. The primary change is we now expect subscription revenue to be $348 million, an upward adjustment of $6 million and representing 34% year-over-year growth. This adjustment was driven by better deal linearity and some meaningful cloud contract extensions on existing customers. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we expect subscription and support gross margins to be between 51% and 52% for the year, an increase of two to three percentage points when compared to our outlook last quarter and five to six percentage points from the Q4 call. This reflect — this adjustment reflects increasing confidence in our margin trajectory as we execute towards our mid- and longer-term margin targets.

We continue to expect services margins in the mid-single digits for the year with significantly better services margins in the second half of the year. This improvement assumes the completion of ongoing arrangements with investments from Guidewire. The ramp of new services hires replacing subcontractors and the redeployment of some Guidewire services resources from non-billable to billable roles. As a result, we now expect overall gross margin of approximately 53% for the year. With respect to operating income, we expect an operating loss of between $17 million and $7 million for the fiscal year. We expect stock-based compensation to be approximately $139 million, representing 1% growth year-over-year. Given this and the impact of the accelerated share repurchase program, we expect a decline in our fully diluted shares outstanding this fiscal year.

There is no change to our cash flow from operations expectations. In general, the positive margin progression gives us confidence in our ability to scale cash flow, but the timing of collections can cause cash flow to fluctuate in a given quarter or year, given how much of our annual collections are due at the end of our fiscal year. Turning to our outlook for Q3. We expect ARR to finish between $715 million and $720 million, which represents 16% growth at the midpoint on a constant currency basis. We expect total revenue between $211 million and $216 million. We expect subscription revenue of approximately $88.5 million. Subscription and support revenue of approximately $107 million and services revenue of approximately $56 million. We expect subscription and support margins of approximately 50%, and we expect services margins of approximately 10%, and overall gross margin of between 50 and 51%.

We expect a non-GAAP operating loss of between $20 million and $16 million in Q3. Finally, as Mike noted, we have entered into an arrangement to complete an office swap with another company in San Mateo. Our new office space is just a couple of blocks from our current headquarters and it is less than half the total square footage. As part of this arrangement, we expect to take a write-off of the leasehold improvements, the right-of-use asset and lease liability in the existing location, and we expect the aggregate amount to be between an $8 million to $9 million loss, and this charge will hit G&A. This will impact our Q3 GAAP financial results, but given the onetime nature of this write-down, we will exclude this from our non-GAAP financials, and therefore, has no impact on the outlook provided above.

We also have approximately $1.5 million in advisor and moving fees in the back half of the fiscal year, which is included in our outlook for the year. Looking ahead to fiscal 2024 and beyond, we expect to save approximately $10 million to $12 million per year as a result of this move. With that, operator, you can now open the call to questions.

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Q&A Session

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

Dylan Becker: Nice job here in the quarter. Maybe starting with Jeff this time on the margin front. I understand there’s maybe some onetime dynamics there; as you called out, but I wanted to dig into the reallocation from customer specific to kind of platform-specific investments. How big of a portion is that headcount and the margin delta, if I recall correctly? And how much does that capacity shift from that small select number of projects contribute in the quarter, but also give you kind of confidence in that long-term margin outlook you guys have called out?

Jeff Cooper: Yes. Look, I think in total, we are seeing — as we realize benefits of the investments we’ve made in the platform to be run and executed much more that will afford us the ability over time to repurpose some headcount. And we talked a bit about this in Q1, where we had folks that were previously in our R&D organization, our product development organization that were for a period of time doing customer-specific work and so ended up in our cost of goods sold, our subscription product. And then over time, those headcount have now moved back into the product organization as they are kind of building product sets for the totality of our customers rather than doing customer-specific work and almost like a support life function.

So we did see that in Q1. There was no movements in Q2 that drove the number was healthy momentum in terms of overall platform efficiency. There was a little bit more update work that we had modeled into our number that is now going to happen in the back half of the year. And so that was a little bit of the explanation for the outsized beat vis-a-vis our expectations. But in general, this is just us kind of managing steady progression in terms of how we think about our cost structure to support our cloud business.

Dylan Becker: Got it. Got it. Super encouraging there. Maybe switching over to Mike. As you talk to customers, again, a lot of emphasis on kind of core back office efficiency and what that improved from an underwriting standpoint. I guess how are carriers thinking about utilizing kind of some of the integrated data as well to prove their own marketing and efficiency? I would assume the challenges in attracting but maybe the bigger challenges in retaining those customers that get kind of that preferred risk profile. I guess how is that discussion evolving from a core adoption standpoint?

Mike Rosenbaum: Great question. I think the component of the platform and on both PolicyCenter, ClaimsCenter, BillingCenter side, but I’d say from a new business perspective, mostly claims are quoting. The digital capabilities around that gives them flexibility and agility to roll out new channels, new mechanisms to quote and price products, new places to put those products better and more effective mechanisms for staying connected with agents and agencies and MGAs are very, very important to a significant number of our customers. And so we support both companies that go direct but also that go through distribution channels. And even you might think if you’re going through a distribution channel, the digital component doesn’t quite matter as much.

It might be even — it might matter even more because that sort of digital user experience that is really expected nowadays for really dealing with any company or any product becomes more and more important over time. And so it’s the flexibility around this that we’re delivering with Guidewire with GWCP and with some really exciting improvements that we have made on the digital front with our digital platform that they are very excited about. And I just think fundamentally, what we’re trying to do for this industry is give them a platform that they can innovate with that they can iterate on. And so that if we can sort of make the projects easier for them to execute on smaller faster, they’re going to be able to, in the same way any software company sort of iterates their way to success, you’re going to be able to see sort of significant improvements in that marketing and distribution channel for both direct and indirect customers.

So great question.

Operator: Our next question is from the line of Kevin Kumar with Goldman Sachs.

Kevin Kumar: Can you give us an update on just the overall demand environment? Any changes in terms of carriers’ appetite for larger upfront deals? And then any comments on kind of geographic differences. It feels like Europe was performing pretty nicely this quarter.

Mike Rosenbaum: Yes, good question. It’s something we continue to pay close attention to given sort of overall sort of constant news about what’s going on in the macro environment. I would say generally, we are seeing a continuation of what we’ve reported over the past few quarters in that the insurance industry is not immune, but is not specifically impinged, I’d say, by this. There are certainly impacts of inflation that a lot of carriers are feeling and working through. But in general, like I’ve said a number of times, I think that the time period around which these carriers are thinking about these modernizations and their strategy for these core systems is sort of at least multiyear, if not for a decade. And so the decision-making process and the demand environment, it can stay steady throughout this period of uncertainty from a macro perspective.

So hopefully, that’s clear like slow and steady winter race like Guidewire, we think that the demand is still there. things that we’ve talked about previously about carriers looking to do sort of more, I don’t know, line of business by line of business type of purchasing strategies we still see that being a popular topic of conversation. I think our cloud approach facilitates that better than what we were offering before. So I feel pretty well aligned to the overall market and the demand environment. And that’s what gives us — I think that drove a bit of the success in the quarter, as we called out, it was a good quarter for Europe as well as America. We saw global live activity across the board. So yes, we feel pretty good about demand right now and feel confident through the end of the fiscal year.

Kevin Kumar: That’s helpful. And then just a question on InsuranceNow. Maybe just an update on that product and maybe Guidewire’s competitive positioning kind of more lower down market and kind of the level of investment you’re making in that set?

Mike Rosenbaum: Yes. So that is a great business for us. We have a bunch of very happy customers in that segment, and we continue to make progress around what I’d say, slowly migrating that customer base over to GWCP. And we’ve talked a little bit about that before. So we still like eventually start to see real synergy between the two platforms. I’d like — the deal volume, the deal velocity there is not sort of multiples every quarter, but we do have a consistent pipeline and we do have a consistent plan. And most importantly, I think we do have a very strong and positive InsuranceNow customer base. And I really like the sort of growing synergy between the InsuranceSuite and InsuranceNow product lines where we’re looking at analytics use cases and like I already mentioned, platform use cases, that enable us to get a little bit of lift about the combination of both of those assets inside of Guidewire.

As you pointed out, it enables us to have a strategic presence down market, which I think is just strategically very important. I don’t want to lose sight of that segment of the market. And I think it enables us to do some interesting things a little bit more quickly than we might be able to do with the InsuranceSuite side of our product line. So that’s going very well for us. And so when you look at it from a fiscal year perspective, it’s easier than looking at it just every single quarter, quarter-over-quarter

Operator: Next question is from the line of Rishi Jaluria with RBC.

Rishi Jaluria: Mike, I wanted to start with you and maybe understand some of the news around the headquarter swap. I’m glad to see you’re kind of embracing the distributed work. I wanted to get a sense for how are you thinking about your own hiring and workforce philosophy in this environment, where you’re kind of finding areas that you think are worth investing in, maybe where you’re being a little bit more deliberate with headcount additions. That would be helpful. And I’ve got a quick follow-up for that.

Mike Rosenbaum: So I think first thing you got to recognize, and we’re certainly not alone in this that when we switch to completely from a work, we recognize that very sign we could be super productive. We could be very effective as a company in that environment. And that immediately causes you right away, we can hire people almost no matter where they are in the world. And so that pushed us mentally to think a little bit more globally. Now even before I even joined, Guidewire had two super presence in Dublin and Krakow Poland where we are doing real strategic product development or in both of those locations. We obviously had a distributed services organization. But in the past few years, we’ve added a significant amount of headcount in India.

And we are using that as a strategic place to add R&D resources. And we just continue to think that we will be more and more distributed, let’s say, as opposed to San Mateo centric. San Mateo, I think, will always be an important part of the company. But we are seeing just absolutely great work from our international teams and our teams outside of California. And this headquarters move is sort of an acknowledgment of that is we just had too much space here. and we weren’t going to grow into it. And the team was looking around at what they could do, and we found this opportunity and executed on it. I think it was just really well done. But I would say if you project out over, I don’t know, 4, 5 years, the strategy of looking for great people in different locations, regardless of sort of where they are, we’re embracing that.

And I would put one caveat is like I don’t know if you’re interested. But we do actually believe that getting people together is also important. And so what we’re trying to do is gravitate hiring and people around hubs and creating sort of reasonably complicated schedules around ensuring that people have opportunities to get together, collaborate in person, but also then go back to their home offices and work individually. And we feel pretty good about that sort of balance that you, I guess, call hybrid work these days. And we feel good about it, and I think that confidence is reflected in the real estate strategy.

Rishi Jaluria: All right. Got it. That’s really helpful. And then, Jeff, we talked about subscription to support gross margins. I want to ask about services gross margin. So I appreciate you gave us some color and expecting it to return to profitability in the back half of the year. I guess, number one, can you help us understand what are kind of the drivers to get that business on kind of a profitable basis? And maybe number two, just philosophically how we should be thinking about longer-term gross margins within services and how you’re balancing treating as a cost center versus maybe wanting to generate at least a decent profit given it is a pretty significant part of your business. And a lot of other vendors in the space maybe do get some level of profit off there. Maybe some color there would be helpful.

Jeff Cooper: Yes, sure. Thanks for the question. I think our services organization is a highly strategic asset for Guidewire. And as we were embarking on the initial part of this cloud transition, we knew that there was a lot of uncertainty that our customers had about the path of going to Guidewire Cloud. And we’ve leveraged our services organization in a variety of ways to help our customers get comfortable with this shift. And some of that came through arrangements like fixed bid arrangements. A big area of anxiety is the overall cost of getting from point A to point B. And some of that was around rolling out some discounted rates as a result of we’re still learning a little bit on how these will play out and may not be operating at efficiency in terms of our billing activity in terms of getting people from point A to point B.

And you see that a bit in our margins as we’ve invested alongside our customers to help them get comfortable to make the shift to the cloud. We’ve learned a lot over the last two or three years, and we put in place kind of a multipronged strategy to bring that business back to where it has been historically where we’re no longer kind of using that as an asset for us to get business over the line. The product has come a long way and certainly delivers and stands on its own two feet in that regard. And so — and the main area of that what we’re seeing in the back half of the year is a lot of these fixed bid arrangements that we had worked on and been executing on are coming to completion. We’re finishing those projects. We are also actively been working on a multi-quarter strategy to bring in entry-level hires train them up and have them replace fairly expensive subcontractors and we’ve been utilizing subcontractors at much higher levels than we had historically.

So that’s a big part of the strategy, and we’re starting to see that part of the strategy to be realized. And then finally, we did some work internally looking at nonbillable roles and seeing how we could improve our efficiency of kind of billable to nonbillable rules. Those are the three things that we’ve been working on as an organization over the last kind of two to three quarters to kind of affect what we expect to see in the back half of the year. And it’s an area that we’re paying a lot of attention on as it’s embedded in our guidance and as part of how we think about our execution for the year.

Operator: Our next question is from the line of Ken Wong with Oppenheimer.

Ken Wong: The first one for Mike. I couldn’t help but notice that your customer commentary sounded a bit top-heavy with the migration of a Tier 1 go lives with Tier 1s and Tier 2s. Is that just simply kind of just convenient timing in the quarter? Or are you seeing greater conviction from some of your largest customers?

Mike Rosenbaum: Yes, super question. I mean, I guess you have to say, just based on the duration of deals and the duration of projects that sometimes the order where everything lands, right? That’s half of the answer. But in general, and I wouldn’t say that this just applies to the Tier 1s. Our confidence is building. I think confidence in the market is building generally. So I’d give ourselves a little bit of credit for that in addition to just maybe this is the quarter where we saw this type of demand. I think we are — I think 31 production customers now is a pretty good milestone. I think dealing with the dealing with all of the work, the project-related go-live work, I think successfully getting these programs live. I think it’s very, very helpful.

And I think that, that’s only going to help us going forward, build confidence with the top end of this market. And I just think especially as it relates to the customer base, we traditionally have been more focused and more successful with Tier 1 and Tier 2 insurance companies. So all strategies of the platform and the approach to our cloud strategy was to ensure that we invested enough to provide a service that they could to — and I think that you can see that starting to come out in the quarter results. So I’ll chalk it up to a little bit of both.

Ken Wong: Got it. Fantastic. I appreciate the color there. And then, Jeff, just diving into the subscription gross margins a little more. I believe you mentioned a kind of a new arrangement with a cloud partner. Just wondering, was that the bulk of the uptick from Q1 to Q2? Or how should we think about what the right quantification of that benefit was?

Jeff Cooper: We’re seeing — there’s a variety of things. There’s been a big emphasis in terms of our engineering team. We kind of — we went through a phase where we were 100% focused on making sure that the product works and making sure that we were meeting the needs of the customers. And we are now thinking through more strategically how we make this thing more efficient over time, right? And so I think we’ve seen that — seen some benefits there. We really — we entered into a long-term relationship with our cloud service provider — that does include some incentives and pricing incentives so that we saw some benefit there. We think about our business on an through a very annual lens many times. And when we look at this year, we know that there is some work that’s required to get our customers from some of the earlier ski slope releases to the later ski slope releases.

Over time, that work becomes smaller and smaller. But we have some of that modeled in the year that ended up not happening as much as we had originally thought in Q2. And so some of those costs have shifted into Q3 and Q4 but when we look at it all together, we started the year with an outlook of around 46% subscription support margins are now guiding to 51% to 52%. So we’re really pleased with the progression that we’ve seen as we work through the year. And it’s a variety of things. It’s a lot of focus and some of it is also the subscription revenue line has firmed up a bit. Some of that is linearity. Q2 was a very healthy bookings quarter for us, a little bit higher than what we were expecting going into in the quarter. And so that linearity also helps on the margin side.

Operator: Next question is from the line of Matt VanVliet with BTIG.

Matt VanVliet: Apologies for any background notes here. But I guess when you look at the competitive landscape out there and sort of the pipeline of deals that you’ve already either gone live or in late stage of deployment today. Are you seeing any of your existing customers? Maybe just kind of check the box and say, and we’re moving to Guidewire. We’re not even going to put this out for competitive bid as they move to the cloud or I guess how are you thinking — or how are you hearing from your their appetite to move to the cloud without really needing to go out and see what else is in the market?

Mike Rosenbaum: Well, I’ll take that. So for an existing Guidewire customer that is already up, already running with a deployed claim center, deployed pulse center in the deployed billing center, our whole strategy is to make it highly unlikely that it would make any sense for them to replace that implementation with something other than Guidewire. We are trying to minimize that switching costs. I think we largely have minimized execution products. The switching cost is not 0, as we’ve talked about previously, there is some amount of switching costs and it is a project. But I would hesitate to say that I have I’m trying to think if I’ve seen a single situation in which somebody has said, we’re going to put the whole thing kind of going to open up the whole strategy and look at it just because it’s so clear that most of the implementation of Guidewire is supported in Guidewire Cloud, right?

So Guidewire on-prem can mostly be upgraded to Guidewire Cloud as opposed to reimplemented on a competitive core system. And that’s fundamental to our strategy. We didn’t start over with the product made any sense, and it would have caused us to have to abandon that customer base. And so we’re not yet — that isn’t just a perfect push the button and the thing upgrades, but it’s much, much better and much more logical for a big deployed, excuse me, insurance company sort of opening it up to competitive bid. Now there still is competition out there for the greenfield implementation lines of business. And we do see existing Guidewire customers saying, “Hey, even though we’ve got Guidewire already for this new line of business that’s not yet modernized, they will do RFPs for that, and we will compete for that business and we compete favorably in those circumstances, and that does occur.

But for the existing base, it’s unlikely that, that would be a dynamic we would worry about, just not because we’re the best. It’s just because that’s fundamental to the strategy here.

Matt VanVliet: Okay. Very helpful. And then, Jeff, not to believe the point too much, but obviously, as you get more scale on GWCP, in particular, how much more of the long-term operating margin target and I guess within that, obviously, gross margin. But how much of those reliant on just getting more and more customers to migrate over versus some of the other things you outlined earlier on the call, like reducing headcount or I guess, restraining headcount growth and some of these others. So I guess the question is just how much — do we need to see more migrations occur to ultimately get to those long-term target gets?

Jeff Cooper: Yes. And we’ve talked about this in the past. I kind of think business, $4 billion of ARR and we need to scale into that $1 billion of ARR. So that does mean that in order to get to our midterm targets, which have us at $1 billion of ARR, we need to add new customers and continued steady progression of migrating our installed base and winning new business. I think what we saw — what we’re seeing this year is we’re starting to see some of these larger new modernizations come back into the market with — and a lot of these have been sitting on the sidelines for a period of time. So that’s an exciting back pattern for us. But absolutely, we need to execute on our plan and continue to sell. And our model assumes that we can do that in a very scalable manner by not adding headcount and continuing to leverage the investments in the platform that we’ve made.

Mike Rosenbaum: So let me just jump on what Jeff said, Matt. I want you to understand this. The positive improvement in the margin I am super, super pleased with because it indicates that the strategy is working, right? And in the case that — you could call it the pivot we made, the decisions we made around prioritizing, constraining headcount growth in these areas and the focus that we made on optimizing our infrastructure spend are starting to work. And it doesn’t mean that if you hold revenue flat that you’re going to get more and more efficient. And it’s sort of like, hey, we said, “Hey, if we take X number of people and they build a capability into our platform that will work for one through 100 customers, we still need those people because we got 31, right?” But as we go from 31 to 100, we don’t need to add more people.

We — the platform marginally will scale much, much more efficiently now — and so that’s why we’re so pleased with the results on the margin side this quarter is that, that strategy is now working. And I think you can start to see it in the financials. So great question, but I really want you to understand that the philosophy here is, like Jeff said, we’ve built the platform to convert this customer base and win the majority of Tier 1, Tier 2, Tier 3 insurance companies in the world, and I think we’re on a path to doing that.

Operator: The next question is from the line of Parker Lane with Stifel.

Unidentified Analyst: This is Matthew Kicker on for Parker. To start, what are your thoughts on the use case for generative AI within the adware where would be the potential for incremental use on future platform updates? Could you see it helping at all with migrations?

Mike Rosenbaum: Yes. Thanks for the question. I’m super excited you asked. It’s one of my little — it’s one of my favorite things to think about these days. The first thing I would say is I genuinely believe that this will have a big effect on every software company in the world, every person in the world. I think it’s a very, very busy. And it’s almost like new in the technology landscape has been invented, and we are all going to go find ways to leverage it super effectively. I think one obvious area is cogeneration. In fact, these systems can generate code is maybe almost miraculous in my opinion, but very, very exciting, no matter what you think. So we think that over time, we’ll improve the efficiency around implementations, maybe upgrades.

But the — but I think of it as every developer in the world will get a little bit more productive as we figure out ways leverage this effectively and leverage it reliable, it’s sure way. And that’s certainly one area of potential. There is a whole host of capabilities that you could imagine around customer interactions, claims management, quoting, the back and forth that is associated with talking to consumers about insurance policies and things like that. And I think fundamentally, the way on that side of it, I think Guidewire will certainly play a role in the innovation side of this and creative ways that we can deploy this in the features of our service. But I also — as one of our colleagues here, John Mullen pointed out to me today, actually, the fact that we have this marketplace that exists and facilitates start-ups and insurtech and smaller companies being into Guidewire deployed is a really big, big boost, I think, to Guidewire, but especially Guidewire customers.

I think I said this before, ChatGPT sort of opened everybody’s eyes to this. I said it a couple of years ago at Connections is — we really do see a world in which there’s a very significant amount of automation that can be unlocked. But I’d say, fundamentally, you’re going to need a modernized core system at the base of your operation. if you really are going to fully leverage tools like generative AI, I think that, that’s a fundamental step. And I think these insurance companies are still going to need platforms like wire on the policy claims and billing side and then you add this generative layer on top. And I think you’ll get a real improvement in the business value and the transformation these companies are able to drive. But like I said, it’s early, early days.

It is early, early days, and the excitement about it comes from the fact that, like I said, I’m not the only one that genuinely think this is a miraculous level invention. And I think the impact to the insurance industry will be profound.

Operator: The next question is from the line of Joe Vruwink with Baird.

Joe Vruwink: I want to expect to the large insurer you’re working with on the new greenfield effort. Can you maybe talk about how the nature of the greenfield engagements have changed just in either use case or maybe relative sizing of ACV? And then, I guess, related to this, how is the experience changing around follow-on activity post greenfield? Do these become the entry way to maybe getting involved with bigger lines of business subsequent to the experience on the greenfield effort.

Mike Rosenbaum: Good question. So yes, we work with different carriers in different ways in this particular one. We have a pretty broad agreement that basically says they will sort of project by project by project modernize to Guidewire. So as opposed to doing one massive deal with us, they look at it as when this line of business is ready to modernize or this line of business is ready to launch and that project is ready to kick off. That becomes a deal that we incrementally add to our contracts with that insurance company. Not everybody wants to approach it that way, not all of our customers do. But in this case, that made the most sense. And so for sure, as experience and confidence builds, both on the platform side, but especially on the customer side, it facilitates an acceleration of those projects, right?

As you say, hey, we got that done successfully, and that’s going well. And so let’s take another bite at more of the modernization backlog and green like that project and get that started and move that to Guidewire. And so that’s basically what we’re seeing there. That’s not unique. We’ve seen that with a number of other companies. We often see this with acquisitions. We’ve seen this with a couple of different carriers over my tenure here at Guidewire where they’ve got a baseline project, but there’s an acquisition that comes sort of after the initial project has been kicked off and that acquisition creates an opportunity to do another line of business with the new implementation of Guidewire. And like I said, the name of the game for me is project go-lives, successful projects, build confidence build success, ensure that we’re just steadily executing because that increases the likelihood that that next line of business, it will just be logical to put that on to Guidewire in the platform.

Joe Vruwink: Okay. That’s all great. And then just on the new modernization activity that’s been talked about a couple of times, would be kind of a reasonable or maybe harder sales cycle that being associated with these. Is this the saying where in that you are able to in these within the next 12 months. Could you be present the potential army I don’t think it would be next year mean that to fiscal 2021?

Mike Rosenbaum: I guess, certainly, there is a potential I had to take to forecast that or predict that. When we do an assessment of the total addressable market that exists in P&C for modernization. We do see a pretty significant amount of these projects and systems that will truly occur. And as confidence builds as our experience builds, as the risk costs associated with successfully executing these monetizations, as those things get more controlled, you do see the potential, I’d say, for the pace to pick up thought, and that’s for many, many times. We’re not the only sector and the technology is not the only factor. The timing of the insurance company’s decisions around these things. They have other priorities and objectives.

And we’ve got deals that are perfectly logical and eventually are going to happen, but help pop up either on the regulatory side or on the — just the baseline insurance side sort of catastrophe like other risks and events can have an impact on this. And so there’s a lot of other factors that control the timing of these things. But we’re going to — we do our best to do our part and the increased likelihood of success and the value we’re delivering. And so that potential exists, but I’m hesitant to forecast it if that makes any sense.

Jeff Cooper: Just to add on, I mean I think this is always part of our plan. It’s very consistent with how we model this. We knew that modernization has been the bread and butter of Guidewire and needed to be a big part of how I think it’s a long-term opportunity here. we’re excited to see that start to kind of meaningful progression. And that was always — it’s kind of validating model and value how we think the opportunity.

Operator: Our next question is from the line of Michael Turrin with Wells Fargo.

Michael Turrin: I think so far so on the macro has been fairly like but maybe one on the competitive environment, if I may. I know it hasn’t belonged, but you had a competitor recently deployed the public market. So I’m wondering if there’s any change in hearing in customer conversions or just how you’d respond to the overall question on the competitive environment.

Mike Rosenbaum: Yes. I think my talk competitive is that things have not changed, and we still have competitors regardless of the circumstances around the ownership of those competitors, they’re still out there. They still remain. I’m super, super happy with our progress to date and I think that I’m positive on our progress is positive about the future at Guidewire. And I think that, that will have impact on our ability to compete in the market successfully. Like I’ve said before, continually up market. I think we have very differentiated offering up market for Tier 1 and Tier 2 insurance company even something to year three. It’s like very clear to me, and I think it’s becoming clearer and clearer that that’s going to be — but the ultimate were in this market will be Guidewire, but we still do have that competition.

And so the news that you’re referring to is pretty recent we — but like my message to the team here at Guidewire, let’s say focus, let’s keep executing, and let’s just keep playing our game. And I think we’ll continue to succeed kind of at least as well or better than we have to date. So that’s my take on the competitive situation. It generally hasn’t changed much.

Michael Turrin: Very balanced. Jeff, stepping away from margin maybe to ARR for just a moment. You’re holding on to the outlook there. You mentioned some of the positive first half impacts, but I think called out tougher compares in the back half. If I look at it, I see constant currency growth rate in 2Q and 4Q that are at least somewhat similar. So just hoping to and that comment a bit more, if there’s anything macro or anything else that might be driving more conservative stance in the revs of your outlook for ARR. Just anything else you can add there is helpful.

Jeff Cooper: Yes, nothing I mean Q4 is a big quarter for us. So we usually move our guidance around too much the earlier part of the year, this comp. So that’s in confidence and in comparison to model. So just when we look at activity in a material like ARR, it’s still happen that this year, the first half was pretty healthy in that regard. And the second out to what we saw last year, closed compares that are toward that. so that’s just kind of closed through the model. In addition to last year being pretty amazing in terms of the overall ARR attrition that we experienced last year. This year, we’re still expecting very solid retention rates around kind of 3% ARR attrition is how we always think about modeling our business. and we’re within the line.

But last year was a very strong year in that regard. So that also created a little bit of a difficult compare. And so those are some of the dynamics that are causing net new ARR to slow down a little bit in the back half of the year, but that was always embedded into how we thought this year would play out.

Operator: Our final question is from the line of Tyler Radke with Citi.

Tyler Radke: Mike, just on the go live, I’m curious how that compared to your expectations and are you expecting kind of the pace of go-lives to increase in the second half of the year?

Mike Rosenbaum: Yes, super question. So the go-live activity has a lot to do with how the projects proceed, whether or not there’s any delays and anything that you catch and whether or not those goal updates are pushed out. I would say generally, all — unlike, I think, every project dynamics a bit like this is like you somewhat aspirationally at the beginning and then unfortunately, you get circumstances that cause a go-live to push out. So we do see those from time to time. And so I hesitate to have you like cash me start to forecast go-lives because that’s not my intention. But I would say it does match our expectations. You know what I mean, like the pace of it is starting to be something that I’d say our company is going to get used to executing at that pace sort of maybe forever, right?

Because when you do the math, we like to do these over the weekends because it inevitably involves some transition downtime for these companies, these core systems when they actually swap over. have to be taken down before they drop back up on the new thing and so you want to do that on the weekend. And so that creates a big complicated project to execute flawlessly between Friday night and Monday morning. And so what we’re doing is looking ahead at every single weekend now until forever sort of filling up those based on the demand that we are seeing. And so it was in line. These things are never perfect and so it wasn’t exactly every single 16 months ago that we thought would go live in the quarter, it went live in the quarter. But we’re very happy with the execution this quarter.

And like I said, I think that this is going to end up being — I kind of tried to point to this in my prepared remarks, it’s like this is going to be just a steady, steady part of Guidewire from now and for time just the numbers in the customer base and the new business activity that we see. — bear that out. If we keep doing deals and we keep filling the pipeline, we keep closing deals and then fill in the pipeline for go-lives, that activity, that go-live activity feels just keep going as it does, the demand on the platform will keep growing. The revenue on the platform will keep growing. And because we’re able to control the headcount and the infrastructure expense, the margin around that product will keep improving. And you see that in this quarter in a really positive way.

So I’m just very, very excited about the progress, the execution and maybe the determination of the people at Guidewire to make those projects happen.

Tyler Radke: We’ll hold you to $50 million a quarter from here on out. Perfect. A quick follow-up for Jeff. Just on the margins. Obviously, a lot of good cost savings stuff this year between hyperscaler contract negotiations and real estate consolidation. Should we think about these as upside to your targets that you gave out? Or just help us understand how those play into those.

Jeff Cooper: Yes. I think on the overall subscription and support margins, we’re clearly tracking a little bit ahead of our FY ’23 targets. So that’s positive. And it’s helpful as we think through our kind of longer-term targets, but I wouldn’t necessarily call them out as upside yet, right? This is helpful for us to kind of feel more and more confident as we execute towards those targets. Like the building and the real estate consolidation was not embedded into our plan. So that is a little bit of an upside in terms of how we built the model previously. And then in general, when we look at some of the cost savings initiatives, the company is doing a number of activities that I think give us a little bit of confidence that we’re tracking a bit ahead of the plan. But know that there’s still a ton of execution between now and FY ’25 or some of those longer-term targets. So at a high level, that’s how I think about it.

Operator: At this time, we are end of our question-and-answer session. I’ll turn the floor to Mike Rosenbaum for closing remarks.

Mike Rosenbaum: Okay. I just wanted to say thanks, everybody, for participating today. We’re obviously thrilled with the continued cloud momentum across new and existing customers. And we had Tier 1 and Tier 2 insurers, going live this quarter and like we talked about, driving margin improvement. We think this quarter is a great validation of our strategy and increases in our long-term opportunities. So I look forward to catching up with you all further throughout the quarter, and have a great afternoon. Thank you.

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