Guidewire Software, Inc.

Greetings and welcome to the Guidewire third quarter fiscal 2023 financial results conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alex Hughes, Vice President of Investor Relations. Thank you, Mr. Hughes. You may begin.

Thanks, Kamala. I'm Alex Hughes, Vice President of Investor Relations. With me today is Mike Rosenbaum, Chief Executive Officer, and Jeff Cooper, Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today, as well as in our related Form 8K furnished to the SEC, both of which are available on the Investor Relations section of our website. Today's call is being recorded, and a replay will be available following the conclusion of the call. Statements made on this call include forward-looking ones regarding our financial results, products, customer demand, operations, 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 representative views as of any subsequent days. Please refer to the press release and the risk factors and documents we file with the SEC, including our most recent annual report on Form 10-K and our quarterly reports on Form 10-Q, filed and to be filed with the SEC for information on risks, uncertainties, and assumptions that may cause actual results to differ materially from those set forth in such statements. We will also refer to certain non-GAAP financial measures to provide additional information to investors. All commentary on margins, profitability, and expenses are on a non-GAAP basis unless stated otherwise. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are also posted in the supplemental on our IR website. And with that, I'll now turn the call over to Mike.

Thank you, Alex. Good afternoon, and thanks for joining us today. We had a strong third quarter highlighted by sustained demand for InsuranceSuite Cloud, and ARR and profitability, both exceeding guidance. We were pleased with overall software revenue, led by 34% subscription revenue growth. However, services revenue was below expectations, primarily due to the timing of revenue from a few complex engagements, which we will address later in the call. We were thrilled to see continued improvement in subscription and support gross margins, which more than offset the services shortfall. Our cloud gross margin trajectory drove operating income outperformance and gives us confidence to raise our full year outlook for operating income. A few highlights of the quarter relating to our main corporate objectives were that we closed eight cloud deals and sales momentum remained solid ahead of our seasonally strong fourth quarter. Cloud deployments were also strong with eight go-lives in the quarter across both commercial and personal lines. And we continued to drive improved cloud efficiency with subscription and support gross margins, finishing five points above expectations. Before I go into more detail, let me just make a couple comments about the P&C insurance industry. To serve this industry and the core system use case well, requires a platform that reliably and securely addresses and ensures complex business requirements while also providing for greater agility and innovation. Sales cycles and deployment projects are lengthy, complex, and sometimes arduous. But when we win a customer and we successfully deploy a customer in production, we establish a durable relationship with significant lifetime value. I believe our hard work demonstrated execution with Guidewire Cloud Platform and the growth of our ecosystem have clearly established us as the cloud leader in our market and have positioned us well to serve the top insurance carriers in the world. From this position, we will continue to expand the breadth and depth of our solutions and ecosystem to help insurers drive innovation and improve decisions at scale. The second point I would like to make is about the macroeconomic environment and its impact on our P&C customers. The industry is generally resilient to economic cycles, but it is not immune. The inflation-driven increase in claims expense has had an impact on the profitability of many insurance companies and is causing scrutiny on near-term investments and budgets. Given this backdrop, We are pleased to see our momentum on strategic deals and projects continue to progress and we remain confident in our sales outlook. Our industry is adept at managing market cycles and this cycle has the undercurrent of the ever-increasing need for innovation and agility in the market, which strengthens our strategic positioning with customers. The value of being on our platform is increasingly clear as carriers navigate the current cycle. So while I'd say we are navigating through this environment well, it is appropriate to acknowledge that expense pressures are present. With that said, let me turn to discussing our Q3 results in a little more detail before handing it over to Jeff to cover the financials. As I said earlier, it was a strong quarter with eight cloud deals, seven of which were for insurance suite. In addition to insurers seeking to modernize legacy mainframe systems, we are starting to see an increased interest in replacing previously modernized on-prem systems, which is a very positive market development for us and a great validation of the investment we've made in the Guidewire cloud platform. Deal volume in Q3 was well-balanced with three new logos, three migrations, and two expansions. First, let me walk through our new customer wins. Texas Farm Bureau, a Tier 2 insurer headquartered in Waco, Texas, selected Full Insurance Suite Cloud to modernize their existing portfolio of legacy and on-prem core systems. We look forward to helping them achieve improved system performance and operational excellence staying current on functional and technical capabilities via Guidewire Cloud updates, taking advantage of Guidewire's extensive marketplace offerings and improving agent and customer experiences. We were also fortunate to welcome a rapidly up-and-coming Tier 3 carrier to the Guidewire community. This commercial insurer selected Guidewire as their long-term partner. and will use InsuranceSuite Cloud to retire legacy systems and transform core operations across policy, billing, claims, digital, and data. Predictive analytics was a key differentiator in this hard-fought competitive deal, and it represents a key mid-market win for us as this progressive carrier has substantial growth aspirations. And the insurance company of Prince Edward Island, a growing Canadian property and casualty carrier, selected Guidewire Cloud Platform to expand their product line and streamline operations so that they can efficiently and effectively support growth in commercial markets across Canada. Turning to cloud migrations. We saw Country Mutual, a Tier 2 carrier focused on personal and commercial lines across 19 states, elected to upgrade their on-prem claim center system to the cloud. And they also expanded their Guidewire footprint, selecting PolicyCenter Cloud for its commercial and agricultural lines of business. A Tier 2 provider of reinsurance and insurance will migrate to PolicyCenter on Guidewire Cloud Platform and expand to additional lines. Advanced product designer capability within PolicyCenter Cloud was a key differentiator to increase agility and support their growth strategy. And the Home Building Compensation Fund, a provider of safety net insurance for homeowners in Australia who are faced with incomplete or defective building work, will migrate to InsuranceSuite Cloud. Finally, looking at expansions, CNA, a top 12 commercial lines carrier based in Chicago, expanded their investment in Claim Center Cloud to support additional commercial lines, and a Tier 4 insurer expanded their Insurance Now investment to include additional lines. This brings the total number of wins for the Guidewire Cloud platform to 20 for the year. Over 70% of this total was with Tier 1 and 2 insurers, which I think really validates the approach we have taken to ensure we can support the most demanding customers in the world, as well as provide a system suited to the success of the Tier 3 through 5 customers that make up a significant proportion of our customer base. The improving maturity of our platform is also reflected in the increased cadence of cloud production go-lifes. In Q3, we added another eight cloud deployments, bringing the total number of customers live on Guidewire cloud platforms to nearly 40, with healthy activity in both personal and commercial lines. In personal lines, some of the deployments included Auto Club of Southern California, the largest member of the AAA Federation with 16 million members and a Guidewire customer since 2004, went live with InsuranceSuite on Guidewire cloud platform. In addition, a large insurer with over 2 million customers across the Nordics and performing 90,000 claims per year and 4,300 new policies per day went live with Policy Center, Claims Center, and Billing Center on GWCP. With respect to commercial lines, Some of the deployments included a commercial trucking and specialty insurer based in South Carolina deployed policy center on GWCP to drive scale operational efficiencies and innovation for agents and customers. A provider of commercial lines to multiple industries across 20 states went live with Claims Center on Guidewire Cloud Platform to further reduce claims processing times and automate claims adjustments and costs. and an insurer of over 1.5 million Texas workers deployed Policy Center, Claims Center, and Billing Center on GWCP to further improve operational excellence and customer satisfaction. All of these deployments represent incredible work by our customers' project teams, our Guidewire service teams, and our ecosystem partners. As I mentioned earlier, this is a community that is increasingly leading cloud deployments, and I'm pleased to see it continue to expand. SIs now have over 22,000 Guidewire consultants as of the end of April, up 27% year-over-year. Moreover, the number of cloud-certified consultants increased 67% year-over-year to approximately 7,300. These are important stats because a healthy partner ecosystem helps to drive customer success. but also because it is critical to providing ever-increasing predictability and cost efficiency to our customers and prospects. We are committed to enabling SIs to serve increasingly as the prime integrator on cloud projects. This will inevitably lead to Guidewire Services' revenue growth slowing relative to the growth of the total services ecosystem and allows us to focus on a more scaled services model that drives expert services in coordination with the SIs and retains the scale required for delivery of new products and strategically important projects. This approach will provide us with a more durable and profitable service model. The services revenue shortfall we saw in the quarter speaks to the importance of this. Earlier in our cloud journey, we took on complex fixed fee arrangements where we leveraged SIs as subcontractors. This was both to actually deliver the work, but also to fuel the SI cloud ecosystem. For the past year and going forward, we are limiting subcontracting and fixed fee arrangements, and we are seeing the SIs step into the prime role on most cloud projects. As this portfolio of early projects are completed and the services margin burden associated with these early cloud customers will lessen. Turning to our solution partner ecosystem, we also continue to grow the number of partners on the Guidewire marketplace. This collection of integrated applications amplifies the total platform innovation for our customers and serves as a powerful differentiator for us. We now have 180 solution partners in our marketplace, and we have added six new solution partners in areas such as providing more granular and accurate property data for better risk scoring and enabling greater workflow automation and speed. We are building a powerful cloud platform where greater innovation will layer on over time and where customers can accept this innovation more easily and with less integration friction. An example of a recent strategic partnership showing good momentum on our platform is the one with OneInk. where we are seeing strong interest from insurers to incorporate its technology to enable a more frictionless payment experience for their customers. I would also like to briefly discuss generative AI and large language models and their exciting potential for Guidewire and the insurance industry. First, And I think the most important consideration as it relates to Guidewire is that insurers begin to look at their systems and processes to evaluate if they are equipped to take advantage of this technology shift. They will realize that modernization is a key first step. We believe that insurers who have already modernized their core systems will be dramatically better positioned to take advantage of the potential this technology provides. Those who are still relying on legacy systems will be held back and will be reconsidering that approach, and I believe this could support efforts to justify modernization initiatives. Second, generative AI has the potential to make developers more productive, which in turn will drive more efficient implementation projects and improved product innovation. I think it's likely that in the course of 12 to 18 months, most developers internally and in our services organization and in our SI ecosystem will be able to leverage large language models to support software development and project execution. Third, like a lot of software companies and many of the companies in our solution partner ecosystem, we are working on incorporating large language model driven product enhancements into our cloud product suite that will enhance the value of the products we offer to our customers. Broad-based productivity gains should be a logical outcome of embracing generative AI, and we expect that our cloud-based product suite will be an enabler of this. Overall, generative AI has tremendous potential to have a positive impact on our mission, and we look forward to taking a leadership position in how the industry adopts generative AI in the months and years to come. Finally, let me spend a minute on leadership in the organization. I was very happy to announce the addition of Michael Howe to the Guidewire team as Chief Product Officer. Michael is a longtime veteran of the insurance technology industry, having led product at Applied Systems for over a decade. He will lead product strategy and product marketing here at Guidewire. We are now in a position to build on the tremendous progress Diego de Valle and the engineering team have made in establishing our cloud platform and insurance suite product releases. Michael will help us increase and optimize our focus on product innovation and the alignment of our data and analytic solutions with our core, while Diego continues to lead platform growth, performance, and scale, which is all foundational to everything else we do. With that, I'll turn it over to Jeff to discuss the financials.

Thanks, Mike. I want to highlight a few topics as I walk through the financial results in the quarter. First, as Mike noted, sales momentum continues to be strong, and notably we are seeing more new customer wins and new modernization programs. We are also seeing some insurers looking to replace core systems put in place over the last decade or two as they evaluate their cloud strategies and want to ensure they have a partner that is investing to grow and innovate with them. This is an exciting development for us. At the same time, we are seeing steeper ramps than last year, which means the initial ARR impact of new sales activity is lower in the first year, but fully ramped ARR is preserved. This, combined with the macro backdrop, are the primary reasons healthy sales activity is not translating into a higher ARR outlook for the year. Continued sales momentum combined with better-than-planned execution on cost controls and efficiency initiatives are driving cloud margins ahead of our FY23 expectations. Our subscription and support gross margin trajectory gives us increased confidence in the long-term earnings power of our operating model. Third, in the services portion of our business, we are working through a number of very complex core system modernization programs. A handful of these are fixed-bit arrangements where changes in the project plan can impact the timing of services revenue. A couple programs had an adverse impact on services revenue in the quarter vis-a-vis our forecast by approximately $4 million. Finally, turning to cash flow, we are seeing slower collections than we expected in our model. Accounts receivable grew by $43 million over Q3 last year, and over 60% of that incremental AR is coming from payments outstanding for over 30 days. In the quarter, we also shifted our operating bank account from Silicon Valley Bank to Bank of America, which did have a brief disruption to our collections cadence, but this is now resolved. Given slower collections, combined with the fact that we have approximately $150 million in collections due in the last five days of our fiscal year, we've adjusted our cash flow expectations for the year. This adjustment to timing of collections has no impact on the long-term cash generation assumptions we have discussed with you all at our analyst day. Now turning to results for the quarter. Third quarter ARR ended at $722 million ahead of our expectations. This represents 17% year-over-year growth on a constant currency basis. Total revenue was $207.5 million. This finished below our outlook due to services revenue results. All product components of revenue were either better than or in line with our expectations. Cloud strength continues to be visible within subscription revenue, which grew 34% year-over-year to $89.1 million. Subscription and support revenue was $107.5 million, up 24% year-over-year. License revenue was $50.5 million, down 6% year-over-year. Services revenue was $49.4 million, down 13% year-over-year. As I mentioned previously, we had two Guidewire-led programs where project replanning resulted in an adjustment to the timelines, and as a result, an adjustment to the revenue recognition timing. This was an approximately $4 million impact when compared with our outlook last quarter. Additionally, there has been increased scrutiny on services statements of work that has caused some streamlining of scope or pushing more services work to lower-cost partners which resulted in lower than expected billings in the quarter, and this accounted for approximately $2 to $3 million. Turning to profitability for the quarter, which we will discuss on a non-GAAP basis, gross profit was $107.7 million. Overall gross margin was 52%. Subscription and support gross margin was 55%, compared to 47% a year ago. We are thrilled with the progress we're making on subscription and support gross margin, which continues to track ahead of our expectations. Services gross margin finished at negative 2% compared with positive 4% a year ago. We have been expecting positive margin in Q3, but revenue headwinds impacted margins in the quarter. We continue to be confident in our services strategy to return to profitability in the fourth quarter and beyond. Operating loss was $12.2 million, better than our expectations due to strong subscription and support gross profit and lower than expected operating costs. These factors more than offset the impact of the services margin shortfall in the quarter. Overall stock-based compensation was $35 million. Stock-based compensation expense was up 6% year-over-year in Q3 and up 3% year-over-year through the first three quarters of 2023. We ended the quarter with $807 million in cash, cash equivalents, and investments. As of the end of Q3, the accelerated share repurchase program was settled in full with the delivery of an additional 648,000 shares of common stock, which resulted in total repurchases under the ASR of 3.2 million shares at an average purchase price of $61.93 per share. Also in Q3, we repurchased an additional 207,000 shares at an average price of $77.19 per share. Turning to our outlook for the full fiscal year 2023, we are adjusting our ARR outlook to $745 to $755 million. As I previously mentioned, we are seeing healthy sales activity and expect this to continue in Q4, but we are seeing steeper ramps this year. This results in less ARR in the first year of new sales arrangements. However, we are still preserving attractive fully ramped ARR terms in these arrangements. So while ARR growth this year is expected to be approximately 13% at the midpoint, I expect fully ramped ARR to grow at 14-15%. We will also provide more detail on fully ramped ARR at year end, as this is a metric we discuss on an annual basis. As a reminder, our ARR outlook assumes foreign currency exchange rates as of the end of the last fiscal year, and then we update exchange rates at year end. Last year, the year-end exchange rate adjustments to ARR were negative 19 million. If exchange rates stay the same as current rates, then we would expect a negative $5 million adjustment at year-end, largely driven by the dollar strengthening versus the Canadian dollar. With respect to revenue, we are increasing our expectations for subscription, subscription and support, and license revenue. We are adjusting subscription revenue to approximately $349 million, a positive adjustment of $1 million. We are adjusting subscription and support revenue to approximately $426 million, a positive adjustment of $1 million. And we are adjusting license revenue to approximately $261 million, a positive adjustment of approximately $5 to $6 million. We are lowering our services revenue expectations by $10 to $12 million. As a result, our outlook for total revenue is $890 to $900 million, a $4 million adjustment at the midpoint. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we expect subscription and support gross margins to be between 54% and 55% for the year, an increase of three percentage points when compared to our outlook last quarter, and eight to nine percentage points from the Q4 call. We expect services gross margins to be around break-even for the year. This implies a Q4 improvement that assumes the successful completion of ongoing fixed-bit arrangements. As a result, we now expect overall gross margins of approximately 54% for the year. With respect to operating income, we expect between a $4 million operating loss and a $6 million operating profit for the fiscal year. We expect stock-based compensation to be approximately $140 million, representing 2% growth year-over-year. Given this, combined with the impact of our accelerated share repurchase program and our active repurchase program, we expect fully diluted shares to decline by approximately 1 million shares this fiscal year. As mentioned above, we are adjusting our cash flow from operations expectations to between 10 million and 40 million. Finally, as we look ahead to fiscal year 2024, we feel it is prudent to wait until after our fourth quarter before discussing ARR growth expectations. With respect to profitability, we are committed to demonstrate non-GAAP operating margins of 6% or higher and GAAP operating margins of negative 10% or better. We will continue to monitor both GAAP and non-GAAP operating income metrics. but we expect to ultimately measure our success in hitting targets that capture the real cost of Guidewire and our shareholders associated with stock-based compensation. With that, let's open the call for questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment please while we poll for questions. Thank you. Our first question comes from Dylan Decker with William Blair. Please proceed with your question.

Hey, gentlemen, I appreciate the question and totally get the product versus services side here. Maybe, Mike, for you, I think you noted some of those existing on-prem customers seeing accelerated migration activity. I wonder how much of that's a function of the updated Garmisch release here and the shift to, I think, three product releases annually versus two, maybe widening the functional gap of the on-prem capabilities versus the cloud. And from a go-live perspective, now maybe having more of those customers that can validate that update versus upgrade kind of type of framework you guys have talked about.

Thanks for the question, Dylan. You know, I appreciate the insight. It certainly helps. I'd say in addition to those, I don't know, topics, which I'll discuss briefly, I think the most important thing is it's just our experience and our track record running these programs at scale, going live, you know, over the special go-live weekends repeatedly now, something that we're getting better and better at. And so just building the overall confidence in the, you know, in the ecosystem, in the community of P&C customers, I think it is helping us The shift to three releases a year I think is also great, and it helps. I think the most important thing is what you should read into that is more and more confidence that we have in that we can execute these updates seamlessly. Now, we're still working through that with our cloud customer base and with the new customers. This is a different approach that, you know, this whole PNC ecosystem, you know, the entirety of the way that this all operates throughout the world is changing, and we are changing it. But I think customers... especially those that have been on the journey with us for a couple years now and are seeing it and are experiencing it, are very excited about the potential that it offers. Just personally, I know I commented a little bit on generative AI. I am very much looking forward to the idea that we have production cloud customers where we can put these changes into updates and then get them shipped out to customers seamlessly, and they can hopefully just literally turn them on. It's just a very, very different operating model than Guidewire has been operating under and the industry has been operating under for the last 20 years. And I think that is helping us drive the continued sales activity that we're seeing. So thanks for the question.

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

Yeah, that's a deep strategic question, and I think it is top of mind as carriers think about modernization and getting to a core platform that provides sort of an agile ability to roll out new innovative products. that take advantage of some of the connectivity and IoT-enabled characteristics that you're describing. I'm not sure I'd go so far as to say those things would have prevented the cycle that we're in right now. I think inflation jumped up and caught lots of industries off. by surprise and has this impact that just has to be worked through. It's just sort of a normal cycle. I guess normal in the sense that if there is inflation, there will be a disconnect between you're feeling the impact of that inflation in claims versus being able to adjust premiums and readjust the policies that support the risk, actually, in the replacement costs. But certainly there is a lot of excitement in the overall industry about modernization in general and the ability for it to reposition insurance companies somewhat around providing risk mitigation services. and actually just controlling the risk as opposed to sort of paying for things that break, actually using the industry and the relationship to prevent that risk, prevent that breakage, reduce the expense of mishaps and perils. And so that is an exciting part of what we do, and I think tied to just this general idea of bringing agility to the core system equation, to the data and analytics equation, which makes these models more possible. So I love the question, and it's definitely part of the story and what we're selling to customers. Thanks, Mike. Appreciate it. Thank you, Dylan.

Thank you. Our next question is from Peter Heckman with DA Davidson. Please proceed with your question.

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

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

Sure, sure. So I'm just trying to think about what percentage of ARR is now either live or committed to migrate to the cloud? I mean, something in the range of 50, 55%.

Oh, okay. So let me pivot to Jeff in a second. I just want to say, like, there's a couple of things that are included in the statistics. We talk about the number of customers that are live. Within each customer, they're going to sometimes have one instance, but oftentimes will have many instances. You know, so when you dig into the actual number of instances of, say, claim center or policy center or policy center for a particular line of business, there might be and often is multiple instances that are live in production. And then each of those, depending on whether or not it's an established line of business or a new line of business for that carrier, will carry with it a certain amount of DWP, right? So, you know, the biggest go-lives for us in terms of scale are are when you have like a fully deployed claim center or policy center, billing center implementation on-prem, and we move that to our cloud, and then immediately you have all that DWP operating on the cloud instance, on the production instance. And there's a factor, Jeff can give you a sense of this, you know, cloud ARR is now larger than you know, non-cloud ARR at Guidewire. And that has to do with the price point as much as it is the momentum and the count. But certainly the predominance of the majority of the ARR at the company now is associated with cloud.

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

Yeah, I would just add, we obviously know this. We obviously track this very closely internally, like the percentage of that ARR that is live or is still in a project to go live. But that's not in my script or in my head because it's not something we talk about publicly, but it's obviously something that we pay very, very close attention to. And look, the culture at the company, and we have a very, very good track record of this, is that 100% of that will successfully get to production. That's the commitment we make, and I think it's part of the brand promise that is Guidewire. Despite these projects being complicated and hard, you know, we are standing shoulder to shoulder with these customers and partners and making sure 100% of that is eventually live in production. Sometimes it takes longer than a year because the projects are complicated, but it all does, or at least the intention is and the commitment is culturally that we will get it all live.

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

Yeah, that's the expectation. You know, it should, you know, the system when in balance is equal on both sides of that equation and, you know, the overall system can operate profitably, you know, and, you know, over time, you know, based on the variety of ways we contract for our core systems that DWP will flow into Guidewire and complicated growth bands and barriers and thresholds that need to be crossed in order to trigger those increases. But generally, yes. Like I said, this is a bit of a headache, let's say, or maybe, you know, issue for us in the short term working through this and causing, like I said in the script, a little bit of scrutiny around short-term expenditures. But in the long run, the industry is equipped to deal with this. And I think Guidewire, as a system providing innovation and agility, facilitates carriers being better able to absorb this. And one of the reasons why we think, you know, sales activity continues to be solid heading into the fourth quarter.

Helpful. Thank you.

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

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

Yeah, it's a good question. And it's interesting because last Q4, we saw a little bit less ramp activity and a bit more kind of smaller starts that would grow in a more organic fashion. So a little bit surprised this year to see a bit higher ramp activity. And interestingly, we're also seeing our deal portfolio skew a bit more than we expected towards new modernization programs and new customer wins. versus migrations. And migrations always had fairly kind of steep ramp elements attached to them because we count a booking as the incremental ARR that's being added to Guidewire. And sometimes, you know, they're already paying ARR and a term license fee, and it takes a little while to get up and running and live in the cloud. And so oftentimes there's not a big uplift associated with ARR associated with migration. So seeing higher ramps this year is both A little bit of an interesting fact pattern, but a positive fact pattern. It means that customers and prospects are willing to make big multi-year commitments to Guidewire and this path with Guidewire. So we are seeing a little bit, we use the phrase steeper ramps, which means kind of the starting point to the end point, that the growth is bigger in those committed ramps than what we saw earlier. uh the prior year and the prior year was notably a little bit shallower in terms of the overall all ramp activities we saw some smaller starts rather than than big commitments so you know it's a it's a mix it's i was a little bit surprised to see that but in general we are pleased to see especially new customer wins and even some competitive displacements, which is very exciting for us to see. And we're seeing healthy fully ramped ARR events. But I do think some of the near-term cost-conscious pressures that are existing in the insurer install base is having a little bit of impact on kind of their appetite to sign up for a new spend over the first year or two. But we're certainly capturing an attractive fully ramped ARR.

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

Yeah, so we are very pleased with the efficiency gains we're seeing in the platform. The engineering team has done a lot of work to help us manage our overall cloud infrastructure costs, and so that is continuing to exceed our expectations, which is a big positive. Another area of cloud cogs at this point in the cloud journey is cloud updates and upgrade costs. And we did see a little bit of those costs push out. So when I think about the outperformance in the quarter, if you think about five percentage points, about two and a half percentage points was related to just core efficiency gains, these would be our expectations. And the other was a little bit of this work getting pushed out. We tend to model this work very conservatively, so we're not surprised by a lot of work coming into a quarter that was unforecasted. But that was the primary drivers of the outperformance in the quarter.

That's helpful. Thank you.

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

Thank you for the question. The first one for Mike, just in terms of the scrutiny of IT budgets, I guess, how has that materialized for Guidewire versus just broad IT spend pullback? And if that has hit sales conversations, is that more on the edges of your products or is that actually impacting core systems? We'd love to get a sense for kind of how that may or may not materialize. Yeah, okay.

Thanks for the question. I would say this. My sense is Guidewire is more immune to this than most. I think people think about Guidewire investment and the Guidewire projects very strategically. Five-year duration, 10-year duration is a very legitimate conversation. one of which I had this quarter. That company is not thinking about as much the day-to-day quarter-to-quarter cash flow as they are thinking about what are we doing for the next 10 years. So in general, Guidewire is more immune to this than probably most IT spend. But it does exist, right? And so you bring it up. I bring it up because it's like the ability for us to manufacture deals, the ability for us to accelerate things, in a climate where the general mindset is conservatism as it relates to budget, it just makes it a little bit harder. You know, the things that were already in flight and the plans that were already in place are continuing to progress, and it does give us confidence in the outlook we've provided for Q4. You know, but it is a bit of a headwind, and it is, you know, coming up much more in the, you know, in the last few months than it has in the past. You know, so I thought it was worth mentioning. That said, I do want to stress, and this was, you know, we touched on this in one of the earlier answers to one of the earlier questions. This is a cycle. There is an adjustment period that we believe the industry will process through, and then I think things will get a bit back to normal, and it'll open up, and the budgets will loosen a bit, and we'll be able to create a bit more acceleration even beyond what we've got right now. So hopefully that helps you give you a sense of things.

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

Yeah, the majority of it was just Given the environment that we're seeing and some of the dynamics that Mike just talked to, putting a bit more conservatism into our collections assumptions vis-a-vis what's going to be billed and invoiced in Q4. That is a big part of it. The overall services billing also had an impact. But if you think about, that's probably a pretty small percentage of the adjustment to cash flow. Most of it is just the timing of collections and making sure we build some more conservatism. We are seeing a bit more process and bureaucracy that insurers are putting in place before they make large vendor payments. And we're having to jump through those hoops and Certainly the shift in our operating bank account in the corridor didn't help as we had to kind of go through a lot of revalidation to make sure that everything was in order. So that created a bit more process. That's behind us now, but as we look ahead, we just felt it was prudent to build more conservatism into our collections forecast.

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

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

Wonderful. Thanks so much for taking my questions. Mike, I wanted to go back to the generative AI theme. I'm really glad to hear kind of the way you're talking about it and some of the transformational effects for Guidewire. I want to think about the impact on the industry itself, right? Not only does it force some of the feet-draggers to modernize and kind of catch up and migrate to the cloud, But what's the potential for P&C insurers to actually change the way that they view the business, and maybe even more importantly, the way that they interact with customers? And what sort of impact do you think that can have on the overall spending environment as it pertains to budget for Guidewire? And then I've got a quick follow-up.

Yeah, thanks for the question. You know, I spoke recently at a Guidewire event and kind of talked about how, you know, you can think of these things on a spectrum sort of near term to long term, and you can get a little bit wrapped up in how dramatically impactful it can be to systems like insurance in the long run. But I think you're making a bit of a mistake if you do that, missing out on the potential for us to just generally improve process efficiency and operational efficiency and all the little things that we do every day. And I think there's, you know, it's not just Guidewire thinking this. There's plenty of industry analysts who are looking at this and looking at the insurance industry, and you just see some potential or maybe a lot of potential to, you know, better To operationalize these models and use them with human beings in the loop, not to replace human beings, but to augment human beings and make people more productive in managing sales processes, managing customer service, managing claims, making sure all of those processes work. are more and more efficient. It's like hundreds and hundreds of little tiny details that can be managed more effectively through systems like Guidewire. I think that there's a very important story to be told. And granted, this stuff needs to be built and fleshed out and rolled out and proven, but it's exciting to see something with this much potential and very accessible. The other thing that I was saying to the audience there was that one of the things I really, really like about these generative AI and large language model solutions is They don't necessitate a replacement of a system like Guidewire. You can just augment what you're already using Guidewire for. Now, I think, you know, if you're running a legacy mainframe system, it will be much more difficult for you to augment that system and that workflow with generative AI, and I think that that might drive these transformations. But a system like Guidewire with a cloud API, you can grab some information, call out to a model, and get an answer back, and that helps the person who's on the phone with the agents or a customer, and it makes the process more efficient. I'm very excited about this. I think a lot of people in the industry are very excited about it. We're excited to, you know, over the next few months start to roll this out and start to think about how do we productize it. You know, and I just talked for five whole minutes maybe, and I haven't even touched on the implementation side of it. You know, as I said, I think that the developer productivity component of this technology is very, very exciting. And I also expect it will improve. You know, we're not yet at the point where we can give you – you know, estimates for objective measures of the productivity improvements. But there's a lot of engineers who are super excited about this. And so hopefully that gives you a little bit of color about, you know, where we are, how we're thinking about it, and how we think it'll have an impact on the industry.

Yep, got it. Thanks. So that's really helpful. Appreciate all the thoughts there. And then I wanted to go back to some of the dynamics around ramped ARR, you know, and maybe, you know, I know you talked about this kind of a little bit of a surprise seeing that versus the smaller lands with potential upside that we saw last year. But, you know, what's driving, in your opinion, that change in behavior? And maybe as we see some of those, you know, shallower lands or whatever you want to call it, the smaller lands from last year, you know, as those kind of come up for renewal, should that be kind of a driver as we think about our models that might lead to a little bit of an uptick in ARR and potential ARR acceleration? Thanks.

Yeah, I mean... Yeah, as I said, I think it's an exciting pattern that insurers in this environment are tackling large strategic programs and making big commitments and investments with Guidewire, and we're seeing that in the total contract values that support these ramped agreements. In terms of you know, the shift over last year, it was a bit interesting. You know, last year, we saw a bit slower starts kind of dipping their toe in the water type of dynamic. And there was a thought that maybe that would persist. And that could have, you know, a pretty big impact on how we think about our model if that was the way that the industry chose to adopt and buy. I think it's a positive fact pattern that we're seeing some of these bigger commitments this fiscal year. But It is driving, just to give you a glimpse into how we think about this is so we measure a booking, a booking for Guidewire is the average ARR that's delivered over a five-year period. And then we have certain metrics that we look at internally such as what is the ratio between the year one ARR to that average ARR over a five-year period? And that ratio, our model is quite sensitive to that ratio. And so if you see that ratio go down a little bit, it means that there's, and the bookings levels are the same, it means you're adding really attractive fully ramped ARR, but the year one dynamics of that are a little bit lower than what we had modeled. So It's just one of these multiple levers that we have to manage through, and we try to provide some insights into that. For a period of time, I thought fully ramped ARR may fade into the background of relevant metrics because if insurers are buying a bit smaller and growing in a more organic fashion, then that metric would just be a little bit less relevant. But as we're executing through this year, you know, we're seeing that metric outpace ARR growth once again, which gives us, you know, confidence as we think about the long term, but does create some dynamics that we have to manage through as related to health expectations. What was the second? Was there another part of the question?

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

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

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

Yeah, and I think what I don't want to do is make this out to be a bigger deal than it is. I mean, we saw ramped activity look more akin to what we saw two years ago. And coming out of last year, we adjusted our models a little bit to make those ramps a little bit shallower. So I don't want to overplay this, but it is a dynamic that we wanted to call out in the business. How it relates to the services engagement is pretty detached. What we're seeing in the services part of our business is a part of our longer-term strategy to shift more and more of this work to the partner community. We had to go through a cycle of certifying and enabling the partners to lead these programs. And that's what we are starting to see more and more of today, which will allow us to build a more scaled and durable services organization in support of the broader ecosystem who will take the lead in managing these programs.

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

Yeah, makes sense. And then I guess on a few of the answers, you talked about a number of customers wanting to lean more into data and really the analytics behind a lot of that. And it sounds like more projects are maybe going live with those implemented originally. But curious on how that overall demand cycle is impacting kind of the upsell, cross-sell motions. versus now just being included from the start because of the value perceived by the customers?

Yeah, it's a great question. I think we're doing a much better job in sort of designing the product to work together, to be integrated from the beginning. to be pitched and sold and packaged and marketed, and then the sales process described as one unified solution that can solve, of course, this modernization problem, but also deliver business benefits through predictive analytics. And so it's exciting to see. You know, very often the economic justification for the modernization is attached to efficiency gains that can be either significantly or partially produced with predictive analytics. There's been a lot of excitement for not just the predictive analytics, but also the sort of operational machinery for what I'd say deploying the prediction into a user experience that actually causes end users to change their behaviors. And I think the industry in general, and this is not just insurance, but sort of the industry overall, the world of IT is pretty good at making analytics and pretty good at making analytics predictions and not as good at activating those predictions and causing a business change. And so a part of what we're producing here and what customers are excited about is is that we'll be able to take these algorithms and turn them into practical, useful predictions that end users will be able to use to either make better decisions about underwriting risks or make better decisions about processing claims. And that's exciting. And it's a bigger and bigger part of the story and the reason that a customer makes the decision to go now with a Guidewire project. So that's exciting to see, and I hope it'll continue to improve, you know, and, you know, we'll see, you know, but my expectation is generative AI, large language model supported capabilities augment that, you know, and kind of fit right into the same story I just told you about our predictive analytics capabilities.

All right. Thank you. Very helpful.

Thank you. Our next question is from Joe Brewink with Robert W. Baird, please proceed with your question.

Great. Hi, everyone. Thanks for squeezing me in. A little bit on the last topic since you brought up analytics, but just on that new logo with the Tier 3 carrier, the mid-market does seem a bit more competitive of late. What are you finding to be the differentiator for Guidewire when you're winning in that segment or, you know, Tier 3 through 5 outside of Tier 1 through 2? Is something like analytics catching on, or would you maybe point to some broader themes there?

Yeah, great question. I'll give you the themes. I think, number one, it's important that it was valuable that we bring a complete solution that is consistent across claims policy billing, right? So, you know, I think the larger carriers probably have more horsepower, maybe more capacity to be able to tolerate different systems for different use cases. But with these smaller companies, more limited IT organizations, a consistent platform with one approach, to integration, data, analytics, configuration, one vendor, the whole stack, the full suite, the whole insurance business process operating very cleanly. That's important. I think that one vendor being responsible for the predictive analytics and that part of the equation is also very valuable to these customers. You know, the other thing that's coming up is just, and I kind of touched on this before, it's just track record of success. You know, that we've got all, you know, I think, you know, 40-some, and, you know, customers in production. We've got multiple years now of track record experience running this. We've got a vision for this three releases a year. And I think that customers, you know, see that momentum, and I think that that does factor into the decision-making process in a significant way and helps us. And I wanted to say something because I'm surprised, actually, nobody asked this question yet. Jeff and I touched on this. Like, in this quarter we're seeing like conversations about competitive displacement that i have not seen uh in you know in my four years at guidewire is like we we mentally think of these systems as being you know the mainframe's been replaced and this package has been deployed and we started thinking of it as like that tam is removed but now it's coming back up you know and these systems that are now at this point maybe more than a decade old you know, these companies are talking to us about what's our potential for replacing them. And that's a very, very exciting development. It's a great conversation to have. And I think the reasoning behind that interest has a lot to do with all the reasons I just gave you about why, you know, that tier of the market is interested in Guidewire. So I think it all plays to our strengths right now.

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

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

Great. Thank you very much.

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

Hey there. Thanks for squeezing me in. Just one for me. Going back to just some of the other comments. The 3QARR came in ahead of the prior guide. The fiscal Q4 compared to the full year is more a tightening of the range. I appreciate you not wanting to turn this into a call around ramp deals, but is the second F impact you're characterizing last quarter there the difference between what was previously expected and is that more what's driving the decision to wait for Q4 before framing the prelim growth outlook as you historically have? Or is some of that also just macro fiscal Q4 being important and that's what's driving the decision process there? Any further context is helpful.

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

Thank you. Yep, thanks.

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

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

Super question. This is a dynamic which we also have noticed, and very often it is the, let's call it the modernization project to modernize something that causes the conversation about let's do the cloud upgrade of the existing implementation as well. Sometimes it's the other way around where, you know, we're talking about a cloud upgrade or a version upgrade, and that causes the conversation about new lines of business or modernization around another component of the core system. But, you know, what triggers – these things are – Deals like this, they need triggers. They need compelling events. They need business-related objectives that can drive the project and the deal for us. And so, like I said, a lot of times this is, hey, we've got an initiative to invest. do X, Y, Z in our business. We need a modern system to do that. Okay, we have Guidewire for claims already, and we're happy, and so let's talk about policy. And then, well, we're going to do policy on cloud. How should we think about claims? Should we move that to cloud also? And that's the way that the conversation goes and evolves and then results in a migration and an upgrade. And there's just a variety of different ways that those conversations can happen, but those compelling events are are created and driven by these business objectives. And so, you know, that's a dynamic that we're absolutely seeing right now and are excited about just continuing it. And so it's like it kind of relates also to this idea that we are a very good solution for a full suite offering, you know, where you can do everything in a very consistent way and One vendor, one approach to configuration, one approach to data and analytics and integration, one approach to the marketplace partners. And having a, you know, a consistency across these core systems, claims policy and billing really just facilitates a better end-to-end insurance process. And it's a big part of, you know, the value prop that we've provided, you know. And even it's like not competitors, but just like Guidewire is pretty unique. in the landscape for PNC core systems in that from the insurance suite perspective, all of these products have been built organically at Guidewire. They haven't been acquired or kind of bolted together through acquisition. It's like this has been built and crafted by great engineers, great teams at Guidewire over the course of many, many years and hundreds and hundreds of implementations. And that's a big part of our success. So I appreciate the insight and the question, and it's definitely one of the things driving a lot of these deals right now.

I appreciate the feedback. Thanks again. Hey, thanks for the question.

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

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

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