Guidewire Software, Inc. (GWRE) Q3 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to Guidewire's Third Guidewire's Third Quarter 2020 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. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Jeff Cooper. Thank you. Please begin.

Good afternoon, and welcome to Guidewire Software’s earnings conference call for the third quarter of fiscal year 2020, which ended on April 30th. My name is Jeff Cooper. I am the Chief Financial Officer, and with me on the call is Mike Rosenbaum, Guidewire’s Chief Executive Officer A complete disclosure of our results can be found in our press release issued today as well as in our related 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 the call. Statements made on this call include forward-looking statements regarding our financial results, products, customer demand, operations, the impact of COVID-19 on our business, certain leadership changes 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 as of any subsequent date. Please refer to the press release and the risk factors and documents we file with the SEC, with the SEC, including our most recent quarterly report on Form 10-Q 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. A reconciliation of non-GAAP to GAAP measures is provided in our press release with the primary differences being stock-based compensation expenses, amortization of intangibles, the amortization of debt discount and issuance costs from our convertible notes, changes in fair value of strategic investments and the related tax effects of these adjustments. Additionally, reconciliations and additional data are also posted in the supplement on our IR website. With that, let me turn the call over to Mike.

Thank you, Jeff, and thanks to those of you joining us for our third quarter earnings call. Quite a lot has changed since our last call in March, and I'm proud of how everyone at Guidewire has adapted and responded to the changes required by the COVID-19 pandemic. A lot has also changed in just from past week. And so before I get to the quarterly results, I want to take a second and relay to everyone how deeply saddened every single member of the team here at Guidewire is regarding the death of George Floyd and the underlying inequality and racism that reflects in our society. I sent a message to our company yesterday that said it's just fundamentally not acceptable to me that a portion of our community feels that the system we live with values their lives less than mine. We are all committed to doing our part and working to address this at Guidewire and in our communities. And I'm confident that we will find some value from this senseless loss of life. It's forcing us to have a conversation we are uncomfortable having. And even though that seems like a very small step, I think it will lead to positive change. With that, I'll proceed to the quarterly update. We had a good quarter all things considered. As you can imagine, we spent a lot of our time working to adapt to a new approach to work in addition to the normal things we do to operate the company. We're happy to report that ARR grew 10% from a year ago to $483 million, in line with our expectations. Additionally, we exceeded our guidance ranges for revenue and profitability in the third quarter. We have adapted to working from home company-wide and I expect us to operate this way through at least our fourth quarter and most likely our first quarter, which ends in October. I've been particularly impressed with our team's flexibility and eagerness to support one another as our colleagues juggled sometimes less than ideal work environments with personal responsibilities and the long list of new stresses and uncertainties we are all now facing. Like many others in the technology industry, we've been pleasantly surprised by how smoothly this transition has gone and we are working to ensure that we take everything we have learned from this experience and apply it logically to how we operate going forward. I have no doubt that we will support a greater percentage of remote work and find new and more creative uses for our office spaces going forward. While we continue to execute effectively as a company, there are COVID-related impacts to our business that we are dealing with. As you know, we sell large heavily negotiated deals for complex IT projects that have long sales cycles. We have been happy to see existing deals and projects continuing to move forward and in many cases our customers are just as motivated to continue to make progress on these initiatives as we are. A large majority of our new sales in any given year come from existing customers and we very often have long-standing relationships with customers and prospects that have transitioned well to virtual engagements. However, we have seen lengthening sales cycles and in some cases, delayed decision-making related to the very significant amount of uncertainty many of our insurance customers and prospects are facing. We expect this to continue in Q4, which is a critical period given the seasonality of our business. We consider ourselves fortunate to operate in a very resilient vertical with a strong recurring revenue business model based on delivering mission-critical applications, but we do expect that the current environment will have some impact on our ability to close new business, and that is considered in our considered in our outlook for Q4, which Jeff will discuss in more detail. Looking at some of the details of our third quarter. We delivered solid results in an uncertain environment and while new business activity was not as strong as a typical Q3, we did add four new customers and seven existing customers selected additional Guidewire products. Momentum for Guidewire Cloud continued in the quarter with over 60% of new sales from cloud, which included InsuranceSuite Cloud, InsuranceNow, and Cyence products. A particularly notable win was with Aviva Italia, an existing customer who has opted to migrate their InsuranceSuite instance to Guidewire Cloud. Given the environment in Italy during the quarter, I found it to be a remarkable example of the perseverance and resilience of our community, and we were all very inspired to get this transformation started in the midst of these difficult circumstances. We also saw momentum continue with InsuranceNow, our all-in-one cloud offering. CFM Insurance, a provider of farm, homeowners, and renters insurance, selected InsuranceNow to modernize their operations in the third quarter. Also, and as discussed on our last call, Tuscarora Wayne Insurance decided in Q3 to migrate their on-premise instance of InsuranceNow to Guidewire Cloud. Cyence contributed three notable wins in the quarter, showing the breadth of our reach by adding to our client base an insurer, an MGA, and a reinsurer. A German insurer selected Cyence Risk Selection and Accumulation for its international corporate underwriting business. And in the U.K., Optio Group Services selected Cyence Accumulation and Risk Selection for small business for cyber. And finally, a market-leading reinsurer based in Bermuda licensed Cyence Risk. Finally, we closed one new on-premise suite customer and an on-premise core system expansion in the quarter. British Columbia Automobile Association, a $225 million DWP insurer, serving one in three households in British Columbia, selected all of InsuranceSuite as well as data and digital. Admiral, a Tier 2 insurer in the U.K., expanded their relationship with Guidewire to add ClaimCenter. As part of our move to work from home, our services organization has successfully transitioned to 100% remote implementations very effectively. In Q3, we completed nine core data or digital go-lives, including a go-live on InsuranceSuite Cloud at MACIF in France, an InsuranceNow go-live and a full InsuranceSuite go-live. In addition to customers who went live on new products, six customers completed major version core upgrades. Our continued momentum would not be possible without our partner community. Notably within our partner community, approximately 475 consultants from 19 partner companies have now earned advanced certifications required for Guidewire Cloud implementations, up from approximately 270 as of the end of last quarter. We believe that this growth is an exciting proof point of the opportunity our partners see in the future of Guidewire Cloud. I'm grateful for the efforts throughout our ecosystem for the continued service and leadership to the P&C industry. I'm also pleased to announce that we closed two small venture investments in exciting innovators in the InsurTech landscape, Betterview and CLARA Analytics. Betterview is a geospatial analytics provider that helps underwriters manage property risk and helps adjusters to remotely manage property claims. CLARA Analytics is a provider of predictive analytics solutions, focused on workers' compensation and commercial claims. These investments totaled $2 million and closed in Q4. We look forward to working with both companies, as they help support what we measure as the largest and most vibrant applications ecosystem in P&C insurance. As I previewed in our previous quarterly call, we completed in May, what I think, is one of the most important releases we've ever done as a company. We're calling this release Aspen, and it is our first cloud optimized release of InsuranceSuite. This is the first release to take advantage of our Guidewire Cloud platform on AWS and introduces a cloud-native rating service, a cloud-native rules engine, a completely new approach to integrated digital experiences and a number of enhancements to PolicyCenter designed to allow insurers to launch new insurance products more quickly and more easily. Our mission is to enable insurers to engage, innovate and grow efficiently, and the Aspen release of InsuranceSuite is a major milestone in that journey. I'd also like to take this opportunity to discuss some leadership changes that we are making in the company. First, after 15 years at Guidewire and an incredible career in enterprise software, Steve Sherry has decided to retire. Steve will continue with the company as Chief Sales Officer through the end of our fiscal year and will stay on after as SVP Strategic Accounts through at least the end of the calendar year, to ensure a complete and seamless transition. We are all incredibly indebted to Steve for the contribution and leadership he provided during his years at Guidewire. He's an incredible sales leader and has built a truly first-class sales division here at Guidewire that will surely outlast him. In anticipation of Steve's retirement, we're excited to welcome Frank O'Dowd to the leadership team here at Guidewire. Frank is a 20-year sales veteran and leader from Oracle, a company that we all deeply respect in his professionalism and approach to NFI sales. Frank was most recently a Group Vice President at Oracle's cloud sales division. We're lucky to get him and excited for him to join. He will start with us on June 15 and have an opportunity to work with Steve and as team as we close out the year. At which point, Steve will smoothly pass the Chief Sales Officer baton to Frank on August 1. Second, I'd like to congratulate Jeff Cooper, our new CFO, who you will hear from in a minute. After an extensive and thorough search, we have decided that there really is no one better to lead our finance organization right now than Jeff. His command of the very complex financial details of our business model transition, in addition to the trust the organization has in him and the leadership he has shown during this Interim period in the COVID-19 transition, all demonstrated to me and our Board that Jeff was the right financial leader for Guidewire right now. During the process, I continually ask myself, who do I trust to financially manage and lead this company and I just kept coming back to Jeff. He had the command of the business and a belief in our potential and I'm excited about what we will build together. Third, I'd like to congratulate Priscilla Hung on a promotion to President, in addition her role as COO of Guidewire. Priscilla joined Guidewire in 2005. She has for many years been a key driver of the most critical Guidewire initiatives, and I expect will remain a key leader of the organization for years and years to come. She embodies the grip determination and resilience of our culture and I'm excited to continue to partner with her as we drive the next chapter for Guidewire, Guidewire Cloud and our partner ecosystem. She's been an invaluable partner to me and coming up to speed here at Guidewire and I look forward to her continued leadership and partnership. I hope that these leadership changes signal to you how extremely optimistic we are about our strategic direction and the long-term opportunity to serve the P&C industry. We are not slowing down investment in our cloud platform and cloud operations team. The investments we are making today will be key to our future success as the industry increasingly recognize the benefits of our cloud products. In summary, like many others we are facing new uncertainties as a result of the COVID-19 pandemic, but we are optimistic that these impacts are temporary when considered against the multiyear timeframe and time horizon we optimize for and the fundamental market pressures driving demand for modern insurance platforms. And as our cloud offering matures, we expect demand will continue to strengthen. We're building the most comprehensive cloud-based platform and ecosystem in the world and I'm confident that Guidewire in the insurance industry we serve will weather the storm. We'll get through this period of social and economic uncertainty and come out a stronger, more efficient company, and I hope a stronger and better world. Now I'll turn it over to Jeff.

Thank you, Mike. ARR ended the third quarter at $483 million on a constant currency basis, an increase of approximately 10% year-over-year. New ARR added year-to-date has been split pretty evenly between new deals sold and ARR step-ups from ramp deals sold in prior years. ARR retention continues to be in line with our expectations established at the beginning of the year, which given the current environment, demonstrates the resiliency of our recurring revenue model. Total revenue in the third quarter was $168.2 million, above the high end of our guidance range. Subscription revenue in the quarter was $30.1 million, up 105% year-over-year due to ongoing InsuranceSuite Cloud activity and some positive Cyence usage resulting in $1.1 million of variable revenue true-ups. License and subscription revenue was $93.2 million, which was also above the high-end of our guidance range and the primary driver of our total revenue outperformance. Through the end of the third quarter, subscription sales as a percent of total new sales was 61%. New term licenses and renewals with contract durations that were longer than our standard two-year initial and annual renewal terms contributed approximately $13 million in incremental revenue when compared to our -- with our standard term durations. As a reminder, last quarter, we mentioned that we expected approximately $10 million of incremental revenue from longer than standard deal duration contracts embedded in our outlook for the back half of the year. And we did expect much of that activity to land in Q3 where we had the most visibility into longer duration contracts. Maintenance revenue and services revenue in the third quarter were largely in line with our expectations at $20.7 million and $54.3 million, respectively. Turning to profitability, we will discuss these metrics on a non-GAAP basis. Gross profit was $94.2 million in the third quarter, compared to $94.1 million a year ago. License and subscription margin subscription margin for the quarter was 76%, down from 87% a year ago as a result of large investments in cloud operations. Services gross margin for the quarter was 12%, down from 16% a year ago. Overall gross margin for the quarter was 56% compared to 58% a year ago. The impacts on margin declines from license and subscription and services revenue were partially offset by a mix shift in total revenue away from services revenue. Total operating expenses were $88.5 million in the third quarter, an increase of 8% from a year ago. Operating income was $5.8 million, exceeding our guidance range due to revenue upside and to a lesser extent, expense favorability. Global work-from-home efforts reduced travel spending in the quarter, which was partially offset by initiatives to better support our employees working from home. Net income was $7.7 million or $0.09 per diluted share. We ended the quarter with $1.3 billion in cash, cash equivalents and investments. Operating cash flow for the quarter was $4.6 million, and free cash flow for the quarter was $1 million, excluding $5.3 million in final expenditures associated with our new headquarters. Operating and free cash flow in the quarter were negatively impacted by approximately $10 million as a result of early partial payment of annual bonuses that would have typically been paid in September 2020 for all active bonus eligible employees, excluding senior executives. Turning to our outlook for fiscal 2020. We are very pleased with the number of active cloud conversations we have going on with existing and potential new customers. Global shelter-in-place mandates have reinforced the need for modern core systems. However, the current environment is expected to impact deal closings in Q4. As a result, we are updating our ARR growth outlook to between 9% and 11% for the year. Also, we did want to comment briefly on fully ramped ARR. As a reminder, fully ramped ARR is defined as the annualized recurring value of all active term license, subscription and maintenance agreements at the fully ramped annual price outlined in the customer contract. In fiscal 2019, full ramped ARR benefited from a flurry of cloud deal activity in the back half of the year with significant ramps. Given the current environment, we are not expecting similar activity levels this year and as a result, year-over-year growth comparisons for fully ramped ARR at year end are expected to be closer to ARR growth levels. Our current outlook assumes that new subscription sales as a percent of total new sales will be at the lower end of our previously disclosed range of 70% to 80%, and our subscription revenue outlook is expected to be between $116 million and $118 million this year, representing 80% growth at the midpoint, a small increase from our prior guidance. We are updating our license and subscription revenue outlook to between $419 million and $427 million for the year as a result updating our of our higher subscription outlook, combined with more than expected multiyear term license activity, partially offset by increased uncertainty on deal timing given the current environment. Currently, incremental revenue from term licenses that are longer than our standard terms is expected to be approximately $2 million in Q4 or $15 million in the back half of the year, which is higher than the less than $10 million that informed our back half of the year outlook last quarter. There is no change in our maintenance outlook. We are adjusting our services revenue outlook to between $198 million and $204 million. This $4 million adjustment at the midpoint is largely due to the fact that our services teams are no longer billing customers for travel expenses since we are not going on site. Billable travel expenses run through our services line at a 0% margin. We have also seen a small number of projects slow down or be put on pause, which has an impact on our expected results. Overall, we are extremely proud of our services organization's ability to execute ongoing projects remotely with limited disruption. We expect total revenue to between -- to be between $703.5 million and $711.5 million for the year compared to our previous range of $702 million to $714 million. With respect to gross margin, we still expect overall non-GAAP gross margin to be between 58% and 59%. We still expect license and subscription margin to be between 78% and 79%, even with a higher overall subscription mix, and we still expect services gross margin to be between 6% and 7%. We now expect operating income to be between $65 million and $73 million, representing a non-GAAP operating margin at the midpoint of 10%. We expect free cash flow to be between $65 million and $75 million, excluding approximately $11 million of cash outlays associated with our new headquarters. This outlook reflects approximately $10 million impact of the partial early payment of annual bonuses. While it has been customary for us to provide some preliminary insights into the next fiscal year during our third quarter call, given the uncertainty of the macroeconomic environment, we are not in a position to do that now. That said, despite the near-term uncertainties, we are confident in our ability to execute against the exciting opportunity in front of us and we plan to continue ongoing investments to build upon our market leadership as insurers embrace the cloud. As we transition into our next fiscal year, we will be -- we are evaluating our approach to guidance with the goal of simplifying the number of metrics to focus investors on the metrics that matter. We will discuss this in more detail on the Q4 call. Additionally, we will be changing the presentation of our income statement, starting with our 2020 10-K. As subscription revenue has grown to more than 10% of total revenue, we needed to revisit our income statement presentation to comply with SEC guidelines. On the face of the income statement, we will report license revenue, subscription and support revenue and services revenue. License revenue will include term license and perpetual license revenue. Subscription and support revenue will include software subscriptions and what is currently maintenance revenue, both of which are recognized ratably. And services revenue will remain unchanged. This will create a more simplified presentation for investors by segmenting the upfront revenue components, the ratable revenue components, and the time and materials revenue components on separate lines. We will also continue to present the details of revenue in the footnotes to our financial statements to allow investors to compare with the current presentation and break out subscription revenue as a stand-alone item. Finally, I would like to thank Mike and the Board of Directors for entrusting me with the permanent CFO role. I'm very honored to move into this position. As some of you know, I was part of the underwriting team on Guidewire's IPO when I was at Deutsche Bank, and I have always had a ton of respect for this organization. I'm most excited about the massive opportunity in front of us, as we deliver the agile cloud-based systems that are chosen industry needs. In summary, we executed well in the third quarter, despite the constraints faced by our employees and customers during the COVID-19 pandemic. The current environment highlights the need for flexible modern core systems, and we look forward to helping our customers navigate these uncertain times. Operator, you can now open the call for questions.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question come from the line of Chris Merwin of Goldman Sachs. Please proceed with your question.

Okay. Thanks so much for taking my questions. I just wanted to ask about COVID, and in particular, how that relates to the conversations that you're having with insurance companies right now. Are they starting to rethink their approach to digital transformations at all? I know before COVID, you had talked a bit about some of these companies were maybe not as willing to jump to on-prem, because they're on a mainframe, and they wanted instead to go all the way to a cloud system. But just curious, like as you have the dialogue with your customers who are seeing, in some cases, some disruption to their business, how are they thinking about progressing their digital transformation efforts? Thank you.

Yes. I think there's absolutely no doubt that I think every insurance company in the world is thinking about the digital interface that they use to interact with their customers. I was speaking to one of our top customers. And they said, the mindset that they've taken is that, every single person and every single company has taken this last couple of months to assess all of their recurring payments, all their bills, and they've been doing that digitally. And so the digital interfaces, the mechanisms that these companies have for engaging with people, have been exercised in a way that is pretty abnormal. And I'm -- and it absolutely is causing companies to think about how they can execute more effectively on those types of projects. That said, you heard us talk about sort of the nature of the solutions that we provide. These are – Guidewire is not something that you put in to deal with a one month deal – project cycle to solve a problem very, very acutely. I think it's the insurance companies that have made the investment over the past few years, they are in a very good position to be able to adapt to these things and adjust to these things very quickly. So I think overall COVID, and like I said that sort of assessment of what is our digital transformation strategy look like is going to help us, but I would say we need to get through this sort of period of uncertainty related to the economic conditions that we're facing right before that sort of kicks in. That make sense?

Yes. That's perfect. Thank you. And maybe just a follow-up on cloud gross margins. I know one of the focuses at the Analyst Day last year was figuring out how to scale up this gross margins in terms of time. Based on what you've seen so far, I mean, can you talk about your confidence level and the long-term outlook that you gave for gross margins for the cloud business? And could we even see a multi-tenant version of Guidewire for the future?

Yes. Good question. Thanks. Let me touch on it for a second, Jeff and then you can offer your perspective. I want to talk about Aspen for a second in the release that I talked about. We've made a very, very significant investment in the layer on top of AWS to facilitate our ability to run multiple instances of Guidewire more efficiently across the service. I wouldn’t exactly technically call that multi-tenancy, but there's a degree of multi-tenancy and the efficiencies it implies embedded into that release. We’ve also – there’s services that I was talking about that we've released as part of this -- as part of the Aspen release are multi-tenant services. And so, we'd want to think about it as a blended model where we're able to give the insurance company, our insurance customers the surety of a single instance, a single database, the segregated data, and at the same time, be able to provide services that are super, super efficient for us to run and update and augment the value that they're getting from the core service. I think we do – I do remain confident that we will get to the long-term economics in terms of the margins that we marked out. The big question is just how long is it going to take us to do that? Aspen was a super, super important milestone in that journey. And I'll let Jeff comment further on how we can provide you detail on that.

Yes. The only thing I would add is as – Aspen is a really critical step for the company. And as we inspect our financial models, each one of these steps we take, that path, that visibility to that end state becomes more and more clear. And so now, as we inspect our financial model, we have a number of inputs that we have some history with. We have some meaningful expectations about where they would go and we can start managing the business with that. So it's becoming more and more clear with each one of these new – more cloud native releases that comes out, so that's been a helpful backdrop.

Thanks so much.

Our next questions come from the line of Sterling Auty of JPMorgan. Please proceed with your questions.

Yeah, thanks. Hi, guys. I was curious in terms of the commentary around elongated sales cycles, obviously, unprecedented environment that we're in. But if you peel back the onion a little bit further, how much of that elongated sales cycle is concerned by the customers around their own internal IT budgets versus just the logistics of negotiating in this environment versus something else?

Yeah. It's an interesting question. The first thing I want to reiterate, just to make sure it's clear is, we do see the demand there. These projects are real. There is a clear demand for this. And under normal conditions, sort of, pre-COVID, we would just have a lot more surety about how these things would progress. The dynamic that we're seeing is just increased questioning about, is this the right month to do this? Is this the right quarter to do this? And are we really looking at all the risks associated with our -- the operating budgets of these insurance companies and so just double and triple checking the assumptions, which in a normal environment with a normal degree of uncertainty just doesn't happen. And so I guess, I would say, as we see -- I'm hopeful that as we see the economy start to open back-up and the surety associated with macroeconomic conditions improve. And some questions as it relates to just how the overall economy is going to function going forward, I think that that will improve. And we're looking at this literally on a daily basis and starting to see signs that some of the even longer term deal cycles are starting to pick up, and people are starting to answer the phone and just have the mindset that they're willing to engage with us on what is very, very often a multi-year journey. So it is a challenge for us to get through, but I really do remain confident in the long-term demand and the long-term potential for us.

Got it. And then one follow-up. Is there any hindrance to implementations by not being able to get on to customer presence in the current environment?

Yeah. It's a super question, and I'll be just totally direct with you. This was the biggest concern that we had when this thing started in early March was where are we going to be able to continue to execute on these project implementations in this environment, and the unequivocal answer to that is yes. It is absolutely amazing. What -- not just Guidewire, but I think the insurance industry itself has pulled off in this transition to a work-from-home environment. Upgrades are happening. Releases are happening. The systems are continuing to run. The call centers are running from a work-from-home environment. And it really is a phenomenal, I don't know, data point, I guess, about the state of where we are with digital transformation in our industry. That went from being something we were all very, very worried about and focused on addressing to something that we feel pretty confident and actually very confident in going forward. And I'll tell you, I think it's going to change in the long run, too. You really don't see -- the majority of people are saying, hey, what can we learn from this? And do we need to be on-site quite as much as we were before. And can we find a new way to do this and break some of the habits that we used to have and maybe just get a little bit more effective and more efficient on these projects going forward? So, I really see that as a positive.

Thanks guys.

Thank you.

Thank you. Our next questions come from the line of Tom Roderick of Stifel. Please proceed with your questions.

Hi guys. Thanks for taking my questions. Appreciate it. I guess I'll kind of piggyback on Sterling's question there. Mike, I'd love to hear a little bit more just in terms of the cadence of conversations. We've heard this time and time again from companies throughout software with big transformational deals. They just hit the pause button in the spring. So, I think we all understand that. Understanding that it's a little bit of a race against the clock with your fiscal year, I'd love to just sort of hear how these conversations with your Tier 1s and your potential cloud deals are shaping up with respect to giving you visibility going into the fourth quarter. And then naturally, some of those will push out a little further. And again, we all understand that. But with respect to the idea of a fiscal year sort of ending, does that kind of put a pause on that sales cycle or do you sense the urgency as you reengage with these Tier 1s and cloud customers that say it doesn't really matter in July or August or whatever. They're ready to do it when the budget is available. Can you kind of take us through the cadence of your conversations at C level?

Sure. I guess I'm trying to think about what additionally I would say. The deals are still there. When we look at the pipeline that we're looking that at in Q4, we've had -- like we said, a deal pushed and we are seeing additional checkpoints on these decisions. Just -- my perspective is just making sure that our customers have as much data as they need in order to make this decision. And so it's sort of -- there's a lot of complexity they're dealing with in terms of the puts and takes associated with COVID and the impacts that it has on their business and the projections they're making about the overall macroeconomic conditions. But as those things improve, it starts to look more like we'll be able to get those deals done. But that said, like I said, we have had deals that have pushed across a boundary. I just keep coming back to the mindset that Guidewire is absolutely a multiyear company, right? We're thinking about this in terms of five, 10 years and creating a system that is going to work for this entire industry and our entire customer base. And so this COVID-19 pandemic, I don't want to make light of it, but we think we're going to get through it. The industry is very resilient. The demand for our core systems and the modernization of these systems is still there. And so whether all these deals happen in Q4 or some of them slipped to Q1 in next fiscal year, we're going to do our absolute best to make the case they should be done in Q4, but we do have that visibility into that overall demand environment and remain very, very confident in the operations of the company. And so I guess in terms of answering specifically your question about giving you a little bit of insight into how they're thinking about it, I just think that as you could probably imagine, everybody is just trying to make triple sure that they've thought through all the ramifications and decisions like this before they make the go decision. And that's just causing the sales cycles to be slightly lengthened. And that's what we're seeing, and we're continuing to work through it. But as things improve, I think that demand environment will improve.

Yeah. That's really helpful. Thanks. Jeff, a quick follow-up for you. We've heard from, again, a number of software companies with customers kind of pushing back on payment terms, and you're not exactly in the most troubled of industries with customers that can't pay or have to push out payment terms, but any issues that we should sort of be aware of in terms of payment deferrals or customers asking for concessions at this point?

It really hasn't been material. A couple of our smaller insurers have asked for some concessions, but we haven't seen anything material on that front.

Fantastic. Thank you both. Appreciate it.

Thanks a lot.

Thank you. Our next questions come from the line of Ken Wong of Guggenheim Securities. Please proceed with your question.

Great. Thanks for taking my questions. The first one for you, Mike. When thinking about the slight pushouts, the delays, just wondering if you're seeing anything different in regards to a cloud transaction versus a traditional on-premise? Is there any – is one longer than the other? Are they both seeing similar type delays from customers?

Yeah. I'm trying to think if there is like a distinction. I would say, no. The biggest thing you guys got to keep in mind with respect to cloud transactions for us is, when they are an existing customer, what we're working through with that customer is the timing around an upgrade, a timing around work related to making sure that that implementation is ready to be run on the Guidewire Cloud. And the timing and how exactly we – they budget for that expense is really more of the issue than anything specifically COVID or non-COVID. I think about the business being a lot of the distinction between the upgrade of our installed base to the Guidewire Cloud and the benefits that we're able to achieve from adding functionality and capabilities around digital transformation and agility with a product release like Aspen, and it's slightly different for a customer that's going from a legacy system and going directly to a modern system. It's those kinds of – each one of those scenarios has unique dynamics. And so, I don't think there's a distinction between those two things as it relates to COVID-related uncertainty. I just think, like I said, these insurance companies are just by nature and by design very careful and very thoughtful about the way they approach these decisions. And these systems decisions are incredibly strategic and important for them. And so it's – this situation is just going to create a little bit of extra work for us all in working through it, and that creates a little bit more uncertainty than in the normal quarter about our ability to project what closes and doesn't close. But I'm very, very confident that we'll get through this.

Got it. Got it. And then, Jeff, one for you. I guess, I was a little surprised to see you guys had sort of a nice surge from multi-year activity driving term, I guess how should we think about customer appetite for longer duration deals going forward? Is that a trend you continue to expect to persist into 4Q and perhaps beyond?

Yeah. Yeah. I mean, we've always had customer appetite for signing longer-term deals. And as you know, as we migrated into ASC 606, we put that limiter on our customers in order to try and preserve a revenue recognition pattern. Our view now is that, we have ARR as a metric that normalizes through a lot of that complexity. We can do the right thing by Guidewire and the customer and start considering some of these longer-term arrangements again. So we are expecting to see some more of them. Our standard 2 plus 1 framework still is our kind of standard contract framework that we are engaging with customers, but my expectation is you may see more of these. It only really impacts the revenue on the on-prem term license deals.

Got it. Thanks a lot guys.

Thank you.

Our next questions come from Bhavan Suri of William Blair. Please proceed with your question.

Hey guys, thanks for taking my question. And to piggyback on Tom’s third question, but it was a different twist. So hopefully not beating this dead horse here. But Tom, we talked about the slowing sales cycle but I'd like to set that a little bit and think about RFP. So talking to some of your bigger partners say, some of the big 4, they've seen an uptick in RFPs, which, again that could be 6 months out, 8 months out. So let's think of that multiyear sort of engagement with the customer. Has that – how those RFPs trickle down to you? Are you seeing an uptick in RFPs and request for proposals across your customers? And then a quick follow-up.

Short answer is no. I would say, it's pretty aligned to the normal – our normal demand cycle. Like I said before, I think that there's 2 levels around which people think about these digital transformation projects because we might think, what can we do sort of immediately and sort of maybe a quicker approach. Guidewire's approach is really to address the issue from a core system perspective. And to be honest with you, the first phase of COVID, we saw a drop-off in that activity. That has started to pick up and get back to normal. But I wouldn't say that we've seen an uptick in RFP activity for core system modernization. But we – like I said, it hasn't changed dramatically one way or the other.

Just one thing that I would add, and Mike referenced this in his script was just the activity we've seen in our partner community around getting cloud certifications, and we've seen a really interesting tick up there, which is, I think, an exciting leading indicator and may correlate to some of the reference checks you're doing.

Yes. Now either it's interesting the RFP affinity from like some of the big 4 was picking up. And again, maybe hasn't trickled down to you yet because it's early, they're going to start filling that up, but that seems interesting, but those are taken out over multiple quarters. I guess a quick follow-up, slightly more longer-term here. Obviously on the consumer side, this disruption and the digital transformation been critical to consumers want responses real-time and the legacy systems aren't doing it. And you think about the SMB business. And today, it's still very much agent based. You guys sort of disrupted obviously, the consumer business, but given the fact that with COVID, with all of this, no one really wants to go see someone, has the agent-based model, are you having more conversations on the business side of the insurance world to say, hey, we need to revamp some of the systems to make more real time or COG enabled? Have you seen any traction or interest or discussions on that side in contrast to the pure consumer side? I'd love to understand if there is a difference on that side at all, given that model is still heavily agent-based in many cases?

Yes. It's a good question. I would say this is – I wouldn't say this is related COVID necessarily, but we have and I have had numbers and numbers of conversations about the relationship and the value chain associated with the way insurance for small business is sold and produced and managed. And there's just an obvious -- there's really a plethora of opportunity to improve the efficiency of that value chain. And Guidewire can play a very, very big role for carriers in thinking about that. That is not an, at all, an uncommon conversation that we have with customers on the demand side. So it's a great insight.

Helpful. Thank you, guys. Appreciate. Thanks for taking my question.

Our next question comes from the line of Michael Turrin of Wells Fargo. Please proceed with your question.

Great. Thanks. Good afternoon. I just want to look at some of the recurring metrics. Subscription revenue remained strong, grew more than 100%, but the ARR target for the year coming back a bit. I mean, it sounds like most of that change just comes down to Q4 in the current environment. Is that right? And then on the ramped ARR comment, are you saying as some of that new business, potentially elongates here that next year, you wouldn't expect to see a similar shape or step-up as compared to what you're seeing this year? Is that the right way to capture that?

Yeah. So absolutely, our adjustment to our ARR outlook is reflective of just the difficult selling environment in Q4, and that's a context there. With respect to fully ramped, fully ramped ARR is a concept that will be a pretty potentially volatile metric, and it correlates to large cloud deal activity with significant ramps. And we just saw a lot of that in Q4 of last year. And as we were moving into this year, our expectation was that that trend would continue. It's a little bit more challenging environment this year that has caused for a difficult compare in Q4, in particular. And so we just wanted to highlight that for investors.

Okay. That makes sense. And then maybe just sticking with you, Jeff, on margin. Can you just expand on some of the key sources of margin upside here, is there any way for us to think about how much of that is related to the new environment? I know you mentioned some cost offsets related to just the initial work-from-home phase. But I guess, I'm wondering if margins are troughing here or if there Is some temporary changes in the model just given the way the work’s being done is changing that we should just be aware of in thinking about forecast here?

Yeah. We're still investing in our platform and what we think is going to be the platform that we monetize for the next 10, 20 years. And we're, obviously, in the midst of what is a very complicated transition. The current environment has an impact on some near-term expenses, whether it's expense -- travel and expense or some other smaller things. But the takeaway is we're still investing. This business model transition, we're kind of in the heart of it right now, and that's when the margin impacts are most acute. And we'll -- we're going to be updating folks as we exit Q4 on expectations for next year. And so not in a position to comment whether this year or next year is where we would expect to bottom out from an operating margin perspective, but that's how we're thinking about it.

Okay. Appreciate the color. Thanks.

Thank you.

Our next questions come from the line of Matt VanVliet of BTIG. Please proceed with your questions.

Hi, guys. Thanks for taking my question. I guess, looking at what some of the business activity has been both through the quarter and through the first month plus of the current quarter, but given your geographic footprint across much of the world, curious if you're seeing, sort of, a pickup in business activity, whether that's in Asia or as European markets look to open up a little bit more than maybe we are in the U.S. at the very moment and just sort of the timeline that you've seen in each of those major regions as -- as you know, COVID has spread across on a delayed basis through much of those reasons.

Yes, it's an interesting question. I would say that I haven't seen any real relationship with the timing of -- the sort of economies opening up. I don't know whether or not that has to do with the dynamic of the way the insurance customers we serve operate, but I haven't seen a pattern with respect to that. I think if anything, it's -- I'm thinking about how it relates to our travel and our ability to work and how it changes, how we operate the company multi-nationally rather than a change in the demand environment associated with what we're selling. But like I said before, we're operating so effectively in this current environment that it's not really something that we're specifically concerned with. But the short answer is no. I haven't seen anything regionally related to how this is evolving. And I don't know, Jeff, if you have something to add.

No, I mean, obviously, our sales cycles are so long that these decisions take a significant amount of time. So, I think it's harder for us to maybe see some of those shorter term geographic macro impacts than others.

Great. Thanks. And then maybe as a follow-up, Jeff. Just curious as you continue to talk about investing in the cloud for the long-term, are you realizing some cost savings from either reduction in travel or potential -- I guess, longer term impacts of having people either work remotely or using some of the tools that you've been utilizing here to reduce costs moving forward and maybe reallocating some of those, in particular. Just curious how you're thinking of that so far and so much as you're looking at planning for next year.

No, there are opportunities there that we're evaluating deeply right now and we are in the pros of our planning for next year, so there are some pretty interesting outcomes as a result of this and just some of the learnings about how efficient we can be that we will build into our thinking. I just wanted to make sure that we're not viewing this as an opportunity to retrench or think about our cost structure just because we're in the early stages of what we think is a very critical platform shift in the industry. So, we're just -- we're not slowing down. We're not taking our foot off the gas, but there are definitely opportunities around some of the areas you mentioned.

Understood. Great. Thank you.

Thank you.

Our next questions come from Mayank Tandon of Needham. Please proceed with your questions.

Hey, good afternoon, guys. This is actually Kyle Peterson on from Mayank. Thanks for taking the questions. Just wanted to get a little more -- a little bit of your thoughts on -- I know there's been a lot of press on a lot of P&C carriers, issuances on policy rebates and such to customers and kind of fewer miles on the road, dealing with some more remote environment. Has that changed in discussions whether it's an interest in -- additional interest in subscription kind of cloud-based deals or any anecdotally, like potential changes in IT budgets? Just kind of want to see how the impact on the P&C industry is having on some of the discussions you guys are having, even if some of sales cycles are getting pushed out.

Yeah. So, this was one of the real early things that we recognized and our customers recognized once these lockdowns got turned on worldwide, was this dramatic drop in the amount of miles driven, claims volume, et cetera. And the insurance industry, in my opinion, has done something phenomenal in these rebates and premium reductions to align to that just as effectively a stimulus that the insurance industry has provided to these people who are, in many cases, need those funds a lot. I really see that as a one-time event, and I think that they're looking at it like that, that we're going to get back to a normal state eventually. And so, in terms of the recurring nature of projects and software IT projects, I haven't seen anybody think about that structurally. I would say, there's a lot of discussion about whether or not this pushes the industry more towards pay-per-mile utilization-based insurance. We've got a great Guidewire customer example of somebody who's using PolicyCenter to do that. With the modern system, you can execute projects like that, and it's really interesting and there's been a lot of discussion about whether or not, that's something that structurally changes has now come from this. But as it relates to IT budgets and projects, the answer is no.

Okay. That's helpful. And then, I guess, just a quick follow-up on margin cash flow. What if -- and your thoughts on what -- how you would balance, whether it's protecting profitability and cash flow versus kind of long-term investments for the cloud, if kind of these sales cycles stay elongated or if we get like a second wave or something like that, just want to see how you guys are thinking about balancing the near-term impact versus the long-term investments.

Yeah. It's a really good question. And it's a very active conversation we're having internally. Obviously, we are tremendously excited about this opportunity in front of us and an opportunity to expand our TAM and build on our market-leading position in the industry. So we want to make sure that we are doing the right things with respect to investing in our product and investing in our cloud operations to be ready for what we think will be a wave of cloud migrations in the future here. So that's first and foremost. And then as we kind of inspect our year and inspect bookings and how things are shaping out in a particular period, we may make adjustments. But we're not -- we just want to make sure that we're keeping our eye on the long term.

All right. Great. That’s helpful. Thanks guys.

Thanks very much.

Our next questions come from the line of Rishi Jaluria with D.A. Davidson. Please proceed with your questions.

Hey, Mike and Jeff, thanks for taking my questions. And Jeff, congratulations on the full-time promotion. Really well deserved. I want to start just by asking a little bit of an industry type of question. Obviously, P&C is much more resilient than -- while other industries out there not seeing the same sort of headwinds. Just wanted to get a sense on the budget side with interest rates kind of at all time low and seeming to be here. Is that something that is pressuring budget at all, or is that really not a factor that comes up in conversations? And I've got a quick follow-up.

Yeah. I would say that the short answer is it's not a conversation that comes up. However, there's a variety of puts and takes that are at play in each individual insurance company related to this. And it's – it really is probably one of the factors that's behind the scenes, they're evaluating and deciding whether it's appropriate for them to invest in green light, the project that they're thinking about with us. Their savings and there's higher expenses and there's more risks and there's less risks and there's just a whole very complicated equation that our customers are dealing with across a variety of different geographies and different lines of business. And all that complexity, they're dealing with creates the dynamic that I was talking in terms of them being able to say that now is the right quarter for them to start this deal -- or start this project, excuse me. I wouldn't say that interest rate dynamics is one of the things that we – specifically we talked about. It's certainly something we think about, certainly something that we think about. But I would say there's a variety of factors in addition to that, that are at play.

That's helpful. And then just quickly, with Guidewire connections going virtual, how are you thinking about the potential impact on pipeline building, on customer networking, on the partner side? Just want to get a sense for what you're thinking about that? Thanks.

Well, it's a really important event for us. So I'm not going to sugarcoat it and say that it's not really disappointing to me that we're not going to be able to see that event in person. And I look forward to getting back to those events and getting back to that approach to enterprise sales, just as soon as it's safe to do so. I will say though that, I've been very, very impressed with a couple of things related to this. Number one is, the creativity that our teams have shown in terms of creating new digital content and new mechanisms for connecting with customers. And number two, I would say that, it is phenomenally easy for us to do phone calls with customers now, right? My ability to do a 30-minute call with a customer or a prospect is much, much easier in this environment. And that's something that I hope stays. So the willingness of people to take a few minutes and watch a piece -- a video or read a piece of collateral that we've made about our latest release that's gone up, that's gone way, way up. Just anecdotally, I had 2 conversations, literally 2 conversations this week where customers in the midst of sales calls have said almost verbatim, 'I don't -- really don't do this, but I watched the video that you guys sent me last week, and I really enjoyed it. And so that gives me some confidence that we're going to be able to use the digital mechanisms to start to replace some of the things that we're losing when we're -- just because we're not able to get together in person as an industry. So hopefully, that helps.

All right, really helpful. Thank you so much.

Our next question come from the line of Pat Walravens of JMP Securities. Please proceed with your question.

This is Joe, on for Pat. Thank you for taking the question. Can you just give us a quick update on the competitive landscape and any changes that you're seeing there? Thank you.

Thanks for the question. Short answer is, we haven't seen any change in the competitive landscape. We've talked about this before. It remains a competitive market, but the dynamics as we see it, in terms of win rates and competitive deals haven't really changed. It remains pretty steady. Okay.

We have no further questions at this time. I'll now turn the call back over to Mike Rosenbaum for any closing comments.

All right. Thanks all for participating in the call today. We delivered solid quarter during a very dynamic macro environment. Despite the near-term challenge, we're all excited about the demand we see in technology and advancement of our cloud strategy. We're as optimistic as ever about the long-term vision and the opportunity that we see in front of us, and I hope you're all safe and well, and look forward to connecting again in Q4, so thanks very much and goodbye, everybody.

This does conclude tonight's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great evening.