GWRE 2024Q3

Greetings. Welcome to the Guidewire Third Quarter Fiscal 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Alex Hughes. You may begin.

Thank you, Shamali. I'm Alex Hughes, Vice President of Investor Relations, and with me today is Mike Rosenbaum, Chief Executive Officer, and Jeff Cooper, Chief Financial Officer. A complete disclosure of our results can be found in our press release issued today as well as in our related Form 8-K furnished to the SEC, both of which are available on the Investor Relations section of our website. Today's call is being recorded and a replay will be available following the conclusion of the call. Statements made on this call include forward-looking statements regarding our financial results, products, customer demand, operations, the impact of local, national and geopolitical events on our business, and other matters. These statements are subject to risks, uncertainties, and assumptions 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, including our most recent annual report on Form 10-K and our prior and forthcoming 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 also will refer to certain non-GAAP financial measures to provide additional information to investors. All commentary on margins, profitability, and expenses are on a non-GAAP basis unless stated otherwise. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are also posted in the supplement on our IR website. And with that, I'll now turn the call over to Mike.

Thank you, Alex. Good afternoon, and thanks everyone for joining today. I'm incredibly excited to share the results of our third quarter and discuss the momentum we are seeing in our business. Q3 was another very strong quarter and puts us in great shape heading into the final stretch of our fiscal year. We have all worked very hard to establish Guidewire Cloud Platform and our InsuranceSuite applications as the trusted worldwide standard for P&C insurers, and I think our Q3 results and year-to-date results clearly show that we're paying off. In April, we released Jasper, our 10th release in under four years, which delivers increased agility in commercial lines, while also expanding HazardHub data for Canada. This release and our continued innovation across our platform and applications improve customer agility, speed, and business intelligence. We are helping our cloud customers innovate faster and make better data-driven decisions across the insurance lifecycle. I'm now more confident than ever that the continual iterative improvements we have demonstrated to customers through our cloud platform's consistent release schedule are helping to align more of the industry around our platform, and this general confidence is resulting in our improved business momentum. In the third quarter, we closed eight InsuranceSuite cloud deals, bringing our total InsuranceSuite cloud deals year-to-date to 24, which is a 33% increase year-over-year. We also saw sustained strength with Tier-1 insurers, including four Tier-1 deals in the quarter. Our continued deal momentum speaks to the tremendous progress we have made establishing the reputation of Guidewire Cloud Platform and also the much improved fiscal year linearity our sales teams are driving. We have been working for the past few years to establish a more linear quarter-to-quarter approach to sales, and I'm very happy with the more balanced year-to-date outcome. It was also a strong quarter for cloud migration activity with a total of five InsuranceSuite cloud migrations. Our customer base is our most valuable asset, and a significant part of our cloud strategy has been anchored around the objective to successfully migrate every single one of our on-prem customers to our cloud platform. Continuing to drive these cloud transitions ensures that we remain the industry leader. It sets us up for further cloud expansion activity down the line and demonstrates the feasibility of Guidewire Cloud to new insurers. Deal activity in the quarter was particularly strong in our Asia Pacific region where we had four cloud migration deals in Australia. We are building on our established cloud position in North America with higher engagement and momentum internationally, and it's great to see this pay off in the quarter. Last month, we conducted three highly successful Guidewire insurance forums, with one in London, one in Sydney, and one in Tokyo. These events serve as important customer touchpoints and an opportunity for the broader Guidewire ecosystem to come together and share ideas and feedback. They are a powerful vehicle we use to influence our existing pipeline, generate new opportunities, and help ensure that existing customers are up to speed on all the product innovation we have planned. Each event brings together insurance professionals from leading customers and partners to discuss the future of the P&C industry. In Sydney, over 135 insurance professionals heard Simone Labady, CEO of Aioi Nissay Dowa, New Zealand, discuss her goals for rapid growth on the cloud, how new Guidewire products and features including APD, data platform, and Jutro are helping them launch new products quickly and increase customer convenience. In Tokyo, nearly 150 people heard Nakagawa-san, President and CEO of Saison Automobile & Fire Insurance, part of Sompo Group, which was the first insurance company in Japan to deploy Guidewire Cloud, discuss their strategic journey, progress to date, and experience with Guidewire Cloud. In addition, Eric Marcoux, VP of IT at Beneva, shared how Guidewire helped the company accomplish an increase in sales and a decrease in time required to train new team members from three to six months to less than a month. Since upgrading to Guidewire Cloud, Beneva has completed three updates, which is in stark contrast to the 12 to 18 month upgrade duration that they were used to when on-prem. Last month, we emphasized our commitment and aspirations for the Asia Pacific region with the hire of Shaji Sethu as our Asia Pacific Managing Director. Shaji has lived in Sydney, Australia for over 30 years and he brings an extensive track record of driving strategic IT programs and insurance outcomes in the region. This leadership addition will further strengthen the connection between Guidewire's global capabilities and the local needs of our customers. We made a similar leadership addition to the EMEA region two years ago when we named Will McAllister as Managing Director and have been very pleased with the progress we are making and he is leading in Europe. In April, we were in London for Guidewire's Europe Insurance Forum. It was also an incredible event with over 250 attending across 70 insurers and 44 customers. Leading insurers such as AXA and Beazley attended and spoke to the importance of agility and the objectives that they have ahead with Guidewire. I'm especially pleased with the progress we're making with the London market, where we are bridging our global capabilities with its specialized content needs. We are seeing a high level of market engagement worldwide and combined with the increasing maturity of our platform, we continue to grow our pipeline both in size and quality of engagement. This momentum and general confidence help position us very well for this fiscal year and more importantly our longer-term outlook. Turning to our ecosystem, another key element of our strategy is to expand the partner community surrounding Guidewire, which helps to accelerate customer adoption, deployments, and time to market. We are seeing the SI community increasingly engage in Guidewire projects. There are over 38 SIs working with us today, and in the third quarter, the number of cloud certified partner professionals from these firms increased 27% year-over-year to 8,900. Similarly, our solution partner community continues to expand. Guidewire Marketplace now has over 210 solution partners. As our marketplace expands with each release and as adoption of these applications increases, we reduce customer costs and accelerate their time to value on our platform. But maybe the most notable and impressive example of our growing global momentum and ecosystem came in May when we held our inaugural Developer Summit in Bangalore, India. Nearly 500 people attended this event, with participation from our leading partners such as EY and PwC. It was a great opportunity to introduce Mohammed Anzy, the new leader of our India operations, to the community. Anzy joins us from SAP, where he led the largest R&D center outside of Germany. We're excited for him to join us and help drive our strategy, execution, and growth in India. We also ran a hackathon, which attracted over 125 entries and made me extremely proud of the progress that we've made in our cloud platform. This event marks a commitment to India as a source of innovation through Guidewire employees, but also connects us more closely to a community of technology professionals who have dedicated their careers to improving the insurance industry by leveraging Guidewire Software. Finally, let me turn to the continued progress we are making driving platform scale and efficiency. As you know, we've been focused on expanding platform efficiency and gross margin, and it's great to see the team's progress reflected in third quarter subscription and support gross margins increasing 10 percentage points year-over-year. This puts us now ahead of plan and we are confident that we will continue to drive improvements here as we continue to execute new approaches to cloud operations and drive more automation and self-service tooling across our platform. This quarter is another validation of the investments we have made and further proof that these investments have produced and will continue to produce long-term profitable growth. Our software is mission-critical and a core system of record for our customers. We price our software as a percentage of an insurer's direct written premium, and are therefore tied directly to the value our customers create underwriting and insuring against risk and the associated premiums they charge. This structure creates durability for our software business at a time when companies across industries are working to gain efficiency and in many cases reduce workforces. This stability combined with our success in instantiating our market-leading cloud platform gives me confidence in our model and our ability to invest in further innovation to create new growth opportunities in the future. With that, I'll now turn the call over to Jeff.

Thanks, Mike. Q3 surpassed our expectations across the board. ARR finished at $828 million and benefited from durable cloud demand. As we have discussed in recent quarters, we continue to see improved bookings linearity, and strength in the first three quarters sets us up well for the year. Total revenue was $241 million. We saw better-than-expected results in all areas of revenue. Subscription revenue grew 35%, and subscription and support revenue grew 28%, as we benefited from deal momentum. License revenue grew 11% as a result of continued DWP true-up activity and expansions upon renewal of term license arrangements. We price our software on basis points of our customers' direct written premiums, and we have seen customers' DWP grow as insurers increase rates to accommodate rising claims costs due to inflation and the risk environment. Services revenue was better than expectations and was up off of the low point last quarter as utilization rates improved. We are thrilled that our partners are investing to help us modernize this industry and we expect them to continue to lead the majority of the cloud programs. We are working hard with our partners to find the right equilibrium to ensure we are supporting their growth while also ensuring that cloud standards are adopted and that our professional services portfolio mix and volume are healthy. Turning to profitability for the third quarter, which we will discuss on a non-GAAP basis, gross profit was $151 million. Overall gross margin was 63% compared with 52% a year ago. Subscription and support gross margin was 65%, which compares favorably to 55% a year ago. This continues to track ahead of our expectations due to increased cloud infrastructure efficiency. Services gross profit was $5 million, and services gross margin was 10%. We expect the cost basis to be relatively stable in the services organization and our ability to drive profit margin will be dependent on growing the top line. Overall operating profit was $21 million in the third quarter. This was better than expected due to revenue outperformance and lower operating expenses. We continue to be thrilled with the operating profit and operating margin momentum. Stock-based compensation was $37 million, up 5% from Q3 of last year. We ended the quarter with $934 million in cash, cash equivalents, and investments. Operating cash flow was $5 million for the quarter. Turning to our outlook for the full fiscal year 2024, we are adjusting our ARR outlook to $856 million to $864 million. Strong activity in Q3 at a healthy pipeline reinforces our confidence in the full year targets and allows us to raise our outlook. We expect deal momentum in Q4 to manifest itself more in fully ramped ARR as customers and prospects are comfortable making significant long-term commitments to Guidewire Cloud. I expect fully ramped ARR to grow at or above 16% for the fiscal year 2024, which is a great result when you consider it is on top of 17% fully ramped ARR growth we delivered in fiscal '23. We are building a strong foundation for delivering on our longer-term growth targets. We will provide more detail on fully ramped ARR at year-end as this is a metric we disclose on an annual basis. As a reminder, our ARR outlook assumes foreign currency exchange rates as of the end of our last fiscal year and we update ARR exchange rates at year-end. If we updated ARR today based on current exchange rates, then we would see a $7 million negative adjustment. We will certainly discuss this and quantify this at year-end. With respect to revenue, we are increasing our expectations for subscription revenue and subscription and support revenue. We are adjusting subscription revenue to approximately $474 million, and subscription and support revenue to approximately $546 million, representing a positive adjustment of $5 million in both instances. We expect license revenue of approximately $247 million, and services revenue of approximately $179 million. As a result, our outlook for total revenue is $968 million to $976 million, a $10 million positive adjustment at the midpoint. Turning to margins and profitability, which we will discuss on a non-GAAP basis, subscription and support gross margins continue to exceed expectations, and we now expect between 65% and 66% for the year. We still expect services gross margins to be between 5% and 8%. As a result, we now expect overall gross margins of approximately 63% for the full year. With respect to operating income, we expect between $94 million and $102 million in operating profit for the fiscal year. This represents an $11 million positive adjustment at the midpoint. We still expect stock-based compensation to be approximately $147 million, representing 3% growth year-over-year. We are also increasing our cash flow from operation expectations to between $130 million and $150 million for the fiscal year. We are proud of our progress. As we look ahead to fiscal '25 targets we discussed at Analyst Day, we remain confident in our ability to achieve our $1 billion ARR goal. We are clearly tracking a bit ahead of our gross margin targets, and this is creating an opportunity to accelerate some product investment while still achieving our operating margin targets. With that, operator, you can open the call for questions.

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Kevin Kumar with Goldman Sachs. Please proceed with your question.

Hi, thanks for taking my question. I wanted to ask a question around the demand environment. Guidewire obviously is seeing some really strong deal activity, and that's perhaps in contrast to some softness with other software vendors where customers are perhaps delaying large purchases. So, Mike, can you just talk a bit about what you're seeing in the P&C market? And in general, how carriers today are thinking about prioritizing these large kind of core system modernizations?

Sure. Kevin, thanks for the question. Very much appreciated. So, I would say we continue to see demand and pipeline steadily build, and I would describe that sort of as two things related to that. Number one is growing confidence around our ability to be successful with the platform in terms of meeting their business objectives. That certainly helps. We've talked about that for years about how the more success we have, the longer the track record we have around these successful implementations is going to build confidence with these customers, both on the migration side and also the net news side. But I also think that there is somewhat of a disconnect between the decision-making process these insurance companies go through in thinking about these implementations and these modernizations as it relates to the sort of general broader enterprise software market. These are decade, if not multi-decade decisions that these companies are making, these partnerships that they're establishing with us. And so, I think that there's a bit of a disconnect between what we see with other software purchases in the decision-making process. We really see these companies recognizing that agility very much matters, that a modern core platform that's going to enable them to make better analytical data-driven decisions is something that's going to help them be successful and profitable and grow out, like I said, for over a decade. And so, that decision-making process can be done sort of outside the quarter-to-quarter stresses that maybe other folks in other industries and other sectors are seeing. And so, you add those two things up and we just see momentum and confidence continue to build for us. And it led to a great Q3, and it gives us confidence in Q4 and the rest of the fiscal year.

Thanks. That's helpful. And then maybe one for Jeff on margins. I think gross margins for subscription and support have been relatively stable the last couple of quarters. So, maybe how should we think about the next inflection point that pushes cloud margins closer to that kind of 70%-plus figure that you and the team have talked about in the past?

Yeah. I mean, we've made tremendous progress this year in finding an inflection point and delivering higher margins. We're thrilled with that progress. The two drivers as how we drive long-term margin is we think the demand environment is strong, and we can see sustained subscription growth. That's a big part of how we've invested in the opportunity and the cloud operations function that supports our cloud delivery. And I think the platform as it gains scale, we continue to recognize some benefits of increasing that scale over time. And third, the engineering team has done a tremendous job thinking through all the architecture decisions to drive more efficiency into the platform. And they are not done. I mean, I think there is more efficiency that we can continue to work on and drive into the platform. We probably won't see the types of gains that we saw this fiscal year, which was tremendous, but can continue to see more linear margin progression as we go towards those long-term targets.

Great. Thank you both.

Hey, thanks a lot.

Thank you. Our next question comes from the line of Dylan Becker with William Blair. Please proceed with your question.

Hey, gentlemen. Great job here. Mike, we've observed some interesting data from carriers that are being more innovative, gaining market share, and enhancing their decision-making in auto. I’m curious how the discussions with customers are shifting more towards business enablement instead of just IT alignment, driving some of that momentum, and how customers view those similar dynamics of share gains extending to additional property and casualty lines over time.

I appreciate the question. It can be challenging to explain the complexity of the use cases we support with Guidewire, considering all the regions, lines of business, and tiers involved. A consistent theme that arises regarding a carrier's ability to compete effectively is agility in product operations. This includes setting prices, adjusting rates, and adapting to changing risk conditions that carriers face. There has been a significant impact from inflation, particularly in the auto line of business, as claims expenses have increased. Carriers that adapted quickly were able to continue their operations successfully and adjust prices appropriately to remain competitive. Guidewire helps facilitate this capability. A core aspect of what we offer through these transformations is that insurance carriers end up with a platform to compete more effectively, especially in auto but also extending to commercial lines. We are observing considerable interest from international carriers that want to be more agile in commercial lines, using Guidewire to rapidly adjust to market changes and enhance their competitiveness. This agility is a significant part of the value proposition we present with these transformations.

That's great. And actually, it's a good segue into the second question, too, Mike. I think Jasper, the most recent release calls out commercial agility within that as well. And you've had some success on the commercial content side. I think you called out London there as well. But if you could elaborate maybe on your efforts here on the commercial side of the market and the right way of thinking about that opportunity?

Certainly! There has been a phase of modernization in the insurance industry that emphasized high volume and efficiency in personal lines. This included a focus on digital interactions and customer convenience, which shaped the core systems' business requirements. One notable aspect of the insurance sector is how the core system is directly linked to consumers, particularly in obtaining quotes for commercial lines. As we transition to a new phase in the industry, the modernization efforts are increasingly centered on commercial lines, which had previously received less attention compared to personal lines. Modern systems like Guidewire are essential as they provide product agility, allowing customers to quickly develop new products or modify existing ones based on market feedback. A prime example is Westfield Specialty, which has effectively leveraged Guidewire to rapidly create and market new products in the commercial and specialty line sectors, gaining market share effectively. Currently, our ability to utilize a shared cloud platform and common policy center architecture across various use cases within different lines of business puts us in a strong position.

That's great. Thanks, Mike. Congrats again.

Yeah, thank you.

Thank you. Our next question comes from the line of Ken Wong with Oppenheimer. Please proceed with your question.

Great. Thanks for taking my question. I wanted to circle up on the fully ramped ARR comment. It seems like you guys are set up really well to wrap up the year. Any color on kind of what's causing that step-up off of a tough comp? Is it just your customers have higher confidence in the business? Is it kind of cloud migration, the premium step-ups, the true-ups? Like, what are some of the factors we should be thinking about that's driving that?

I would answer the question by saying it's a bit of all factors combined. We're experiencing strong demand and a robust pipeline, and we're confident in our coverage ratios. When we analyze the specifics of the deals and opportunities, we note that many of these agreements are long-term. The ramp-up activity we anticipate for Q4 indicates that a significant portion of the value we expect to close this quarter will contribute to our fully ramped figures. A portion of our booking activity translates into Annual Recurring Revenue, but much of it is recognized over time through long-term agreements. This reflects not only the quality of our deals but also the strength we see in the company for the long haul.

Thank you, Mike. Jeff, building on that, as we consider the guidance, we had a very strong Q3, but Q4 may be a bit softer. Should we align the full year 2024 guidance with the fully ramped commentary, acknowledging that there is still strength from Q3 while realizing that the actual ARR will come later?

Yeah. Ken, that's the right way to think about it. And as we look at the pipeline for the year, we're obviously thrilled with where we are, as we tend to think about the business on annual terms much more than quarter-to-quarter. We did raise the ARR guide by $3 million at the midpoint. That followed a $5 million raise that we did last quarter. So that's pretty healthy progression for us. And as we look ahead at the Q4, we're very excited about the demand profile that exists, and that excitement is leaning a little bit more towards those fully ramped outcomes as customers are clearly feeling confident in the maturity of the platform and there's a willingness to make long-term commitments.

Okay. Perfect. Thanks a lot, guys.

Thank you. Our next question comes from the line of Peter Heckmann with D.A. Davidson. Please proceed with your question.

Hey, good afternoon. Can you just remind us about the frequency with which the pricing is adjusted relative to DWP? And as regards to that, how do you think about the effect of some personal lines, insurance company or even commercial like exiting certain markets, just given the need to really raise premiums in the face of higher catastrophe risks? I mean, I guess, how does that trade-off work?

I'll let Jeff touch on the approach to pricing and resetting price with respect to DWP, and then I'll give you a context on carriers exiting markets.

Yeah, sure. Yeah, so, foundationally, our contracts are built around a direct written premium baseline that's embedded into our customer contracts. We have the ability to inspect the direct written premium on an annual basis. Typically at renewal, there are instances where a longer-term initial contract may take a couple of years before we see that sort of inspection into what the direct written premium is. And it's not uncommon for customers to purchase a slightly higher direct written premium than they're running today to give them a little bit of room to grow, but typically we have the ability to look at that on an annual basis.

Yes, I want to address the recent headlines regarding carriers exiting certain markets and specific lines of business. We are actually having many discussions with carriers that are eager to enter those markets as well. It's important to recognize that the overall need for property and casualty insurance remains constant. However, the way different carriers choose to meet that demand in various regions can change. Our platform can help carriers interested in these markets, which could drive growth for Guidewire. This helps to offset concerns when one of our customers decides to leave a market. We've had engaging discussions about this trend, and the flexibility our platform offers can facilitate successful market entry with innovative strategies to meet essential needs, particularly in markets like California's homeowners insurance, where effective P&C coverage is crucial. We monitor these dynamics closely, and they help balance our overall perspective.

Okay. That's helpful. And then, just can you remind me of the number of net new logos in the last year? And if my tracking is right, it looks like about nine net new logos so far this year. But number one, is nine right? And then, what was the number for last year? It looks like I missed the fourth quarter.

I am hesitant to provide a specific number that we can confirm later because I don't want to risk being incorrect during the call. However, I can say that we are very confident in the growth of our business mix as we move through the fiscal year. It can be challenging to specifically classify something as a new logo since the relationships we maintain with many of our clients often involve complex multinational agreements where some countries may or may not qualify as new logos. Overall, I would say we are very comfortable with the consistent year-over-year growth we are experiencing in this area.

And Pete, we often talk about new modernization activity, so workloads that are currently running on legacy systems that are new to being modernized and cloud migrations and then expansions. There's a lot of new modernization activity that we do at existing customers. And to Mike's point, how you count a logo in this industry can get quite complex with the hierarchies of our customers.

Okay, that makes sense. I appreciate it.

Thank you. Our next question comes from the line of Rishi Jaluria with RBC. Please proceed with your question.

Wonderful. Thanks so much for taking my questions. I want to start with the comment you made about managing to less linearity. Can you maybe walk us through kind of the steps that you took to get there outside of just the shift to a more ratable model? And as we think about our own models beyond this year, is this year's numbers inclusive of your Q4 guide the right proxy to use for future years or how should we think about seasonality? And I've got a quick follow-up.

A lot of this is about taking a more rigorous approach to our sales processes. We're focusing on what we do each week and each month regarding pipeline creation, deal maturation, setting monthly targets, tracking progress toward those targets, and establishing challenging internal objectives for the first and second quarters so we can stay ahead. We're aiming for a continuous business operation instead of just resetting at the start of a new year. We want to run the company on a nearly monthly basis. By advancing our internal sales objectives, pipeline generation, maturation, and bookings activities, we've achieved the linearity we're experiencing, which allows us to operate the business much more effectively. It has taken time to steer everyone in the right direction and educate the market about our desired outcomes, but it's encouraging to see our booking success at this stage in the third quarter, making the fourth quarter much more manageable.

I would like to emphasize that as the platform has developed, the scope and depth of our pipeline have significantly improved compared to two or three years ago. This development enables us to analyze it in a much more substantial way. We understand that we cannot rely on the same linearity as before, and we need to proactively address it. Nonetheless, the enhanced scope and depth of our pipeline have empowered us to influence certain behaviors effectively.

Okay. That's really helpful. And then, I just wanted to ask a question about Jutro. Since you announced that at the Connections last year, picking up a lot of interest. Can you maybe walk us through what adoption and use cases look like so far with Jutro? And as we think about, it's a developer kit. Is there an opportunity for you to leverage generative AI just given that GenAI has been really helpful from a coding perspective to maybe even speed up time to value even faster than what we've seen before? Thanks.

Absolutely, great question. For everyone's understanding, Jutro is our technology platform designed to help customers create digital experiences directly on top of our core systems, like ClaimCenter and PolicyCenter. Customers can use it to create experiences such as first notices of loss for claims, quoting experiences, or account management updates. Carriers can push these directly to customers or agents, enhancing business processes and operations, benefiting consumers, agents, and carriers alike. Jutro improves the efficiency of delivering these services; instead of building separate digital applications that require synchronization and integration, we can construct these experiences directly on our core system, making it faster, cheaper, and more efficient for our cloud customers. Adoption has been strong, and now that the products are generally available, we’re working on several projects to launch Jutro capabilities in the real world. For instance, in Australia, we’re collaborating with Hollard, one of our top customers who was the first to launch a Jutro-driven claims flow experience with us. That project has been very successful due to their partnership throughout the process. We’re pleased with our progress and adoption and are optimistic about future opportunities to develop more packaged content around Jutro to further accelerate experience creation. You can think of these as small digital applications that carriers use for increased efficiency. Regarding generative AI, we believe it can enhance our software development efforts, improving coding efficiency significantly. The technology is based on React, a widely recognized web programming language that developers around the world are familiar with, facilitating seamless interactions between React-based applications and Guidewire. We’re confident that generative AI and related tools will help us going forward. Thanks for the question.

Thank you. Our next question comes from the line of Matt VanVliet with BTIG. Please proceed with your question.

Hey, good afternoon. Thanks for taking the question. Maybe I wanted to dig in a little bit on maybe what some of the specific drivers were that got some of the APAC deals in particular over the line, and sort of improving performance that you called out there on the cloud side of the business. How much of that is sort of product maturation and other things you're doing versus John and his team continuing to sort of knock on doors and get deals done? Anything you can provide us with a little more details on what's working there that maybe wasn't just as a few quarters ago?

A lot came together in Australia this quarter, thanks to John and the sales team in the region, along with support on a global scale. This outcome is built on many years of hard work. We have been laying the groundwork in Australia over the past few years with several smaller deals and early successes in the cloud. We also have established long-term relationships with major Australian insurance companies, working diligently to earn their trust and align with their modernization and business goals. All these efforts culminated this quarter in significant demand. Additionally, our successes in North America and our proven track record, including over 60 live cloud customers, have fostered confidence that we can ensure the success of these programs. This all contributed to a remarkable quarter in Australia. We are also excited about Shaji joining our team; he is an exceptional leader who will help us maintain our momentum in Asia Pacific, where we see ample opportunity for further growth.

All right, helpful. And then, just two quick follow-ups, Jeff. One, it looks like a pretty big perpetual deal came through on the quarter. Any additional details you can sort of help us with there? And then, from a more strategic standpoint, on the gross margin reinvestments you talked about, anything specifically that you're targeting there? Is it just sort of an acceleration of things on the roadmap already?

So, on the perpetual deal, it wasn't any sort of new perpetual deal, that was just expansion orders at an existing customer. So, it was a little bit of a blip, but nothing I would highlight as a trend or anything along those lines. And then, what was the second question?

You mentioned the upside to gross margins that maybe are going to accelerate some investments in the platform. Just curious if that was pulling things forward or...

We are clearly ahead of our gross margin targets for this year and are already exceeding the targets we set for next year. This is very exciting for us as we witness this growth. We believe there are many opportunities for us to invest in, and as we look into fiscal year 2025, we are tracking a bit ahead on gross margin. We see healthy investment areas to leverage this momentum. Therefore, we still believe our overall operating margin targets remain appropriate.

Okay. Thank you.

Thank you.

Thank you. Our next question comes from the line of Alex Sklar with Raymond James. Please proceed with your question.

Great. Thank you. Mike, a lot of comments today around the maturity of your cloud solution kind of helping drive faster demands. Can you just talk about your cloud customers staying closer to the latest release and where that stands today versus a year or two ago? And is there any kind of way to characterize how that piece of it is factoring in broader demand and cloud adoption? Thanks.

Thank you for the question. I appreciate it because it has been a significant focus for us this year. We have gone through several phases in establishing our cloud and its infrastructure, which enables us to scale and securely run the InsuranceSuite applications. The change we made in our release schedule was a crucial part of the cloud value proposition and our future commitments. At one point, we transitioned from releasing updates twice a year to three times a year. Alongside this, we have dedicated significant engineering effort to ensure that these updates provide a much-improved experience for customers compared to their previous on-premises solutions. In the past year, we measured the release versions our customers are using in their non-production and production environments, often referring to them as N minus 1, N minus 2, and N minus 3. We monitor this closely each week and report it to our Board. We have implemented various technical programs and collaborated with our cloud customers to build trust, enabling them to feel confident in adopting these updates. Customers accustomed to 12 to 18-month update cycles often approach their first cloud update with caution. However, after completing it once, twice, or three times and realizing they can implement updates in just days with minimal impact on their operations, they begin to trust the process. They can then stay current on the latest release or possibly one release behind. This initiative has been successful and has been a topic we discuss with customers and prospects worldwide as it is vital to the cloud value proposition. If we weren't able to keep customers updated, delivering groundbreaking product enhancements, workflow functionalities, and generative AI capabilities would be difficult. We have made significant progress in this area, which has been a major achievement for the company this year. Thank you again for the question.

All right. I appreciate all the color, Mike. Jeff, maybe just a quick follow-up for you on Rishi's question around linearity. We obviously have the fourth-quarter ARR guide. I think you also implied that Q4 might not reflect the strength of fully ramped bookings just given ramp schedule. So I just wanted to clarify, is the smoother linearity comment and kind of less reliance in Q4, is that a phenomenon you're seeing on the fully ramped side too, or is there an added aspect in terms of the mix of ramp deals that you're looking at in the fourth quarter versus the rest of the year? Thanks.

Yeah, I think what I was trying to communicate there is as we look at the upside and as we look at Q4 and where we think some of the upside may exist, we're seeing some really interesting deal momentum and longer-term commitments that come across us some ramps. So, on the ARR side, as we look at the overall momentum there, we're thrilled with the deal activity, but a lot of that kind of more interesting upside is coming in those ramped outcomes. So that's an exciting fact pattern for us.

All right. Thanks for that.

Thank you. Our next question comes from the line of Alexei Gogolev with JPMorgan. Please proceed with your question.

Hello, everyone. Mike, I was wondering if you could give us some insight into the customers that are still on the old prem software versions. When do you think these customers would be ready to migrate to the cloud? I'm assuming that they haven't received any upgrades since you guys moved and started to introduce cloud products. So, do you think 2026 or 2027 would be a pivotal year when many of these customers will begin to consider cloud migration?

Thank you for the question. I would say that all of those customers are currently under consideration. We maintain close engagement with them, helping to make plans that align their objectives with our ability to support, whether through upgrades to the cloud or ongoing enhancements to their on-premise implementations. We continue to provide security fixes for those on-premise systems and remain available to assist customers when necessary. While this area still contributes significantly to our revenue, there has been little to no new investment in terms of product innovation for those releases. Customers can operate their on-premise systems reliably and safely, and we support them, but the true advantage of partnering with Guidewire also lies in product innovation. We can achieve far more efficiently and effectively in the cloud, and we make it clear to our on-premise customers that this is our primary focus. Predicting exactly when these migrations will take place is challenging because it involves factors beyond just Guidewire and our program. Customers often have other internal IT objectives to consider. Therefore, upgrading to Guidewire cloud needs to be sequenced with their broader IT goals. We communicate regularly with each customer about their current status, plans, and our timeline commitments for support. As we look towards fiscal '26, '27, and '28, I believe that the plans for all those on-premise implementations to transition to Guidewire Cloud will become more concrete. However, this is a three-year outlook, and a lot can change in that time. We are collaborating with them and recognize the demand. As I mentioned in my prepared remarks, this customer base is Guidwire's most valuable asset, and our company culture emphasizes our commitment to supporting these customers and facilitating their migration to the cloud when it aligns with their needs.

Perfect. Thank you, Mike. And Jeff, very quick question for you. Does this strategy of passing on low-margin service revenue to partners mean that you would not need to add a significant amount of additional talent and labor capacity in the midterm, which would potentially help improve your margins going forward?

Yeah. I mean, I think the way we look at it is that there's a massive amount of work to modernize this industry. And if we were to try to tackle that with all Guidewire resources, we would have to staff up quite significantly, and that's not our strategy. We want to work with the best partners in the world to help us tackle that opportunity. We need to have a highly strategic skilled services organization, and we think that we have the right size and scale in that organization today to allow us to partner with the global SIs to get this work done. So, kind of as we look ahead, we think we have the right cost basis. And I think as we go through this process of dividing up the labor to tackle this opportunity, finding that right equilibrium point where our resources and our highly skilled people are appropriately utilized and our partners have an exciting opportunity to execute against as well. So, that's what we're tackling.

Appreciate the answers. Thank you, Jeff. Thank you, Mike.

Hey, thank you.

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

Hey, it's David Unger on for Michael Turrin. Thanks for taking the question. Just one from us. Can you guys just talk through the trends you're seeing in terms of the sales cycle and any differences to note by either geography or tier? Thank you.

Yeah, I don't know whether or not I'd call out any particular difference and change in the sales cycle. Our sales cycles are still very long. We close deals that are very often open in our system for multiple years, and that hasn't changed. We feel like we've got a great connection to customers, a very deep connection often, whereas like Guidewire is running in some component of their enterprise, and so we have a relationship, and that enables us to have an opportunity for a sort of large enterprise kind of open and working for a long time. I wouldn't say we've seen much of a change in that cycle. It's just generally we're able to pull the deals in and get them closed based on the confidence and the momentum that we've established in the market today.

Thanks, Mike.

Thank you. Our next question comes from the line of Tyler Radke with Citibank. Please proceed with your question.

Hey, this is Peter on the line for Tyler Radke. Congrats on the quarter, Mike and Jeff. I just have one question here. Curious if AI is having any impact on recent deal activity and if customers are wanting to modernize their systems sooner rather than later to invest in AI projects down the line as you start to introduce more of those applications onto your platform? Thanks.

That’s a great question. AI definitely plays a role, and I will provide a detailed response. When we talk about AI broadly, data is crucial for machine learning and leveraging AI techniques to enhance predictions and improve the efficiency of insurance operations. Gaining better access to data is a significant aspect of Guidewire's modernization initiatives and the decisions companies make about adopting Guidewire. This is an important factor. When discussing generative AI specifically, it’s clear that modernizing systems like Guidewire around claims and policy processes is the ideal way to incorporate generative AI features into a new platform. Attempting this on a legacy mainframe system would be nearly impossible. In my discussions with customers, there’s a vision for a future where many of the tedious tasks required to run insurance operations could be streamlined and improved with generative AI. Guidewire serves as a logical platform for this transition. It helps us consider the necessary steps to leverage generative AI in the insurance sector effectively. We are beginning to engage with customers regarding generative AI products and features that will be integrated into ClaimCenter and PolicyCenter to enhance efficiency for the users of Guidewire. This is beneficial and positively influences their perception of the advantages of opting for Guidewire. Overall, it’s very advantageous and fits well with a broader transformation initiative that supports a Guidewire decision.

All right. Thanks.

Thank you. Our next question comes from the line of Aaron Kimson with Citizens JMP. Please proceed with your question.

Thanks for the question. Can you provide any color on the specific areas in accelerated product investments that Jeff mentioned at the end of his prepared remarks?

We see significant opportunities to enhance our PolicyCenter, ClaimCenter, and InsuranceNow applications to improve their effectiveness. As I mentioned in response to a previous question, we're exploring better digital applications and components for continued investment. We've discussed our strategy for applying Guidewire in London markets, and we're also looking at enhancements for various countries and regions based on localization needs. There are numerous areas where we can invest in our products to drive growth across our current product landscape. There's considerable excitement in the industry around underwriting and leveraging generative AI to improve underwriting processes, as well as enhancing pricing and rating through better analytics and AI. This presents a wealth of opportunities for us. With our establishment of a modern cloud platform that we are confident will scale and serve our customers effectively over the coming decade, we can now expand our focus on where to apply product investments to improve outcomes for insurance companies, enhancing their agility and efficiency throughout the insurance lifecycle. We're transitioning from a phase of intense focus on cloud infrastructure to one where we can think more strategically about product and innovation investments to support industry growth effectively.

Very helpful. Thank you. And then, stepping back...

Sorry, could you repeat it?

One of your cofounders, former CEO, and current Board member Marcus Ryu talked last month about his belief that the future of software verticals will become increasingly specific over time. A key factor for vertical software is that LLMs are expected to boost engineering productivity, enabling agile startups to capture significant value that many vertical software applications offer at a much lower cost. Mike, where do you see the insurance market aligning on this spectrum of ideas?

When large language models and specifically cogeneration emerged about a year ago, we dedicated significant time to consider the implications. In my view of Guidewire and the property and casualty industry, the need for a core system of record that meets the stringent, highly regulated financial requirements of insurance companies will continue to be a complex software solution with a long shelf life. I am very optimistic about this outlook and confident in our position, our track record, and the substantial investment we have made in building a platform that operates globally for carriers of all sizes and across various lines of business. I believe the insurance companies we collaborate with are making long-term decisions for the next decade or two, and we are the ideal partner for them. Generative AI will play a distinct role in the insurance sector, aiding in the development of digital applications that integrate with Guidewire core systems, and enhancing generative AI features within PolicyCenter and ClaimCenter to improve efficiency. It will also streamline submission processes for commercial lines insurance, where traditional structured database approaches have struggled. Generative AI now enables us to tackle more complex, less data-driven challenges effectively. I am confident that our position in vertical software is robust, and generative AI will support our advancement. This is my specific perspective on the property and casualty space. While I could comment on the broader vertical category, it may not be appropriate for me to do so. However, I firmly believe in Guidewire's strong standing in the P&C insurance industry.

Thank you.

And thanks for the question.

Thank you. Our next question comes from the line of Mike Funk with Bank of America. Please proceed with your question.

Great. Thanks. Hi, this is Matt on for Mike. Just a quick one for me. You called out that DWPs are growing because of rising claim costs and inflation. Understanding that there isn't a one-to-one link between DWP growth and because of tiered pricing, can you help us quantify the contribution to growth this year and remind us how we should be thinking about factoring in DWP growth overall in our models going forward?

Certainly. This is a consistent aspect of our model, and we observe DWP true-ups and CPI adjustments during annual renewals. We've noticed an acceleration in this over the past few years. Due to the nature of the contracts, some are longer-term, and certain customers have purchased more DWP than they currently utilize, which means it will take time for true-ups to be fully realized. However, this has likely added an extra percentage or one and a half percentage points to our growth this year, and last year also showed elevated growth compared to historical trends.

Really helpful. Thank you.

Thanks for the question.

And we have reached the end of the question-and-answer session. I'll now turn the call back over to Mike Rosenbaum for closing remarks.

I just wanted to thank everybody for joining. We're incredibly excited about the results of Q3 and the momentum that we see in the business and look forward to seeing everybody and talking about what we hope will be a great Q4. So, thanks very much for joining today and we'll see you later.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.