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Executives

Marcus Ryu - Chief Executive Officer

Karen Blasing - Chief Financial Officer

Analysts

Nandan Amladi - Deutsche Bank

Sterling Auty - J.P. Morgan

Tom Roderick - Stifel Nicolaus

Brent Thill - UBS

Brendan Barnicle - Pacific Crest Securities

Walter Pritchard - Citi

Guidewire Software, Inc. (GWRE) F1Q 2013 Earnings Call November 27, 2012 5:00 PM ET

Operator

Good day and welcome to the Guidewire first quarter 2013 earnings conference. Today’s conference is being recorded.

At this time I would like to turn the call over to Ms. Karen Blasing, Chief Financial Officer. Ms. Blasing, please go ahead.

Karen Blasing

Thank you. Good afternoon and welcome to Guidewire Software’s earnings conference call for the first quarter of fiscal 2013 which ended on October 31. This is Karen Blasing, Chief Financial Officer of Guidewire and with me on the call is Marcus Ryu, Guidewire’s Chief Executive Officer.

A complete disclosure of our results can be found in our press release issued today, as well as in our related Form 8-K furnished to the Securities and Exchange Commission. To access the press release and the financial details, please see the Investor Relations section of our website at www.guidewire.com. As a reminder, today’s call is being recorded and a replay will be available following the conclusion of the call.

During today’s call, we will make statements related to our business that may be considered forward-looking under federal securities laws. These statements reflect our views only as of today and should not be reflected upon as representing our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook.

These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations. These risks are summarized in the press release that we issued today. For a further discussion of the material risks and the other important factors that could affect our actual results, please refer to our Annual Report on Form 10-K for the period ended July 31, 2012, which is on file with the SEC.

Also, during the course of today’s call we will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in our press release issued after the close of market today.

Finally, at times in our prepared comments or responses to your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business or our quarterly results. Please be advised that this additional detail may be one-time in nature and we may or may not provide an update in the future.

With that, let me turn the call over to Marcus for his prepared remarks and then I will provide details regarding our first quarter and our outlook for fiscal 2013.

Marcus Ryu

Thanks Karen and welcome. We are off to a good start in fiscal 2013 with first quarter revenue and profitability above the high end of our guidance range. Moreover, a growing pipeline of opportunities with new and existing customers reinforces our confidence in the long-term demand, the legacy core system replacement being expressed by our target market.

At the same time, we believe we are widening our competitive differentiation to service demand in two key respects: to our technology and the continuously expanding track record of our customers implementation success and both of those are extremely important to our future ambitions.

In light of the opportunity to win a disproportionate share of this growing demand, we continue to make judicious investments across the organization, with an emphasis on expanding the reach and capacity of our sales and services team.

Reviewing our financial results for the first quarter, revenue grew 21% from a year ago to $63.3 million, which was $1.3 million above the high end of guidance. We saw revenue upside in term license, maintenance and services revenues. Importantly, term license growth of 67% was very strong, reflecting our continuing focus on generating recurring revenue and on term versus perpetual licenses.

As a result, our most strategic financial metric, recurring revenue recognized on a rolling four quarter basis grew 31% from the first quarter of fiscal 2012 to $115 million. Our revenue upside in the first quarter flowed to the bottom line with non-GAAP operating income of $9.7 million, which was also above the high end of our guidance.

We see multiple factors driving our continued success, including increasing traction with tier one insurers, our ability to land and expand opportunities on a global basis, our expanding track record of successful implementation and our development of innovative products that capitalize upon and reinforce our differentiation.

Last quarter we discussed that while successfully deploying ClaimCenter, tier one P&C insurer Nationwide adopted PolicyCenter and will later deploy BillingCenter to be our largest suite customer. Our momentum with multi-billion dollar insurers continued in the first quarter, with a ClaimCenter win at the Hartford, a venerable and highly respected tier one insurer. They selected ClaimCenter to better serve customers and achieve higher quality claims outcomes for almost $9 billion in written premium.

We’ll be working with the Hartford and Cognizant as the systems integrator to deploy ClaimCenter to replace multiple legacy claim systems, including one from a key competitor of ours. We believe high profile wins such as Nationwide and the Hartford are not going unnoticed by other tier one insurers and that these wins advance our ambition to eventually serve many of the largest insurers in the industry worldwide.

Precisely because the industry is global, our traction overseas is vital to our long-term growth and we are investing accordingly. After reporting our first win in Central Europe last quarter, with Poland’s largest insurer PZU, as well as our first one in Germany, we are pleased this quarter to earn a ClaimCenter selection by Insurance Australia Group, IAG. While we already serve IAG’s commercial line subsidiary, this will mean the ClaimCenter now covers all lines of business for the largest insurer in Australia.

In addition to reflecting international growth, IAG exemplifies a key pattern for us. Customers often evaluate our entire suite, select one or more of our products for an initial scope where they have the greatest pain, and then show strong a tendency to expand their deployments over more of their underwritten premium and license additional products. Both decisions would deepen their enterprise commitment and expand our recurring revenue base.

This of course requires that the initial deployment is highly successful. We have made implementation success to our foremost mission and this quarter we had numerous successful go-lives representing all of our products, including CGU and Guild in Australia, SBI insurance in Japan, QBE Americas in the US, Aviva Canada, AAA of Northern California, Nevada and Utah and the go-live of our largest customer by premium, Tokyo Marine.

To-date nearly two-thirds of our customers are in live production with at least one of our products and we are hard at work to make sure that our more recent customers achieve similar success. This track record is a unique differentiator and an essential driver of new business.

In addition to success with core system functionality, we continue to up sell existing customers with add-ons, our reinsurance management and rating management add on modules. While these modules do not drive the same kind of revenue as our three core products, they are important elements of our suite portfolio, which provide value-add to our customers.

Guidewire customers and prospects converged in San Francisco at the end of October for our Annual User Conference called Connections. We had record attendance this year with close to 600 customers and prospects, up approximately 25% from a year ago. The conference was preceded by an executive summit for over 40 industry executives and those events strengthened the growing community of Guidewire customers who shared their expenses.

The event underscored our long-term opportunities to call in our uniquely strategic customer relationships to build additional products that add value to our core solution that is InsuranceSuite. Execution against this strategy will not only produce follow-on sales opportunities, But we believe that continued expansion of our value proposition will also enable Guidewire to continue attracting new customers, while significantly enhancing the ROI of our modern software platform.

At Connections we launched Guidewire Live, the release version of project Vega, which we discussed at our analyst meeting in early October. Guidewire Live is the network connecting Guidewire customers to one another’s aggregated information, curated external content and external tools.

Customers access Guidewire Live through instant-on apps, deployed in the cloud-based environment hosted by us. The apps utilize the technology platform and core data model shared by all insurers using Guidewire application, as well as applicable externals content, such as weather, geographic and demographic data. This common data model enables our customers to compare their operational performance against the aggregated data of their peers, with an accuracy, granularity and timeliness never before seen in the industry.

To give you one example, in response to super storm Sandy, which struck a week after launching Guidewire Live, we were able to develop and deploy a prototype app to visualize the distribution of policy holders, impacted in different wind speed regions of the storm. Other examples include an app marrying current or historical climate data starting with hail, to policy and claims data and an app that provides comparative benchmarks with aggregated data of industry peers on a wide array of operational metrics.

We continue to direct a portion of our R&D investments towards building additional apps that complement our core product suite and utilize our growing and global customer community. While Guidewire Live is just getting started and is still pre-revenue, we are excited about its potential to transform the category of insurance core system software and perhaps eventually how insurance itself is delivered.

In summary, we are off to a strong start in fiscal 2013. We believe its still very early days in the inevitable replacement of legacy P&C core systems to modern software and we believe that Guidewire is increasingly well positioned to lead this transformation and to be the company that benefits disproportionately relative to others targeting the opportunity.

Now I’ll turn the call over to Karen to discuss our financial results and our outlook in more detail. Karen.

Karen Blasing

Thank you Marcus. We are pleased to report our results that exceeded our revenue and earnings expectations for the first quarter of fiscal 2013.

Total revenue was $63.3 million, a 21% increase from the first quarter of fiscal 2012. Within revenue, license revenue was $20.8 million, consistent with the year ago quarter. It is important to understand the composition of this license revenue as it reflects our purposeful emphasis on recurring term licenses versus perpetual licenses.

Term license revenue increased 67% year-over-year to $20.6 million, while perpetual license revenue is approximately 200,000 down from $8.5 million in the first quarter of fiscal 2012. As we shared last quarter, we expect a much lower level of perpetual license revenue in fiscal 2013 as we continue to focus on signing multi year occurring term licenses.

Maintenance revenue, which is recognized ratably through the year, was $9.4 million for the first quarter, up 32% from a year ago and reflecting overall license growth trends. Services revenue was $33.1 million, up 35% from a year ago, reflecting the increase in number and scale of projects we are engaged in.

Revenue upside in the quarter came from increases in term licenses, maintenance and services revenue. Consistent with expectations we discussed on our last call, total revenue include approximately $5 million in catch-up revenue from a historical transaction, that net revenue recognition criteria during the first quarter. This compares to $1.8 million in catch-up revenue in the first quarter of 2012.

Catch-up revenue in the first quarter of fiscal ‘13 from this historical transaction consisted of $3.2 million in term license revenue, $0.1 million in maintenance revenue and $1.7 million in services revenue. With this historical transaction now fully recognized, we do not anticipate any meaningful catch-up revenue in future periods.

Our high annual revenue visibility is driven by the recurring nature of our multiyear term licenses and ongoing maintenance agreements, both of which are generally built annually. Term license and maintenance revenue for the fourth quarter ended October 31 totaled $115 million and was up 31% compared to a year ago.

With respect to geographic mix, the United States represented 56% of revenue in the quarter, with 44% of revenue coming from outside the U.S. In the year ago period, 38% of revenue came from outside the United States, reflecting increased geographic diversification in our customer base.

Our geographic mix can be variable on a quarter-to-quarter basis, depending on the timing of larger transactions and the associated revenue recognition. From a high level perspective, we continue to see solid demand both domestically and overseas, despite the challenging global economic environment.

We will discuss our profitability measures on both a GAAP and non-GAAP basis, and we have provided a reconciliation of GAAP to non-GAAP measures in our earnings press release issued today, with the primary difference being stock-based compensation expenses.

Non-GAAP gross profit in the first quarter was $38.6 million, representing a 61% non-GAAP gross margin. Breaking that down, gross margin for license was 99.2%, non-GAAP gross margin for maintenance was 86.1% and non-GAAP gross margin for services was 29.9%, which benefited from both the catch-up services revenue of $1.7 million and somewhat slower hiring of personnel than was anticipated.

We continue to anticipate non-GAAP services margins in the mid-teens range for the next several quarters, as we continue to increase staffing levels in our services organization to support a growing number of implementations, particularly for PolicyCenter and our full suite offering.

Turning to operating expenses, total non-GAAP operating expenses were $28.9 million in the first quarter, an increase of 30% compared to a year ago. This resulted in non-GAAP operating income of $9.7 million, representing a non-GAAP operating margin of 15.4% and exceeding our guidance for non-GAAP operating income from a loss of $500,000 to income of $2 million.

Non-GAAP operating income was down 15% on a year-over-year basis, due primarily to increased investments across the business to capitalize on our strong business momentum and significant marketing opportunity.

For the first quarter we generated $10.8 million in adjusted EBITDA or an adjusted EBITDA margin of 17.1%. Non-GAAP pretax income was $10 million in the quarter. Our non-GAAP effective tax rate was 33%, slightly below the 35% tax rate expected for the full year.

Non-GAAP net income for the first quarter was $6.7 million or $0.11 per diluted share, above our guidance of breakeven to $0.02. On a GAAP basis, gross margin was 56.5%, operating expenses was about $35.8 million and operating loss was $62,000. GAAP pretax income was $169,000 and net income was $447,000 or $0.01 per diluted share above the high end of guidance.

Turning now to our balance sheet, we ended the first quarter with $185.5 million in cash and cash equivalents, down from $205.7 million at the end of the fourth quarter. Reflecting typical seasonal effects, cash flow from operations from an outflow of $16.3 million in the first quarter compared to an outflow of $27.1 million in the year ago period, which included a $10 million litigation settlement payment.

Our current deferred revenue was $41.5 million. Total deferred revenue was $43.6 million at the end of the first quarter, a decrease from $55.5 million at the end of the fourth quarter. This was primarily due to two factors: first, we recognized $5 million in catch up revenue from a historical transaction in the first quarter; second, the recognition of a licensed invoice from an existing customer that was billed in the fourth quarter, but recognized in the first quarter.

As we have shared in the past, we do not believe that deferred revenue is a meaningful indicator of business activity during the quarter, since we typically bill term license contracts annually and recognize the full annual payment upon their due date, generally 30 to 60 days after the original contract date and each anniversary date. There is no specific pattern to whether an invoice and due date happen to span the end of a quarter and therefore resulted in an increase in deferred revenue.

Further our multiyear contracts combined with annual payment terms mean that a significant amount of our contractually committed fees are not visible on our balance sheet. We believe that the combination of this large base of business under contract combined with our best-in-class renal rates provides us with a high level of visibility towards 2013 revenue today.

Our metrics of rolling fourth quarter recurring revenue is the best measure of our business under contract. Combined with our guidance it is a better indicator of our business momentum. On that note let me turn to our financial outlook.

From a high level perspective, we believe that we have been successful in driving near and longer-term top line growth as a result of the investments we have been making in our business. Our plan is to continue this proven strategy to help drive our long-term growth and to strengthen our leading market share position.

Looking at the second quarter of fiscal 2013, we anticipate total revenue to be in the range of $62.5 million to $65.5 million, representing mid to high teens growth on a year-over-year basis.

During our analyst day we provided a breakout of our forecast for license, maintenance and services revenue and we thought that this would be helpful here as well. Revenue guidance for the second quarter include the license revenue in the range of $25.5 million to $26.5 million, mostly from term licenses with only a minimal perpetual license component.

We anticipate maintenance revenue of $8 million to $8.5 million and services revenue of $29 million to $30.5 million. We expect most license revenue to come from term licenses, with only a small amount of perpetual licenses revenue, primary from existing customer arrangements.

In looking at our anticipated sequential growth in the second quarter compared to a year ago, it is important to keep in mind that our results for the second quarter of fiscal 2012 included $5.9 million in perpetual revenue and approximate $3 million related to a payment that was received and recognized before its due date.

Were it not for these two events or either individually, total revenue in the second quarter of fiscal 2012 would have been flat to down sequentially from the first quarter of that fiscal year. By comparison, the mid point of our guidance for next quarter, the second quarter of fiscal 2013, calls for modes sequential growth.

We anticipate a GAAP operating income of a loss of between $11.3 million and a loss of $8.3 million. We anticipate a GAAP net income of a loss of $9 million to a loss of $6.6 million or an EPS loss of $0.16 to $0.12 per share, based on an estimated weighted average basic share count of 55.9 million shares. We anticipate an effective GAAP tax of approximately 20% in the second quarter, primarily due to foreign-based stock comp that is ineligible for tax deductions.

Our GAAP operating income and net income per share expectations include $10.8 million in stock based compensation expense. Excluding this non-cash expense we anticipate non-GAAP operating income of between a loss of $500,000 to a gain of $2.5 million for the second fiscal quarter and adjusted EBITDA to be between $1 million and $4 million.

We anticipate non-GAAP net income of between a loss of minus $0.3 million to income of $1.6 million, or a loss of $0.01 to an income of $0.03 per share, based on an estimated average weighted basic share count of $55.9 million and a fully diluted average weighted share count of 62.3 million shares. We anticipate an effective non-GAAP tax rate of approximately 35% in the second quarter.

As in the first quarter, we expect to use cash during the second quarter as we typically use cash in the first half of the year and rebuild cash balances from operations during the second half of the fiscal year. This is due to the seasonality of invoicing of our customers.

Based on our strong first quarter results, strong pipelines and business models that provides us a high degree of visibility, we are increasing our fiscal 2013 guidance as follows. We anticipate total revenue in the range of $279 million to $289 million and increase from prior revenue guidance of $276 million to $288 million and representing year-over-year growth of 22% at the mid-point.

As a reminder, we continue to drive new licenses to a recurring term base model and we expect less perpetual license revenue in 2013 as compared to 2012. Additionally, we continue to expect services revenue will grow significantly this year to service our recent and anticipated new customer wins, particularly in support of policy center implementations.

For the full year we anticipate license revenue in the range of a $110.5 million to a $113.5 million. Maintenance revenue in the range of $33.5 million to $35 million and services revenue of a $135 million to a $140.5 million, so services revenue was over 50% of total revenue in the first quarter. We anticipate services representing approximately 48% to 49% of total revenue of a full year basis.

Additionally, keep in mind that the fourth quarter is seasonality our strongest quarter, typically with significant sequential growth and we expect our results in 2013 to reflect this historical patter.

In terms of profitability, on a GAAP basis we anticipate a fiscal 2013 operating loss of between $18.8 million and 10.8 million, a net loss of $15 million to $8.6 million or an EPS loss of $0.27 to $0.15, based on an estimated weighted average share count of 55.9 million shares.

Our GAAP operating income and an income per share expectations include $40.8 million in stock base compensation expense. Excluding this non-cash expense, we expect full year non-GAAP operating income in the range of $22 million to $30 million, an increase from our prior expectations of $20 million to $29 million and representing non-GAAP operating margin of 9% at the mid-points of our revenue and operating income guidance.

We anticipated adjusted EBITDA in the range of $28.2 million to $36.2 million in fiscal 2013 and we anticipate non-GAAP net income in the range of $14.3 million to $19.5 million or $0.23 to $0.31 per share, based on our fully deluded share count of 62 million shares. We anticipate a non-GAAP effective tax rate of approximate 35% for the full year.

In summary, we are pleased to report a strong first quarter. We believe we are well positioned to capitalize on the significant opportunities in front us, driving strong revenue growth and expanding profitability in the years ahead.

Operator, can you now open the call for questions?

Question-and-Answer Session

Operator

Certainly, thank you (Operator Instructions). And we’ll take our first question today from Tom Ernst with Deutsche Bank.

Nandan Amladi - Deutsche Bank

Hi, good afternoon. I’m Nandan Amladi on behalf of Tom. A question on the number of policy assigning at the analyst day that you talked about 13 customers who have basically started out Guidewire suite with policy versus three in ’11. Have you had any more success in the last six weeks or so?

Marcus Ryu

Yes, Nandan. That pattern of customers starting with engage with us, with the PolicyCenter as opposed to always with ClaimCenter and that trend continued in the quarter and we certainly expect it to be the case through the year.

We go to market now with the full suite, not with any specific product and in every case, even if the project is looking at one specific domain, we are always trying to broaden the conversation to encompass a full operating platform, which is the full suite.

Nandan Amladi - Deutsche Bank

And a short follow-up if I might. There is a significant jump in CapEx this quarter and also the last quarter. Is this related to any new products like the Live product you just launched?

Karen Blasing

No, it’s really related to the move to the new corporate headquarters here that we leased in Foster City. We didn’t own much furniture in the old building and so we had to buy some furniture and do a modest amount of lease hold improvements there.

Nandan Amladi - Deutsche Bank

Okay, thank you. That’s all for now.

Operator

We’ll take our next question today from Sterling Auty with J.P. Morgan.

Sterling Auty - J.P. Morgan

Yes, thanks. Hi guys. On the term licenses, can you give us an indication, how much of the near term license are equally ratable through the year versus term licenses where you are recognizing revenue kind of on that once per year based on payment.

Karen Blasing

Sterling, most of the term licenses are still annual [in advance][ph], and so those would be recognized, the license portion of it once a year on the invoice due date. Some of our larger transactions and I think we shared with you last time that Nationwide which was completed in the fourth quarter was a quarterly billing and so that particular transaction will be recognized once a quarter instead of once a year.

We’re really depending on the commercial terms of what our customers would like. It may end up with some additional quarterly license payment terms similar to the Nationwide, but it’s not still the predominant method, it’s still annual [in advance] [ph].

Sterling Auty - J.P. Morgan

Okay, got it, and then just to clarify on the guidance, because I think looking at how the stocks are acting, I think there’s some confusion there. It sounds to me like you are trying to give us some sense of what the pattern will look like through the year. So you got the modest growth sequentially in the second quarter and then I think if I heard you correctly, the way that the business flows, you get the biggest jump in the fourth quarter, so maybe we see the modest and then we have that big jump in the fourth quarter and that’s how it should play to the new increased guidance level. Is that correct?

Karen Blasing

That’s correct and those are consistent with the historical pattern as well. If you refer back to the last couple of years, our fourth quarter has typically been higher than the highest quarter of any period.

Sterling Auty - J.P. Morgan

Okay, and then last housekeeping question, can you give us an essence of what the headcount was at the end of the quarter or at least give us a sense what the hiring was in the quarter, because you mentioned you weren’t able to quite hire to the levels that maybe you thought.

Marcus Ryu

We don’t have a headcount number to share - with a specific number. I can tell you that we were just slightly behind our target for the quarter. In previous quarters there was a larger gap between our goal and achievement on headcount hiring and this quarter we were a lot closer than not quite at the target.

Sterling Auty - J.P. Morgan

Okay great, I’ll go back in the queue. Thank you.

Operator

Moving on we’ll take our next question from Tom Roderick with Stifel Nicolaus.

Tom Roderick - Stifel Nicolaus

Hi guys, good afternoon. So maybe if I could ask you or just more directly address the question of hurricane Sandy I understand it’s not the nature of your quarters to be very back end loaded with respect to license sales, but undoubtedly there’s an impact to your customers, particularly on the eastern seaboard.

Can you talk about any impact that might be having the way you construct your guidance for the second quarter here, just around perhaps services demand, services capacity, license roll out as it pertains to deals that closed at the end of the quarter. Just anything that might give us a sense as to what might have happened at the end of the quarter that could be temporary in nature.

Marcus Ryu

Sure. None of the forward looking guidance reflects any impact from Sandy and it would if we had any basis to believe that it was going to change buying decisions or demand for services or anything of that sort. That hasn’t been the case and that’s not surprising to us it hasn’t been the case, because insurers are, they exist to cope with these kinds of catastrophes. They are very well capitalized. It’s part of the norm for them, but this was a particularly bad event of course.

So there was no adjustment in our outlook based on the storm and even though it’s a frequent topic of conversation with insurers, it has not changed in any way our outlook for the near medium term.

Tom Roderick - Stifel Nicolaus

Got it, that’s helpful. Maybe turning to the question of the policy products as you had the Nationwide win last quarter, I know these things don’t happen overnight, but can you share with us just any sort of industry anecdotes or data point that would help us to understand what the pace of demand for the policy product might look like, particularly in the wake of the Nationwide win and what that’s doing to your systems integrator ecosystem and the customer demand out there for policy? Thanks.

Marcus Ryu

Sure, the demand is very robust and though we think that the main driver for that is not any specific customer win, including Nationwide, but from the very long pent-up demand for core system replacement, driven by a lot of frustration with the inflexibility of the existing legacy environment.

Among the most egregious constraint of most legacy environment is that all the products and pricing are essential hard coated, which is just a huge problem if you have any kind of growth ambition or want to flex to changes in the market. So that’s always been there and that continues to be very strong and long term and secular in nature.

The Nationwide win was a bit of a watershed for both us and the industry. As we talked about it in the last earnings call, it is to our knowledge the first time that a major Tier 1 insurer has bought a packaged product for their core book of business, for a core multibillion dollar book of business to go on to a modern packaged solution.

It is to our knowledge the first time it’s happened, and so that has definitely stimulated a lot of other conversations, but as you noted Tom the evaluation cycle is long. It’s a serious decision by any insurer to replace their core policy system and getting conversation started is fantastic, but it doesn’t translate into a cascade of new sales in the next quarter.

Tom Roderick - Stifel Nicolaus

Great, and Karen one last one for you real quick. I think you mentioned that the cash flow from operations line is expected to be negative yet again this next quarter. I know that the line, that can move around quarter to quarter, but I guess last year we did see a pretty solid snap back in the positive territory. Can you just highlight that particular line items that we ought to wrap our head round with respect to why that number would be negative again next quarter.

Marcus Ryu

So, in the first and second quarter we have higher invoices to our customers in the third and fourth quarter, than we do in the first and second, so that’s always been more cash inflow coming in from customers. And then in the first quarter of fiscal year, that’s when we pay our annual bonuses to all of our employees, and we typically pay higher commission and dollar amounts as well, based on those higher fourth quarter sales. So generally we use a little bit of cash in the first half of the year and then have more substandard pick-up in Q3 and Q4.

Tom Roderick - Stifel Nicolaus

Great, thanks Karen. I’ll jump back in queue also.

Operator

Up next we have Brent Thill with UBS.

Brent Thill – UBS

Thanks, just on the term versus perpetual, as I understand you have been pushing customers towards the term for some time. Can you just help us understand why the perpetual piece, dried up as quickly as it did, especially in Q1, why your not expecting anything for the year. Is that a conscious decision from a sales go market perspective or are you pushing your sales force away from that. What caused that versus what we saw last year?

Marcus Ryu

Sure. You’re quite right Brent. Its been a very long standing objective of the company, really from the beginning of the company to license our software on a recurring term basis, that’s now new, but a number of things have changed over the last, really just over time to make it increasingly possible for that to happen.

The more significant change actually is the rolling adoption across the IT environments, in insurance and beyond to license software in that mode and companies like Salesforce have been very helpful in establishing that as a right paradigm for a relationship between a software company and a large enterprise customer.

And then secondly of course we have a lot more precedent now in our customer base to talk to new customers about this being the really more sensible way to license software from us and we’ve done everything possible with respect to our own internal incentive structures, to insure that that those incentives are aligned with it.

Now I wouldn’t characterize what happened as a drive in perpetual licenses. Those are all relationships, those are all customer wins that we have become I think more successful, more persuasive in licensing in the term structure as opposed to a perpetual structure. It’s not as though there is some segment of the market that no longer wants to buy from us. It’s that we’ve become more persuasive in having everyone who wants to buy from us license is that recurring fashion, which is not only in our interest, but we think in the customer’s interest as well.

Karen Blasing

The other thing that I would like to clarify a little bit is it’s not a complete drive, perpetual licenses. We do so anticipate that we will have some revenue recognized this year from perpetual licenses, much of that is actually from existing customer relationships, where maybe a new purchase or maybe an increase in the use of an existing customer license as well, as well as an occasional customer or two who are still pretty happy about perpetual. We just don’t expect it to be nearly a high as it was in 2012.

Brent Thill – UBS

Okay, so you are not going to eliminate it. It will still be part of the go to market, it’s just…

Marcus Ryu

It is part of the go to market, but we structure incentives for both our team and for the customer to strongly motivate a term license structure.

Brent Thill – UBS

Okay, thanks for the clarification on that and just on the service side you’re seeing great out performance there from your perspective and bringing the ecosystem apart isn’t helping you out. Can you give us a sense of where you are at and some of the milestones you hope to pass this year on that side?

Marcus Ryu

Certainly, so the growth in the ecosystem is absolutely vital to our long-term strategy and that’s been the case for a long time as well. We are seeing a pattern of scaling up by the ecosystem on policy, just as we saw it with claims, following a very similar pattern, just from your clients or some years staggered after clams.

We now have claims projects that are essentially implemented entirely by the FI with maybe one or half of a person from Guidewire overseeing the project and providing advice.

We are still at least a year away from that happening in policy, where just given the maturity of the ecosystem with respect to policy customers still want to feel the Guidewire presents. But in terms of the ecosystems response to the demand it’s been fantastic and we had a year of enormous growth in the ecosystem as measured in trained third party consultants and when we see that trajectory continuing into the future.

Brent Thill – UBS

Thank you.

Operator

Moving on we’ll hear from Brendan Barnicle of Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

Thanks so much. Karen, I wanted to follow up just quickly on – about your comments about sequential growth. So as we look out, historically looks like Q1 or rather Q2, Q3, you’ve had really sort of modest sequential growth. So we’ll be modeling that same sort of kind of modest growth through the first three quarters and then have the big spike in the fourth.

Karen Blasing

That’s correct.

Brendan Barnicle - Pacific Crest Securities

And then as you think...

Karen Blasing

I was just going to add, typical software sales guys are always successful and mindful that their quota is received over an annual basis and they are very mindful of that in the forth quarter.

Brendan Barnicle - Pacific Crest Securities

And then as we think about cash flow for the full year, does that most typically growth in line with adjusted EBITDA.

Karen Blasing

On it, but that quarterly seasonality, yes that’s true.

Brendan Barnicle - Pacific Crest Securities

On a full year basis though, does that grow in line with, who look at that full year adjusted EBITDA growth, is that sort of the same sort of implication we should have for operating cash flow.

Karen Blasing

It typically is, because we are not a heavenly capital-intensive business. As we mentioned, we have purchased some leasehold improvements and some furniture for the lease headquarters here, but we are not heavily capital intensive.

The only other use that we usual have for cash is we almost have our restricted stock units which are an incentive program for our employees and so we typically use a little bit of that cash in lieu of giving the full amount of the restricted stock grant to that employee, so we can’t…

Brendan Barnicle - Pacific Crest Securities

Great, and then Marcus with Guidewire Live you demoded a few of the initial apps. Can you give us any sense of what their expectation is for the rollout of additional apps over the next couple of quarters?

Marcus Ryu

We are not at a stage of declining a roadmap for that yet though. I can tell you that our ambition is to release products on a much more rapid pace by their very nature than given our big three core applications. So a low single digit number of new apps per year, I think is a reasonable ambition for us to have now and if the up-take of Live is as we hope, that’s something that we may chose to invest even more heavily in.

Brendan Barnicle - Pacific Crest Securities

Terrific. Thanks guys.

Operator

And we will take our next question from Walter Pritchard of Citi.

Walter Pritchard – Citi

Thanks. Hey Karen, just wanted to ask you about the license guidance. It’s relatively in line with what we provided before. I’m just wondering given the perpetual versus term mix this quarter and the outlook for Q2, if within that guidance range for license you’ve adjusted internally, your mix for perpetual and term loan is just the same as you were thinking at the analyst meeting.

Karen Blasing

Yes, it’s pretty similar to what we were thinking at the analyst meeting, which is kind of third to a half of what the full amount of perpetual license was in 2012, which was about $22 million. It’s simply that it’s probably adjusted more towards the back half of the year rather than in the first half of the perpetual licenses.

Walter Pritchard – Citi

Great and then just it does seem like from a delivery perspective internally you’re hiring a little bit on the services side. I’m wondering if you could quaintly sort of the year-over-year increase and your delivery capacity, the headcount in the quarter and then where you think that was for you after your partners.

Karen Blasing

Yes, so actually headcount was up pretty nicely for the professional services. So we ended the year on a professional services tune of about 368 people; that’s available out on the 10-K and we hired another 35 to 40 people in the first quarter, just on that services team. Not we anticipated hiring probably another half a dose to a dozen of those, but just didn’t get to quite those numbers. So we are having very good success now in finding very qualified people.

Marcus Ryu

With respect to the partner community Walter, I mean you’ll recall the comments, which are part of the public record now from one of our lead partners E&Y and their characterization of how heavily they are trying to recruit. I think he said something to effect of wanting to essentially double this practice over the next two to three years, if not sooner and I think that’s kind of in to share buy, a number of his fellow travelers in the space.

And we’ve also significantly expanded our relationship with the new SI. I mentioned the Cognizant being the partner at Hartford and while we work with Cognizant and a couple of places in a more minor in a somewhat second tier capacity, that makes a big difference as well and there are of course very large organizations with a lot of local reach. So I think the growth in the partner ennoblement community is as robust as it’s ever been in the company’s history.

Walter Pritchard – Citi

Got it and just one last question. I apologize for the background noise here. But on the mix of business on the suite side, can you talk about what sort of realization, now that you have more examples, what realization you are seeing in terms of percentage of DWP as you move to from a suite from a single product?

Marcus Ryu

Is the sense of your question – actually maybe you can zero in on what aspect you are asking.

Walter Pritchard – Citi

I guess what I’m trying to figure out is if you’re getting, say $1 or a certain ratio of DWP with just the single product. Now that you have more of these suite and multi-product deals under your belt, I’m just wondering if there’s any sort of economics you can outline to us in terms of where things are settling out on a percentage of DWP basis versus where they were with a single product.

Marcus Ryu

Yes, what we said in the past is that our historical experience has been something like 15 to 30 basis points on premium for when a customer licenses the full suite. Obviously we make it a little bit more economically advantageous for the customer to license multiple products at once as opposed to in sequence, which accounts for some of the range.

The other important parameter is how large the customer is. There is essentially a volume discount as you would expect, so large carriers pay a bit less per unit premium than smaller ones.

I say, while we assiduously measure our historical pricing experience the end isn’t so large that we can draw any definitive patters. I can say that qualitatively we are much better situated in the negation than we were earlier in the company’s history.

Walter Pritchard – Citi

Great, thanks a lot.

Operator

We’ll take a follow-up question from Sterling Auty of JPMorgan.

Sterling Auty – JPMorgan

Yes, thanks. Actually I wanted to talk just a quick moment about the EPS guidance for the full year. Karen, can you remind us what the guidance was previously and what it is now, because it looked like a big EPS fee and I just want to drill into maybe some of the expense forecasts for the full year.

Karen Blasing

And you are asking for the full year?

Sterling Auty – JPMorgan

Yes.

Karen Blasing

So, hang on a quick second and I’ll get that for you. So it’s a little bit of an increase for the full year. So it’s at Analyst Day we were projecting on a non-GAAP basis $0.23 to $0.30 and right now we’ve moved it up a little bit from $0.23 to $0.031.

Sterling Auty – JPMorgan

Okay, now given the large fee in EPS and granted you hire closer to the target, maybe the headcount was backend loaded in the quarter, but is there an increase in what you think the full-year total operating expenses would be to kind of take some of the upside from the first quarter away in kind of quarters two, three and four?

Karen Blasing

No, it’s really just a timing difference. So much of the headcount increases that we did have was pretty backend loaded in the first quarter and again, we see that actually probably in our second quarter as well, because we have Thanksgiving and the Christmas holiday here.

So we hired a lot of people in September and then we expect to hire the bulk of the additional ones in Q2 as well. So we’ll have the bulk in the January quarter. So we’ll have the full quarter expenses for both of those in the third and fourth quarter.

Sterling Auty – JPMorgan

Okay. And again, because it sounds like – I’m sorry say that again?

Karen Blasing

Yes, so we don’t really expect expenses to be going up from what we had provided earlier in the year. It’s simply that some of the discretionary expenses and some of the more fully loaded headcount will hit us a little bit harder in the third and fourth quarter than they have in the first and second.

Sterling Auty – JPMorgan

Okay. And then you’re still expecting some perpetual license revenue. You mentioned that you’re expecting it now to be more in the back half. Is that a change based on discussions that you’ve had with customers, and is any of that impacted from maybe sales cycles because of Hurricane Sandy or anything else? So just trying to understand what if anything may have changed around that timing.

Karen Blasing

We hadn’t provided to the community our expectation per quarter. So our internal guidance has been always to have more perpetual licenses occur in the third and fourth quarter. And to be clear Sterling, most of the revenue that we expect from those perpetual licenses are from existing customer arrangements, where they are buying additional product or they have expanded the use of their existing products under their already existing perpetual licenses. So that’s when we are just simply eligible to involve for them for that additional product of the additional usage.

Sterling Auty – JPMorgan

Okay. So it’s just you wanted to give additional transparency because it looked like estimates didn’t match up with what your kind of guide or internal plans were looking like.

Karen Blasing

That’s correct. Yes.

Sterling Auty – JPMorgan

Okay, thank you.

Operator

Next we’ll move to a follow-up from Tom Roderick with Stifel Nicolaus.

Tom Roderick - Stifel Nicolaus

Hey Karen, let me follow up on Sterling’s line of questioning there and just around perpetual, because I think its worthy of digging into a little bit deeper here. So last year you had $22 million in perpetual and over half of that came in the first half of the year. This first quarter, effectively nothing. It seems like you’re guiding for effectively nothing next quarter.

How are you thinking about that total number just in terms of that compared to $22 million last year, within the construct of your whole year guidance? What should we sort of be slotting in there for perpetual?

And then you noted its back half loaded this year. Can you just go into a little bit more detail about what level of choice the customer has in that and how much visibility you get into that choice, particularly with respect to certain customers that may have already been on perpetual, but couldn’t renew on a term or something along those lines. Just any help into the sales process would be great. Thank you.

Karen Blasing

Sure, happy to do that. So on the perpetuals we had little over $22 million in perpetual licenses in 2012 and you are right, almost all of it was front loaded in the first couple of quarters there.

In this year we don’t expect as we mentioned before perpetual licenses to be more than half of that number and it would be mostly in Q3 and Q4 and mostly related to existing customers relationships that we have.

So I think our sales team is being much more effective as Marcus explained with selling the value of the term licenses to our customers. So we are pricing them appropriately in the marketplace and we are also incenting our sales team I think probably better now to encourage term licenses over perpetual.

Marcus Ryu

And Tom, Marcus here. Its worth noting that even for those customers that we would expect, those deals that we would expect to close later in the year, that are most probable to close as in a perpetual structure. Even in those cases we are employing every form of persuasion we have to, to have them licensed in a term structure, even if their first relationship have started on a perpetual basis. So we think that’s just in our interest and the customer’s interest to do so.

But we are also trying to handicap the challenges in doing that sometimes, which is where we come to number that Karen has projected, about a third to a half of last years numbers in perpetual, its still happening that way.

Tom Roderick - Stifel Nicolaus

Got it, that’s helpful. Thank you guys.

Operator

We do have time for one last question today that will come from Brent Thill with UBS.

Brent Thill – UBS

Karen, I know you mentioned not to look at the DR too closely, but it is down 20% some year-over-year. I’m just curious in terms of what are the dynamics that you are seeing in the DR that is driving that type of decline?

Marcus Ryu

Sure, so you are looking at the October-to-October quarter, is that one correct?

Brent Thill – UBS

Yes.

Marcus Ryu

So there’s a couple of thing about that. One, we still have that $5 million worth of cash revenue, which has been sitting in deferred revenue for a long time and was finally recognized as earned revenue here in the first quarter. It’s the last one that’s out there, which is really a nice thing for the simplicity of our financial statements going forward.

The second is, that really took care of a lot of the decline. We’ve also discussed it on the services piece of the deferred revenue that will continue to decline and has really been kind of working its way through our percentage of completion contract that we stated recognizing in about Q2 of FY’12 and is expected to complete by Q4 of FY’13. So deferred service revenue will continue to go down, almost to nothing.

The deferred maintenance will continue to build as our base of customers and our base of maintenance fees continues to increase. It just ends up with a little bit of quarter variability, because it depends on – generally we invoice those maintenance contracts on an annual and advance basis as well. So you’ll see some kind of interim quarter spikes in that maintenance.

And then deferred license revenue, really what’s left is kind of a short term holding place for license to specifically invoice in one quarter, but the invoice due date straddles the quarter, so its really short term depository.

Brent Thill – UBS

Okay. And just to be clear, there is no change in the contract term or the billing. The majority of the contracts are billed annually, correct?

Karen Blasing

The majority of them are. We have mentioned that on some individual cases, much line Nationwide, we are invoicing that on a quarterly basis, so you don’t see the full amount of the annual fees that will be charged to our customer every sitting, but its only a quarter of it and there are a handful of other contracts that are on that quarterly basis as well.

Brent Thill – UBS

Okay, so your effective backlog is way better than what we can see then.

Karen Blasing

The backlog is much better, because we may have only built a quarter of the annual amount to any one customer, not to mentioned all of the other years under contract, some of those customers is completely off the balance sheet. So differenced revenue only includes amounts that has been build, not the unbilled, but firmly committed fees due from our customers.

Brent Thill – UBS

Okay. And just one quick follow-up and thanks for taking the time on the follow-up. The $10 million litigation payment, is that a one-and-done?

Marcus Ryu

One-and-done, and so that was complete settlement of the essential lawsuit. The only thing that’s still remaining really is a $20 million possible payment that could be made to Accenture if in the court they are able to overturn in an appellate process, the judgment that was ruled against them.

At this stage we think that Guidewire still will prevail. We have not reserved that and we also don’t anticipate that that’s going to get resolved anytime soon. It’s probably likely to be many quarters before we’d have the absolute resolution under that.

Brent Thill – UBS

Thanks for the follow-up

Operator

That does conclude today’s question-and-answer session. Mr. Ryu, I will turn the conference back to you for any additional or closing remarkets.

Marcus Ryu

Thank you all for participating on our call today and we look forward to speaking to you again soon. Goodbye.

Operator

Ladies and gentlemen, that does conclude today’s conference. We thank you again for your participation.

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