Guidewire Software's (GWRE) CEO Marcus Ryu On Q4 2014 Results - Earnings Call Transcript

Sep. 2.14 | About: Guidewire Software, (GWRE)

Guidewire Software Inc (NYSE:GWRE)

Q4 2014 Earnings Conference Call

September 02, 2014, 5:00 pm ET

Executives

Karen Blasing - Chief Financial Officer, Treasurer

Marcus Ryu - President, Chief Executive Officer, Director

Analysts

Nandan Amladi - Deutsche Bank

Brent Thill - UBS

Brendan Barnicle - Pacific Crest Securities

Sterling Auty - JPMorgan

Matt Van Vliet - Stifel

Ken Wong - Citigroup

Alex Zukin - Stephens

Operator

Good day, and welcome to the Guidewire fourth quarter fiscal 2014 earnings conference call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Karen Blasing, Chief Financial Officer. Please go ahead.

Karen Blasing

Good afternoon, and welcome to the Guidewire Software's earnings conference call for the fourth quarter and full year fiscal 2014, which ended on July 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 SEC. 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 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, 2013, and our subsequent quarterly reports on Form 10-Q which are 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. Additionally, we are providing detailed reconciliation data as well as recurring revenue calculations in a supplement posted on our IR website at ir.guidewire.com.

To be aligned with peers, the company changed its policy for recognizing stock-based compensation expense from the accelerated attribution method of accounting to the straight-line method of accounting for its time-based units in the fourth quarter of fiscal 2014. This change in accounting method has been retrospectively applied to all prior periods presented herein. Two years of historical financial statements reflecting this change are in a supplement on our website. Therefore comments made in today's call on GAAP profitability for prior and future periods are based on the new straight-line method.

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 on our fourth quarter and fiscal year financial results and our outlook for fiscal 2015.

Marcus Ryu

Thanks, Karen. Our fourth quarter results exceeded expectations for both revenue and profitability and featured progress on multiple dimensions toward a market leadership position. Total revenue grew 22% from a year ago to $118 million, including better-than-expected results on all three revenue lines. The metric we use to evaluate our longer-term performance, recurring license and maintenance revenue measured on a trailing-12 month basis grew 21% to $182 million. Our revenue upside fell to the bottom line with fourth quarter non-GAAP earnings of $0.37 per share. I would like to review the quarter in the context of full-year goals and then comment on our ambitions for 2015 and beyond.

Our goals in 2014 were; one, to expand our global reach with investments in sales and marketing; two, to extend our track record of successful implementations while leveraging our large SI partner ecosystem; and three, to achieve early market traction with our new offerings in data management, mobile, and portals, and Guidewire Live hosted analytics apps. These goals are facets of one central ambition, to lead the transformation of the global P&C industry with software products core to the insurance lifecycle. Achieving this would entail a position of central relevance to the business strategy and IT investments of hundreds of insurers, and thereby to the $2 trillion industry we serve.

To this end, our sales and marketing investments during the year were directed toward more comprehensive account coverage of every insurer in the geographies in which we are active, building pipeline and deepening our regional presence, especially in Europe. During the quarter, we achieved a host of new sales, with both new and existing customers for both InsuranceSuite and our newer products. As with all our sales, these were demanding long-term efforts in which we worked to align with each insurer's strategic goals as they planned a major capital investment of a multiyear transformation program.

Our fourth quarter deal with the Hartford is an illustrative case of how these programs can entail multiple transactions with Guidewire. For Hartford, a leading Tier 1 all lines insurer with over $10 billion in P&C premiums, licensed ClaimCenter in fiscal 2013, and then in the fourth quarter expanded the PolicyCenter, BillingCenter, and our data management products, DataHub and InfoCenter.

Another Tier 1 win during the quarter was the selection of ClaimCenter by Erie Insurance, a $5 billion carrier with over 4 million policies enforced. We also had several other wins in the quarter with $1 billion insurers. Endurance Specialty Insurance with operations in London, Zurich, and Singapore, extended the relationship with Guidewire to become an InsuranceSuite customer after having selected ClaimCenter earlier this year. MetLife Auto & Home, a well-known insurance brand-name with $3.5 billion in P&C premiums, selected InsuranceSuite in its entirety. Economical Insurance, a $1.8 billion Canadian insurer, selected PolicyCenter and BillingCenter for a full replacement of multiple legacy core systems. And Texas Mutual, a $1 billion leading workers compensation insurer, extended their relationship with Guidewire by adding PolicyCenter and BillingCenter to become a full InsuranceSuite customer after their enterprise go-live with ClaimCenter earlier this year.

While many of these wins with large insurers were in North America, we closed new business in all three of our theaters in the fourth quarter. Some of our other international wins included Farmers' Mutual Group in New Zealand, Mutuelle Saint-Christophe in France, and P&V Assurances, a group of six insurers in Belgium. In aggregate, we added 26 new customers during the year ending with 183 insurers in our customer community who have selected at least one Guidewire product.

Our market penetration can be further measured by the 82 insurers who have now selected more than one Guidewire product, up from 61 at the end of fiscal 2013. Among these, we now have 69 PolicyCenter customers up from 50 a year ago, 151 ClaimCenter customers up from 131 a year ago, and 82 BillingCenter customers up from 61 at the end of fiscal 2013. Our product strategy of building best in class applications, working together in a unified core systems suite is validated by the breadth of these additions as well as the growth in full InsuranceSuite customers from 34 a year ago to 48 at the end of the quarter.

Another market penetration metric is total direct written premiums under management, which increased by 11% from $235 billion at the end of fiscal 2013 to $260 billion at the end of fiscal 2014, reflecting approximately 13% of total global industry premiums. This metric, combined with our market intelligence, supports our belief that we are still in the very early days of an industry transformation. The large majority of P&C insurers are still to upgrade to modern core system software in the coming years in order to compete in an increasingly automated and digital marketplace.

The fourth quarter was also significant in extending our most important differentiator, our track record of successful customer implementations. In the fourth quarter, we had several significant go-lives worldwide, including ClaimCenter at two Tier 1 customers, the Hartford and Nationwide. Santam, South Africa's largest insurer, went live with PolicyCenter and BillingCenter. PZU, the largest insurer in Poland, went live with a major rollout of two additional business lines. Then in the U.S., Mercury Insurance went live with additional lines of business while Southern Farm Bureau went live with ClaimCenter and BillingCenter. During fiscal 2014, we had a total of 27 additional customer go-lives versus 25 in 2013. We now have 127 customers live with at least one Guidewire product.

Fiscal 2014 was also an important year for services team operationally. While reaffirming the critical role that our service consultants play as leaders of Guidewire implementations, we continued our focus on building SI partner credentials while also expanding our network in order to scale our services delivery capacity without expanding our own services team. During the year, our partners added approximately 600 consultants supporting Guidewire, bringing the total now to over 4,300. In 2015, we plan to continue our strategy to transfer a greater proportion of implementation projects to our SI partners as they continue to build their credentials. This represents progress toward our long-term goal of increasing license and maintenance as a percentage of total revenue.

On the product front, we are seeing the P&C industry start to evince many of the same strategic themes transforming other industries, namely sophisticated market segmentation, multichannel distribution, customer self-service, and of course data centricity and analytics. Because it serves as a system of record for products, policies, claims, and all insurance financial transactions and in many cases the customer record, Guidewire InsuranceSuite’s core capabilities are crucial to these transformation initiatives. However, we also see considerable opportunity to offer new products, leveraging InsuranceSuite and directly advancing these aims as evidenced by the traction in the newer products we have invested in over the last two years, data management, mobile and portal solutions, and analytics on the Guidewire Live SaaS platform.

At the end of the fiscal year, we have 35 customers contributing to Guidewire Live and 20 customers using our data management technology along with several early adopters for each of our portal offerings. As we indicated last quarter, we are increasing technology investments directly toward two goals, one advancing InsuranceSuite to position as the most functional and broadly adopted P&C operating platform in the industry, and two further developing our portfolio of products that leverage InsuranceSuite's mission critical role for the insurers who have adopted it. At this point, these product investments entail that operating margins in fiscal 2015 will not be as high as our 2014 results, which were well above original expectation. However, we believe the greater operational leverage will be achieved from achieving and leveraging an industry-standard position for our platform overall.

In summary, we are pleased with the quarter and fiscal year that delivered revenue and profitability well ahead of our initial expectations while expanding the number and breadth of our customer relationships. So our better-than-expected topline results, and continually moderation of services revenue will make comparisons in fiscal 2015 more challenging. We are optimistic that we can grow term license revenue at our long-term goal of approximately 20%. We are energized by the opportunities ahead, both for Guidewire and the enormous global industry that we serve.

I will turn it now to Karen for further financial details.

Karen Blasing

Thank you, Marcus. We are pleased to report that our results for the fourth quarter exceeded our revenue and earnings expectations. Total revenue was $118.2 million, a 22% increase from the fourth quarter of fiscal 2013. Within revenue, license revenue was $65.9 million up 34% from a year ago. Fourth quarter revenue included $6.6 million in perpetual license revenue, up from $4.2 million in the fourth quarter of 2013. Perpetual revenue was higher than expected in the fourth quarter with a new perpetual license agreement from an existing customer in the fourth quarter. We had anticipated that, that transaction would be a term license. Maintenance revenue, which is recognized ratably throughout the year, was $11.9 million for the fourth quarter up 21% from a year ago, reflecting overall license growth trends. Services revenue was $40.4 million, up 6% from a year ago, as our strategic partnering data model with system integrators continues to grow and we shift towards a higher mix of license and maintenance revenue as a percentage of total revenue to improve our gross margins.

Our high annual revenue visibility is driven by the recurring nature of our multiyear term licenses and ongoing maintenance agreements, both of which are typically billed annually. Recurring term license and maintenance revenue totaled $181.8 million in fiscal 2014, up 21% from $150.4 million for fiscal 2013. Geographically, the U.S. represented 65% of revenue in the fourth quarter, with 35% of revenue coming from outside the U.S. For the full fiscal year, our U.S. revenue represented 58% of total revenue while International was 42% compared to 43% of revenue from outside the U.S. in fiscal 2013. Even though our large and growing presence in U.S. makes it hard for other geographies to impact the overall mix, our investments in EMEA showed kind of paying off with fiscal 2014 revenue from that territory increasing to 21% of revenue from 16% in fiscal 2013.

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. I would also like to point out an accounting policy change that impacts our GAAP results. Whereas we had historically expensed stock-based compensation on an accelerated basis, we have updated our accounting to now expense stock-based compensation on a straight-line basis for our time-based awards. This brings our accounting policy in line with industry peers. Comments on our GAAP profitability are based on the new method.

non-GAAP gross profit in the fourth quarter was $83.3 million, an increase of 30% on a year-over-year basis and representing 70.4% non-GAAP gross margin, compared to 66.1% in the year ago quarter. Breaking that down, in the fourth quarter, non-GAAP gross margin for license was 98.9%, maintenance was 82.6% and 20.4% for services. Overall, our non-GAAP gross margin increased as a result of our shift in revenue towards higher margin license and maintenance revenue as we rely more on our SI partners for service implementations, as well as improvements in maintenance and services gross margin levels.

Turning to operating expenses. Total non-GAAP operating expenses were $45.6 million in the fourth quarter, an increase of 22% compared to a year ago. This resulted in non-GAAP operating income of $37.6 million, which was up 42% on a year-over-year basis and above expectations as revenue upside flowed to the bottom line. Non-GAAP operating margin was 31.8%, an increase from 27.3% in the year ago period. Non-GAAP net income was $26.4 million or $0.37 per share, compared to non-GAAP net income of $16.6 million by $0.27 per share in the fourth quarter of 2013.

Looking at our results on a full-year basis. Revenue of $350.2 million in fiscal 2014 was up 17% from the prior year. For the full year, term license and maintenance revenue represented 52% of revenue compared to 50% in fiscal 2013, and we expect our revenue mix to continue to shift even more rapidly toward term license and maintenance in fiscal 2015. Full year non-GAAP gross margin was 61.6% compared to 60.9% in fiscal 2013. We continue to expect to see a gradual uptick in non-GAAP gross margins as we shift our revenue mix toward higher-margin license and maintenance revenue. Non-GAAP operating income was $62.4 million, up 12% from a year ago and represented a non-GAAP operating margin of 17.8%, well ahead of our original target of approximately 6%.

Turning now to our balance sheet. We ended the fourth quarter with $647.8 million in cash, cash equivalents and investments, up from $60.1 million at the end of the third quarter, primarily due to cash flow generated during the fourth quarter. Operating cash flow was $49.4 million in the fourth quarter and $75.5 million for the fiscal year 2014. Our total deferred revenue was $55.3 million at the end of the fourth quarter, compared to $58.3 the end of the third quarter. As a reminder, 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 the due date. 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 contracted business and our best-in-class renewal rates provides us with a high level of visibility towards fiscal 2015 revenue today.

Now I would like to turn to our outlook for fiscal 2015, which is consistent with the initial view we provided last quarter. We anticipate total revenue for fiscal 2015 to be in the range of $364.2 million to $381.9 million, representing an increase of 7% over fiscal 2014 at the midpoint. Within revenue, we believe that license revenue will be in the range of $168.3 million to $180 million, an increase of 11% to 18% from fiscal 2014. Consistent with our comments last quarter, we believe that term license revenue will grow at approximately 20% in 2015 and the perpetual license revenue will be an insignificant amount. We expect maintenance revenue to be in the range of $47.9 million to $49.9 million, an increase of 17% at the midpoint, reflecting overall license revenue growth in fiscal 2014. We expect services revenue to be in the range of $148 million to $152 million, down slightly from 2014 as we complete a few large PolicyCenter implementations, and engage more heavily with our system integrator partners on recent wins.

In terms of geographic mix, we recognize that international success is key to our long-term growth and although sales cycles in new territories are inherently longer, we continue to make progress as we are increasingly recognized for our best-in-class solutions. As we discussed on our third quarter call, we plan to significantly increase R&D investments in fiscal 2015 to invest in enhanced and new software products increasing the size of our available market opportunity. We plan to increase investments in sales at about the same pace as in fiscal 2014, as we steadily make progress in new geographies like Europe. As a result, we do not expect operating margin levels to be at the same levels as we saw in 2014, as we continue to invest in sales expansion and enhance and new product offerings, though we expect an improvement from our original expectations for fiscal 2014.

We expect full year non-GAAP operating income in the range of $39.2 million to $50.4 million, which would produce a non-GAAP operating margin of 12% at the midpoints of our revenue and operating income outlook and it represents an improvement from the original fiscal 2014 expectations, but will be lower our actual 2014 results. We expect to continue to achieve better margins beyond fiscal 2015 as we grow the contribution of recurring term license and maintenance revenues as a percentage of total revenue. We anticipate non-GAAP net income in the range of $25.5 million to $32.7 million or $0.35 to $0.45 per share, based on an estimated dilution average basic share count of 72.3 million shares. We anticipate an effective non-GAAP tax rate of 35% for the full year.

On a GAAP basis, which includes an estimated $54 million of stock-based compensation expense under the straight-line method and $1.4 million in amortization of intangible assets, we anticipate a fiscal 2015 operating loss of between $16.3 million and $5.1 million and a net loss of $10.9 million to $3.4 million or an EPS loss of $0.16 to $0.05, based on an estimated weighted average basic share count of 70.5 million shares. We anticipate an effective GAAP tax rate of approximately 33% for the full year.

From a seasonal perspective, we expect quarterly term license revenue as a percentage of annual revenue to be similar to what we experienced in fiscal 2014, with the fourth quarter being the period that we naturally have a significant portion of our annual billings based on the timing of customer invoicing and contracting activities which is generally the basis for the recording of license revenue.

Looking at the first quarter of fiscal 2015, we anticipate total revenue to be in the range of $71.5 million to $78.5 million, an increase of 13% from a year ago period at the midpoint. Within revenue, we expect license revenue to be in the range of $23 million to $27 million, maintenance revenues of $11.5 million to $12.5 million and services revenue of $37 million to $39 million. I also want to point out included in our revenue guidance for the first quarter is approximately $4 million in revenue from one customer that has been held in long-term deferred revenue as revenue recognition criteria have been met since the start of Q1. Of this amount, we expect $1.8 million in license revenue, $1.9 million in services and $0.4 million in maintenance revenue.

For the first quarter, we anticipate non-GAAP operating income to be between $1 million and $5 million and non-GAAP net income of between $0.7 million and $0.3 million or $0.01 to $0.05 per share, based on an estimated diluted weighted average basic share count of 71.7 million shares. Unlike recent years, where Connections, our annual user conference have occurred in the first quarter, in fiscal 2014 Connections will occur at the beginning of the second quarter, shifting some sales and marketing expenses from the first to second quarter as compared to fiscal 2013.

Our non-GAAP operating income and net income expectations for the first quarter include approximately $12.6 million in stock-based compensation expense and $0.4 million in amortization of intangible assets in the first fiscal quarter. Including these non-cash expenses, we anticipate a GAAP operating loss between $12 million and $8 million. We anticipate a GAAP net loss between $8 million to $5.3 million or an EPS loss of $0.12 to $0.08 per share, based on an estimated weighted average basic share count of 69.4 million shares. We anticipate an effective non-GAAP tax rate of approximately 35% and a GAAP tax rate of approximately 33% in the first quarter. We expect to use cash during our first 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.

In summary, we are pleased to report fourth quarter and full year results ahead of expectations and we remain focused on expanding our market leadership position and capturing opportunities trough strategic investments in 2015. We believe our leadership position will help us to achieve strong recurring revenue growth and expand our profitability in the years ahead.

Operator, can you now open the call for questions?

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from Nandan Amladi with Deutsche Bank.

Nandan Amladi - Deutsche Bank

Hi, good afternoon. Thanks for taking my question. The first question is on the upsells that you have made and expansion of the full suite. Can you talk about how the cadence of your revenue recognition varies from a fresh sale to a new customer, perhaps that has bought one or two modules versus a customer who might then add more modules, because your DWP under management presumably doesn't change that much of a new upsell in existing customer like the revenue terms.

Karen Blasing

Nandan, it's an excellent question. So that's correct. The way we count DWP is the amount of license that we have under contract. So if the first time the customer buys ClaimCenter, the DWP under that contract is what we report. When they come back and buy PolicyCenter as an upsell opportunity, the amount of DWP doesn't change. It simply means that we have sold more product now under that DWP. So the cadence is very similar to -- so the revenue occurs in the second purchase just like it does in the first, and the license revenue for each purchase is recognized on the invoice due date, typically annually.

Nandan Amladi - Deutsche Bank

But you are still not -- the implementation schedule does occur separately, right? Because of your (inaudible)?

Karen Blasing

That's correct. That's absolutely right, and the service revenue is recognized typically on a time and materials basis, for both the first sale as well as the subsequent ones.

Nandan Amladi - Deutsche Bank

Thank you. And on the system integration partner network, an addition of 600 seems a little bit smaller than we might have expected. So the question is, do you have enough capacity to deliver the big pipeline that you have during fiscal year 2015 or do you need to bring more certified integrators into the fold?

Marcus Ryu

I would say, that we do have enough capacity to meet the demand. Of course, we are also always looking for efficiencies in our implementation methodology. That's one of the many respects in which our interests are closely aligned with our customers to have a more efficient project and for our customers to be able to do more of the project entirely on their own or with their own staff. There have also been cases, historically where particularly in a new geography where the first customer -- where the training of the partner will kind of happen in parallel with the initial implementation and will play a larger role in terms of our participation. So sometimes that will be another catalyst for getting more systems integrator partners enabled. But the headline answer to your question is that we feel confident we can meet the customer demand with a combination of our services team and the SI network that we have.

Nandan Amladi - Deutsche Bank

Thank you.

Operator

And next will be Brent Thill with UBS.

Brent Thill - UBS

Good afternoon. Marcus, on PolicyCenter, I believe the numbers you gave that you still have not penetrated half your install base with Policy, and I am just curious how you think about the pipeline for PolicyCenter going into this year? I just wanted to make sure I understood the metrics correctly that PolicyCenter is still carrying a 50% to 70% higher pricing versus the core ClaimCenter. Is that similar to kind of what you are seeing now in the pricing? I had a quick follow-up for Karen.

Marcus Ryu

Sure. I think your facts are all on target. You are right about the pricing, the pricing for PolicyCenter versus ClaimCenter as well as the fact that of the 183 customers we have, now 69 of them have licensed PolicyCenters, so that is indeed less than half of the total, but we have seen very strong uptick in PolicyCenter from 50 to that 69, and across our pipeline, you will see demand for all of our products represented pretty close to equally. It's a good position that we are in today that we can be responsive to whichever priority the customer has first and the maturity of the product is not really a factor because it's just understood that they are all well adopted mature products that work together, can be implemented in any sequence, and sometimes that leads to a policy project first, sometimes to a claims one, sometimes the billing one and all of that is to the customer's benefit.

I think you asked about – I think you had another question, but I might have missed it there. Or do you have one for Karen?

Brent Thill - UBS

Yes, I guess just as it related to the demand for you on the policy side. Are you seeing momentum building there? I guess, for Karen, the big question from investors right now is, your model makes sense that you are shedding the lower margin services business. However, your guidance certainly doesn't imply that that's going to happen given that you are taking the margins down in 2015. You saw a modest margin decline over the last year, but I am just curious to the magnitude of the margin decline relative to your position and then relative to the offload, just it's counterintuitive why we keep going down. So I am just curious, and if I can add more color? I know there are a lot of questions around that.

Karen Blasing

Sure. So let's start with the gross margin side of the house. So gross margins naturally get better as services revenues as a percentage of total revenue is a smaller part of that mix and because we enjoyed very substandard of gross margins on our license and our maintenance fees of it. We do recognize, however, that it takes a while actually for that shift of services revenues to come down, and therefore you will see that impact actually affected in the gross margin line. Most of the place where we are actually making investments is really in the operating expenses and that's with a pretty substantive investment that we are making in our research and development team. What we found is that we hit the market some of the recent products that we have made out there and seemed to be getting pretty good traction on that. So we need to we hire engineers now to really build out those product lines and that will take operating expenses. We believe that we have early indications those products are going to sell quite well and so that's why we continue to invest additional amounts in products and that's the bulk of why our operating margins would be coming down.

Brent Thill - UBS

Okay, just a quick one follow-up. Do you look at a floor when you would say to investors, we inherently think this business is 10% margin business as a flight. I think the worry is that you keep taking the margin lower and, and so it is everyone's understanding that are you saying this is about a floor or you are going to keep raising this every single year. There has been many companies that have given for us so just maybe something that you want to picture going forward?

Karen Blasing

Yes. We haven't discussed actually an up floor. Certainly every year when we have discussed what our guidance would be for operating margins, they tend to be a bit more modest than the actual results were in the current year that we just finished out. And again, because we think we still have such an opportunity in this marketplace that we think it is well worthwhile to flesh out the additional products in that space.

Brent Thill - UBS

Great. Thanks.

Operator

And next will be Brendan Barnicle with Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

Thanks so much. Marcus and Karen, the rolling four quarters recurring revenue grew 21%. We saw that back in Q2 but that is a bit little bit lower than what we had seen in prior quarters. I know you had a tough compare last year, where it grew 44%, what are some of the puts and takes that are going into that deceleration?

Karen Blasing

Sure. So let's talk about FY 2013 first, the 44%. So one, we had a couple of very large wins in fiscal 2013 where we get the benefit of not only the license revenue in that year, but both of those transactions were closed pretty early in those years as well. And so we get the benefit of 12 months with our maintenance revenue for those transactions as well. And so that added quite a bit to the benefit.

In fiscal 2014, yes we did have some sizable transactions that were completed as well, but they were not closed as early in this fiscal year. So we got the benefit of the license but not as much of the maintenance because not as many days were left to expire from the date of the contract. So that had some natural effect of actually reducing the amount of growth in that year as well.

And the other thing is the denominator just keeps getting bigger year after year in any of these recurring revenue companies. So fiscal 2013, probably a little higher because of the items that we discussed. Fiscal 2014, we think is a very solid performance of growth in that recurring revenue.

Brendan Barnicle - Pacific Crest Securities

Karen, is there any way to look at like normalized for timing, what would might be a better comparable growth rate to that 21%? Is there a certain amount that impacted?

Karen Blasing

Let me think about it, Brendan, and see if there is a way that we could express that. As you know, we are having our Analyst Day coming up on September 18 in New York City that will be broadcast as well. And let me put some pen to paper there and we will have a fuller discussion about it at that point.

Brendan Barnicle - Pacific Crest Securities

Great. That would be helpful. And then Marcus, during the quarter, you had a turnover in the head of product development. I was wondering if you could give us a little more color on that transition?

Marcus Ryu

Sure. That was Jeremy Henrickson. He has been with the company for a very long time, just about a decade in fact, and he presided over along a very successful things that happened in the organization from scaling the development team from about 70 or so to the 330-some professionals the work in the team now, as well as many successful product releases. It is really motivated by the desire to well, first that we have to manage a much more complex product portfolio, including investments in new products and it's also motivated by a desire to incorporate newer technologies and to make sure that our platform stays current with the latest developments in the industry that we operate in. And it seemed like a good moment for the company to expand the breadth of its product leadership with a much larger team and a more complex product portfolio.

Brendan Barnicle - Pacific Crest Securities

Great. Thanks, guys.

Operator

And next will be Sterling Auty with JPMorgan.

Sterling Auty - JPMorgan

Thanks. Hi, guys. I want to focus on three areas. Let's start with the professional services revenue. You mentioned a couple of contracts that rolled off, but what other things do you see specifically in the plan for 2015 that will cause a greater percentage of additional services revenue to move to the integrators? Because obviously we thought we are going to get more of that movement in 2014 and yet you upsized, most people's expectations, in term services revenue throughout the year.

Marcus Ryu

So you question, Sterling, is what are the factors that would went into the equation of figuring out a range for services revenue in the current year. So there are a multitude of factors. One is the contracts that Karen alluded to that have a fairly substantial impact, jus tin percentage terms, because of the way they are structured and the way the revenues flow to our P&L, and Karen can elaborate on that. At a business level, we are really on the same trajectory that we have been on now for a few years with SI enablement and enthusiasm for the market.

I think it's fair to say that for all of the SI partners that we have in our ecosystem, which are basically all of them but our primary competitor in Accenture, that we are the premier software solution partner that they are going to market with and all of them have very enthusiastically invested in their practices, their practices in order to meet the demand that they see. So trying to guess exactly what portion of the revenue that we will get in every project and exactly the expectation for Guidewire resources versus SI resources is a little bit of an art and that that number is interesting, but generally in the direction of greater partner resources over time. And we expect that that trend will continue.

Then the other factor, of course, is just overall demand, the number of projects we expect and the distribution of that demand, because projects in newer geographies tend to take more Guidewire resources than ones in more mature geographies like Canada or the U.S. and when putting those together leads to a picture of services revenue that's roughly flat to a bit down going into next year.

Sterling Auty - JPMorgan

Okay, and then the second question is, Karen you mentioned, there was a contract that went perpetual that you expected to be term. Can you quantify what that takes away from the license revenue or what the license revenue impact in FY 2015 is from that going perpetual instead of term?

Karen Blasing

Sure I can, Sterling. So we had really helped that this existing customer that we would be able to convince them to sign a term license with us instead of a perpetual license like they had for the first purchase. At the end of the day, they wanted to really exercise that right under their original contract. And so they end up buying perpetual from us. So it wasn't a new customer. It was an existing contract situation that would have to back again to their legal team and they just got more comfortable wanting to buy that old contract. So it does take away because it's perpetual license revenue that's recognized this fourth quarter, it is no license next year because it's perpetual along the term but we do get the benefit of the higher maintenance revenue associated with that without perpetual license that we will enjoy from now going forward. So one of the thing about our perpetual licenses is still those come with a good healthy amount of recurring maintenance revenue. It's the full amount of the perpetual license revenue of $6.6 million. So its roughly between $4 million to $5 million.

Sterling Auty - JPMorgan

Okay. So that's a negative impact to license. Even if you net out the maintenance, it's a negative to revenue in FY 2015 to the tune of about $1 million? Is that fair?

Karen Blasing

To the tune of about $4 million to $5 million.

Sterling Auty - JPMorgan

Okay. To just FY 2015. So FY 2015 revenue would have been $4 million to $5 million higher if they went with a term license?

Karen Blasing

That's correct.

Sterling Auty - JPMorgan

Okay. Thank you. And then the last area is, talking about the margins, at the 12% midpoint operating margin, I think that's increase in total expenses of about somewhere in the neighborhood of $40 million, which I would guesstimate is somewhere in the high 100, approaching 200 heads to increase. Obviously its not all headcount related in terms of that expense increase, but even if it's a 175 people, it seems like a healthy jump, because that would have to be the full-time equivalent on board for the entire year. Is there something that's changing in your hiring policies, et cetera that you feel that you can onboard that level of people if you get to that level of expense in FY 2015?

Karen Blasing

So a couple of things. One, there is obviously a higher commissions expense anticipated in 2015 as well with higher bookings associated to achieve that growth. So as that fair amount of the increase. The second thing is, all the people that we hired in fiscal 2014, we now actually have the 12 month full cost of those in 2015. So its not jus the incremental hires in this current year. You already see the (inaudible) effects of that.

Sterling Auty - JPMorgan

Yes. Maybe the better way to ask is, what is the hiring plan then for FY 2015 in terms of headcount?

Karen Blasing

So broadly speaking, it is still about at 20% increase in research and development for engineers and its roughly the same size as sales and marketing headcount growth that we saw this year, and that's somewhere around the 20% mark.

Sterling Auty - JPMorgan

In terms of numbers, what does that equate to, if you don't mind?

Karen Blasing

So roughly, hold on just a minute, let me get that for you. So it's kind of pretty close to it, a couple hundred people that we would hire in fiscal year. That's all the expectation.

Sterling Auty - JPMorgan

Okay. Great. Thank you, guys.

Karen Blasing

With most of them being in research and development and then an expansion of the sales team as well.

Sterling Auty - JPMorgan

Right. All right. Thank you.

Operator

And next will be Tom Roderick with Stifel.

Matt Van Vliet - Stifel

You have Matt Van Vliet, on for Tom. First question with relation to Guidewire Live and what your roadmap is there for continuing to expand that? And then additionally, some of the data management products, and how much of the incremental R&D spend do you see focus there so that as we look at it on a year-over-year basis for the core business, how does that impact?

Marcus Ryu

Sure. So significant investments ahead on both data management and in the hosted analytics platform, which is Guidewire Live. Those are two separate things. The data management being focused primarily in operational reporting and more conventional BIA enterprise data warehouse, whereas what we are doing with Guidewire Live being a different category of data visualization and predictive analytics. It's working with syndicated data. So all data related but different domains of it that require two different technology approaches in our view. We have significant investments ahead in both. Broadly speaking, I would say between the core suite and some of the newer initiatives that we have alluded to something like maybe a 70/30-ish kind of split in terms of development effort allocations coming into the year.

Matt Van Vliet - Stifel

Okay, and then switching to the Tier 1, both deals you were able to get closed this year and looking forward at the pipeline, what was the sales process at the Hartford to expand to the full suite? What was the timeline there? And how do you see that playing out at other Tier 1s? And then I guess maybe growing on that, how much of the pushoff to the SI community and maybe reducing the overall cost for the services is helping you benefit on the sales process for some of these large deals?

Marcus Ryu

Sure. The two Tier 1s that we highlighted in our remarks here were a bit different. Hartford is an existing relationship. They just had a very successful go-live of their claims implementation and it's an aggressive rollout across operations. And naturally we had relationships that came from that interaction and that whole transformation program, though the policy evaluation was on the other side of the house with a different set of strategic goals primarily growth oriented. The contract at Erie which is a net new name, one that we have been talking to for quite a long time but was a full-blown competitive side-by-side comparison of the market and was more conventional net new relationship that we have to develop on the merits versus competitors directly. Sometimes that's the case even with an existing relationship, where they have licensed one product but really want us to compete vigorously to be awarded the next opportunity. Sometimes as things flow more organically from one program to the next phase of it, and that was somewhat more the case at the Hartford.

The other aspect of your question was the role of systems integrators in the sales process. Systems integrators are certainly important to the sales process, in that the implementation, the scale of it, the actual mechanics of it, are a huge portion of what an insurer has to grapple with and evaluate before moving forward with the project. But in general, the software evaluation is one that we are leading that we are the ones doing all of the presentation and customer facing activities with and its only after the customer has made a selection about technology platform that the implementation side of the equation is really evaluated hard. So the activities with the partners are important in that we have to have robust relationships, but for the most part we are really achieving the sale, at least of the license really on our own merits.

Matt Van Vliet - Stifel

All right, great. Thank you.

Operator

And next will be Walter Pritchard with Citigroup.

Ken Wong - Citigroup

Hi, guys. This is Ken Wong for Walter. First on the margins. I am just wondering, kind of building out what Sterling was asking, as you thing about 2015 versus 2014, how much transparency on the OpEx do you in terms of, is a lot of it dependent on hiring versus stuff that's rolling through from fiscal year 2014? Because as you think about 2014, you guys did deliver a lot of upside on the margin side and trying to get a sense of whether or not that something similar could happen in 2015 or if the cost are a little firmer than you guys were expecting in 2014?

Karen Blasing

Let me respond to that, Ken. So we have pretty good visibility on 2015. Obviously we have all the existing headcount. We still have a very low attrition rate. So we have a pretty good beat on what our employee expenses would be. So the two wildcards in here always are, how fast can we actually achieve the hiring goals that we want to, and we have been working very tightly with both the hiring managers as well as our human resources training team. So we have got an enhanced, I would say, management view of our capabilities of hiring to our goal. The second thing is obviously commissions. Because we expense commissions at the time of new bookings, so who wins in those new bookings, if its concentrated in a few of the reps who are significantly exceeding their quotas, then commissions end up being a little bit higher. If the commissions, as we hope are spread across more sales rep winning in the marketplace, our commissions expense is a little bit lower as well. So that's a little bit of a variable wildcard that can happen in that basis. And then thirdly, we really try, as a management team, continue to do things better, faster, cheaper. We were able to do that last year in a number of areas. The one area I will call to note is in the translation of our products to eight significant languages. We made some significant savings in how we can plan to do that and we continue to look at ways on how we can manage those programs so that we can deliver more and spend less on that. So that's a mantra that we try to deploy throughout the company as well.

Ken Wong - Citigroup

Got it, and that's very helpful. And then, I guess, also on margins, gross margins you expected them to expand. Within there, should we expect that pro-serve margins should stay in this kind of 20s range? Or does that start to trend down as you deemphasize it?

Karen Blasing

It would certainly depend on the quarter and the number of projects that we are working on. But I think we are at pretty good service margins now around the 20% mark. We have an increased focus with the new head of professional services there. Mike Polelle is giving a really good eye on it. And he is also balancing the mix of employees that we have as well as the number of prime arrangements where we have some larger contracts which have required us to use, say, local contractors and the mix of all that. So he has got a good read on it.

Ken Wong - Citigroup

Got you, and then a quick question for you, Marcus. You mentioned earlier longer sales cycles in EMEA. Anything you guys doing to shorten this? Is this something that gets solved from expanding coverage or just more of a regulatory environment in Europe that's causing some of this?

Marcus Ryu

I would say that the length of the sales cycle is not really that influenced either by the degree of account coverage or by regulatory factors. It's certainly a macroeconomic factors and how flush various insurers in different geographies are feeling about their business prospects, of course. But the most important factor that's somewhat under our control is our market stature, our stature in that market. How well we are regarded? How well we are believed to understand the requirements of the market, the kind of credentials that we have established through our relationship and successful projects and the like, which is why we play such a disproportionate emphasis, you might say, on the early customers that we win in new geographies, because they become so important, absolutely critical, in fact, for others to follow. Sometimes there is even a strange effect where winning one customer or one or two customers early on in a market causes others to pause and to wait until they see the successful result of those first few customers and we have seen that multiple times in different geographies including places like the U.K. and Canada. And then either you have you demonstrated your bona fides with those first few customers, then others would follow with more confidence and that's a pattern that we seem to see in every geography.

Ken Wong - Citigroup

And I guess, on that, is there a way to accelerate that process, whether it's by just buying a more local vendor? Or is it really just keep chugging along with the strategy that you guys have had and just prove that you guys are the better player here?

Marcus Ryu

Well, like politics, they are ultimately local in one sense, but we are trying, as we grow in presence in the market, we have other means to project or to support the confidence of carriers evaluating us. For example, our user conference, we place a very heavy emphasis on the international customer community and brokering conversations between like-minded carriers or very similar ones that may have absolutely no -- may operate in radically different theaters, but actually have a lot in common with the IT challenges that they are going through and that's proved to be very, very useful technique to match a Japanese carrier with a Canadian one and have them talk about their challenges. So we do a bit more of that. And I think the opportunity to do that increases our customer community increases and as the percentage of total industry represented by our customer base increases. But ultimately we have to we have to win it and prove it in each geography by itself at some level.

Ken Wong - Citigroup

Got you, all right. Thanks for answering my questions, guys.

Operator

And next will be Alex Zukin with Stephens.

Alex Zukin - Stephens

Yes, hi guys. Two questions for me. Looking at the growth of DWP and the distribution of that growth between new and existing customers, I guess first off, what was that distribution and how did this compare to your internal expectations and maybe at a high level, what does that outlook look like for next year?

Marcus Ryu

Right. Broadly speaking, though we expect something like a two-third, one-third mix in terms of opportunities between new names and existing customers. I would say, over this last year, we were a bit heavier towards current customers than the new names, but we don't identify any pattern in that. That's just the variance inherent in the number of transactions that we do. And going forward, if you were to look at our pipeline, you would see something like that roughly two-third, one third or 60/40 kind of distribution between net new names and an existing relationship, at least at a transaction count level. But part of that is also that our newer products are ones that we naturally sell to our existing customers. They are relevant once you have implemented one or more of the core applications in the suite and as we build more products of that sort, that may have a different kind of influence on how many on the transaction count that we get from current customers versus new ones. But in terms of insurance suite sales, we still expect to get more sales from net new names than our current ones, simply because there are many more out there that have not yet bought our software or done anything indeed with respect to their legacy core systems yet.

Alex Zukin - Stephens

Got it, and then a question about the pipelines. Particularly if you look at your pipeline, is there any particular sub-segment, top of funnel, middle or low that you can comment on in terms of being strong or ahead of your expectations?

Marcus Ryu

I would say that we have expanded the top end of the funnel more during the last year than any other segment in proportionate terms. That's partly because we have more sales and marketing coverage, I think partly because there is a recognition more broadly across the industry that legacy systems aren't going to sustain them through the next chapter of ambitions they have whether it's a digital strategy or more data centric and analytics oriented strategy, or simply just to meet customer expectations. And so there are many more conversations I think that are sparked simply by budget competitive factors as opposed to sheer frustration with their internal environment which is always a source of motivation for the conversations we have. But the number of transactions that we do or that we are in pursuit of in any given year is never a huge number. They are large significant transactions, each in their own right. And so there is just a variance there both in the pipeline and in the specific transactions we close in any given period.

Alex Zukin - Stephens

Helpful, and then finally just on the competitive environment. Any kind of changes that you observed in the fourth quarter and maybe around win rates and just competition in general that you can talk about?

Marcus Ryu

Nothing specifically in the quarter. We continue to compete very vigorously against the same set of competitor that we have faced for years. We have been very disclosed about our primary competitor in the market being Accenture and that's been the case pretty much from the company's founding. They are the one competitor that we encounter in multiple geographic theater. And then there are various more regional competitors that we would tend to face either in one country or one region. No specific changes in that. And we saw a win rate that was very consistent with what we have had in previous years. Neither a real improvement or a degradation.

Alex Zukin - Stephens

Got it. Thanks, guys.

Operator

And that does conclude the question-and-answer session. I will now turn the conference back over to Marcus Ryu for any additional or closing remarks.

Marcus Ryu

No other comments. Thank you all for joining our earnings call.

Operator

Thank you. That does conclude today's conference. We do thank you for your participation today.

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