Curtis Smith - CFO Marcus Ryu - CEO

Monika Garg - KeyBanc Capital Markets Jesse Hulsing - Goldman Sachs Sterling Auty - JPMorgan Taylor Reiners - Piper Jaffray Justin Furby - William Blair Rishi Jaluria - D.A. Davidson Tom Roderick - Stifel Nicolaus Brad Sills - Bank of America

Good day, and welcome to Guidewire's Third Quarter Fiscal 2018 Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Curtis Smith, CFO. Please go ahead.

Good afternoon, and welcome to Guidewire Software's earnings conference call for the third quarter of fiscal year 2018, which ended on April 30, 2018. My name is Curtis Smith. I am the 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, both of which are available on the Investor Relations section of our Web site at ir.guidewire.com. As a reminder, today's call is being recorded, and a replay will be available following the conclusion of the call. During the call, we will make forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 regarding trends, strategies and anticipated performance of the business, including additional information related to our recent acquisition activity. These forward-looking statements are based on management's current views and expectations as of today, and should not be relied upon as representing our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. Actual results may differ materially. Please refer to the Risk Factors in our most recent Form 10-K and 10-Qs filed with the SEC. We will also refer to certain non-GAAP financial measures to provide additional information to investors. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are posted in a supplement on our IR Web site. During the call, we may offer incremental metrics to provide greater insight into the dynamics of our business. These details may be one-time in nature and we may or may not provide updates in the future. With that, let me turn over the call to Marcus for his prepared remarks, and then I will provide details on our third quarter results before providing our outlook for Q4 and fiscal 2018. Marcus and I will then take your questions.

Thank you, Curtis. Our third quarter financial results exceeded our revenue and non-GAAP profitability guidance ranges, with total revenue of $140.5 million and non-GAAP earnings of $0.05 per share. Momentum with cloud-based solutions continued in the third quarter. Almost 50% of our year-to-date new sales are subscriptions, and we continue to be at the high-end of our prior communicated rage of 30% to 40%, with nearly all of the remainder coming in the form of traditional recurring term licenses. The transition to cloud-based solutions continues for both the P&C industry and for Guidewire. Cloud-based core systems and a delivery model in which the solution is delivered by the vendor in production are still relatively new concepts for P&C insurers, but we are seeing broad interest in all regions and from all segments of our market. Smaller insurers have been earlier adopters of cloud core systems, but the benefits of simplification and risk transfer are just as compelling to large and midsized insurers. Cloud implementation should enable us over time to reduce the total cost of ownership for our customers through more standard implementation and integrations and the leverage of cloud-native architectures. Our market experience strongly suggest that lowering TCO combined with the transfer of risk and complexity away from our customers' operations to a trusted partner will increase the rate of market adoption. Cloud adoption comes at a time when insurers and their CIOs are challenged with managing extremely ambitions technology project agendas with finite resources and management bandwidth. By transferring non-differentiating core operations to Guidewire, our clients can focus their resources on driving value for policyholders by delivering new products and digital engagement. Cloud economics are also compelling for Guidewire, because we are compensated for bearing that additional risk and complexity with annual subscription fees that are substantially greater than comparable annual term licenses. Although we are still in the early stages of price discovery, we expect cloud deployments to drive a material expansion of our TAMs as both existing and new customers are attracted to the convenience, efficiency, and value that cloud-based core systems offer. The shift to cloud deployments also enables us to ensure that customers are on the latest release of our software, which avail some of the full benefit of our R&D investments and reduces our maintenance burden. So we're very excited about the opportunity, and customers are excited as well, as reflected by the adoption of InsuranceSuite Cloud in the third quarter by two existing customers. One of these is a Tier 1 insurer who will be using InsuranceSuite Cloud to drive premium growth in a new line of business. The other is Grinnell Mutual, a regional insurer based in the Midwest, which had already licensed InsuranceSuite and has now opted for Guidewire to implement and manage it as a cloud-delivered solution. Looking at sales activity beyond InsuranceSuite Cloud for the quarter, we again enjoyed a mix of activities from new and existing customers. In the quarter, we added five new insurers to our customer community, four of whom selected InsuranceSuite, including an international business unit of Travelers, the second-largest writer of U.S. commercial property and casualty insurance and also a leading provider of auto, home, and business insurance. Ayr Farm Mutual based in Ontario, Canada, a provider of auto, home, farm and commercial insurance selected a broad set of products, including InsuranceSuite, Datahub, InfoCenter, and our digital products. Argentina's La Segunda Co-op, a group of companies offering P&C, group life and retirement selected InsuranceSuite, business intelligence for InsuranceSuite, and client data rating and reinsurance management products. Also in North America, IAT Insurance Group, a specialty insurance company based in Texas, licensed PolicyCenter and rating management. In addition to these four, we added an InsuranceNow customer, Farmers Union Insurance, a mutual insurance company serving farmers, ranchers, homeowners, and businesses across North Dakota who selected our all-in-one cloud-based solution InsuranceNow to replace their current core solution. We also continue to gain traction with our digital and data products; 13 existing customers selected one or more of these in the quarter. In addition to sales momentum, we had an active quarter for implementations, with nine customers going live with InsuranceSuite, InsuranceNow, data or digital products during the quarter, and four customers having major version core upgrades. Turning to products, last month we announced the latest release of Guidewire insurance platform. This release includes enhancements to our core data and digital and all-in-one product families, along with more than 80 ready-for-Guidewire validated accelerators. Collectively, these product enhancements and third-party solution additions enable insurers to reinvent customer, agent, and employee experiences. We also announced availability of our first P&C insurance CRM applications for Salesforce Financial Services Cloud. These applications will be natively integrated to FSC and enable P&C insurers to unify their core, digital, and CRM strategies with much less complexity. Finally, our leadership continues to be recognized by the industry, as demonstrated by our winning two awards for policy administration by industry analysts Celent. In summary, our third quarter performance reflects continued momentum in the marketplace including continued adoption of products across the Guidewire insurance platform, and notable successes with the selection and implementation of InsuranceSuite Cloud. Adoption of our cloud services as well as the robust attach rates of our digital and data products continue to validate our platform value proposition and contribute to our growth. We look forward to our customers' and prospects' reception of the many products we are releasing this year, as well as celebrating the great progress many of them are making in their transformation initiatives relying on Guidewire. With that, I'll turn it over to Curtis to detail the financial results of our third quarter.

Thank you, Marcus. We had an active Q3. We exceeded our guidance ranges on both the top and bottom line. We successfully completed a capital raise, and we closed two new InsuranceSuite Cloud customers. As a result of this cloud momentum, and as noted by Marcus, almost 50% of our new sales year-to-date were subscription, and we continue to expect to be at the high-end of our prior communicated rate of 30% to 40% of this year's new sales and subscriptions. We know that seasonally high Q4 activity will have a large impact on the final percentage. We are also on track to add four to five InsuranceSuite Cloud deals this year with three closed year-to-date. Total revenue for the quarter increased 14% from a year ago to $140.5 million. Within revenue, license and other revenue of $50.4 million represented a decrease of 15% from a year ago. As a reminder, a very sizable recurring payment from one of our Tier-1 customers was recognized in Q3 last year, but will be invoiced for payment, and therefore recognized in Q4 in this and subsequent years. In addition, approximately $4.6 million of revenue that was expected in Q3 was recognized in Q2 due to earlier payments last quarter. Perpetual revenue in the third quarter was $5.7 million. Maintenance revenue was $18.7 million, representing 11% year-over-year increase and at the midpoint of our guidance range. As we shift toward cloud subscription services, we do expect maintenance growth rates to moderate as ongoing maintenance activities are included in the subscription fees. Our rolling four quarter recurring revenue consisting of term license, subscription and maintenance revenue totaled $334.4 million in the third quarter, up 10% from a year ago. In Q3, this metric was significantly impacted by the quarter shift in invoicing for the customer I just referenced. Additionally, as we have mentioned previously, our ongoing transition to subscription and the eventual adoption of ASC 606 in fiscal year 2019 make this metric less relevant to our business. After this fiscal year, we will no longer highlight rolling four quarter recurring revenue as a key metric. Services revenue was $71.4 million, a 50% increase from a year ago, and also above our guidance range. Faster services growth in the quarter was driven by three primary factors: greater demands for Guidewire services personnel and in some of our initial InsuranceSuite Cloud implementations, inclusion of and growth in InsuranceNow implementation and hosting services following the acquisition of ISCS, which did not incur until partway through Q3 of last year, and recognition this year of previously deferred services revenue. Turning to profitability, we will discuss these metrics on a non-GAAP basis, and we have provided the comparable GAAP metrics and reconciliation of GAAP to non-GAAP measures in our earnings press release issued today with the primary difference being stock-based compensation expenses, amortization of intangibles, the amortization of debt discount and issuance costs from our convertible note, and the related tax effects of these adjustments. Non-GAAP gross profit of $77.5 million decreased 4% from a year-ago and represented the non-GAAP gross margin of 55.2%, compared to 65.1% a year ago. The expected decrease in margin was due primarily to the previously-mentioned payment shift of a Tier-1 term customer as well as the increase in our services revenue and investments in our cloud operations. The non-GAAP operating expenses were $75.2 million in the third quarter, an increase of 19% compared to a year-ago. This increase was primarily driven by continued investments in R&D and sales. Impact of our recent acquisition of Cyence, and to a lesser extent, the work associated with several large infrastructure projects, including new ERP and configured price quote systems and related implementation expenses. This resulted in non-GAAP operating income of $2.3 million, which was above our guidance range, primarily due to higher-than-anticipated revenue and modestly lower-than-anticipated expenses in the current period. Non-GAAP net income was $3.9 million or $0.05 per diluted share, compared to non-GAAP net income of $12.3 million or $0.16 per diluted share a year ago. Turning to our balance sheet, we ended the quarter with $1.2 billion in cash, cash equivalents, and investments, up from $569.5 million at the end of our second quarter, primarily due to $571 million in net proceeds adjusted for the cost of the cap call from the financing we completed in the third quarter. In addition, operating cash flow in the third quarter was $20.2 million, and free cash flow was $19 million. Total deferred revenue was $134.6 million at the end of the third quarter, an increase from $130.9 million at the end of the second quarter. As a reminder, our deferred revenue balance can vary widely from quarter to quarter and has not been a meaningful indicator of business activity since we typically bill term license contracts annually and recognize the full annual payment on the due date. However, deferred revenues will likely sustain higher levels as we increase sales of subscriptions, though we expect deferred revenues to continue to be highly variable. The growth of deferred revenue in the quarter was in part attributed to higher license deferred revenues generated by subscription sales. Now, turning to guidance, first, let me address our expectations for the full-year, I will then speak to Q4 and finally I will make some high level comments on fiscal year 2019. For the full-year, we now anticipate total revenue to be in the range of $647 million to $653 million, an increase of 26% to 27% from fiscal 2017. We expect annual license and other revenue to be in the range of $306 million to $312 million, an increase of 13% to 15% from fiscal 2017. Our license and other revenue is being impacted by our transition to cloud based subscription sales, which as noted earlier we expect to be at the high end of our previously communicated 30% to 40% range. Compared to term and perpetual licenses, we can recognize only a portion of the annual subscription invoices in the initial year due to ratable revenue recognition. Additionally, we expect perpetual license to be -- expect perpetual license revenue between $9 million and $10 million for the year, a decrease from $13 million last year. Our outlook for maintenance revenue is $76 million to $77 million. Services revenue continues to be elevated in fiscal 2018. In particular, cloud implementations and our work on -- for new European customers currently require greater Guidewire participation. Our outlook for services revenue is $262 million to $266 million. The required build-out of services process and best practices to support the cloud will require increased services support that cannot all be passed on to the customer. As a result, we expect services margin to be between 18% and 19% this fiscal year. Due to higher profitability in Q3 and our higher revenue outlook, we are raising our non-GAAP operating income guidance for fiscal 2018 to $104 million to $110 million. We're also increasing our free cash flow guidance for the year to $115 million to $125 million. In addition, we are raising our outlook for non-GAAP net income to $83.3 million to $87.7 million or $1.05 to $1.11 per diluted share based on approximately $79.3 million diluted shares. Turning to Q4, we anticipate total revenue to be in the range of $234 million to $240 million. Within revenue we expect license and other revenue to be in the range of $141 million to $147 million maintenance revenue of $19 million to $20 million and services revenue of $71 million to $75 million. For the fourth quarter, we anticipate a non-GAAP operating income between $78 million to $84 million and non-GAAP net income between $58.8 million and $63.2 million or $0.72 per share to $0.77 per share based on approximately 82 million diluted shares. Looking ahead now to fiscal 2019, we want to provide some preliminary qualitative commentary; unless otherwise stated, all of our commentary is based on our adoption of ASC 606 on August 1st of 2018. As we have discussed in the past, the transition to subscription contracts and the adoption of 606 have an impact on our outlook for 2019. And this outlook is very much evolving. We will spend more time discussing this on our Q4 call and during our Analyst Day in September. With respect to top line, fiscal '19 will be impacted by a number of factors; two primary factors positively impacting growth. Subscription revenue associated with contracts sold in fiscal '18 will increase in fiscal '19 since we will be able to capture the full annual value of these contracts when compared to a partial year amount in fiscal '18. And new term license contracts will recognize two years of annual license amounts due to our standard contracts being two years of duration at signing, coupled with annual auto renewals. Under 606, we will typically recognize the full two-year contract value upfront. These positive factors will be offset by growth in new subscription sales, which will result in lower revenue recognized in fiscal '19 due to ratable revenue recognition as well as two accounting effects associated with our adoption of 606; the first, amounts due in fiscal '19 for two-year licenses sold in fiscal '18 will not be recognized as revenue and will be accounted for as retained earnings. And two, revenue lost to retained earnings due to existing long term customer contracts that we are not able to modify to annual auto renewals. Netting these factors, we expect license and other revenue to grow modestly faster than in fiscal 2018. This assumes subscription contracts will be approximately 40% to 60% of new sales. At this mix and assuming the successful modification of remaining long-term contracts, we expect 606 will have a net neutral impact on license and other revenue. With respect to total revenue, we expect growth to taper slightly as services revenue growth begins to normalize in 2019. Turning to profitability, there are three primary factors putting pressure on operating income and operating margin in fiscal year '19. First, gross margin will be lower due to transition to the cloud and continued elevated services revenue as a percent of the total mix. Second, we previously indicated that 2018 would be a year of investment as we migrate to the cloud and invest in R&D and cloud operations to support this transition. We have spent less than initially anticipated year-to-date in 2018, largely due to headcount additions being slightly back and weighted in 2018. In 2019, we expect to slow our hiring and digest the investments made. However, the full impact of the investments made this year will be reflected in our operating expenses in 2019. Third, we continue to expect Cyence to be diluted to our operating income in fiscal 2019. As a result of these factors we do not expect to see operating margin expansion in 2019. As we have mentioned in the past, cash flow and other metrics will be key indicators of progress moving forward and further discussed at our analysts day. In summary, we executed well in the third quarter to deliver the revenue and profitability that exceeded our guidance levels. We are optimistic that we will see a seasonally strong fourth quarter and that we remain well-positioned to continue capturing a meaningful share of the multi-billion dollar opportunity ahead of us. Thank you. Operator, can you now open the call for questions.

Thank you. [Operator Instructions] And we'll take our first question of the day from Monika Garg with KeyBanc.

Hi, thanks for taking my question. First, I just want to confirm, I remember last time you gave us a metric like each 10% higher mix of subscription is about $3 million to $4 million negative impact to license revenue. Given that, that mix is almost 10% higher than your previous guidance, is that the right way to think about negative impact on the license?

I think that's one way of looking at that. We have done some sensitivity around that, looking at different ranges, and we are currently expecting to be at the high-end of the previously-announced range of the 30% to 40%. And as we have that, as we move to the higher end of that range and have more subscription, we do then see less revenue come in given that it's ratably recognized.

Got it. And then, Curtis, the ASC 606 impact for next year what you talked about, could you share how much is the negative impact on the license because of ASC 606 change, like a dollar amount, like -- any metrics you can share quantitatively?

Yes. So we did do some preliminary analysis of that and we're not sharing those numbers here, but we'll spend some more time on that when we get to our Q4 earnings call, and when we talk about metrics going forward and impact of 606 going forward in our Analyst Day. One thing we did note though when we provided the preliminary commentary on '19 is when we take both the puts and the takes from 606, both the positive and the negative along with the subscription as a percent of revenue range we're expecting in fiscal '19, which is now the 40% to 60%, we believe that taking that all into account that there is a net neutral impact from 606 on license and other revenues.

Got it. Thank you so much. That's all for me.

Next, we'll hear from Jesse Hulsing with Goldman Sachs.

Yes, thank you. Marcus, it seems like you're seeing a pretty big step up in interest from new customers and existing customers on expansions for your cloud product. I'm wondering if you've given much thought to extending cloud beyond just new business and migrating the base, and if that were to happen, what would the timing of that look like?

Absolutely. Migrating the base is an important expected portion of the demand that we have ahead of us, and some of the acceleration in demand has been stimulated by us because we actively have been initiating these conversations, not necessarily with the mind to transacting on them in the near-term, but so that our customers understand our strategic direction and can start thinking about their overall deployment strategy as they roll our the current projects they may be enrolled in or future products they may license from us. It's very early in the transition. We're at low single-digit number of InsuranceSuite Cloud customers out of a customer base of hundreds of insurers. But our expectation is that over time a very large portion, quite possibly a majority or even a significant majority of our customers will want the kind of division of labor that's involved in our cloud deployments as preferable to them. I think we have quite a few degrees of freedom in modulating the speed at which that happens. And obviously we would never make commitments that we could not follow through with confidence. But I think we'll be much more -- I think if anything we will be constrained by our own appetite to follow through on that well than it will be by customer demand.

Yes. And Curtis, a question for you, given the multiple puts and takes next year on growth with the subscription transition and the ASC 606, and just in the lumpiness of your contracts already playing into that, have you given thought to any metrics beyond what's being provided? You mentioned retiring trailing 12-months recurring revenue. I'm wondering if you've given any thought to ARR or some sort of metric to replace that to give us a little bit more visibility into demand quarter to quarter.

Yes, and thanks for that question. We spent some time in the last past quarter talking to investors and analysts about what metrics might be helpful from their standpoint to better understand the progress we're making as we transition to a cloud business. And some of the things we've provided already. Just as a reminder, the number of IS Cloud deals, and so we confirm that that number this quarter that we're expecting four to five IS Cloud deals this year, and added two in the quarter. Another metric that we've been sharing is subscription as a percent of new sales. And in the quarter, we confirmed that 30% to 40% range with the expectation for us to land at the high end of that range this year. In the past, we've also talked about breaking up and talking to subscription as a percent of license and other revenue. And we pointed to at the end of year that's getting pretty close to 10% when that happens that we intend to break that out in fiscal year '19. To your question, on the other key metric, the ARR ACV, it's clearly one that is at the top of our list to be thinking about and to be potentially adding to the mix to give you a better idea of how the progress we're making in the transition to cloud. And so our expectation is to talk about that more during analyst day and potentially on the Q4 call.

Fantastic. Thank you both.

Next, we'll hear from Sterling Auty with JPMorgan.

Yes, thanks. Hi, guys. First one for you Marcus, for an InsuranceSuite Cloud customer, what do the implementation times that you expect to be like for a brand new customer, and what is the implementation time for an existing customer shifting into the cloud?

I appreciate the question, Sterling, because it's a chance to remind and to those listening that, at least at this stage, there is no meaningful acceleration in implementation time for a cloud-based project versus our traditional on-premise one. And that's because the main drivers of implementation effort are our configuration and integration, and those are not meaningfully different in a cloud world. But what we do -- we do believe that we have a lot of levers to drive higher standardization. That's something that we've been working on earnestly for years now, and we're doubling our effort every year to urge customers and to give them strong professional guidance about the importance of conforming to a more standard solution. And of course, we're evolving our platforms to be evermore complete. And in the cloud modality we think that we'll have -- that that will be able to advance that further, as well as make certain architectural advances in the product that will really leverage cloud scalability and [technical difficulty] architecture and so forth. So over time it's not only our expectation, it's our mission to significantly reduce the cost of ownership, and to simplify and standardize projects. But that will take time to evolve. And for the time being programs are really very comparable in duration to what they are now. And we've talked about this many times in the past. There's a lot of variation between our customers depending on what products they're implementing and with what scope and so forth, but typically we want our core system -- our significant core system transformation program to go live in something like 12 to 18 months from the start.

That's great. And as we think about the significant increase in revenue that you would get from a existing customer moving into the cloud, how should we think about how that layers in. And what I mean is, if you have an existing full InsuranceSuite customer are they going to move claims, and then once claims is in the cloud move policy. Or would they do the entire InsuranceSuite insurance line by insurance line or geography by geography, just so we can understand how we might see the increase in the revenue associated with the customer moving in to the cloud.

Yes, that's a thoughtful question. I think that the sort of minimum unit of transition will be one of the core applications, policy, claims, or billing. It really wouldn't make sense to migrate slices of a claims implementation or slices of a policy implementation. But it's quite possible that a customer would opt to do one core application at a time versus the entirety, though there may be cases where they would try to shift multiple at the same time. And of course we have large complex customers that may have more than one instance of our core applications because their businesses are disparate and may even operate semi-independently of each other. So there's going to be -- it's very case-by-case, but I think again the minimum unit will be a transition of one of the core applications to the cloud. And as we've talked about in the past, something somewhere between 2X-2.5X to 3X kind of improvement or increase in the annual recurring revenue to Guidewire, but now coming in subscription form would be our expectation from where we sit today.

Got it. Thank you.

Our next question comes from Alex Zukin with Piper Jaffray.

Hi, this is Taylor Reiners on for Alex. I had a question for Marcus. I wanted to dig in on the Salesforce announcement from a couple of weeks ago, that you now have two applications for their Financial Services Cloud. So wondering if you could speak to any early indication to tractions that you've seen in that area, and then maybe any updates that you have for us from a go-to-market standpoint and any potential joint early customer wins? Thanks.

Sure. So the Salesforce partnership is a highly strategic one for Guidewire. We're not in the habit of announcing lots of partnerships with other technology companies. They tend to be very difficult to implement successfully at a product level, and then of course there's go-to-market complexities. Salesforce is a very notable exception to that because of their -- obviously their tremendous market traction and the awakening of interest over the last few years in the P&C industry to rethinking, sometimes dramatically, their whole approach to CRM. And then quickly following that is the recognition that any kind of CRM initiative they undertake has to be deeply integrated with the transactional and operational core, which is of course what we do. So there's a very natural complementarity between our businesses and our value propositions, though it did take us a few years to mutually persuade each other of that. But now I think we're completely on the same page, and are working together in stride. And there has been like a very encouraging level of interest across the industry, including internationally for this connection. And I think the expectation of a lot of insurers is that they would -- that we would productize this integration and solve that complexity for them rather than them doing it themselves. And at a go-to-market levels it's -- they are a great organization to work with. They're enormously successful and professional sales teams that we can complement with our deeper industry understanding, as well as now a very coherent complementarity of value proposition.

Got it. Thank you.

Next, we'll hear from Justin Furby with William Blair & Company.

Thanks guys. Marcus, I thought the Travelers announcement I think in the international markets in Europe was interesting because I don't think you have a relationship with them, at least here in the U.S. And I guess I'm just wondering more broadly speaking what the cloud does for you in terms of just strengthening your Tier 1 pipeline. And then second to that, can you just give some sort of update on overall bookings versus your expectations in the quarter. I guess, with all the moving parts it's sort of hard to get a sense here. And then I've got one quick follow-up for Curtis.

Sure. So with respect to the -- I mean the relationship between cloud and the Tier 1, I would say Tier 1 insurers as just as interested as any other segment in the market in disburdening themselves of some of the complexities of their core environments. And some Tier 1 insurers are really in aggregation of multiple smaller businesses that work under one corporate umbrella. And it's very -- we think it's extremely likely. In fact, we're already seeing this happening, that some of those individual divisions will -- who kind of think of themselves actually smaller insurers will be motivated to transition more quickly to the cloud for the same reasons that a completely standalone smaller insurer would be, namely that they just don't have the bandwidth to undertake all the different transformation programs that they want to do in data, and analytics, and digital engagement, et cetera. And so the cloud delivery model becomes increasingly appealing to them. So I think as we mature this model and as we have references to show for it, and especially as we reduced total cost of ownership, I think we're going to see acceleration across all segments motivated by the cloud, including the Tier 1. There was another portion to your question that I just forgot.

Yes, just around overall bookings in the quarter in terms of how they came in versus what you expect.

Yes, as you know, we think of bookings very much in an annual cycle, which is also, I think, explains some of our reticence around bookings metrics because it's challenging enough to corral that on an annual basis, and it's kind of daunting to think about doing so and reporting on a quarterly basis. So that's some of the hesitation you hear from Curtis and me on that score. But specifically with respect to this year on an annual basis, I think we feel really good about how things have gone. And across the board, across InsuranceSuite, InsuranceNow, the data products, the digital products, the active conversations around the newer things we're doing like Cyence and Salesforce partnership, which will be a licensable addition -- which is a licensable addition to our product portfolio. And it's the breadth as well as the quantitative aggregate of the demand that's been really encouraging. That said, we have a lot of work ahead of us still in the remaining two months of the year. And sales execution will be extremely important if we're going to fulfill that commitment.

Got it. Thanks for that. And then, maybe just quickly for Curtis. Really appreciate the initial read for next year. I guess just wondering on the services line though if you could, because it's such a big number for you guys, just wondering if there's any high level commentary? I think the Street said it's sort of a 20% growth number. Is that sort of a reasonable way of thinking about next year for now or any other framework would be helpful. Thanks.

Yes, so we commented that the subscription growth level this year was unusually high, and we expect that to begin to coming back down to normal levels next year and in the coming years. So that's part of the guidance that we provided around the services line. And we'll be able to talk in more detail about that too in the Q4 call and in the analyst call as well.

Okay, got it. Thanks very much guys.

Next, we'll hear from Rishi Jaluria with D.A. Davidson.

Hey guys. Thanks for taking my question. I guess Marcus, starting with you. As you look at the potential M&A landscape here, be it larger acquisitions like Cyence or smaller tack-in technological acquisitions. I mean, no secret that we've seen some very elevated multiples and in software and technology in general just wanted to kind of get your viewpoint on what you're seeing out there? How that sort of M&A pipeline looks, and if there's - how you're thinking about maybe valuation, and where there's opportunities. And then I have a follow-up for Curtis.

Sure. Yes, as you know, if you've followed [ph] all the insurer tech phenomenon over the last few years it's certainly a very target rich environment. Far more opportunities and in early stage technology companies then I would personally have ever imagined serving -- even explicitly focusing exclusively on the P&C industry. It's an utterly different landscape than when the company was started some decade-and-a-half ago. So that's a -- it's a very interesting vector of exploration for us that we had not put a lot of mindshare towards in previous years. But now through the very natural partnerships that we have for lots of analytics and digital offerings that naturally complements our transactional and operational platform in InsuranceSuite, as well as just our location here in Silicon Valley where the preponderance of the insurer tech phenomenon that's happening. And kind of the -- put it this way, our statue in the industry and the fact that we have so many prominent names in our customer community. All of these things help us be I think in an advantaged position for these conversations, and allow us to be very patient in making the right choices and not overpaying to the degree that's possible in this environment. One individual in my team that's well known to most of the community on this call, Richard Hart, leads that whole evaluation and management of the pipeline, and he's very busy with a lot of conversations, but he's also extremely disciplined about valuations. And I think that's served us very well so far in the deals that we've consummated to date.

Okay, thanks. That's helpful. And then Curtis, appreciate the color on next year and helping us break down all the moving parts with subscription and ASC 606. In terms of 606, I mean I understand revenue impacts basically awash. From an OpEx standpoint, should we expect some benefit from 606 on the OpEx side which is maybe offset from increased subscription deals and higher services mix shifting a drag on gross margins?

Yes, so with more subscription, right. And we guided preliminarily to a 40% to 60% of new sales and subscription. That will have an adverse impact on gross margin and then operating margin. So that's part of what we were factoring in when we provided the guidance around our operating margin, that we did not expect to see operating margin expansion in 2019. And then we noted some other things. Obviously we continue to invest in the cloud and the cloud transition. We noted that some of the investments we made this year were to some extent backend loaded. We'll see the full-year impact of that in 2019 that we didn't necessarily see in '18. And so those are some of the things that we preliminary took at look at when we gave some guidance that we don't expect to see operating margin expansion in 2019 from sort of the guidance we've provided today for the full-year.

Okay, thanks. And sorry, just to clarify. So from just 606 alone is there any benefit on the OpEx side from the adoption of 606, or is there no change there?

Modest but -- potentially modest, yes.

Okay, perfect. Thanks guys.

We'll move on to Tom Roderick with Stifel.

Hey gentlemen, thanks for taking my question. So Marcus, I wanted to just build on that earlier question about Salesforce.com. Given that in your prepared remarks you highlighted the transformation journeys that a lot of your customers are undertaking to the cloud, and really updating their offerings. And we hear very similar remarks from Salesforce which highlighted some very big deals in insurance just recently. If we think about what's driving some of these transformation journey, particularly for your bigger customers and in thinking about sort of two choices that drive this. One sort of being inside-out starting with policy, and claims, and billings, sort of inward facing functions, as opposed to outside-in, the digital functions that face the consumer, which of those two options are driving that? And with respect to that, can you talk a little bit more about the integration points with Salesforce's FSC?

I think the motivations for core system replacement and undertaking digital transformation, there are many unvaried, but they are also kind of consistent across companies. So what I mean by that is there are lots of frustrations that can vary from organization to organization with the specific deficiencies of their systems -- specific frustrations they may have with their current system environment i.e. they cannot - they can't instantiate the product that they want to sell, or there is limitation in their system environment that prevents them from selling in a particular market or adjusting their pricing with a frequency that they think they need to be competitive, or their customer engagement value proposition is eroding, because the bar has been rising so much faster than they were able to keep up with. And so, the specifics of which concern is most urgent will definitely vary, but it's a menu of maybe five to eight themes that we hear over and over again across our entire customer and prospect base that are strikingly similar, and they are -- very positively for us they continue to grow in urgency. Now, where CRM fits into that is I think a recognition by insurer that they need to think about their policyholders not just as units of risk, which insurers are excellent at doing, modeling what financial exposure each customer might represent an underwriting carefully, but also as customers and consumers and who want to be catered to life events with different preferences about how they want to behold in service et cetera. And the need to have a much more customer-friendly or omni-channel like experience that the customers now expect from a retailer or other financial services world has really come with condition to the industry. And that requires marrying two quite disparate domains, the very horizontal CRM -- and I should say, like functionalities that you have in the Salesforce. And then the transactional and operational platform that we have in insurance, which really need to intersect at the moment that you don't just want to look for information but actually want to transact on either an existing customer or potentially new customer. So, that transactional intersection is where we have -- where our customers want us to build product type integration between us and Salesforce. And so what we're doing is natively embedding Guidewire data entities and transactional loads into Salesforce Financial Services Cloud, so that natively in Salesforce screens you can -- you are seeing Guidewire data, and we think that that will be compelling to a very large array of -- very large segment of the industry, I should say. But it requires some fairly heavy lifting at the product level, so that it's a true native integration and not just punching out into different screens.

Makes perfect sense. That's really helpful detail, thank you. Curtis, follow-up question just around the number, so targeting now on the subscription side, sort of high-end of the 30% to 40% range for new sales for the year, can you break out -- and apologies, if you've done this before, I don't think you have, but if we think about sort of the InsuranceSuite Cloud versus InsuranceNow, so the four to five high-end customers you hope to win on ISC as opposed to the myriad of Tier-3 and lower customers that you might see on InsuranceNow, how should we think about the rough split that drives that that high-end of the 30% to 40%? And maybe a better way to look at it is what's a typical average deal size for InsuranceSuite Cloud as opposed to InsuranceNow, just any direction you can give us on the split there would be really helpful. Thank you.

Yes, thanks for the questions, Tom. We haven't broken that out or provided detail around sort of where the segmentation around that 40% to 50% among peers as they wanted Tier-4 or InsuranceSuite Now versus other. And so, that's not something we've historically talked to, something that we consider going forward as we continue to evaluate some of the different metrics that might be helpful for investor community to better understand our progress in the cloud, and that's one that we consider when we start to prepare for our Analyst Day in September in our Q4 call.

I'll ask again, it's September. Perfect, thank you.

Next we'll hear from Brad Sills with Bank of America.

Hey guys, thanks for taking my question. One, please on digital and data, just if you could illustrate for us maybe some scenarios or used cases where customers have gone really deep there, you know, what does the deployment look like over time, and what are some of the scenarios that they're using digital and data for? And then, with the move to the cloud represent a potential catalyst for adoption of those offerings? Thanks so much.

Thanks for the question, Brad. So you can think of digital as externalizing all of the data, all of the products, the pricing, the underwriting business logic, the transactional flows, everything that happens at the heart of the core systems that we build, but externalizing all of that to participants outside of the four walls of an insurer, of course you can extend that all to your own employees, but the primary used cases are to the distribution channel, namely brokers and agents that are still a hugely important part of how insurance is distributed. And then, also directly to policyholders either for point of sale or equally importantly for customer service, which can mean policy maintenance or it can mean claims. And really what you're trying to do is enable a much more contemporary potentially human or human-involved process, but one that is self-service and intuitive as possible to actually transact much more efficiently. And insurers have a sense of being behind-the-curve in delivering the contemporary consumer-grade experience that the people have been trained to expect from the likes of Amazon, Uber et cetera. And so, we divide our digital products into three families, one that support the distribution channel, which we call Producer Engage, one for direct-to-consumer as a policyholder engage, and then one for vendor partners such as body shops and others involved in the claim supply chain who have a need to interact with the insurance transactional flow. And these are very broad in appeal and we are experiencing very high attach rate with them pretty much across all geographies and market segments. On the data side, data is a huge frontier with many different dimensions to it, there's -- a portion of it is just managing the operational data and transactional data that's generated by the system and putting it into an operational data store that can be accessed by other enterprise systems. We call that product Data Hub. Then there is somewhat conventional business intelligence that naturally our customers want -- using that data, that's a product called InfoCenter. And then, we have been mining that data for statistical predictive insights with a different set of machine learning-based tools at Guidewire Predictive Analytics that increasingly we are embedding directly in the screen flows of the core system themselves. That's the principle that we call Smart Trends. And then, there are other data horizons beyond that, namely what we're doing with Cyence, which is to incorporate for the first time data from outside the enterprise that's generally out in the Internet and using it to build -- essentially build the profile of potential insurers in advance of actually having them as customers as you're making -- as insurers are making underwriting decision. And then, there's much more beyond that that we still aspire to. So we think of data and digital, not so much as products, but as product frontiers, where we can do a lot more with the current products we have as well as build lot of new one. Your question then was -- second was about cloud I think, and everything that we are building today, every major unit of functionality that we will be building going forward is cloud-based or cloud-native, cloud-only. So, all of the multiple of the data products are only available in cloud form, and we are in the process of transitioning all of our digital products as well to be cloud-delivered. And I think just as with the core itself that we expect that will accelerate adoption.

That's great. Thanks, Marcus.

We have a follow-up question from Sterling Auty with JPMorgan.

Yes. Thanks, guys. I just want to clarify a couple of items, so as we're all going to modify our models and incentives mix, including for fiscal '19, you mentioned that in respect to total revenue, expect growth to taper slightly in 2019, but against the taper of as compared to what growth rate in 2018, because you do have some acquisition-related revenue with Cyence, so I want to make sure we are all level set in thinking about which growth rate do we start with and then taper to come to the 2019 expectation?

Yes. So the growth rate - thanks for the follow-up question, Sterling, and so the guidance growth rate that we provided in the call for the full-year -- and that's when we're basing our '19 growth rate offer, is you know, the total revenue range we provided $647 million to $653 million, that's a 26% to 27% growth rate over 2017, and includes all revenue in that number. And so, what we talked about in terms of that high-level sort of preliminary commentary on our total revenue growth rates for '19 is we expect to taper slightly off of that 26% to 27% growth rate that we saw in '18 over '17. And that's partly due to -- to us seeing as noted earlier that services revenue growth begins to normalize, it was at sort of an accelerated level in '18, and we see that coming back down in '19.

All right, perfect. That really helps. And then, I want to take a step back, so when you guys began the work, and I know Curtis this predates you, but I'm sure Richard kind of gave you the full download. As you started to work on 606, the discussion was going back to the customers; customers typically I think had around a five-year average first contract length, and with 606 because of the high renewal rates you go back and re-work those deals, but I thought the idea was to get them on to one-year deal, so that with the upfront recognition you didn't end up with kind of a dramatic impact. So when you talk about the two-year term, is that - did customers want to not go to one-year, they want two-year for some reason? And for new customers if they choose term, are they also going with two-year, or is there an option to go longer or even shorter with one-year?

Yes. So we have made a lot of progress on modifying the existing customer's contracts to address this potential 606 issue. In many cases though it ends up being a two-year term, and that's part of I think what we were evaluating when we were trying to assess the impact of 606 on our 2019 numbers. And then, when we looked at that together with some of these other puts and takes we talked about, along with, now we're projecting to be our subscription as a percent of new sales mix bumping up the 40%-60%. We think overall, the impact on 606 will be net-neutral to license and other revenue. That being said, we know there are still some work to do between now and the end of the quarter, and we intend to fine-tune our thinking around that and provide updates in more detail when we get to our Q4 call.

Okay. And last question, subscription, because we have several terms being thrown around here, we have subscription, we have term, we have cloud; does subscription include all of the cloud licensing, or maybe flipping it around, is there subscription revenue that is not cloud, and if so, why does that get ratable treatment versus term?

That's a sample answer to that, Sterling, all subscription and cloud revenue are synonyms for us, and the all cloud revenue comes in subscription form and there is no subscription revenue that is not cloud-based.

Perfect. Thank you, guys. I appreciate it.

Thank you.

That will conclude the question-and-answer session. I will now turn the call over to Mr. Marcus Ryu for any additional or closing comments.

No additional comments, but thank you for all participating on our call today. Goodbye.

That does conclude today's conference call. Thank you for your participation. You may now disconnect.