Guidewire Software Inc

NYSE:GWRE

Earnings Call Transcript 2019-Q2

[Operator]

Good day, ladies and gentlemen and welcome to the Guidewire’s Second Quarter Fiscal 2019 Financial Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Curtis Smith, Chief Financial Officer. Please go ahead.

[Curtis Smith, Chief Financial Officer]

Good afternoon and welcome to Guidewire Software’s earnings conference call for the second quarter fiscal year 2019, which ended on January 31, 2019. 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 website 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. 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 obligations 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 also will 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 also posted in a supplement on our IR website. During the call, we may offer incremental metrics to provide greater insight into the dynamics of our business. These details maybe one-time in nature and we may or may not provide updates 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 results before providing our outlook for Q3 and fiscal 2019. Marcus and I then will take your questions

[Marcus Ryu, Chief Executive Officer]

Thank you, Curtis. Our second quarter financial results exceeded our revenue and profitability guidance ranges with total revenue of $169.3 million and non-GAAP earnings of $0.34 per share. It was an active Q2 for new subscription sales, which represented 53% in the second quarter and 47% in the first half of all new sales. As such, we believe we remain on track to see 40% to 60% of this year’s bookings to be close to subscriptions.

In the second quarter, we made progress against two of our strategic sales objectives, namely advancing momentum for InsuranceSuite cloud and Guidewire Digital for Salesforce. With respect to the former, we sold InsuranceSuite cloud to TD Insurance, our first InsuranceSuite cloud deal of the fiscal year. TD Insurance is part of TD Bank Group, one of Canada’s largest banks and the top three personal, home and auto insurer. They licensed InsuranceSuite and Guidewire Digital via Guidewire Cloud and will be upgrading and migrating their existing implementation of InsuranceSuite to Guidewire Cloud as part of their journey to better protect more Canadians and be the most trusted insurer in the country. Additionally, two existing InsuranceSuite cloud customers expanded their commitments with us. Grinnell Mutual expanded their use of Guidewire cloud to include digital and our largest InsuranceSuite cloud customer reaffirmed their commitment by increasing their minimum spend in future periods.

While there is considerable sales work ahead, this progress and the number and quality of discussions in which we are engaged informs our confidence regarding InsuranceSuite cloud deals this year, which we now expect will be between 5 and 8 in number. And most importantly that demand for Guidewire cloud will be enduring and broad-based across most or all segments of our market. Our ambition is to serve a major portion of the $2 trillion global P&C industry with a cloud-based industry platform driving standardization, contributory data and simplified integration to a marketplace of insurance technology partners. Consequently, it is imperative that we continue to build scale and customer referenceability for Guidewire cloud, which has led us to actively position somewhat steeper subscription ramps for deals in our cloud pipeline than we have historically for self-managed term licenses. A lower point of entry facilitates the journey for customers as they migrate on-premises instances of InsuranceSuite to Guidewire cloud and convert term license contracts into subscription. We in turn benefit in the out years from significantly higher annual subscription value as customers expand their production use of our platform in the cloud. In other words, this approach enables us to build scale and maximize the lifetime value of customer relationships in the cloud.

Turning to our partnership with Salesforce, we closed two deals with existing customers. One of the industry’s largest P&C insurers that distribute its products primarily through a large captive agency force licensed both components of our Salesforce offering ServiceRepEngage and ProducerEngage. We also sold ServiceRepEngage and ProducerEngage for Salesforce to P&C insurance in Belgium. This early traction validates the strategic rationale of our Salesforce partnership in unifying the domains of horizontal CRM and our P&C core platform to enable digital distribution and policyholder service.

Outside of cloud and Salesforce, we signed multiple new customers, among them PSA Insurance, a subsidiary of Banco Santander, who selected InsuranceSuite, Guidewire Digital and Data. PSA’s implementation expands Guidewire’s geographic footprint to 40 countries. In the United States, Lincoln Financial Group, a Fortune 250 American holding company operating multiple insurers, selected BillingCenter. Two new customers in the quarter selected Cyence products, a private reinsurance broker and risk management advisor selected Cyence accumulation and a leading insurer focused on the energy industry selected Cyence risk and Cyence accumulation. Additionally, four customers expanded their use of Cyence, including two large and longstanding Guidewire customers, one of whom will now be using Cyence in their underwriting of a new line of business beyond commercial cyber.

While we were pleased to see new Cyence customer wins, we also experienced higher than expected churn from Cyence customers in the quarter. We are learning that demand for Cyence, a cloud native application is sensitive to the volatility of the emerging cyber insurance market it serves. Nonetheless, we see long-term demand for Cyence as cyber growth become a mainstream insurance line forecasted to grow to tens of billions in new premiums over the next decade and as we broaden the Cyence data listening platform to other new and established lines of insurance over this year and next.

Turning to existing customer expansions in the second quarter, we expanded our relationships with 26 customers. We extended our momentum with digital and data products with 11 customers selecting Guidewire Digital bringing the number of digital customers to approximately one-third of our customer base. We also added two new data customers in the quarter. As we continue to build on the key differentiator of our track record of successful implementation, we had five customers going into live production in the quarter with our core data or digital products. This includes icare’s go live on ClaimCenter in Q2 and Grinnell’s go live last month, both via Guidewire cloud. Also within the quarter, we saw 7 customers complete major version upgrades for InsuranceSuite.

Expanding on our launch of Guidewire Marketplace in 2018, last month we launched our ecosystem developer environment, Guidewire DevConnect. DevConnect provides software development kits that our partner connect ecosystem can use to build add-ons to Guidewire insurance platform. We continue to strongly believe that a large set of standardized pre-built integrations to insurance technology partners is one of the most effective drivers of lower TCO and faster time to value for our customers and we are investing R&D and business development efforts accordingly.

In summary, our second quarter advanced our progress in overall market adoption and in two of our key growth sectors, namely cloud and digital transformation. We enter the second half of the year optimistic in our long-term ambition to serve as the most trusted and strategic technology partner to the $2 trillion global P&C industry.

I now turn the call over to Curtis to cover our results and financial outlook for Q3 and FY ‘19.

[Curtis Smith, Chief Financial Officer]

Thank you, Marcus. We finished the first half of the year on a strong note, exceeding revenue and non-GAAP profitability guidance for the second quarter, signing our first InsuranceSuite cloud deal of the fiscal year and showing strong momentum in our digital products.

As Marcus stated earlier, total revenue for the second quarter was $169.3 million, which is an increase of 3% from a year ago and was above the high-end of our guidance range. License and subscription revenue was $87.1 million. Our better-than-expected performance was driven by high new sales activity, including the large sales digital deal that Marcus discussed in his remarks. This deal was structured as a 2-year term license, consistent with our 2 plus 1 term license framework. Year-over-year license and subscription revenue growth was 3%.

As we noted in our Q1 earnings call, year-over-year license and subscription revenue comparisons are impacted by the adoption of ASC 606, which affected the timing of revenue recognition of many of our agreements. Subscription revenue was $14.8 million compared to $7.7 million a year ago, representing a year-over-year growth rate of over 93%. The sequential decline in subscription revenue of $0.5 million was largely driven by churn of Cyence customers at the beginning of the quarter partially offset by new subscription deals completed toward the end of the quarter, which are ratably recognized. Perpetual license revenue in the quarter was $0.4 million. This amount reflects the usage true-up from an existing customer. Maintenance revenue was $21.3 million, an increase of 11% from a year ago and was also above the high-end of our guidance range. Services revenue for the second quarter was $60.9 million, up 1% from a year ago.

Turning to profitability, we will discuss these metrics on a non-GAAP basis and we have provided the comparable GAAP metrics and a reconciliation of GAAP to non-GAAP measures in our earnings press release issued today, with the primary differences 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.

Gross profit was $101.9 million, representing a gross margin for the quarter of 60% compared to 66% a year ago. The decrease in gross margin was impacted by lower license and subscription margin as we continued to invest in cloud operations and by lower services margin. Additionally, gross margin in any given quarter is impacted by quarterly revenue fluctuations. And as noted, revenue in Q2 was negatively impacted by some timing shifts due to ASC 606.

Total operating expenses were $75.8 million in the second quarter relatively flat to last year. While we continue to invest in our cloud transition during the quarter, this growth in spend was offset by three factors: M&A costs related to Cyence in Q2 last year, the timing of connections, our annual customer conference which incurred in Q2 last year, but was in Q1 this year and capitalization of commission costs under ASC 606. As a result, operating income was $26.1 million, which exceeded the high-end of our guidance range was largely due to license and subscription revenue upside and better than expected cost management. Operating margin for the quarter was 15%. Net income was $27.9 million, or $0.34 per diluted share.

Turning to our balance sheet, we ended the quarter with $1.2 billion in cash, cash equivalents and investments, flat compared to the end of the first quarter. Operating cash flow in the quarter was an inflow of $14.2 million compared to an inflow of $47.7 million a year ago. We are maintaining our services revenue outlook of $257 million to $265 million. With respect to gross margin, we still expect our overall non-GAAP gross margin to be between 59% and 61% and for services, we still expect non-GAAP gross margin to be between 12% and 13% this fiscal year.

We are increasing the midpoint of our outlook for non-GAAP operating income by $3.5 million, which we now expect to be in the range of $112 million to $118 million, representing a non-GAAP operating margin of 16% at the midpoint. With respect to cash flow, we continue to expect free cash flow to be between $115 million and $130 million before the one-time impacts associated with the build out of our new headquarters, which is expected to be approximately $35 million to $40 million and completed in fiscal 2019. In addition, our outlook for non-GAAP net income is $100.8 million to $115.8 million or $1.35 to $1.41 per diluted share based on approximately 82.4 million diluted shares and an assumed non-GAAP tax rate of 17% for fiscal 2019.

Turning to the third quarter, we anticipate total revenue to be in the range of $152.5 million to $156.5 million. Within revenue, we expect license and subscription to be in the range of $68 million to $72 million. We expect Q3 maintenance revenue of $19.5 million to $20.5 million and Q3 services revenue of $63 million to $66 million. For the third quarter, we anticipate a non-GAAP operating income of between $0 million and $4 million and non-GAAP net income of between $4.1 million and $7.5 million or $0.05 per share and $0.09 per share based on approximately $82.4 million diluted shares.

Finally, with respect to ARR, there is no change to the expectations provided at Analyst Day. As Marcus referenced, we note that ramped deals where existing customers are transitioning to Guidewire cloud can dampen ARR in the current year while providing a tailwind in subsequent years. We believe these ramps are positive helping to facilitate deal closures while maximizing the lifetime value of the customer relationship in the cloud.

In closing, it was a strong quarter, highlighted by the InsuranceSuite cloud deal, the two deals with our Salesforce partnership and the cloud activity we see in the second half of the year. While we know there is a lot of work ahead of us, we are pleased with the multi-year cloud opportunity we see and the progress we have made to-date. Thank you. Operator, can you now open the call for questions?

[Operator]

Thank you. [Operator Instructions] We will take our first question from Sterling Auty with JPMorgan.

[Sterling Auty, JPMorgan]

Yes, thanks. Hi, guys. I apologize I jumped on late, but noticed with the cloud win, you also increased the target for cloud wins I think for the year. Do you think that this win provides a little bit of a domino effect in terms of some of those discussions and any additional color in terms of how you think about the sales process on the cloud side?

[Marcus Ryu, Chief Executive Officer]

Thanks Sterling for the question. We are engaged with a huge array of customers across all the different segments of our both customer and prospect base that goes by size, by geography, by line of business. Really, the cloud discussion is relevant to almost the entirety of the market that we speak to and there is a lot of activity underway. As we talked about in previous calls, each of these transactions is very complicated and in many cases, it’s new terrain for the insurer to think about moving one of their core mission-critical systems in a production context to us as a partner. And so every one of them is challenging, but we are encouraged by the number of them that we are involved in. And as you suggest the more that we get done, the easier they will be, the more standardized our terms will be, the more kind of pre-negotiated, a lot of the surface area that we are going through with customers will be. And so every deal incrementally helps standardize and accelerate the pace of these conversations, but I would emphasize, it’s still early days. We increased the number to represent that we are incrementally more confident about the target, but make no mistake, these are still very challenging deals to wrestle to the ground and we have a lot of work ahead in the second half of the year.

[Sterling Auty, JPMorgan]

Alright, great. And then one follow-up, just where the partners are in their training to help on the implementation side for the cloud deals or should we expect that the first handful will still be predominantly Guidewire implementation driven?

[Marcus Ryu, Chief Executive Officer]

So we have done a lot of work to activate and engage our SI partners with respect to the cloud. I think they are all excited by the opportunity and I think I speak for really all of the major ones with whom we have done dozens of projects, different geographies. I think to the last, they are all – they also recognize their importance in our scaling to the demand that we want to serve and also the economic opportunity for them. I would expect that the next set of customers that we have that there will be SI involvement in most or all of them. And over time, perhaps as soon as next year I would think that the proportion of the implementation work being done by our partner versus Guidewire will be pretty similar to what we see for ourselves managed customer base.

[Sterling Auty, JPMorgan]

Great, thank you.

[Operator]

We will take our next question from Ken Wong with Guggenheim Securities. Please go ahead.

[Ken Wong, Guggenheim Securities]

Great, thanks a lot. Marcus, I wanted to circle back on a comment you made about the steeper subscription ramp, is this simply a willingness on your guidance to have to take a lower upfront economics for obviously longer term value or just a willingness to deploy at lower minimum thresholds at the start of a deployment?

[Marcus Ryu, Chief Executive Officer]

Yes. It reflects an intentional decision on our part to ease the transition for customers economically to the cloud relationship. The majority of the customers that we are talking to are existing or even longstanding Guidewire customers where we have a term license relationship in place and we have to bridge that transition, so that it feels like it makes economic sense for the customer, but we are really focused on the total area under the curve for a long-term relationship and our customers understand that as well. They are focused on the same kind of timeframe, but they need to bridge a year or possibly 2 years of transition for one type of license to the other and not have be too disruptive to their IT budgets, etcetera. So it’s an intentional choice. All these discussions are multi-year in nature. No customer would think about moving to the cloud for a single year that would be nonsensical. So they are all thinking about it over a multiyear horizon. But we are just doing our part to bridge the first year or two so that to remove that obstacle from the table while focusing on the total lifetime value of the customer.

[Ken Wong, Guggenheim Securities]

Got it. Got it. And then Curtis, in terms of the guidance, Q2, obviously a pretty significant beat on the license side and didn’t move it up all that much on a full year basis, was that simply there was some pull forward that you guys are reflecting or is it maybe a term deal went cloud and that’s what’s impacting it. Any thoughts there would be great?

[Curtis Smith, Chief Financial Officer]

Yes. Every quarter there are deals that can’t come in and out of the quarter. And so we saw this quarter too there were some deals that came out of Q3 and came into Q2, but some that came out of Q2 into future quarters. But the overall outlook for the year wasn’t impacted that much. And that’s why we modestly increased the revenue guidance we gave on both the overall revenue side of things and the subscription side of things and also the maintenance side of things.

[Ken Wong, Guggenheim Securities]

Got it. Thanks a lot guys.

[Operator]

We will take our next question from Chris Merwin with Goldman Sachs.

[Chris Merwin, Goldman Sachs]

Great. Thanks very much for taking my question. So, just as it relates to the cloud deal you signed, I think you might have said it was a migration, but please correct me if not. And I think in the past, you talked about seeing three different types of cloud deals migrations, brand new customers and existing customers taking additional cloud products. Is that still the expectation for the year? Maybe can you comment in particular about new cloud customers? And then I have a follow-up. Thanks.

[Marcus Ryu, Chief Executive Officer]

Right. Thanks, Chris. That’s right. Those are basically the three flavors of cloud deals that are ahead of us and the one that we just announced today is a longstanding relationship where they are in production with InsuranceSuite. They are migrating that in production implementation to Guidewire cloud, but there is also meaningful anticipated growth of the scope of that implementation to cover essentially the entirety of their book of business. So, there is intended growth. Some of that growth or perhaps all of it would have happened in the on-premise mode, but now that will be happening in Guidewire cloud.

[Chris Merwin, Goldman Sachs]

Okay, great. And then just a follow-up was around pricing, as you talk to customers, I know you have – some of these discussions have been longer in nature. Has pricing ever really been a sticking point or as you have talked about in the past as it relate then much more about the new service level agreements and information security, all the additional features that you need to work into the contracts? And I guess for the cloud deal, you did sign was that within the pricing range that you had guided to previously?

[Marcus Ryu, Chief Executive Officer]

Sure. So, economics reports are always a relevant dimension of the discussion. But I think the parts that are complicated that have led to these deals being intrinsically more complicated and challenging to get finally closed are not economic in nature. They are generally about the distribution of liabilities and risks and the specification of our service levels in all kinds of different situations that arise with the production mission-critical system. So, that’s the primary locus of discussion and negotiation and discovery and that’s primarily what contributes to the duration. With respect to this particular transaction, I think we are pleased with the economics of it, but again, thinking about over a multiyear horizon and that’s also the same terms in which the customer thought of it, but they had to transition an existing term license to now a new cloud subscription arrangement and that had to make sense in the transition year, but the overall economic value of that customer relationship is expanding materially as a result of this deal.

[Chris Merwin, Goldman Sachs]

Okay, great. Thank you.

[Operator]

We will take our next question from Rishi Jaluria with D.A. Davidson. Please go ahead.

[Rishi Jaluria, D.A. Davidson]

Hey guys. Thanks for taking my questions. Marcus, I wanted to circle back to the IS cloud deal with TD Insurance. Was that one of the deals that you had mentioned in the past one or two quarters that, that was a little bit of slip deal because of deal complexity or was this a new deal that kind of came in the fray? And was it the same size of initial sign-up as you expect it or was this one of these ramp deals that you had kind of a lower entry, but you expect it to expand very significantly over time and maybe kind of what motions help close this deal that you can apply to some of the future deals that are currently in motion? And then I have got a follow-up.

[Marcus Ryu, Chief Executive Officer]

Sure. It was indeed one of the relationships that we had hoped to get closed earlier. But as we have talked about in previous earnings calls, it has an education for us to explore the full terrain of the valuation and risk mitigation and negotiation that we have to go through with all of our prospective customers. And this one was I think TD was a particularly good partner to work with. They were very rational, but they were also extremely thorough. And I think they would be fine to hear me say that it was not only there in the insurance division, but also the governing bank that had a considerable surface area that they wanted to be satisfied on with respect to data security, to service levels, to liabilities and so forth. And so I think it was particularly a helpful test case for us to go through and to reach a conclusion with, because it will inform really hopefully a lot of the other conversations that we are in who are in general are not insurers, but owned by banks or managed by banks, but are standalone insurance entities.

[Rishi Jaluria, D.A. Davidson]

Got it. Thanks. And then any commentary just around the size of the deal relative to your expectations?

[Marcus Ryu, Chief Executive Officer]

I think it’s in line with our expectations. And we are still – there is still a price discovery ahead of us with the market, but in general, this conversation and the other ones that we are in have been broadly aligned with what we talked about in the past.

[Rishi Jaluria, D.A. Davidson]

Got it. Thanks. And then just quick follow-up for Curtis, in cash flow, the operating cash flow was little light in the quarter I think it was relative to what I was expecting. How should we be thinking about kind of the puts and takes on cash flow in the quarter and maybe what should we be expecting or how should we think about cash flow for a full year basis? Thanks.

[Curtis Smith, Chief Financial Officer]

Yes, great. So, for the full year basis, we are maintaining our original forecast of $115 million to $130 million in free cash flow and that excludes the one-time costs related to the headquarter build-out we talked about being approximately $35 million to $40 million. In the quarter, we noted that free cash flow was lower this quarter than it had been last quarter. The biggest driver of that year-over-year change can be attributed to the timing of billings and collections. And also in this quarter, we paid a total of $7 million in initial cap expenditures related to the new headquarters build-out. Secondarily, we noted at the beginning of the year, we expected free cash flow in fiscal ‘19 to be in line with fiscal ‘18, excluding the one-time headquarter CapEx and this is due to the investments we were intentionally making in the cloud and in R&D to be cloud ready.

[Rishi Jaluria, D.A. Davidson]

Okay, that’s helpful. Thank you, guys.

[Operator]

We will take our next question from Michael Turrin with Deutsche Bank.

[Michael Turrin, Deutsche Bank]

Great. Thanks for taking my questions. Just going back to the Cyence comment a little bit and maybe some higher churn than expected there, can we just talk more about that for a moment? Is that something that could persist or is that somewhat of a quarter specific event and then how should we think about – is there any potential for that to impact the trajectory of the subscription number going forward or just how to think about sort of the magnitude of look some influence from that would be helpful?

[Marcus Ryu, Chief Executive Officer]

Yes, those are fair questions, Michael. And the ones that we are – we have been very focused on as you would expect, churn as a phenomenon is not one that we Guidewire are much accustomed to thinking about. It’s very difficult for us to secure new customer relationships, but generally they tend to be lifetime once we consummate them. So, any kind of churn is very, very unusual for us. And so we were surprised with the trend that we experienced with some non-renewals in Cyence in the first half of the year. Things have progressed kind of back to the mean here since then and I think we feel cautiously more optimistic or secured with respect to the latter half of the year. But as I mentioned in the remarks, the underlying cause and we did as much root cause analysis as we could in each case, is not about the products, the software as a service, all of which we could get very, very high marks and strong customer support for, but the volatility of the underlying business that the product is designed to support primarily cyber insurance, which is an emerging line of insurance. It’s growing very quickly. So, certainly relative to other insurance lines, but it is not growing as quickly over the last 12 months as it was projected, it’s something like half the speed by some estimates of what was expected. I think there’s no doubt in the industry or among analysts that the cyber insurance will become a large and significant line of insurance. But it’s still in the early days and the trajectory has been bumpier than one would have guessed and so some business initiatives on the part of some Cyence customers just prove not to be making the cuts and that impacted the business.

Now, as you’ll recall from if you’ve followed our commentary about Cyence in the past, you know that it was never just about cyber insurance. It was a broader data listening platform that we saw applicability across many other lines of insurance, including well established multi-hundred billion-dollar lines of insurance and we’ve been working hard to generalize that and we have some early progress that we look forward to talking more about that as we have customer wins to describe. But that’s still early days and most of the almost all of the existing revenue from Cyence comes from cyber insurance. And so, we were a bit vulnerable to that. It is a headwind, it’s reflected in our guidance for the remainder of the year. We don’t think it’ll be a long-term headwind for the business, but certainly relative to the expectations with which we started the year, it was an adverse surprise.

[Curtis Smith, Chief Financial Officer]

And couple of things I’d add to that too. We noted that Cyence’s historical Q4 lines up with our Q2. So, there are high volumes of renewal activity in the quarter that we don’t expect to see going forward, one, and number two, with respect to our subscription revenue outlook, we are confirming the $60 million to $66 million this year. And as previously stated by Marcus, we foresee subscriptions as a percent of new sales to be between 40% and 60% in this fiscal year.

[Michael Turrin, Deutsche Bank]

Okay, appreciate all the color there guys. And then maybe just to go back to the cloud one more time, you added one cloud deal in Q2 and you also took this opportunity to increase the lower end of that target range. Is there a way for us that all parse through how much, if at all, the change in ramp trajectory of deal structure is influencing, how you’re thinking about that range, and just more on your continued confidence in back half strength of those deals, I think is always appreciated? Thank you, guys.

[Marcus Ryu, Chief Executive Officer]

Yes, I think the year is more back-end loaded with respect to cloud deals than we would ideally like of course. And so, we are calibrating our forecast in that number based on bottoms up and then the number and quality of the discussions that we’re in to kind of a range we find where we think we will end up. And each of them, taken individually, is challenging, but I would say that the nature of the challenges is lessening with each passing week of additional experience. I think more and more of the terms that we are discussing with customers are going to growing familiar to us and we’re getting more practice in the answers. That said, we’re also pursuing cloud deals, not just in the U.S. or in North America, but also in other geographies and different geographies, different countries have different requirements as well as language barrier that inevitably slow things down. So, we are handicapping all of those factors and coming up with that range and standing by it with the same seriousness that we put forward any number to the investor community.

[Michael Turrin, Deutsche Bank]

Appreciate the detailed responses. Thanks guys.

[Operator]

We’ll take our next question from Tom Roderick with Stifel. Please go ahead.

[Unidentified Analyst]

Yes, hi, Matt Bentley on, for Tom, thanks for taking my question. I guess, thinking about first, Curtis, some of the spending in the quarter, obviously a little better on the margin performance than most of us were expecting and I think it serves notice that you guys are always very good stewards of capital, but just curious if any of that resulted more from timing of hiring in the quarter and how are your overall hiring plans are on the trajectory for the rest of the year in terms of budget, was there some done right at the end of the quarter that we’ll see more in the next two quarters. And just any comments around hiring within the quarter and the outlook for the rest of the year?

[Curtis Smith, Chief Financial Officer]

Yes, so we noted some of the in the quarter at least the spend improvement had to do with us actively managing the cost. Hiring is always a challenge for us and that impacts our expenses, both in the quarter and how we’re thinking about it for the rest of the year. That said, as we noted, we were increasing the midpoint of our outlook for non-GAAP operating income by $3.5 million. Part of that has to do with us managing our expenses, part of that has to do with our hiring trajectory and part of this has to do with some efficiencies that we are seeing as well.

[Unidentified Analyst]

Great. Thanks. And then looking at what you’re seeing on Cyence from a new deal pipeline, how is the initial conversation bandwidth lot of your existing customers around their demand for cyber insurance elements, what may be the overall product can do, I know you mentioned you’re looking at some new used cases as well. I’m just curious how the cross-sell opportunity has been relative to your expectations and how much of that is maybe built in over the next 24-36 months?

[Marcus Ryu, Chief Executive Officer]

Yes, I mean, our revenue expectations for Cyence are relatively modest and are not they are not a fundamental driver of our growth expectations for the next year or two, I would say. I of course think we hope to be surprised by that in a positive way. But we do see it as a strategic asset because their approach to large-scale data management and the underwriting, it’s so fundamentally different and also appropriate to emerging categories of risks that are huge areas of growth for the industry that we know it will be relevant and our customers tell us it will be relevant. But the emergence and maturation of a new category of insurance as you know is a slow process, we’re learning. Cyber insurance has been talked about for a long time, everyone agrees on this need, everyone agrees that the underlying risks are enormous and need to be indemnified and yet it’s still very, very small relative to other well-established lines of insurance. So, wherein for the long game with that and to make sure that it doesn’t unduly distract the other strategic goals, we have such as moving to the cloud for our course our core platform, we have a separate division in the Company that is focused on that and that operates with a fair degree of autonomy and latitude to do the right thing for the long-term there. I think we’ve gotten tremendously positive feedback about the product, about its distinctiveness, about the signal that it defines, but ultimately the success of any insurance business requires people who want to buy that category of insurance and that market is still in its early days. And that’s why we are not just betting on cyber insurance, but in the conviction that the same approach will be relevant to huge well, established lines of insurance like workers’ compensation, like commercial auto insurance etcetera.

[Unidentified Analyst]

Great. Thank you.

[Operator]

We’ll take our next question from Alex Zukin with Piper Jaffray.

[Unidentified Analyst]

Hey, Marcus. Hey, Curtis. This is Scott on for Alex. So, my question, one of my first questions, if I just take us factoring on to the prior earnings call on, you had taken down your services revenue expectation and told us that your guidance panel apply a back half InsuranceSuite cloud expectations. So, we have the new InsuranceSuite cloud customers and we’ve got to up-sell this quarter, which would imply that things are better than they were three months ago. I’m curious what’s keeping your from increasing that services rev guide, is that an indication that maybe delay in deals are going to be rolled out a little bit slower than you thought. Just curious what’s going on there?

[Marcus Ryu, Chief Executive Officer]

No, Scott. I wouldn’t read that into the services guide. I mean that’s it is one of the more challenging aspects of our business to forecast because now it’s not just about when the deal will close, but the degree of services attach we will have on that particular deal and then the exact timing of when the deal when the project itself will start, which can be immediately or sometimes some weeks delayed after the or some weeks after the deal is signed. So, it’s always been one of the harder parts of our, of our business to forecast but we stand by the guide we have now.

I think to the larger context of your question about our degree of confidence and how it’s changed over the last three months, I would say, incrementally we are more confident, because we have some of these conversations have firmed up more, some that were a bit more abstract and we’re interest are now trending towards what we would call selection and papers being exchanged, the negotiations are happening. So yes, that we made progress on deals, but then again, sometime in the last and we’ve committed ourselves to getting something done by an arbitrary deadline, but that what businesses have to operate by of the end of our fiscal year. So, I think we as the remainder of the time and the relationships that we have, we can put those on the balance, we think we will get there and we are incrementally more confident of that, but a lot of work to be done.

[Unidentified Analyst]

Maybe taking that on that a little bit, are there any analogies to if I think about the potential for the long-term ramp of InsuranceSuite cloud, are there any analogies you might be able to provide us with maybe how the launch of PolicyCenter, BillingCenter post your ClaimCenter launch kind of tracked within a certainty time period and those products being generally available, was there a certain number of customers, critical mass and allowed for acceleration, I’m curious how we might be anticipating the potential for not just fiscal ‘19 deals, but ‘20 and ‘21 [indiscernible] that you can provide.

[Marcus Ryu, Chief Executive Officer]

Yes, that’s a thoughtful question, Scott. In fact we often talk in those terms like, the first time we brought out PolicyCenter, that was a massive additional step beyond claims system ClaimCenter and the first few customers were very, very hard to secure and things got incrementally, but only incrementally easier with each new customer until we were really able to lay claim to having the leading and most probably adopted solution in the market, which was depending on how you want to count it, five or eight years hence, all right. So, I think it’ll be faster for us in the cloud, both because there is a deeper and broader appetite for that transition, I think our Bonafide as a well-established trusted partner to the industry is a significantly different from when we launch policy. I think the urgency of digital transformation and doing things that are more differentiated as opposed to more standardized is much stronger for the industry than it was 10 years ago. So, a lot of things are positive in terms of that happening faster. But there is still a cycle of early adoption. We are definitively in that stage where customers can feel confident that we have the right partner to entrust with something truly mission-critical and in high-stakes for them. And we’re really confident we’re going to get through it, we’re every day is progress on that. And we’re bringing those cloud customers into production and they’re referenceable and the next wave of customers will be referenceable in turn. But it is still in the early adopter phase. Make no mistake.

[Unidentified Analyst]

Perfect. Thank you.

[Operator]

We’ll take our next question from Justin Furby with William Blair & Company.

[Justin Furby, William Blair & Company]

Hey guys. Thanks for taking my question. Just I wanted to ask on InsuranceNow, Marcus, what you saw in the quarter and you see now that business is progressing? And then in Europe, just any commentary on sort of pipeline for the back half and you mentioned you alluded to other geographies on cloud. Can you give a sense for what that mix looks like if you’re sort of, call it 50% of new business bookings coming from cloud does it look similar in Europe? Is it a lot lower? Just any sort of directional commentary would be helpful.

[Marcus Ryu, Chief Executive Officer]

Sure, Justin. So, first with respect to InsuranceNow, we didn’t have a win to announce. We still have a meaningful target and a lot of business to get close by the end of the latter half of the year. We think we have the pipeline for it. But unfortunately, unlike the rest of unlike the rest of everything else we’re doing, there is more pressure on the second half of the year than ideal. But we’re fully committed to that product and is a segment of the market for which we’re highly confident, it is the best solution and one that is differentiated not only from the competitors, but from what we can offer with InsuranceSuite. With respect to Europe, still a hugely important geography for us, where every year we invest more at a product delivery and sales level to succeed in Europe. It’s enormous portion of our TAM. And if you look at the multinationals that we serve, the majority of them are in Europe, in fact, not in North America. We think that there are cloud discussions in Europe and we are hopeful of one or more of the remaining cloud deals to close that will happen in Europe. But I would say overall, it’s a bit slower there with respect to cloud. How much so, it’s hard to calibrate, but we definitely have more conversations about cloud, more advanced ones here in North America. But there are some significant wins in Europe as well. So, I would guess that the portion of bookings that will come in subscription form will be a bit lower in Europe than it will be in North America. That’s pretty much what we expect and have modeled. But I think that that difference will equalize over time maybe in the next year or two.

[Justin Furby, William Blair & Company]

Okay, that’s helpful. And then, competitively markets like once a, insurer has made the decision, let’s just take a new prospect and they made the decision they want to go cloud for core, how does that change the dynamics for you versus Duck Creek versus Majesco versus any other vendor that you come up against?

[Marcus Ryu, Chief Executive Officer]

Yes, I think the competitors are the same, but I don’t think the cloud fundamentally changes the competitive dynamic. Obviously, it changes the evaluative scope of the sales cycle to ask other cloud-focused questions and we are in a couple of pretty high stakes and important competitive sales cycles now that will likely be cloud and we are being examined on those criteria, but it is essentially the same competitors. I think it will be – so far the buying pattern is not to say which partner do we want and then to say well, should we go cloud or not after that discussion. It’s – at this stage of market evolution, our prospects generally know what they want and now are evaluating us versus our competitors or versus doing nothing at all.

[Justin Furby, William Blair & Company]

And just look quickly Salesforce like how does that change like the partnership there? I know they announced something with Duck Creek I think as well, but how does that change the conversation in terms of insurers’ willingness to go cloud and the partnership you have the integration? Thanks.

[Marcus Ryu, Chief Executive Officer]

I think that – I think the Salesforce and cloud are kind of related, but still very distinct conversations. The Salesforce discussion is about CRM, the need to bring CRM capabilities, horizontal CRM capabilities to the problems of insurance distribution and insurance policyholder service. And Salesforce has a very relevant proposition with respect to those, but they would agree and this is the foundation of our partnership that it is hard to distribute insurance products and hard to service them without deep integration to the core environment and that is the power of our partnership. Not every insurer is ready to tackle the CRM question. Many of them feel like they have a bigger issue with their products or with their core underwriting or with their claims system. But the general topic of digital service, digital distribution, especially for those insurers with a captive agency for us like one of the customers we talked about in the prepared remarks, especially for that group, Salesforce’s proposition, CRM proposition is highly relevant. But it’s a distinct one from the cloud, the cloud is – it’s almost like a lateral dimension to that functional question.

[Justin Furby, William Blair & Company]

Got it. Thanks very much.

[Operator]

We’ll take our next question from Tyler Radke with Citi. Please go ahead.

[Tyler Radke, Citi]

Hey, Marcus, hey, Curtis, thanks for taking my question. Marcus, I was wondering if you could talk a little bit more about the revenue opportunity that you see in the digital business? I think you said roughly a third of the customer base is using the digital products at this point like what would that look like on revenue and how big as a percent of just Guidewire business do you think digital could become as you look down the road?

[Marcus Ryu, Chief Executive Officer]

It’s a fascinating question, Tyler, because the full scope of digital is not yet known to insurance, right. Just how much of insurance can really be digital, how many of – how many insurance processes, what would they really look like in a truly digital future, and I think that novel is still being written. There is the sort of V1 or V0 of digital, which is, can you sell an insurance product online, but that’s just really scratching the surface of the potential to have for really offering consumer grade, always-on, device based, continuous advisory and protection services and the like that insurers are talking about. So, I think that the digital opportunity is really unbounded and it’s certainly a more strategic topic than just – than core policy administration in most insurers, and of course, part of our messages and which is I think we have broad consensus for is that you can’t do a lot of these exciting digital things if you have a 1980s mainframe, it’s very challenging, right. You need to do it on a modern core policy admin environment. So today, I would say, our – the digital attach to our core system is worth somewhere in the 20% – sorry, in the 10% to 20% or maybe even 25% range of the value of the underlying core. But that number could increase significantly as the functional scope of what’s done digital, “digital” expands over time as it truly will. And so if you were to look at the allocation of our R&D spend, obviously, there’s a lot that’s going towards cloud under the hood. But functionally speaking, we have – we’ve directed as much as we can into the digital domain as possible, because that’s where a lot of the functional and user experience innovation is happening and it’s certainly the business catalysts that is driving core system transformation overall in the industry we serve.

[Tyler Radke, Citi]

Great, that’s helpful. And then as a follow-up for Curtis, I noticed on the slide deck that it looks like subscription revenue actually declined sequentially and I – obviously, we’ve talked a lot about Cyence. But I would have thought with most of your bookings coming in as subscription we would just kind of see that increase each quarter. Is there anything else going on in that line or is that just the Cyence churn that you called out?

[Curtis Smith, Chief Financial Officer]

Yes, we noted two things in a sequential, the $0.5 million in sequential decline from Q1 to Q2. The primary driver was churn in Cyence that we saw at the beginning of the quarter and that was partially offset by new subscription deals that we completed towards the end of the quarter. And as you know, the subscription deals are ratably recognized, so you don’t see the big uptick of the revenue because it’s ratably recognized. That said, we noted too, we feel confident about our outlook of the $60 million to $66 million of subscription revenue for the year and are confirming that range.

[Tyler Radke, Citi]

Thank you.

[Operator]

We’ll take our next question from Brad Sills with Bank of America. Please go ahead.

[Brad Sills, Bank of America]

Hi, thanks guys for taking my question. I wanted to follow up on your comments earlier, Marcus, on the SI channel preparedness is kind of ramping up on the implementation side. Does that translate also to them becoming more of an asset in the sales cycle, in other words, going to market together and kind of influencing some of these cloud deals in the sales cycle?

[Marcus Ryu, Chief Executive Officer]

Absolutely. It would be quite challenging to have them involved if they didn’t feel that they – if they were not aligned with that direction. And I think the real progress we’ve made over the last 2 quarters with a lot of focused effort and really great work by a new leader of our Alliances organization has been to convey to them in-depth like how their strategic and economic interest are really aligned with the Guidewire’s transition to the cloud and how it’s not – it’s not a competitive journey at all. It’s one where – and I think that, that appreciation is now – has been internalized across our SI community. We spent a lot of time on road shows and executive discussions to make sure that was really understood, maybe we underestimated that a bit last year or the year prior, but I would say we’ve worked hard to correct any misperception on that count. And I think that’s – it’s enhanced our confidence that we can – that our long-term model will look like the kind of services attach rates that we were trending to before the cloud transition took on such urgency.

[Brad Sills, Bank of America]

That’s great. Thanks, Marcus. And then one more if I may, I know, earlier in the year you formed a separate organization for digital. Do you feel like that organization is hitting its stride now with some of the success you’ve seen here in that offering? How much would you attribute that to just the execution of this new organization? Thank you.

[Marcus Ryu, Chief Executive Officer]

Well, I think as a point of clarification, the new organization was focused on data, if you are referring to the analytics and data services group, which is called ADS –

[Brad Sills, Bank of America]

Yes.

[Marcus Ryu, Chief Executive Officer]

And they were the ones that took a bit of a body blow in the first half of the year with the Cyence churn, that wasn’t as expected. I think the team understands and it’s been reassured that this is not been about product execution or delivery. It’s been just the volatility that’s in the emerging markets that we’re serving and I think that’s well understood by the team and I think there’s all kinds of other encouraging progress as we generalize the platform and other applications for it. But one of the reasons we’ve separated them and give them a bit more autonomy is so that they did not – they didn’t get lost in the shuffle with the main and strategic thrust we’re making in cloud and to know that they can pursue a long term, really long-term opportunity we think to find new signal in data, potentially persuade our customers to contribute data and the like to, there’s a whole manifold of fascinating potential insurance applications, but we won’t be able to serve that unless we invest now and have the right talent on the team.

[Brad Sills, Bank of America]

Great, thanks again, Marcus.

[Marcus Ryu, Chief Executive Officer]

Sure.

[Operator]

We’ll take our next question from Pat Walravens with JMP Securities. Please go ahead.

[Pat Walravens, JMP Securities]

Great, thank you and congratulations. Marcus, I have a little bit of a sort of bigger picture question, which is recently when I’ve asked the CEOs of other cloud companies that are selling financials like Workday and Anaplan about the sensitivity of CFOs to put their financial data in the cloud like the response from Anaplan was it’s amazing how far that’s come in the last year or 2. I said this is the same, it’s not quite true for the insurance industry, what would you say?

[Marcus Ryu, Chief Executive Officer]

No, Pat, I think I would broadly agree that, that there is increasing comfort with that. I think a key understanding is recognizing that security is an endless quest that your own house is not perfectly secure and that if you work – that there are capabilities at public infrastructure, the respect in this public infrastructure are actually safer than what you can achieve on your own, but it doesn’t mean that you can just hand over the keys to the kingdom to a third-party and just trust everything will be fine. There is a significant duty of care to make sure and believe me, our customers are exercising that duty very rigorously. But there is a, I think there’s a deeper recognition that other parties with the right controls, with the right legal framework are perfectly capable of handling even mission-critical data and that’s actually a strategic necessity since there’s just too much work to get done and it’s too much burden for any internal IT organization or security operation to cover every risk on their own. And I think we’re seeing a very rapid evolution in the thinking on that. And to your point, when – often when they are IT leaders in insurance that have come from other industries, other financial services perhaps other consumer services, they often bring that perspective, that is a pattern that we’ve noticed, and I think it’s all very healthy.

[Pat Walravens, JMP Securities]

Alright, great. Thank you for that perspective.

[Operator]

Ladies and gentlemen, this does conclude today’s question-and-answer session. At this time for closing remarks, I would like to turn the conference back to Mr. Marcus Ryu.

[Marcus Ryu, Chief Executive Officer]

No other comments. Thank you for participating in our earnings call today. Go on.

[Operator]

And ladies and gentlemen, this does conclude today’s conference. We appreciate your participation.