Please stand by. We are about to begin. Good day. Welcome to the Guidewire First Quarter Fiscal Year 2018 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Richard Hart, Chief Financial Officer. Please go ahead, sir.
Good afternoon. Welcome to Guidewire Software's earnings conference call for the first quarter of fiscal year 2018, which ended on October 31, 2017. My name is Richard Hart. I'm 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. 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 developments in connection with 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-Q 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 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 may be one-time in nature. We may or may not provide updates in the future. With that, let me turn over the call to Marcus for his prepared remarks. I will provide details on our first quarter results and our outlook for Q2 and the rest of fiscal 2018.
Thank you, Richard. As anticipated by our announcement earlier in the month, first quarter revenue of $108.2 million was above our guidance range, moderately exceeding expectations on all revenue lines. That upside carried through to the bottom line and narrowed our non-GAAP net loss to $4.8 million. Q1 was a significant quarter for Guidewire. We completed the next unified release of Guidewire Insurance Platform, which introduced numerous enhancements to our complete product set. We unveiled several new cloud-based products and announced a strategic partnership with Salesforce. We also won a second mandate for InsuranceSuite Cloud to be deployed and wholly managed by Guidewire in the cloud, and we made significant progress developing our InsuranceNow business with both new sales and customer go-lives. Just after the end of the quarter, we closed our largest acquisition to date, namely for the next-generation risk analytics company Cyence.
We recently held our Connections user conference, which grew by 25% in attendance and refreshed our perspective of our market's priorities. This is a time of rapid change for both Guidewire and our end market, and in this call, I'd like to elaborate on the most important of these trends to offer context on the moving parts of our business that impact our guidance for the fiscal year. The dynamic most visible in our results and our current sales efforts is the pace at which the P&C insurance industry appears to be moving toward cloud-based solutions. In addition to interest for our cloud-only offerings, such as InsuranceNow, Underwriting Management, and Predictive Analytics, we see a growing proportion of our prospects considering both cloud and on-premises options for InsuranceSuite.
This leads us to increase the estimate we shared last quarter of 20%-30% of new sales coming in subscription form this year to a range of 30%-40%. Our first quarter reflects this transition with a substantial majority of sales from cloud-based solutions. Indeed, our second InsuranceSuite Cloud transaction also illustrates how current customers may participate in this transition. This customer, whose name we cannot share at this stage in their project, had already licensed ClaimCenter but revised their approach prior to implementation and opted for a Guidewire cloud-based arrangement instead. As a result, we were able to consummate the transaction and provision the software more rapidly than we would otherwise expect for a cloud transaction, contributing modestly to our outperformance in Q1. The appetite for cloud-based delivery and the accompanying willingness to further standardize implementations are quite positive in the long term.
They will drive more rapid upgrade cycles, reduce customer TCO, improve our understanding of how customers use our products, and speed the development and adoption of new Guidewire offerings. Moreover, we continue to expect that InsuranceSuite Cloud arrangements will increase the economic value to Guidewire of the customer relationship by 2x or more versus our current on-premises model, albeit at a somewhat lower gross margin. There are two adverse impacts on our reportable results, however. First, an increasing proportion of our license revenue coming in ratable form will negatively impact our license revenue growth this year. Second, prospective customers evaluating cloud-based and on-premises delivery options may increase the complexity and duration of sales processes in the near term, which could offer us less time to recognize new ratable revenue streams in the current year.
These considerations, combined with an anticipated decline in perpetual licenses, have led us to reduce our license and other revenue outlook for the year. At the same time, and for related reasons, we expect services revenues to accelerate in the near term. As we've noted previously, InsuranceNow implementations are led by Guidewire, augmented by subcontractors, and we are in the early stages of developing an SI ecosystem for that product. Similarly, our goal for InsuranceSuite Cloud is to have our SI partners responsible for significant portions of implementations in the future. For these critical early projects, we believe much heavier Guidewire involvement is necessary to minimize risk. Heavier Guidewire involvement is also motivated by the robust demand we are seeing in Continental Europe, which has become meaningfully more active for us over the previous four quarters.
Our experience is that European insurers expect Guidewire to bring experts with local language skills, and that they often prefer to have key software vendors lead their implementations to the degree that we may agree to act in a prime capacity in select strategic cases. Because of this increase in European demand and the overall transition of our market's preferences, we believe it is important to avoid gating new sales wins with capacity constraints in delivery. Consequently, in the near term, we will experience an outsized growth in services revenue as we continue to hire aggressively to ensure that we can service the new core system mandates we win.
These adjustments in our resourcing strategy are part of a larger evolution for the company that we highlighted at our recent user conference Connections, a shift towards shouldering more complexity and risk on behalf of our customers and the global P&C industry overall. We believe that insurers are seeking this transfer to a proven partner in order to redirect focus on transformation initiatives. Catalyze and the leverage of new data sources and machine learning to find operational insights, to automate underwriting and claims decisions, and to grow by creating new insurance products to address emerging risks such as cyber. In addition to cloud-based delivery of the core, we are also well-positioned to serve these data and digital initiatives after the investments we have made. This year, we are accelerating in product expansion.
We are now sharpening the use of our organically developed digital products, which have enjoyed rapid adoption on their own, into a focused offering to support the drive of insurers for digitally distributed small commercial insurance, which we call DSB. We are also integrating our digital portfolio with Salesforce's Financial Services Cloud to provide a unified digital front office for captive agents and customer service reps. We are integrating our predictive analytics capabilities into InsuranceSuite to support decisions at key points in the insurance lifecycle, enabling what we call a smart core. We are evaluating significant investments we have made to introduce these new products, aligned as they are with the increasingly future-focused priorities of our customers, will become engines of our future growth, even though they are contributing only modestly to revenue today. Our investments continue to gain us industry recognition.
We are doubly pleased that this year Gartner rated InsuranceSuite as a category leader and placed InsuranceNow in the challenger quadrant of their Magic Quadrant for P&C core platforms, the inaugural year for this category. Finally, we formally welcomed our colleagues from Cyence on November first. Cyence's internet-scale data listening platform and its machine learning-powered risk analytics will enable insurers to grow by underwriting new categories of risk for which actuarial data is not available or is incomplete. Longer term, we see a unique opportunity to integrate Cyence's external data with the internal data gathered in real time by live analytics and to provide insurers the full life cycle from product design to transactional management of these new insurance products. We were fortunate to retain the employees of Cyence and Arvind Parthasarathi, its founder and CEO. He will continue to serve as the head of Cyence Risk Analytics.
Arvind's Connections keynote is available on our investor relations website, ir.guidewire.com, and it explains Cyence's unique value proposition. In addition to Arvind joining my core team, I want to comment on previously announced organizational changes. I thank Scott Roza for his service to Guidewire since 2013 as he leaves for another opportunity at the end of the calendar year. I was pleased to be able to promote two 12-year Guidewire veterans, Steve Sherry, who was already responsible for worldwide sales and now reports to me, and Eileen Maher, who assumes Scott's title of Chief Business Officer and heads our product line business strategy, pre-sales, product marketing, and value consulting teams. Recognizing the importance of the cloud to our growth ambitions, we also named 14-year Guidewire veteran Alex Naddaff as Chief Cloud Officer, adding to his current title of Chief Customer Officer.
It is my great privilege to work with such a capable and long-tenured leadership team at Guidewire, and I believe that we're well-equipped to extend our collective success. With that, I'll turn it over to Richard to detail the financial results of our first quarter and update our view for the fiscal year.
Thank you, Marcus. As Marcus indicated, we exceeded our revenue and earnings guidance for the first quarter. Total revenue in the first quarter was $108.2 million, an increase of 15% from a year ago. Within revenue, license and other revenue decreased by 22% from a year ago to $30.1 million. As we previously noted, any sequential comparison must take into account the $6.1 million, which was recognized in the fourth quarter due to the early receipt of customer payments. I also note that the first quarter of fiscal 2017 featured a significant perpetual license amount, while this quarter was marked by a substantial majority of sales coming in as subscriptions. Adjusting for these factors, license and other revenue would have grown year-over-year. Maintenance revenue was $18.9 million in the first quarter, a 15% increase from a year ago.
As a reminder, maintenance services are included as part of subscriptions. As a result, increases in subscription sales as a percentage of total sales will reduce maintenance revenue growth in the future. Our rolling four-quarter recurring revenue, comprising of recurring license and maintenance revenue, totaled $324 million in the first quarter of fiscal 2018, up 19% from a year ago, even as its sequential growth was negatively impacted by the shifts in deal mix, which characterized the first quarter, will reduce the growth rate calculated by this metric while this shift is underway. Services revenue was $59.1 million, a 52% increase from a year ago, and was above our guidance, primarily due to the higher-than-expected services revenue from InsuranceNow implementations.
Turning to profitability, we will discuss these metrics on a non-GAAP basis. 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 difference being stock-based compensation expenses. Non-GAAP gross profit in the first quarter was $55 million, compared to $58.3 million a year ago. This represented a non-GAAP gross margin in the quarter of 50.9%, compared to 62% a year ago, due to the higher mix of lower margin services revenues and the decrease in license and other margin compared to a year ago. This resulted in a non-GAAP operating loss of $8.3 million, which was better than our guidance range, primarily due to higher than anticipated revenue.
A non-GAAP net loss of $4.8 million or $0.06 per basic and diluted share, compared to our non-GAAP net income of $1.1 million a year ago. Turning to our balance sheet, we ended the quarter with $653 million in cash equivalents and investments, down from $687.8 million at the end of the fourth quarter. Operating cash outflow in the first quarter [ was $31.2 million] which closed on November 1st, after the end of our first quarter. Total consideration net of cash for Cyence was $265 million, consisting of net cash of approximately $130 million, as well as $1.6 million newly issued shares of Guidewire common stock and options. The impact of this acquisition will appear in our second quarter and fiscal year financial results. Total deferred revenue remained at $111.2 million at the end of the first quarter, compared to the end of the fourth 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 upon the due date. However, in the future, deferred revenue may continue to be variable, but may increase as we sustain higher levels of percentage of subscription-based sales, which as you know, we recognize ratably. Now I'd like to turn to our updated outlook. For clarity of presentation, I'll first detail our revised outlook for Guidewire standalone and then combine that outlook with our view of Cyence's contribution to our revenue and operating income. Today, we are modestly increasing our standalone total revenue outlook for the year from $611.5 million-$623.5 million, up to $640 million-$652 million .
For reasons Marcus elaborated, we are anticipating a greater percentage of orders to be subscriptions, leading us to moderate our license revenue outlook and increase our services revenue estimates for the year. This revision is atypical for us and underscores the uncertainty we face in estimating the pace of adoption of our cloud-based solutions. Our revised fiscal year outlook for license and other revenue now incorporates a 10% increase in the percentage of subscription orders, raising prior expectations of 20%-30%, to 30%-40% of software sales. Term and perpetual licenses are expected to decline as a result, with perpetual licenses declining to approximately half of last year's $13.1 million, and well below the 5% of total revenue which perpetual licenses have represented in the last three fiscal years. We are monitoring two other dynamics that have emerged as market sentiment has evolved.
First, as Marcus mentioned, we are experiencing an elongation of certain sales cycles where customers are considering both cloud-based and on-premise deployment solutions. This is driving a more back-end-weighted year and may extend a few purchasing decisions into our next fiscal year. Second, sales of the newer offerings, which Marcus itemized, could lead to a deferral of revenue if those offerings are combined with existing products. In these situations, we will defer revenues until product delivery requirements have been met. As a result of these factors, we are revising our license and other revenue to $292 million-$302 million, representing a decline of approximately $7 million at the midpoint of the range.
Together with the anticipated contribution of $9 million-$11 million of Cyence subscription revenues, which we reaffirm, we anticipate license and other revenue of $302 million-$312 million, an increase of 11%-15% from fiscal 2017 on a reported basis, and 16%-20% after excluding the effect of the $6.1 million in early payments in the fourth quarter of fiscal 2017. Conversely, we now anticipate higher services revenue for the year for two primary reasons. First, the combination of aggressive hiring and an expansive use of subcontractors to remediate capacity constraints in our InsuranceNow implementations. Second, our intention to lead InsuranceSuite Cloud implementations in the near term to ensure the effective transition of newly implemented systems to Guidewire Professional Services. We believe that after several InsuranceSuite Cloud implementations, we will be better positioned to leverage SI partners as we currently do in our on-premises business.
As a result, increases in the number of InsuranceSuite Cloud subscriptions will likely result in higher service revenue estimates for the fiscal year. Consequently, we are representing a $15 million increase at the midpoint of the range. We are mindful that the services revenue increase is not consonant with past expressions of our target revenue model. Nevertheless, we believe this hands-on approach is necessary to manage this transition effectively, and we intend to reduce services revenue growth as we leverage SI partners, as I described. We expect maintenance revenue to remain in the range of $73 million-$75 million, representing an increase of 6%-9% from a year ago. I again note that customers that subscribe to our cloud services obtain maintenance support as part of their [subscription fees] to be in the range of $631 million-$641 million, representing an increase of 23%-25% over fiscal 2017.
Turning to expenses and profitability, as we noted at our Analyst Day in September, fiscal 2018 will be one of increased but necessary investments as we lay the foundation for future growth. We intend to return to our more historical pace of expense growth starting in fiscal 2019. Our hiring this year is focused primarily on research development and services, with tactical additions to sales to help grow our broader array of products, including Cyence, and to capitalize on European demand. This year, we felt a greater sense of urgency in meeting our hiring goals and increased our recruiting efforts. As a result, unlike in past years, we have met our hiring goals for the first quarter and expect to meet our targets again in the second quarter.
We also expect to experience an increase in G&A this year in order to scale our business, meet new revenue standards, and accommodate the increasing breadth of products and variety of go-to-market models that we are deploying. Our operational teams in finance, IT, HR, and sales implemented a new ERP system and a new configure price quote system in the quarter. Our upgraded planning software application will be delivered in December, and the implementation of a new ASC 606-compliant revenue module will be completed in February. We estimate that these investments, which will not regularly recur, will cost approximately $8 million-$9 million over the year, all of which will be expensed. Even with these additional expenses and gross profit compression, we are maintaining our standalone non-GAAP operating income expectations.
When we announced Cyence, we indicated that costs and assumed operating losses associated with that acquisition would dilute operating margin by approximately three percentage points. We are confirming that view today as we expect total transaction costs of approximately $5 million and anticipate operating losses in the fiscal year of $12 million-$13 million. Including this impact, we anticipate non-GAAP net income in fiscal 2018 to range from approximately $90 million-$100 million or $0.82-$0.90 per diluted shares, based on approximately 77.5 million diluted shares. We are raising our free cash flow guidance for the year from $94 million-$106 million to $105 million-$115 million. This revised range includes an anticipated use of cash by our newly acquired Cyence business unit, which we currently estimate to be $15 million-$20 million for the year, and which was not included in our previous forecast.
For the second quarter of fiscal 2018, we anticipate total revenue to be in the range of $152 million-$156 million. Within revenue, we expect license revenue to be in the range of $76 million-$78 million, with growth challenged by a faster-than-anticipated shift to subscription licenses even in the second quarter. We anticipate maintenance revenue of $18 million-$19 million and services revenue of $57.5 million-$59.5 million. For the second quarter, we anticipate a non-GAAP operating income of between $18 million-$22 million and a non-GAAP net income of between $13.2 million-$15.8 million or $0.17-$0.21 per share based on approximately 77.2 million diluted shares. In summary, we're excited by the dynamic changes in our industry. Operator, you can now open the call for questions.
Thank you. If you would like to ask a question, please signal by pressing *1 on your touchtone. We'll pause for just a moment to allow everyone an opportunity to signal. We'll take our first question from-
Bhavan Suri. Thanks a lot for taking my questions. The first one, either for Marcus or Richard. With another quarter under the belt, I just wanted to kind of confirm, are you still seeing that 2x uplift from moving to the cloud? I just want to confirm, is that a comparison of, in the old world, term plus maintenance versus subscription today?
Yeah. Thanks, Bhavan, for the question. It's still very early days, but we have the same reasons for confidence I think that we've had throughout, that there will be significantly greater economic value for Guidewire in these arrangements and that customers will be enthusiastic, I think, to pay that additional amount to us because not only is there a cost transfer, but there is an absolute reduction in risk and complexity for them. Something like 2x or even a bit higher than that is what we use in our internal modeling. Is also the basis for the commercial discussions that we're having with a variety of different insurers right now. It is still early days, and today we just talked about only our second arrangement under this new form for InsuranceSuite. We'll continue to update you as we have more experience on that count.
To confirm, it does include both the license and maintenance numbers of our on-premises sales.
Got it. Services are not in that, correct? Just to be sure.
No, not at all.
Not at all.
Got it. Marcus, just following up, you mentioned Europe. Could you talk a little bit about the pipeline that you're seeing in Europe and then maybe add some color on the mix of cloud versus traditional license deals in that region, and then perhaps how Accenture is sort of helping in that at all?
Sure. I think the most striking thing about what's happening in Europe is that we have sales activity in a number of geographies that have been pretty dormant for us, despite years of trying, that have now gotten to be quite active. These are the major countries in continental Europe, like Spain and France and Germany. We can't take credit for that, of course. I think there are dynamics in each of those markets, including the rise of a local insurtech industry in each of these countries on its own that has helped catalyze some of the demand. It's been very encouraging to be able to pursue a whole new set of opportunities, including with some of the major insurers in those geos, as well as in the Nordics and parts of Central Europe as well.
Accenture, as you know, has been allied with us outside of North America. I would describe the relationship as helpful but not transformative so far in those efforts. It's always good to have more systems integrator options and partners in helping insurers make these major capital investments. I think you also had one other dimension to your question.
Cloud versus
Cloud versus
Cloud, yeah, for your-
A bit to our surprise, I would say that deliberation has pretty much the same character all around the world, and I would include even Asia Pac in that statement. That insurers really everywhere are looking for the same things, namely a transfer of risk and complexity and acceleration of the kind of transformation initiatives in data and digital that we've been talking about.
Perfect. Thanks.
Thank you.
We'll take our next question from Monika Garg.
Revenue would have gone into license line. Now, you're reducing license by almost $10 million. Is that all of that reduction is to the move to subscriptions?
Yeah. What we've said, Monika, is that we've reduced license and other by about push a little bit later in the fiscal year as these sales cycles take a little bit longer to conclude. If you recall, when we first started talking about the effects of this transition on our P&L, we suggested that every additional 10% of subscription revenue percentage would decline yield hitting the fiscal year that is subscription, because we simply have less time to take on those ratable revenues. The other very significant element, to be fair, is the reduction of perpetual licenses by about a half. I mean, one of the things that a lot of these conversations are doing are actually pushing out some of the perpetual demand that we sometimes have to fight against in our sales process.
We think that those perpetual numbers are going to be halved, and that also has an impact on our planning and our year.
Got it. If I include SI as people are coming for more cloud implementations, and that's why your service revenue is going up?
Yeah. Service revenue is going up for two reasons. One is that, we're anticipating that we need more InsuranceSuite service representation on our engagements, simply because if they come in as an InsuranceSuite Cloud engagement, we will actually see a significant increase in the per-engagement service revenue that we would generate, right? Almost an order of magnitude. The big influencer, especially in the beginning of the year, is really a reassessment of the InsuranceNow customer base, their needs, and our ability to actually staff the services professionals that will help them get to their finish line on time and on budget.
Got it. Just the last one for housekeeping here, just to understand the model transition. As you move the customers to cloud, you can get 2X to 2.5X higher revenue. That will all go to the license line and the service revenue, the implementation cost or implementation revenue will go into service line. Is that right understanding?
That's right.
Thank you.
We'll take our next question from Nandan Amladi with Deutsche Bank.
Hi, good afternoon. Thanks for taking my question. Marcus, with this groundswell of cloud projects coming your way, how ready do you feel to be able to execute against the opportunity, particularly on the hiring and training front as you bring more services people on?
I think it's a thoughtful question, Nandan. It's something that we have a lot of discussion about as a management team. I think we're enthusiastic for this change. It's one that we have been discussing for years and anticipating. Of course, it's always hard to calibrate exactly the pace at which these changes come, and we've had to make some guesses. It's also quite sensitive to any individual relationship. A single major cloud relationship with a big tier 2 or tier 1 insurer has a really meaningful impact on the services requirements from Guidewire. There's a lot to try to forecast and calibrate in making our resource plans.
What you heard from us in the prepared remarks was a determination not to have new sales gated by not being able to service them, to really err on the side of extra capacity, if anything, to ensure that we can meet the demand for the cloud deployments as well as some of the additional demand that we talked about in Europe. I'd say that we're ready and enthusiastic, but part of this journey has also been learning new skills in cloud production services, in cloud-based security, many other things as well. We've been able to develop those skills in tandem with a strategic customer, MetLife, that we've talked about quite a bit on these calls. That's been super helpful.
We think we'll be tested again as we take on the next wave of customers, which we expect just to continue to grow into the future.
Might be in terms of metrics or some additional metrics that you might be able to provide us that help with visibility?
Well, I think a couple of things, right. We introduced a couple of new metrics at our Analyst Day, we'd like to let those season a little bit and settle in. I will say that one of the things that we are really focused right now on, as opposed to figuring out what the new metrics will be that can best describe our business, is really trying to understand how the business is shaping up. The fact that after setting our guidance for the fiscal year, we've had to shift both license and services lines, which for us is a very significant change, should indicate how much the variability of these lines may continue in a couple of quarters.
Thank you.
Thanks, Mike.
We'll go for our next question to Sterling Auty with JPMorgan.
Richard, I hate to do this to you, I had the same question around metrics. Is there a thought to maybe giving us ARR or the number of cloud or subscription customers, just so we have something that we can tick off to see the growth of the help in the business sense it's going to be a while? This is, I think, a little bit more of a unique subscription transition than the 14 or 15 others that I've seen over the last 10, 12 years.
Obviously, I don't want to necessarily say anything that The Street or you will want me to update over time, because obviously this would not be a considered metric. Let me just give you a framing for what is driving some of our considerations. We had begun the year thinking that there would be two new InsuranceSuite Cloud customers. That's what we were thinking. I think as we look at the year now, that number has crept up to four, and may go a little bit higher still. The one thing that is a little bit of a challenge for us is that a lot of these discussions are at very early stages. We pretty much started from a standing start. The company had done very well at selling three or four transactions that they'd been working on for a while before we acquired them.
The pipeline, which was still pretty good, really required rebuilding. We've done a very good job at that. I think now as we come into the second quarter, I think we feel much more comfortable that we can double the InsuranceNow business in terms of number of customers from what they were able to do in our first year, stewarding this group with the help of the former founder, Andy Scurto, and his chief engineer, Doug Moore. Those are the two significant numbers that will really pivot our P&L around the service and license line going forward.
That makes sense. Just, Marcus, as you look at the types of customers that are having conversations around InsuranceSuite in the Cloud in particular, is there any commonality to them in terms of the type of P&C carrier or which insurance lines are looking to move first or anything else that you can really trend line?
There's certainly a commonality in the motivation, which we talked about, mainly risk and complexity transfer, and a greater confidence in the stability and the inevitability of using public infrastructure and having major core business applications delivered as services. That's getting to be more and more universal across the industry. We are having conversations with both current and prospective customers across really all of the applications in InsuranceSuite along those kinds of themes. As for the ones that will actually move forward, I think it is more likely that smaller insurers, they generally have fewer inhibitions about making that transition. We are having these conversations also with very large and even tier 1 insurers as well. I just think that they tend to have a longer list of reservations that they have to get over institutionally before they can make the big decision.
I think the motivations are really the same. We expect to see it across all segments, all tiers of our market go more rapidly at the lower end, the smaller end, I should say. That's exactly what you see with InsuranceNow which, of course, is only in cloud delivered form.
Got it. Thank you.
We'll go now to Ken Wong with Citigroup.
Hey, thanks for taking my question, guys. Marcus, you mentioned earlier about elongation of sales cycles. Is that just purely due to, as you just mentioned, kind of institutional reservations? Is it the actual concerns around cloud? Is it pricing? Any thoughts there? Then, you also mentioned being able to accelerate the deployment of a deal in this quarter that went cloud, going from traditional ClaimCenter. I guess, should we expect that those two kind of offset each other? Kind of longer sales cycles, shorter deployment cycles?
I appreciate the question. To the first part about what could drive a potential elongation, I think it's not so much reservations as it is the need to evaluate two different options and contrast them side by side to consider what would it mean to deploy this in our conventional data center, or what would it mean to have Guidewire take on full responsibility. It's not quite twice the set of questions, but it's a considerable expansion of the set of questions and topics that a prospective customer would go through. That could include an existing customer. I don't think that that will always be the case.
There's an element of novelty to it that as we routinize things more and have more examples to look for, more references, just like any new offering, we would expect are actually simplified by the cloud, and that's really the longer-term hope. On the second part of your question about possible acceleration for existing or even long-standing InsuranceSuite customers, I think we're hopeful for that as well. These are insurers that have been using one or more applications in InsuranceSuite for some time, and now there's no real product evaluation to go for. It's just a matter of rethinking the service relationship that they have with Guidewire and the transfer of responsibility.
That's what happened in this second case, we fully expect there to be more of these, and these will in general be faster than when a prospective customer or a current customer is considering a completely new application implementation. As for the mix of those two effects, that's very hard for us to guess. Of course, we have our whole pipeline kind of mapped out with a guess of when they will all happen, there's no way I could right now for you digest it all and cash it out into which effect dominates. I think what you hear from us overall and reflected in the guidance is the general kind of caution about the pace at which the transactions will close, given this whole ratable element, how much of the revenue we'll get to recognize within the current period.
Got it. Thanks for that. Richard, you mentioned the services number could continue to trend higher. In the past, you guys have gotten as high as mid-40s and on a quarterly basis, as high as into the 50s as a % of total revenue. Where do you think that could potentially settle in? Right now, your guide has 40%. Is that mid-40s a good ceiling or any help there would be great.
Ken, I think the answer is not one that I can easily give right now, and let me tell you why. We are right now embarking on a course of action which says we will help the industry transition as fast as it needs to be. We need to absorb all the services demands for any cloud implementation, whether InsuranceNow or InsuranceSuite Cloud, or frankly, for any of our other products that kind of tag along with those two core systems. That is our first priority. Our first priority is simply to absorb that demand because we do not want to hold our companies back and our customers back from whatever transformation they want to progress with.
At the same time, we are instituting new processes and coming up with new skills to be able to hand that back off to the SIs as soon as we feel comfortable that the risk is assessed and minimized, and we have trained those SIs appropriately in being able to help us with these exercises. It's the speed of that transition that gives me a little bit pause of being too comfortable knowing how high the services number can go. I do believe right now that services will outpace license growth for at least 2 years, you may see services revenue actually rise above 50% if this transition accelerates or paces at the speed which we're seeing right now. You're going to see it come back down after 2019. That is my current gut.
Obviously, this is not a model that we are embracing in any way. This is simply the exigencies of the moment that are driving our decisions. As soon as we can, you will see us replicate the model that was able to bring down services revenue down to 30%-35% of total revenue.
Okay. Fair enough. Thanks for that, Richard.
We'll take our next question from Tom Roderick with Stifel.
Yes. Hi, Matt VanVliet for Tom. Thanks for taking my question. I guess sort of building on the last question about the overall services mix. As that accelerates, does this help get to sort of the low point in margins and then a buildup moving forward that you sort of went through at the Analyst Day? Or is the acceleration really sort of pulls forward some of that?
Yeah. What'll happen is start declining, right? That's our current assumption. Obviously, we want to improve services margins, I think right now, with all the. That will obviously have a gross margin effect that will then drop down to the operating margin. The other issue, though, is that right now our license margin is actually down to 91% because we've invested in all these cloud teams and infrastructure. Now these teams over time, as that line starts to increase because the ratable revenue start being recognized. That will also be the other improvement that you will see affecting the gross margin line sometime end of 2019, starting 2020.
I have one other comment, which I think speaks to your question, Matt, as well as the previous one, which is that essentially all of the newer products that we have outside of InsuranceNow have almost no services attached with them. Predictive Analytics, anything to do with Cyence, Guidewire Live, none of these products have really any services attached. While they're all relatively modest in their adoption so far, if they attach to our core system customers at the pace that we're aspiring to or even faster than that would have a positive effect with respect to the lightness of the subscription to services mix. That's certainly a lever that we want to push on hard.
By the way, to Marcus' point, and to further it, those products also have a higher license margin associated with them because they don't necessarily share the infrastructural and production environment costs that InsuranceSuite Cloud and InsuranceNow require. Therefore, those margins will actually improve. As the mix towards the new products increases, our gross margin will improve over time as well.
Great. Looking at from a sales compensation and overall management perspective, what are you doing to push or not push more cloud revenue? Is it still based on total contract value, or are you really pulling into a recurring revenue basis, driving higher upside for individual salespeople?
Well, we've always had a recurring revenue basis for sales compensation. We try to keep it very simple, which is essentially an ARR target for each of our quota-carrying reps. We wanted to apply that with a minimum of modification to cloud-based revenue as well. Actually, because of the economics of these InsuranceSuite Cloud relationships, where there is a transfer of cost as well, we apply a bit of a haircut to that ARR that comes in cloud form. Even taking that haircut into account, a rep has substantially more to gain in total quota attainment for consummating an InsuranceSuite Cloud opportunity. There's plenty of enthusiasm on the sales team because there's a chance to go for larger.
We'll go next to Rishi Jaluria with JMP Securities.
Hey, guys. Thanks for taking my questions. Appreciate the detailed commentary. Marcus, I hate to keep going back to the commentary around the elongating sales cycles, just kind of want to get a sense, where are you seeing this? Is this with new customers, with expansions, with potential conversions? Help me understand where you're seeing this the most often.
Let me try to characterize it this way. In every sales evaluation with a prospective customer or even an existing customer who's considering licensing a new product, there's a portion of the sales evaluation which is functional. They want to know, does this meet all of our business requirements? Can we achieve the business benefits that we want? There's a substantial portion of the sales cycle which is planning the project and estimating the scale of the project and figuring out what resources will we need, what Systems Integrator partner might we need, how long will it be, what are the levers we have to bring this in to a certain envelope of expectations, et cetera. That's a distinct part of the sales cycle. That part of the sales cycle is a bit complicated when a prospective customer has to think about two different approaches.
One where they are implementing on-premise, which is pretty much how all of their core applications certainly are running today, or a new cloud model. What we're seeing is that some customers or prospective customers are essentially modeling out both of those scenarios and comparing them to make a decision. There are lots of quantitative and qualitative factors that go into making that choice. That takes a bit longer. Again, I don't believe that will always be the case. We think that over time we will probably start to lead much more aggressively and confidently with the cloud option being the right one. There will be more references to attest to that. The increasing preference that we see in the market for that simplification and risk transfer will motivate them to really opt maybe exclusively for evaluating the cloud option. That's our expectation.
I think that this temporary period of greater analysis requirement will be a temporary phenomenon maybe on the order of a year, something like that. That's our best guess right now. I hope that clarifies.
Yeah, that's helpful. Marcus, I wanted to go back to a comment you made earlier. Can you just help me understand why you expect Cyence to have little to no services attached, especially because it's in kind of a more emerging business than what your typical InsuranceSuite has?
Right. As a technical [repository] of companies that they have modeled the cyber risk for and they're keeping that data current, then you look at a set of score dashboard tools to appraise the amount of cyber risk. This is what an underwriter would look at. Their current customers today have effectively zero integration and really zero implementation. Now, there's an oversimplification there because sometimes a customer may want to add additional data streams. Of course, there's a business change, process change dimension to this that has to be involved. Cyence has a few folks who come from an industry background to help advise on that. When you contrast that to the kind of services that are required for a full core legacy system replacement, there's no comparison. Not in absolute terms, not in relative terms. It's extremely light touch.
Okay, got it. That's helpful. Last one from me, Richard, just want to look into the guidance for Q2. There's a really big sequential increase, higher than we normally see going from Q1 to Q2, even controlling for the Q4 prepayment. Can you help us understand the dynamic here, especially given that we're seeing increased subscription adoption and the associated headwind with that?
I don't think there's much that I can explain. I think that we're seeing a quarter firm up, which will lead to a particular set of license revenue and subscription revenue dollars that come into the quarter. We also have Cyence that increases our quarterly revenue by about $2 million. Don't forget, right in Q1, we had that $6.1 million that simply disappeared and came into Q4 of the previous year. That's one of the things that's showing and making that jump that much more visible.
Okay. Got it. All right. Thanks, guys.
Thanks for your question.
We'll take our next question from Brad Sills with Bank of America Merrill Lynch.
Oh, hey, guys. Thanks for taking my question. Just one on Cyence. I know it's early, and I know the deal just closed, but to the extent you can provide some color on early reception, particularly in the tier 1 and tier 2 market. What type of use cases are being considered for deployment of Cyence, and what kind of traction are you seeing there, just in terms of interest at this point?
Brad, in terms of interest, it has been significantly ahead of my own expectations. Not only in the breadth of insurers that are interested, these are some insurers who explicitly target these emerging risks, like try to write a new cyber product. Also very traditional mainline, standard line insurers that are concerned about the degree of embedded cyber risk that they have even in their traditional lines of insurance. There's tremendous interest across the board and across all these categories of customers at all sizes. That's been very encouraging. Of course, we have to convert that early enthusiasm into actual commercial relationships and deals. We've just recruited a new sales leader, a veteran sales organization at all. It was entirely founder- and executive-level sales. We're hoping to implement a much broader outreach to the market.
As for use cases, I talked about those insurers that are focused on new risks and those who are worried about embedded risks. We are also very interested in the possibility of using their data listening approach to standard lines and to more standard insurance use cases. The conventional way that data is gathered in the insurance industry is from the insured. You ask the insured for a lot of information, then on the basis of that, you underwrite the risk. It's supplemented with some other data, but primarily they have applied for an insurance policy and come to that insurer very informed about the character of their business and their risk. That could have significant implications for both a much more satisfying digital distribution experience as well as making better underwriting judgments.
Great. Thanks, Marcus. Then one on InsuranceNow. Any commentary on how that performed amongst kind of the new market entrants with insurtech companies coming in increasingly and how that offering's resonating with that end market?
We're pleased with InsuranceNow. I think after a little period of complication, I think we've stabilized the customer relationships well, we've been able to convert a number of deals in their pipeline and have been building the go-forward pipeline pretty much according to plan. I think we would enthusiastically ratify the decision we made to add that second core to our product portfolio. With respect to insurtech, this huge wave of investment in insurtech, almost none of it has gone to funding new core system providers that we would consider competitors. An enormous amount has gone towards funding competitors to our customers. New insurance companies that have some kind of new angle or value proposition. As for software players that are trying to sell to the insurance industry, a new core system, essentially none.
Some of our competitors have been recapitalized, but in terms of completely new entrants coming in out of the blue, we really haven't seen any of that in the last few years, despite the huge wave of insurtech investment. I think there's a lot of interest in competing with insurers as opposed to serving insurers, and we're very much on the serving insurers side of the equation.
Great. Thanks, Marcus.
We'll go next to Alex Zukin with Piper Jaffray.
Hi, thanks for taking my question. This is Taylor Radke on for Alex. I was wondering if you could maybe dig in a bit on what you're seeing with respect to attach rates on your data and digital products, and then is that at all being impacted by the uptick in cloud that you've been seeing?
I think attach rates for data and digital continue to be very strong. I don't have exact numbers for you, Taylor, but they are at least as strong as they have been historically, and we're confident that will continue or even increase as they just become thought of as all different aspects of the same platform. You heard that theme from me at our Analyst Day and maybe at our user conference, too, if you heard those presentations. I think that'll continue. We're very confident that there'll be strong attach rates for basically everything we're doing in data and digital, and that's really the heart of our strategy.
Cloud does not really intersect with that in any particularly novel way, i.e., whether or not you have deployed InsuranceSuite in the cloud or in a traditional on-premise mode, you would still want to access these other ancillary products, which themselves are generally all cloud-based. From a business user's perspective, it's all the same application. It's all the same environment. It's sort of an orthogonal dimension to the question. It's worth mentioning here that essentially all the new products that we expect to build or acquire in the future will be cloud-based. It's really a question of getting that huge core application adopted and implemented that gates the adoption of most of these products. We want to make it as easy as possible then to adopt the data and digital products once you've made that big core decision.
Q1 is always our lightest quarter, and therefore, the data is not so revealing as a look at the full year. At the end of the last full year, our attach rates for data and digital had been 50% or better, so they had continued to strengthen over the last couple of years. Hello?
We'll take our next question from Kevin Kumar with Goldman Sachs.
Hi. Thanks for taking my question. Regarding InsuranceSuite and InsuranceNow, is having high-end and low-end cloud offerings accelerating growth in the number of opportunities in the pipeline, even if some of those opportunities elongated in some cases?
Yes, that's very much the strategy here. We want to cover the waterfront. Any primary insurer, pretty much anywhere in the world, that writes non-life insurance, we want to have a core system offering for them. We want to give them, if they're a very small insurer, they will probably insist themselves on having it be delivered in the cloud, and that's what InsuranceNow is for. If they're a medium or large insurer, we want to be sure they have the option either to deploy on-premise or in the cloud. We try to meet the customer on their own terms, and I think now with the array of choices we have, we really are covering the waterfront.
One interesting fact to note is that I would say at least half of the InsuranceNow prospects that are in the pipeline, we would not even have gone after with only InsuranceSuite because they'd be too small for us to have an effective solution for those customers.
Yeah. It's also worth adding, of course, that we are not selling InsuranceNow internationally yet, though we have a couple of early conversations in English-speaking geographies. Another dimension of market expansion for us is to ensure that we can sell it around the world the same way that we do with InsuranceSuite today.
Great. Thank you.
That concludes today's question and answer session. At this time, I'll turn the conference back to Marcus Ryu for any concluding remarks.
No additional remarks. Thank you for joining our earnings call.
This does conclude today's conference. Thank you for your participation. You may now disconnect.