Greetings. Welcome to Guidewire's second quarter fiscal 2023 financial results conference call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero from your telephone keypad. Please note this conference is being recorded. At this time, I'll turn the conference over to Alex Hughes, Vice President of Investor Relations. Alex, you may now begin.
Thanks, Rob. I'm Alex Hughes, Vice President of Investor Relations, and with me today is Mike Rosenbaum, Chief Executive Officer, and Jeff Cooper, Chief Financial 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. Today's call is being recorded, and a replay will be available following the conclusion of this call. Statements made on this call include forward-looking ones regarding our financial results, products, customer demand, operations, the impact of local, national, and geopolitical events on our business, and other matters. These statements are subject to risks, uncertainties, and assumptions, and are based on management's current expectations as of today and should not be relied upon as representing our views of any subsequent date.
Please refer to the press release and risk factors and documents we file with the SEC, including our most recent annual report on Form 10-K and our quarterly reports on Form 10-Q filed to be and to be filed with the SEC for information on the risks, uncertainties, and assumptions that may cause actual results to differ materially from those set forth in such statements. We also will refer to certain non-GAAP financial measures to provide additional information to investors. All commentary on margins, profitability, and expenses are on a non-GAAP basis unless stated otherwise. A reconciliation of non-GAAP to GAAP measures is provided in our press release. Reconciliations and additional data are also posted in a supplemental on our IR website. With that, I'll turn the call over to Mike.
Thank you, Alex. Good afternoon, and thanks for joining us today.
I'm pleased to share the results of what was another great quarter for Guidewire. We continue to steadily execute and improve in all key areas of our business, and second quarter results were a good demonstration of this. We combined strong sales execution, great cloud adoption, and improved cost discipline to deliver better-than-expected results. We exceeded our targets for ARR, subscription and support gross margin, operating margin, and our performance this quarter gives us a strong foundation to build on for the remainder of the fiscal year. As we continue to lead an industry transition to modern cloud-based core systems, we enable our P&C insurance customers to better engage with their customers, innovate with new products, channels, and agile approaches to risk management, and structurally grow more efficiently than is possible with legacy core systems.
We continue to make steady progress in the key pillars of our strategy: cloud adoption, cloud deployments, cloud efficiency, and growing our ecosystem of partners that amplify everything we do ourselves. On the call today, I'll talk about our quarterly progress in each of these areas. Starting with cloud adoption. Q2 sales activity was strong with eight cloud deals in total, including two new customer wins, three migrations, and 3 InsuranceSuite expansions at existing customers. In the Americas, we had two new customer wins, including one for InsuranceSuite with a $2 billion DWP insurer and another for ClaimCenter with a $1.4 billion DWP insurer. We also closed two cloud migration deals, including one for ClaimCenter with a global Tier 1 insurer and another for InsuranceSuite with a longtime Guidewire regional customer.
In addition, we continued to work with one of the largest insurers in the world to steadily expand on Guidewire Cloud with a new greenfield initiative. In EMEA, we had three cloud wins, which is a strong quarter for us in this region. Two of these deals were with one of the largest Finnish insurers, who will be migrating an on-prem implementation of InsuranceSuite to Guidewire Cloud Platform, while also expanding InsuranceSuite to a new line of business. In addition, a major U.K.-based insurer will adopt BillingCenter on Guidewire Cloud Platform after adopting PolicyCenter on the platform last year. All of these transactions represent the growing confidence in our platform and cloud capabilities and the unique benefits we can provide in cloud-based modern core systems. Turning to cloud deployments. We continue to build momentum with nine more go-lives on the Guidewire Cloud Platform in the recent quarter.
The breadth and pace of deployments in Q2 was exciting and has kept us all very busy. The go-live activity this quarter was international, with three deployments in the United States, three in EMEA, three in Canada, and it was upmarket, with one Tier 1 and five Tier 2 deployments. In the quarter, we saw a Tier 1 insurer and a top 20 P&C insurer in the United States deploy ClaimCenter on Guidewire Cloud Platform, illustrating GWCP's ability to scale with the largest insurers. At the same time, a startup insurer was able to deploy PolicyCenter and BillingCenter on Guidewire Cloud Platform in just a few months, demonstrating that GWCP can be deployed quickly. I was also pleased to see insurers successfully modernize and transform their core systems to GWCP.
This included AMA Insurance Company, one of Canada's largest motor insurers, deploying InsuranceSuite on GWCP to deliver greater efficiency and better experience for its customers and its agent network. We also saw a major U.K. insurer with over a 300-year history deploy ClaimCenter on Guidewire Cloud Platform to begin its transformation journey. To date, 31 customers have gone live on Guidewire's Cloud Platform. This total includes migrations, modernizations, and greenfield deployments. I believe this speaks to the capability, flexibility, and agility of our platform. We will obviously continue to increase this total each quarter. As we do, we'll continue to improve our operating capabilities and efficiency with each new deployment and each new release. We also still have a lot to learn. Every time we complete a go-live, we learn something.
We identify ways we can improve, both for our internal operating efficiency, but more critically, we learn how to make these experiences and projects better for our customers. We remain determined to relentlessly drive further improvement in our cloud operations, reliability, performance, and security. While we are thrilled to now have 31 production customers and proud of the work we have done to achieve this, we also recognize that eventually, and I might say inevitably, this number will be in the hundreds or maybe even the thousands. The work we are doing right now to improve the efficiency of our operation in the future is critical to our long-term success and a key component of our intention to be a source of durable, long-term, profitable growth.
One of the assumptions we made coming into this year was that we could hold our cloud operations headcount flat while continuing to scale cloud adoption. This was based on the significant investment we have made and continue to make in our cloud platform. In the past six months, we have nearly doubled the number of production customers on Guidewire Cloud and have been able to effectively control the infrastructure and headcount expenses required to support that growth. The significantly improved subscription and support gross margins we saw this quarter were driven by these decisions and the determined execution of our teams. We will continue to learn and improve as we grow and continue to leverage the experience and feedback we gain from each project go-live so that we can confidently position Guidewire Cloud for every relevant insurer everywhere in the world.
Turning to Guidewire's partner ecosystem, we continue to build momentum with both our SI partners and our solution partners. The number of Guidewire consultants at System Integrators grew to over 21,000 at the end of Q2, up by 27% year-over-year. The number of cloud-certified consultants increased 82% year-over-year, passing 6,600 at the end of Q2. This gives our customers a valuable bench of cloud-trained professionals to draw on as they start down the path of modernization or embark on cloud upgrades. The importance of this community is illustrated by the fact that SIs have participated in over 70% of our cloud projects to date, and of these, 60% have been SI-led. Before I hand it over to Jeff, let me just comment on last week's news regarding our headquarters.
Around four years ago, we moved into a beautiful new building in San Mateo, California, with approximately 180,000 sq ft of space. Shortly after this move, the COVID pandemic changed the world. Post-COVID, our teams have become more distributed, and our hiring strategy has become more global. This move allows us to realize significant savings while right-sizing and aligning our office footprint to the needs of a more distributed, flexible, and global workforce. Jeff will comment in more detail about the financial impact of this move, basically it will save us $10 million-$12 million a year starting next fiscal year. I want to congratulate our real estate team on executing this transaction in a very challenging environment for these sorts of activities. I look forward to discussing this move further with Guidewire colleagues in the coming weeks.
With that, I'll turn it over to Jeff.
Thanks, Mike. We are thrilled with our second quarter cloud momentum and improved operational efficiency and cost discipline, all of which resulted in a great outcome in Q2 and a strong foundation to build upon as we execute toward our fiscal 2023 and longer-term financial targets. Second quarter ARR ended at $707 million, ahead of our expectations. This represents 17% year-over-year growth on a constant currency basis. The first half of fiscal 2023 benefited from minimal ARR attrition and healthy growth in ARR coming from deals sold in prior years with escalating fees, which we refer to as a ramped deal. Total revenue was $232.6 million, above the high end of our outlook. Cloud strength continues to be visible within subscription revenue, which grew 37% year-over-year to $86 million.
Subscription and support revenue was $105.8 million, up 25% year-over-year. License revenue was $73 million, up 5% year-over-year. Services revenue was $53.7 million, up 6% year-over-year. Turning to profitability for the second quarter, which we will discuss on a non-GAAP basis, gross profit was $131.9 million. Overall gross margin was 57%. Subscription and support gross margin was also 57% compared to 49% a year ago. This was significantly ahead of our expectations. Strong subscription revenue growth combined with our focus on cloud infrastructure efficiency is having a positive impact.
We are also recognizing benefits associated with our new agreement with our cloud provider, including some one-time savings that positively impacted Q2. We are expecting some higher costs in the back half of the year related to cloud customer upgrades to the latest release and healthy go-live activity. Collectively, we were pleased with our margins in the quarter and with how subscription and support margins are tracking for the year. Services gross margins in Q2 was just below breakeven compared to positive 8% a year ago. We continue to make steady progress working through complex early cloud programs and other programs that have been leveraging subcontractors at higher than normal levels, and we still expect services to return to positive margin in the second half of the fiscal year. Operating income was $15.1 million.
This was significantly higher than our expectations due to better than expected subscription and support gross profit and lower than expected operating costs. Overall stock-based compensation was $36.2 million. SBC expense was down 4% year-over-year in Q2 and up 2% year-over-year in the first half of 2023. We expect muted growth in SBC in the back half of this year. This is consistent with our slowdown in hiring as we scale our business without adding additional headcount. We ended the quarter with $870 million in cash equivalents and investments. In Q1, we announced a $400 million share repurchase program.
As part of that program, we executed a $200 million accelerated share repurchase program, which was finalized in February 2023, with an aggregate share delivery of 3.2 million shares at an average price of $61.93 per share. The initial tranche of 2.6 million shares were delivered in Q1, and the remaining approximately 600,000 shares were delivered in February, which is in our Q3. Turning to our outlook for fiscal year 2023, we are maintaining our ARR outlook of $745 million-$760 million. We are pleased with our progress in the first half and feel confident in our pipeline for the back half of the year, but feel it is prudent to maintain our outlook at this point in the fiscal year.
As I previously noted, the first half benefited from strong ARR coming from ramp deals and very low ARR attrition. The second half of this year has more difficult year-over-year compares in these two areas, which was already embedded into our guidance. We are excited by the pace of new modernization activity this year, whereas in the early part of the cloud transition, much of the bookings activity was focused on customer cloud migrations. This momentum is exciting for two reasons. One, it indicates increasing confidence in the maturity of our cloud platform, and two, it is demonstrating our ability to compete and win at a high level since most of these deals are competitive. We are raising our outlook for total revenue, which we now expect to be between $894 million and $904 million, representing 11% growth at the midpoint.
The primary change is we now expect subscription revenue to be $348 million, an upward adjustment of $6 million, and representing 34% year-over-year growth. This adjustment was driven by better deal linearity and some meaningful cloud contract extensions at existing customers. Turning to margins and profitability, which we will discuss on a non-GAAP basis, we expect subscription and support gross margins to be between 51%-52% for the year, an increase of 2 to 3 percentage points when compared to our outlook last quarter and 5 to 6 percentage points from the Q4 call. This adjustment reflects increasing confidence in our margin trajectory as we execute towards our mid and longer term margin targets. We continue to expect services margins in the mid-single digits for the year with significantly better services margins in the second half of the year.
This improvement assumes the completion of ongoing arrangements with investments from Guidewire. The ramp of new services hires replacing subcontractors and the redeployment of some Guidewire services resources from non-billable to billable roles. As a result, we now expect overall gross margin of approximately 53% for the year. With respect to operating income, we expect an operating loss of between $17 million and $7 million for the fiscal year. We expect stock-based compensation to be approximately $139 million, representing 1% growth year-over-year. Given this and the impact of the accelerated share repurchase program, we expect a decline in our fully diluted shares outstanding this fiscal year. There is no change to our cash flow from operations expectations.
In general, the positive margin progression gives us confidence in our ability to scale cash flow, but the timing of collections can cause cash flow to fluctuate in a given quarter or year given how much of our annual collections are due at the end of our fiscal year. Turning to our outlook for Q3, we expect ARR to finish between $715 million and $720 million, which represents 16% growth at the midpoint on a constant currency basis. We expect total revenue of between $211 million and $216 million. We expect subscription revenue of approximately $88.5 million, subscription and support revenue of approximately $107 million, and services revenue of approximately $56 million.
We expect subscription and support margins of approximately 50%. We expect services margins of approximately 10% and overall gross margin of between 50%-51%. We expect a non-GAAP operating loss of between $20 million and $16 million in Q3. Finally, as Mike noted, we have entered into an arrangement to complete an office swap with another company in San Mateo. Our new office space is just a couple blocks from our current headquarters, and it is less than half the total square footage. As part of this arrangement, we expect to take a write off of the leasehold improvements, the right of use asset, and lease liability in the existing location, and we expect the aggregate amount to be between an $8 million-$9 million loss. This charge will hit G&A.
This will impact our Q3 GAAP financial results, given the one-time nature of this write down, we will exclude this from our non-GAAP financials and therefore has no impact on the outlook provided above. We also have approximately $1.5 million in advisor and moving fees in the back half of the fiscal year, which is included in our outlook for the year. Looking ahead to fiscal 2024 and beyond, we expect to save approximately $10 million-$12 million per year as a result of this move. With that, operator, you can now open the call to questions.
Thank you. We'll now be conducting a question-and-answer session. If you'd like to ask a question today, please press star one from your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Thank you. Our first question comes from the line of Dylan Becker with William Blair. Please proceed with your questions.
Hey, gentlemen. Nice job here in the quarter. Maybe starting with Jeff this time on the margin front. Understand there's maybe some one-time dynamics there that you called out. Wanted to dig into the reallocation from customer-specific to kind of platform-specific investments. How big of a portion is that headcount and the margin delta, if I recall correctly, and how much does that capacity shift from that small select number of projects contribute to upside maybe in the quarter, but also give you kind of confidence in that long-term margin outlook you guys have called out?
Yeah, I mean, look, I think in general, we are seeing as we realize benefits of the investments we've made in the platform to be run and executed much more efficiently, that will afford us the ability over time to repurpose some headcount. You know, we talked a bit about this in Q1, where we had folks that were previously in our R&D organization, in our product development organization that were for a period of time doing customer-specific work, and so ended up in our cost of goods sold of our subscription product. Over time, those headcount have now moved back into the product organization as they are kind of building product sets for the totality of our customers rather than doing customer-specific work in almost like a support-like function.
We did see that in Q1. There was no movements in Q2 that drove the number. Q2 was, you know, healthy momentum in terms of overall platform efficiency. There was a little bit more update work that we had modeled into our number that is now gonna happen in the back half of the year. That was a little bit of the explanation for the outsized beat vis-a-vis our expectations. In general, this is, you know, this is just us kind of managing steady progression in terms of how we think about our cost structure to support our cloud business.
Got it. Got it. Super encouraging there. Maybe switching over to Mike. As you talk to customers, again, a lot of emphasis on kinda core back office efficiency, and what that can improve from an underwriting standpoint. I guess, how are carriers thinking about utilizing kinda some of the integrated data as well to improve their own marketing and distribution efficiency? I would, I would assume the challenge in attracting, but maybe the bigger challenge is in retaining those customers that fit kind of that preferred risk profile. I guess, how is that discussion evolving from a core adoption standpoint? Thanks.
Great question. I think the component of the platform and, you know, on both PolicyCenter, ClaimCenter, BillingCenter side, but I'd say, you know, from a new business perspective, it's mostly ClaimCenter and quoting, the digital capabilities around, you know, that give them flexibility and agility to roll out, you know, new channels, new mechanisms to quote new price products, new places to put those products. Better and more effective mechanisms for staying connected with agents and agencies and MGAs, are very, very important to a significant number of our customers. You know, so we support both, you know, companies that go direct, but also that go through distribution channels.
You know, even, you know, you might think, you know, if you're going through a distribution channel, the digital component doesn't quite matter as much. It might be even, you know, it might matter even more, because that sort of digital user experience that is really expected nowadays for, really dealing with any company or any product, becomes more and more important over time. It's the flexibility around, this that we're delivering with, Guidewire, with GWCP, and with some really exciting improvements that we have made on the digital front with our Jutro platform that they are very excited about. You know, I just think fundamentally, what we're trying to do for this industry is give them a platform that they can innovate with, that they can iterate on.
That if we can sort of make the projects easier for them to execute on smaller, faster. They're going to be able to, in the same way any software company sort of iterates their way to success, you know, you're going to be able to see sort of significant improvements in that marketing and distribution channel for both direct and indirect customers. Great question.
Super helpful. Thanks, guys, and congrats again.
Thank you very much.
Our next question is from the line of Kevin Kumar with Goldman Sachs. Please proceed with your questions.
Thanks for taking my question. Mike, can you give us an update on just the overall demand environment and any changes in terms of carriers' appetite for larger upfront deals? Any comments on kind of geographic differences? Feels like Europe was performing pretty nicely this quarter.
Good question. It's something we continue to pay close attention to, you know, given sort of overall sort of constant news about what's going on in the macro environment. I would say generally, we are seeing a continuation of what we've reported over the past few quarters in that the insurance industry is not immune but is not specifically impinged, I'd say, by this. There are certainly impacts of inflation that a lot of carriers are feeling and working through. In general, you know, like I said a number of times, I think that the time period around which these carriers are thinking about these modernizations and their strategy for these core systems is sort of, you know, at least multiyear, if not for a decade.
The decision-making process and the demand environment, it can, it can stay steady throughout, you know, this period of uncertainty from a macro perspective. You know, hopefully that's clear. Like, slow and steady wins the race at Guidewire. We think that the demand is still there. You know, things that we've talked about previously about carriers looking to do sort of, you know, sort of more, I don't know, line of business by line of business type of, purchasing strategies. You know, we still see that being a popular topic of conversation. I think our cloud approach, facilitates that better than what we were offering before. I feel pretty well aligned, to the, to the overall market and the, and the demand environment.
That's what gives us, you know, I think that drove a bit of the success in the quarter. As we called out, there's, you know, it was a good quarter for Europe as well as America. We saw go live activity across the board. Yeah, we feel pretty good about demand right now and feel confident at, you know, through the end of the fiscal year.
That's helpful. Just a question on InsuranceNow, maybe just an update on that product and maybe Guidewire's competitive positioning kind of more lower down market and kind of the level of investment you're making in that segment. Thank you.
Yeah. That is a great business for us. You know, we have a bunch of, you know, very happy customers in that segment, and we continue to make progress around what I'd say, slowly migrating that customer base over to GWCP. We've talked a little bit about that before. We still, like, eventually start to see real synergy between the two platforms. You know, I like, you know, the deal volume, the deal velocity there is not, you know, sort of multiples every quarter. We do have a consistent pipeline, and we do have a consistent plan. Most importantly, I think we do have a very, a very strong, and positive InsuranceNow customer base.
you know, the sort of growing synergy between the InsuranceSuite and InsuranceNow product lines, where we are looking at analytics use cases and, like I already mentioned, platform use cases that enable us to get a little bit of lift about the combination of both of those assets inside of Guidewire. It, you know, as you pointed out, it enables us to have a strategic presence down market, which I think is just strategically very important. I do not want to lose sight of that segment of the market, and I think it enables us to do some interesting things a little bit more quickly than we might be able to do with the InsuranceSuite side of our product line. That is going very well for us.
When you look at it from a fiscal year perspective, it's easier than looking at it just every single quarter-over-quarter.
Great. Thanks for taking my questions.
Thank you.
Next question is from the line of Rishi Jaluria with RBC. Please proceed with your questions.
All right. Wonderful. Thanks so much for taking my questions. Mike, I wanted to start with you and maybe understand, you know, some of the news around the headquarters swap, and glad to see you're kind of embracing distributed work. I wanted to get a sense for how are you thinking about your own hiring and, you know, workforce philosophy in this environment, where you're kind of finding areas that you think are worth investing in, maybe where you're being a little bit more deliberate with headcount additions. That would be helpful, and I've got a quick follow-up for you after.
Hey. Yeah. Thanks for the question. I think first thing you gotta recognize, and I think we're certainly not alone in this, is that, you know, when we switched to completely remote work, we recognized that, you know, we could be super productive. We could be very effective as a company in that environment, and that immediately causes you to recognize, you know, wait, we can hire people almost no matter where they are in the world. You know, that pushed us mentally to think a little bit more globally. You know, before I even joined, Guidewire had, you know, super presence in Dublin and Kraków, Poland, where we're doing real strategic product development work in both of those locations.
We obviously had a distributed services organization, but in the past few years, we've added a significant amount of headcount in India. We are using that as a strategic place to add R&D resources. We just continue to think that we will be more, more and more distributed, let's say, as opposed to San Mateo-centric. San Mateo, I think will always be an important part of the company, but we are seeing, you know, just absolutely great work from our international teams and our teams outside of California. You know, this headquarters move is sort of an acknowledgment of that, is we just had too much space here, and we weren't gonna grow into it.
The team was looking around at what they could do, and we found this opportunity and executed on it. I think it was, you know, just really well done. I would say if you project out over, I don't know, four or five years, you know, the strategy of looking for great people in different locations, regardless of, you know, sort of where they are, we're embracing that. You know, and I would put one caveat on that, just like, I don't know if you're interested, but it's, you know, we do actually believe that getting people together, is also important.
What we're trying to do is gravitate hiring and people around hubs and creating sort of reasonably complicated schedules around ensuring that people have opportunities to get together, collaborate in person, but also then go back to their home offices and work individually. We feel pretty good about that sort of balance that you'd, I guess, call hybrid work these days. We feel good about it, and I think that confidence is reflected in the real estate strategy.
All right. Got it. No, thanks. That's, that's really helpful. Then, Jeff, we talked about subscription support gross margins. I want to ask about services gross margins. I appreciate you gave us some color and expecting it to return to profitability in the back half of the year. I guess, number one, can you help us understand what are kind of the drivers to get that business on kind of a profitable basis? Maybe number two, you know, just philosophically, how we should be thinking about longer-term gross margins within services and, you know, how you think about balancing, treating it as a cost center versus maybe wanting to generate at least a decent profit, given it is a pretty significant part of your business.
You know, a lot of other vendors in the space maybe do get some level of profit off there. Maybe some color there would be helpful. Thanks.
Yeah. Yeah, sure. Thanks for the question. You know, I think our services organization is a highly strategic asset for Guidewire. As we were embarking on the initial part of this cloud transition, we knew that there was a lot of uncertainty that our customers had about the, you know, the path of going to Guidewire Cloud. We leveraged our services organization in a variety of ways to, you know, help our customers get comfortable with this shift. Some of that came through arrangements like fixed bid arrangements. A big area of anxiety is the overall cost of getting from point A to point B.
Some of that was around rolling out some discounted rates as a result of, you know, we're still learning a little bit on how these will play out and may not be operating at peak efficiency in terms of our billing activity, in terms of getting people from point A to point B. You see that a bit in our margins as we've invested alongside our customers to help them get comfortable to make the shift to the cloud. We've learned a lot over the last two to three years, and we've put in place kind of a multipronged strategy to bring that business back to where it has been historically, where we're no longer kind of using that as an asset for us to get business over the line.
The product has come a long way and, certainly, delivers and stands on its own two feet in that regard. The main area what we're seeing in the back half of the year is a lot of these fixed bid arrangements that we had worked on and been executing on are coming to completion. We're finishing those projects. We are also actively been working on a multi-quarter strategy to bring in entry-level hires, train them up, and have them replace fairly expensive subcontractors. We've been utilizing subcontractors at much higher levels than we have historically. That's a big part of the strategy, and we're starting to see that part of the strategy be realized.
Finally, we did some work internally looking at non-billable roles and seeing how we could improve our efficiency of kind of billable to non-billable roles. Those are the three things that we've been working on as an organization over the last kind of two to three quarters to kind of affect what we expect to see in the back half of the year. It's a, you know, it's an area that we're paying a lot of attention on as it's embedded in our guidance and is part of how we think about our execution for the year.
All right. Wonderful. Really helpful. Thank you so much, guys.
Sure.
Okay. Thank you.
Our next question is from the line of Ken Wong with Oppenheimer. Please proceed with your questions.
Great. Thanks for taking my question. This first one's for Mike. I couldn't help but notice that your customer commentary sounded a bit top-heavy with the migration of a Tier 1, go lives with Tier 1s and five Tier 2s. Is that just simply kind of just convenient timing in the quarter, or are you seeing greater conviction from some of your largest customers?
Yeah, super question. I mean, I guess you have to say, just based on the duration of deals and the duration of projects that, you know, sometimes there'll be a quarter where everything aligns, right? That's, that's half of the answer. In general, and I wouldn't say that this just applies to Tier 1s, you know, our confidence is building. I think confidence in the market is building generally. I'd give ourselves a little bit of credit for that in addition to just maybe this is the quarter where we saw this type of demand. I think 31 production customers now is a pretty good milestone.
I think dealing with the dealing with all of the work, the project-related go live work, I think successfully getting these programs live, I think is very, very helpful, and I think that that's only gonna help us going forward build confidence with the top end of this market. You know, and I, and I just think, especially as it relates to the customer base, you know, we traditionally have been, you know, more focused and more successful with Tier 1 and Tier 2 insurance companies. The whole strategy of the platform and the approach of our cloud strategy was to ensure that we invested enough to provide a service that they could trust. I think that that's, you know, you can see that starting to come out in the quarterly results.
I'll chalk it up to a little bit of both.
Got it. Fantastic. Appreciate the color there. Jeff, just, diving into the subscription gross margins a little more, I believe you mentioned a kind of a new arrangement with a cloud partner. Just wondering, was that the bulk of the uptick from Q1 to Q2, or how should we think about, you know, what the right quantification of that benefit was?
Yeah, I mean, we're seeing there's a variety of things. There's been a big emphasis in terms of our engineering team on, you know, we went through a phase where we were 100% focused on making sure that the product worked and making sure that we were meeting the needs of the customers. We are now, you know, thinking through more strategically how we make this thing more efficient over time, right? I think we've seen that, seen some benefits there. We entered into a long-term relationship with our cloud service provider that does include some incentives and pricing incentives so that we saw some benefit there. We think about our business on a very annual, through a very annual lens many times.
When we look at this year, we know that there is some work that's required to get our customers from some of the earlier ski slope releases to the later ski slope releases. Over time, that work becomes smaller and smaller, we have some of that modeled in the year that ended up not happening as much as we had originally thought in Q2, some of those costs have shifted into Q3 and Q4. When we look at all together, you know, we started the year with an outlook of around 46%, subscription support margins are now guiding to 51%-52%. We're really pleased with the progression that we've seen as we've worked through the year. It's a variety of things.
I mean, it's a lot of focus, and some of it is also the subscription revenue line has firmed up a bit. Now some of that is linearity. Q2 was a very healthy bookings quarter for us, a little bit higher than what we were expecting going into the quarter. That linearity also helps on the margin side.
Got it. Appreciate the context. Thanks, Jeff.
Mm-hmm.
The next question is from the line of Matt VanVliet with BTIG. Please proceed with your questions.
Yeah. Hi, guys. Thanks for taking the question. Apology for any background noise here. I guess when you look at the competitive landscape out there and sort of the pipeline of deals that you've already either gone live or in late stage of deployment today, are you seeing any of your existing customers, maybe just kinda check the box and say, "We're moving to Guidewire. We're not even gonna put this out for a competitive bid," as they move to the cloud? You know, I guess, how are you thinking or how are you hearing from your customers about their appetite to move to the cloud without really needing to go out and see what else is in the market?
Well, I'll take that. You know, for an existing Guidewire customer that is already up, already running with a deployed ClaimCenter, deployed PolicyCenter, even a deployed BillingCenter, our whole strategy is to make it highly unlikely that it would make any sense for them to replace that implementation with something other than Guidewire. You know, we are trying to minimize that switching cost. I think we largely have minimized that switching cost. That switching cost is not zero. As we've talked about previously, there is some amount of switching costs, and it is a, it is a project. You know, I would hesitate to say that I have...
You know, I'm trying to think if I've seen a single situation in which somebody has said, "We're gonna, you know, put the whole thing kinda, you know, we're gonna open up the whole strategy and look at it," just because it's so clear that, you know, most of the implementation of Guidewire is supported in Guidewire Cloud, right? Guidewire On-Prem can mostly be upgraded to Guidewire Cloud as opposed to re-implemented on a competitive core system. That's fundamental to our strategy. You know, we didn't start over with the product, and it wouldn't have made any sense, and it would've caused us to have to abandon that customer base. You know, we're not, we're not yet...
That isn't just a perfect push the button and the thing upgrades, but, you know, it's much, much better and much more logical for a big deployed, excuse me, insurance company, you know, sort of opening it up to competitive bid. Now, there still is competition out there for the greenfield implementation lines of business. And we do see existing Guidewire customers saying, "Hey, you know, even though we've got Guidewire already, for this new line of business that's not yet modernized," they will do RFPs for that, and we will compete for that business, you know, and we compete favorably in those circumstances, and that does occur. But for the existing base, it's unlikely that that would be a dynamic we would worry about.
Just not because we're the best, it's just because that's fundamental to the strategy here.
Okay, very helpful. Then, Jeff, not to belabor the point too much, but obviously, as you get more scale on GWCP in particular, you know, how much more of the long-term operating margin targets, and I guess within that, obviously gross margin, but how much of those are reliant on just getting more and more customers to migrate over, versus some of the other things you outlined earlier on the call, like reducing headcount, or I guess restraining headcount growth and some of these others? I guess the question is just, you know, how much do we need to see more cloud migrations occur to ultimately get to those long-term targets? Thanks.
Yeah, I mean, we've talked about this in the past, but, you know, I kind of think of the way we built this and attacked this opportunity is that we built a business to support $1 billion of ARR, and we need to scale into that $1 billion of ARR. That does mean that in order to get to our, you know, midterm targets, which have us at $1 billion of ARR, we need to add new customers and continue steady progression of migrating our install base and winning new business. I think, you know, what we're seeing this year is we're starting to see some of these larger new modernizations come back into the market. A lot of these have been sitting on the sidelines for a period of time.
That's an exciting fact pattern for us. Absolutely, we need to execute on our plan and continue to sell. Our model assumes that we can do that in a very scalable manner by not adding headcount and continuing to leverage the investments in the platform that we've made. Let me just jump on what Jeff said, Matt. I want you to understand this. You know, the positive improvement in the margin this quarter, I am super pleased with because it indicates that the strategy is working, right? It indicates that the what you could call the pivot we made, the decisions we made around prioritizing constraining headcount growth in these areas and the focus that we made on optimizing our infrastructure spend are starting to work.
It doesn't mean that, you know, if you hold revenue flat, that you're going to get more and more efficient. It's sort of like, hey, we said, "Hey, if we take X number of people and they build a capability into our platform that'll work for 1 through 100 customers, we still need those people because we got 31, right? As we go from 31 to 100, we don't need to add more people. The platform, it marginally will scale much, much more efficiently now. That's why we're so pleased with the results on the margin side this quarter, is that that strategy is now working, and I think you can start to see it in the financials.
Great question, but I really want you to understand that, you know, the philosophy here is, like Jeff said, we've built a platform to convert this customer base and win the majority of Tier 1, Tier 2, Tier 3 insurance companies in the world, and I think we're on a path to doing that.
All right. Great. Thank you. Really appreciate it.
The next question is from the line of Parker Lane with Stifel. Please proceed with your question.
Hi, this is Matthew Kickert for Parker. Thanks for taking my question. To start, what are your thoughts on the use case for generative AI within the Guidewire platform? Where would be the potential for incremental use on future platform updates? Could you see it helping at all with cloud migrations?
Yeah. Thanks for the question. I'm super excited you asked. It's one of my little, you know, it's one of my favorite things to think about these days. The first thing I would say is, you know, I genuinely believe that this will have a big impact on every software company in the world, every person in the world. I think it's a very, very big deal. It's almost like, you know, something new in the technology landscape has been invented, and we are all going to go find ways to leverage it super effectively. You know, I think one obvious area is code generation. The fact that these systems can generate code is maybe almost miraculous, in my opinion, but very, very exciting, you know, no matter what you think.
You know, we think that over time we'll improve the efficiency around implementations, maybe upgrades. You know, I think of it as every developer in the world will get a little bit more productive as we figure out ways to leverage this effectively and leverage this in a reliable and secure way. That's certainly one area of potential. There is a whole host of capabilities that you could imagine around customer interactions, claims management, quoting, you know, the back and forth that is associated with, you know, talking to consumers about insurance policies and things like that.
You know, I think fundamentally, on that side of it, I think Guidewire will certainly play a role in the innovation side of this and creative ways that we can deploy this in features of our, of our service. I also, you know, as one of our colleagues here, John Mullen, pointed out to me today, actually You know, the fact that we have this marketplace, that exists and facilitates, startups and insurtechs and smaller companies plugging into Guidewire deployed systems is a really big, big boost, I think, to Guidewire, but especially Guidewire customers. I think I said this before, you know, ChatGPT sort of opened everybody's eyes to this.
I said it a couple years ago at Connections, is we really do see a world in which there's a very significant amount of automation, that can be unlocked. I'd say fundamentally, you're gonna need a modernized core system at the base of your operation if you really are gonna fully leverage tools like generative AI. I think that that's a fundamental step. You know, I think these insurance companies are still gonna need platforms like Guidewire on the policy claims and billing side, and then you add this generative layer on top, and I think you'll get a real improvement in the business value and the transformation these companies are able to drive. Like I said, it's early days.
You know, it is early days, the excitement about it comes from the fact that like I said, I'm not the only one that genuinely thinks this is a miraculous level invention. I think the impacts to the insurance industry will be profound.
Terrific. That's great color. Congrats on the quarter. Thanks for taking my question.
Thanks a lot. Great question.
The next question is from the line of Joe Vruwink with Baird. Please proceed with your question.
Great. Hi, everyone. I wanted to go back to the large insurer you're working with on the new greenfield effort. Can you maybe talk about how the nature of the greenfield engagements have changed, just in either use case or maybe relative sizing of ACV? I guess related to this, how is the experience changing around follow-on activity post-greenfield? You know, do these become the entryway to maybe getting involved with bigger lines of business subsequent to the experience on the greenfield effort?
Yeah, good question. Yeah, we work with different carriers in different ways. In this particular one, we have a, you know, a pretty broad agreement that basically says they will, sort of project by project by project, modernize to Guidewire. As opposed to doing one massive, deal with us, they look at it as, you know, when this line of business is ready to modernize or this line of business is ready to launch and that project's ready to kick off, you know, that becomes a deal that we incrementally add to our contract with that, you know, with that insurance company. You know, not everybody wants to approach it that way. Not all of our customers do, but in this case, that made the most sense.
You know, for sure, as experience and confidence builds, you know, both on the platform side, but especially on the customer side, it facilitates an acceleration of those projects, right? As you say, "Hey, we got that done successfully and that's going well, let's take another bite at more of the modernization backlog and green light that project and get that started and move that to Guidewire." That's basically what we're seeing there. That's not unique. You know, we've seen that with a number of other companies. We often see this with acquisitions.
You know, we've seen this with a couple of different carriers over my tenure here at Guidewire, where they've got a baseline project, but there's an acquisition that comes sort of after the initial project's been kicked off, and that acquisition creates an opportunity to do another line of business with a new implementation of Guidewire. Like I said, you know, the name of the game for me is project go-lives, successful projects, build confidence, build success, ensure that we're just steadily executing because, you know, that increases the likelihood that that next line of business, it'll just be logical to put that onto Guidewire and the platform.
Okay. That's all great. Then just on the new modernization activity that's been talked about a couple times. What might be kind of a reasonable or maybe guardrails around sales cycle that could end up being associated with these? Is this the type of thing where in magnitude, if you are able to win these within the next 12 months, it maybe presents the potential to see a sharper rise in ARR, I don't think it would be next year, but maybe in that fiscal 2025 timeframe?
I guess certainly there is that potential. I hesitate to forecast that or predict that. You know, when we do an assessment of the total addressable market that exists in P&C for modernizations, we do see a pretty significant amount of, you know, these projects and systems that will eventually occur. You know, as confidence builds, as our experience builds, as the risks and costs associated with successfully executing these modernizations, as those things get more controlled, you do see the potential, I'd say, for the pace to pick up. I've said this a number, you know, many times, we are not the only factor, and the technology is not the only factor in the timing of the insurance company's decisions around these things. They have other priorities and objectives.
We've had deals that are perfectly logical and eventually are gonna happen, but something else pops up either on the regulatory side or on the, just the baseline insurance side, you know, sort of catastrophe-like risks and events can have an impact on this. There's a lot of other factors that can control the timing of these things. We do our best to do our part and increase the likelihood of success and the value that we're delivering. You know, that potential exists, but I'm hesitant to forecast it, if that makes sense.
Yeah. I just add, I mean, I think this is always part of our plan. It's very consistent with how we model this. We knew that modernizations has been the, you know, the bread and butter of Guidewire and needed to be a big part of how we think about the long-term opportunity here. We're excited to see that start to kind of show some meaningful progression. That was always, you know, it's kind of validating the model and validating how we think about the opportunity.
Okay. thank Mike. Thanks, Jeff. Appreciate it.
Our next question is from the line of Michael Turrin with Wells Fargo. Please proceed with your questions.
Hey, thanks. Appreciate you taking the question. I think so far the commentary on the macro has been fairly clear, Mike, but maybe one on the competitive environment, if I may. I know it hasn't been long, but you had a competitor recently depart the public market. I'm wondering if there's any change you're hearing in customer conversations or just how you'd respond to the overall question on the competitive environment?
Yeah. I think my talk track on competitive is that things have not changed. You know, we still have competitors, you know, regardless of the circumstances around the ownership of those competitors, they're still out there, they still remain. I'm super happy with our progress to date. I think that, you know, I am positive on our progress and positive about the future at Guidewire. You know, I think that that'll have an impact on our ability to compete in the market successfully. Like I say, like I've said before, continually upmarket. You know, I think we have a very differentiated offering upmarket for Tier 1 and Tier 2 insurance companies, even top end of Tier 3.
It's like very clear to me, and I think it's becoming clearer and clearer, that that's gonna be the ultimate winner in this market will be Guidewire. You know, we still do have that competition. You know, the news that you're referring to is pretty recent. Like, my message to the team here at Guidewire is, let's stay focused, let's keep executing, you know, let's just keep playing our game. You know, I think we'll continue to succeed kind of at least as well or better than we have to date. That's my take on the competitive situation. It generally hasn't changed much.
Very balanced. Jeff, stepping away from margin and maybe to ARR for just a moment. You're holding onto the outlook there. You mentioned some of the positive first half impacts, but I think called out tougher compares in the back half. If I look at it, I see constant currency growth rates in 2Q and 4Q that are at least somewhat similar. Just hoping to understand that comment a bit more, if there's anything in the macro or anything else that might be driving a more conservative stance in the rest of your outlook for ARR or just anything else you can add there is helpful. Thanks.
Yeah, nothing really. I mean, as you know, Q4 is such a big quarter for us, we usually don't move our guidance around too much at the early part of the year. Had a really good first half. Q2 was really strong, that gives us increasing confidence. On the compare side, that's more of estimate of our model, right? Just when we look at ramp activity and when that materializes into ARR, it just so happened that this year, the first half was pretty healthy in that regard. The second half, compared to what we saw last year, those compares are much more difficult. That just kind of flows through the model.
In addition to last year being pretty amazing in terms of the overall ARR attrition that we experienced last year, this year, we're still expecting, you know, very solid retention rates, you know, around kind of 3% ARR attrition is how we always think about modeling our business. We're within those guidelines. Last year was a very strong year in that regard. That also created a little bit of a difficult compare. Those are some of the dynamics that are causing net new ARR to slow down a little bit in the back half of the year. That was always embedded into how we thought how this year would play out.
Appreciate the details there. Thanks.
Yep.
Thank you. Our final question is from the line of Tyler Radke with Citi. Please proceed with your questions.
Yes, thanks for taking the question. Mike, just on the go lives, I'm curious how that compared to your expectations. Are you expecting kind of the pace of go lives to increase in the second half of the year?
Yeah, super question. The go-live activity has a lot to do with, I don't know, how the projects proceed, whether or not there's any delays and anything that you catch and, you know, whether or not those go-live dates are pushed out. I would say generally, you know, unlike, you know, I think every project dynamics a bit like this. It's like you plan somewhat aspirationally at the beginning. You know, unfortunately, you get circumstances that cause a go-live to push out. We do see those from time to time. I hesitate to have you, like, catch me start to forecast go-lives 'cause that's not my intention. I would say it does match our expectations. Do you know what I mean?
Like, the pace of it is starting to be something that I'd say our company is gonna get used to executing at that pace sort of maybe forever, right? Because when you do the math, you know, we like to do these over the weekends, you know, because it, and then it inevitably involves some transition downtime for these companies. These core systems, when they actually swap over, have to be taken down before they're brought back up on the new thing. You wanna do that on the weekend. That creates a big, you know, complicated project to execute flawlessly between Friday night and Monday morning.
What we're doing is looking ahead at every single weekend now until forever, sorta, and filling up those slots based on the demand that we are seeing. You know, it was, it was in line. You know, these things are never perfect. It wasn't exactly every single one, you know, six months ago that we thought would go live in the quarter went live in the quarter. We're very happy with the execution this quarter. Like I said, I think that this is gonna end up being. I kinda tried to point to this in my prepared remarks.
It's like this is gonna be just a steady part of Guidewire, from now and for a real long time, just because of the numbers and the customer base and the new business activity that we see bear that out. You know, if we keep doing deals and we keep filling the pipeline, we keep closing deals and then filling the pipeline for go-lives, you know, that go-live activity will just keep going. As it does, the demand on the platform will keep growing, the revenue on the platform will keep growing. Because we're able to control the headcount and the infrastructure expense, the margin around that product will keep improving. You know, you see that in this quarter in a really positive way.
I'm just very excited about the progress, the execution and maybe the determination of the people at Guidewire to make those projects happen. Thanks.
Awesome.
I don't know.
Yeah.
Did that help it?
Yeah. Thanks a lot.
We'll hold you to 50 a quarter from here on out.
Yeah. Perfect. Perfect. Thank you.
A quick follow-up for Jeff, just on the margins. Obviously, a lot of good cost-saving stuff this year between hyperscaler contract negotiations and real estate consolidation. Do we think about these as upside to your long-term targets that you gave out? Just help us understand, you know, how those play into those. Thank you.
Yeah. I mean, I think on the overall, subscription and support margins, we're clearly tracking a little bit ahead of our FY 2023 targets. That's positive. It's, it's helpful as we think through our kind of longer-term targets. Wouldn't necessarily call them out as upside yet. Like, this is, this is helpful for us to kind of feel more and more confident as we execute towards those targets. Like, the building and the real estate consolidation was not embedded into our plan. That is a little bit of upside in terms of how we, how we built the model previously.
In general, when we look at some of the cost savings initiatives, the company is doing a number of activities that I think give us a little bit of confidence that we're tracking a bit ahead of the plan. Know that there's still a ton of execution between now and, you know, FY 2025 or some of those longer-term targets. At a high level, that's how I think about it.
Great. Thank you.
Thank you. At this time, we've reached the end of our question and answer session. I'll turn the floor to Mike Rosenbaum for closing remarks.
Okay. I just wanted to say thanks, everybody, for participating today. We're obviously thrilled with the continued cloud momentum across new and existing customers. We had Tier 1 and Tier 2 insurers going live this quarter. Like we talked about driving margin improvement, we think this quarter is a great validation of our strategy and increases our confidence in our long-term opportunities. Look forward to catching up with you with you all further throughout the quarter and have a great afternoon. Thank you.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.