The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the Risk Factors included in Item 1A of Part II of this Quarterly Report on Form 10-Q. All information presented herein is based on our fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to our fiscal years ended in July and the associated quarters of those fiscal years. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law. Overview Guidewire delivers a leading platform that P&C insurers trust to engage, innovate, and grow efficiently. Guidewire's platform combines core operations, digital engagement, analytics, and artificial intelligence ("AI") applications delivered as a cloud service or self-managed software. As a partner to our customers, we continually evolve to enable their success and assist them in navigating a rapidly changing insurance market. Our core operational services and products are InsuranceSuite via Guidewire Cloud, InsuranceNow, and InsuranceSuite for self-managed installations. These services and products are transactional systems of record that support the entire insurance lifecycle, including insurance product definition, distribution, underwriting, policyholder services, and claims management. InsuranceSuite via Guidewire Cloud is a highly configurable and scalable product, delivered as a service and primarily comprised of three core applications (PolicyCenter, BillingCenter, and ClaimCenter) that can be subscribed to separately or together. These applications are built on and optimized for our Guidewire Cloud Platform ("GWCP") architecture and leverage our in-house Guidewire Cloud operations team. InsuranceSuite via Guidewire Cloud is designed to support multiple releases each year to ensure that cloud customers remain on the latest version and gain fast access to our innovation efforts. Additionally, InsuranceSuite via Guidewire Cloud embeds digital and analytics capabilities natively into our platform. Most new sales and implementations are for InsuranceSuite via Guidewire Cloud. InsuranceNow is a complete, cloud-based application that offers policy, billing, and claims management functionality to insurers that have limited internal information technology resources. InsuranceSuite for self-managed installations is comprised of three core applications (PolicyCenter, BillingCenter, and ClaimCenter) that can be licensed separately or together and can be deployed and updated by our customers and their implementation partners. Our digital engagement applications enable digital sales, omni-channel service, and enhanced claims experiences for policyholders, agents, vendor partners, and field personnel. Our Analytics and AI offerings enable insurers to manage data more effectively, gain insights into their business, drive operational efficiencies, and underwrite new and evolving risks. To support P&C insurers globally, we have localized, and will continue to localize, our platform for use in a variety of international regulatory, language, and currency environments. Our customers range from some of the largest global insurance companies or their subsidiaries to predominantly national or local insurers that serve specific states and/or regions. Our customer engagement is led by our direct sales team and supported by our system integrator ("SI") partners. We maintain and continue to grow our sales and marketing efforts globally, and maintain regional sales centers throughout the world. Because our platform is critical to our new and existing customers' businesses, their decision-making and product evaluation process is long, which results in an extended sales cycle. These evaluation periods can extend further if a customer purchases multiple products or assesses the benefits of a cloud-based subscription. Sales to new customers also involve extensive customer due diligence and reference checks. Our sales cycle has lengthened due to the COVID-19 pandemic. The success of our sales efforts relies on continued improvements and enhancements to our current services and products, the introduction of new services and products, efficient operation of our cloud infrastructure, continued development of relevant local content and automated tools for updating content, and successful implementations. We sell our cloud-delivered offerings through subscription services and our self-managed products through term licenses. We generally price our services and products based on the amount of DWP that will be managed by our platform. Our subscription, term license, and support fees are typically invoiced annually in advance. Subscription services are generally sold with an initial term of between three and five years with optional annual renewals commencing after the initial term. Subscription revenue is recognized on a ratable basis over the committed term, once all revenue recognition criteria is met including providing access to the service. Term licenses are primarily sold with an initial two-year committed term with optional annual renewals commencing after the initial term. We may enter into term license arrangements with our customers that have an initial term of more than two years or may renew license arrangements for longer than one year. A small portion of our revenue is derived from perpetual licenses. Term and perpetual license revenue are typically recognized when software is made available to the customer, provided that all other revenue recognition criteria have been met. Our support revenue is generally recognized ratably over the committed support term of the licensed software. Our support fees are typically priced as a fixed percentage of the associated license fees. We also offer professional services, both directly and through SI partners, to help our customers deploy, migrate, and utilize our platform, services, and products. Substantially all of our services revenue is billed monthly on a time and materials basis. Over the past few years, we have primarily been entering into cloud-based subscription arrangements with our new and existing customers and we anticipate that subscription arrangements will be a majority of annual new sales going forward. As this sales model 24 -------------------------------------------------------------------------------- Table of Contents matures, we may decide to change certain contract terms in new arrangements to remain competitive or otherwise meet market demands. To extend our technology leadership in the global market and to drive operating efficiency, we continue to invest in product development and cloud operations to enhance and improve our current services and products, introduce new services and products, and advance our ability to securely and cost-effectively deliver our services in the cloud. Continued investment is critical as we seek to assist our customers in achieving their technology goals, maintain our competitive advantage, grow our revenue, expand internationally, and meet evolving customer demands. In certain cases, we may also acquire skills and technologies to manage our cloud infrastructure and accelerate our time to market for new products, solutions, and upgrades. Our track record of success with customers and their implementations is central to maintaining our strong competitive position. We rely on our global services team and SI partners to ensure that teams with the right combination of product and language skills are used in the most efficient way to meet our customers' implementation and migration needs. We have extensive relationships with SI, consulting, technology, and other industry partners. Our network of partners has expanded as interest in and adoption of our platform has grown. We encourage our partners to co-market, pursue joint sales initiatives, and drive broader adoption of our technology, helping us grow our business more efficiently and enabling us to focus our resources on continued innovation and further enhancement of our solutions. We work closely with our network of third-party SI partners to facilitate new sales and implementations of both our subscription services and self-managed products. Our partnership with leading SI partners allows us to increase efficiency and scale while reducing customer implementation and migration costs. We continue to invest time and resources to increase the number of qualified consultants employed by our SI partners, develop relationships with new partners in existing and new markets, and ensure that all SI partners are qualified to assist with implementing our services and products. We believe this model will continue to serve us well, and we intend to continue to expand our network of partners and the number of certified consultants with whom we work so we can leverage our SI partners more effectively, especially for future subscription migrations and implementations. We face a number of risks in the execution of our strategy, including risks related to expanding to new markets, managing lengthy sales cycles, competing effectively in the global market, relying on sales to a relatively small number of large customers, developing new or acquiring existing services and products successfully, migrating our business towards a subscription model with ratable revenue recognition, increasing the overall adoption of our services and products, and cost-effectively managing the infrastructure of our cloud-based customers. In response to these and other risks we might face, we continue to invest in many areas of our business, including product development, cloud operations, implementation services and sales and marketing. Seasonality We have experienced seasonal variations in our license revenue and, to a lesser extent, in our subscription revenue as a result of increased customer orders in our fourth fiscal quarter. We generally see significantly increased orders in our fourth fiscal quarter, which is the quarter endingJuly 31 , due to efforts by our sales team to achieve annual incentives. Because we recognize revenue upfront for new term licenses and multi-year renewals compared to over time for subscription services, changes in the mix between term license and subscription services may impact our quarterly results. Additionally, any quarter in which a significant multi-year term license or multi-year term license renewal or non-renewal occurs could be impacted. For example, in the first quarter of fiscal year 2021, we experienced license revenue growth due to a five-year term license renewal under which revenue was recognized upfront, which overshadowed the comparison with our second quarter of fiscal year 2021 and created a challenging comparable period for the first quarter of fiscal year 2022. Additionally, as subscriptions increase as a percentage of total sales, the revenue we can recognize in the initial fiscal year of an order will be reduced, deferred revenue will increase, and our reported revenue growth will be adversely affected in the near term due to the ratable nature of these arrangements. The concentration of our sales in our fiscal fourth quarter increases this impact as the revenue impact of most fiscal fourth quarter subscription sales will not be realized until the following fiscal year. Our services revenue is also subject to seasonal fluctuations, though to a lesser degree than our license revenue and subscription revenue. Our services revenue is impacted by the number of billable days in a given fiscal quarter. The fiscal quarter endingJanuary 31 usually has fewer billable days due to the impact of theThanksgiving , Christmas, andNew Year's holidays. The fiscal quarter endingJuly 31 usually has fewer billable days due to the impact of vacations taken by our services professionals. Because we pay our services professionals the same amount throughout the year, our gross margins on our services revenue are usually lower in these quarters. This seasonal pattern, however, may be absent in any given year. COVID-19 Impact InMarch 2020 , theWorld Health Organization declared the outbreak of COVID-19 a pandemic, which has continued to spread throughoutthe United States and the world and has resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. While we are 25 -------------------------------------------------------------------------------- Table of Contents unable to accurately predict the full impact that COVID-19 will have on our results of operations, financial condition, liquidity, and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures and if there are any periods of increases in the number of COVID-19 cases or future variants of the virus in areas in which we operate, our compliance with containment measures has impacted our day-to-day operations and could continue to disrupt our business and operations, as well as that of our key customers, SI partners, vendors, and other counterparties, for an indefinite period of time. To support the health and well-being of our employees, customers, SI partners and communities, a vast majority of our employees are working remotely. In addition, many of our existing and potential customers are working remotely, which may continue to delay the timing of new orders and professional services engagements in the future. Our business and financial results since the third quarter of fiscal year 2020 have been impacted due to these disruptions, including decreases in annual recurring revenue ("ARR") growth rates, services revenue and margins, operating cash flow, potentially higher employee attrition, and the change in fair value of strategic investments. ARR and revenue, especially services revenue, continued to be impacted in fiscal year 2022 as a result of the challenges related to our compliance with government-mandated or recommended shelter-in-place orders in jurisdictions in which we, our customers, SI partners and vendors operate. Although vaccines are making progress against the COVID-19 pandemic inthe United States and certain other parts of the world where vaccinations are widely available, the economic impact of the pandemic on our business and the businesses of our customers, SI partners, and vendors may continue through fiscal year 2022, if not longer. We believe that new sales activities are being delayed, not cancelled, and implementation engagements are being rescheduled to later periods or being completed over a longer period of time. Certain marketing events have or will be cancelled or postponed, while others are being hosted both in-person and virtually, like our customer conference, Connections. Our customers may be unable to pay or may request amended payment terms for their outstanding invoices due to the economic impacts from COVID-19, and we may need to increase our accounts receivable allowances. A decrease in orders in a given period could negatively affect our revenues and ARR in future periods, particularly if experienced on a sustained basis, because a substantial proportion of our new software subscription services orders is recognized as revenue over time. Also, the pandemic's global economic impact could affect our customers' DWP, which could ultimately impact our revenue as we generally price our services and products based on the amount of DWP that will be managed by our platform. Additionally, we may be required to record impairment related to our operating lease assets, investments, long-lived assets, or goodwill. In response to the pandemic, various government programs have been announced which provide financial relief to affected businesses. As an example, the Canadian Government enacted theCanada Emergency Wage Subsidy ("CEWS") under their COVID-19 Economic Response Plan to prevent layoffs and help employers offset, for a limited time, a portion of their employee salaries and wages. Beginning inJanuary 2021 , we applied for the CEWS, to the extent we met the requirements to receive a subsidy. We have not and do not expect to receive a subsidy under the CEWS for the three months endedOctober 31, 2021 . We will continue to evaluate the nature and extent of the impact of COVID-19 on our business. Key Business Metrics We use certain key metrics and financial measures not prepared in accordance with United States Generally Accepted Accounting Principles ("GAAP") to evaluate and manage our business, including ARR and Free Cash Flow. For a further discussion of how we use key metrics and certain non-GAAP financial measures, see "Non-GAAP Financial Measures" in this Quarterly Report on Form 10-Q. Annual Recurring Revenue ("ARR") We use ARR to quantify the annualized recurring value outlined in active customer contracts at the end of a reporting period. ARR includes the annualized recurring value of term licenses, subscription agreements, support contracts, and hosting agreements based on customer contracts, which may not be the same as the timing and amount of revenue recognized. All components of the licensing and other arrangements that are not expected to recur (primarily perpetual licenses and professional services) are excluded. In some arrangements with multiple performance obligations, a portion of recurring license and support or subscription contract value is allocated to services revenue for revenue recognition purposes, but does not get allocated for purposes of calculating ARR. This revenue allocation only impacts the initial term of the contract. This means that as we increase arrangements with multiple performance obligations that include services at discounted rates, more of the total contract value will be recognized as services revenue, but our reported ARR amount will not be impacted. During the three months endedOctober 31, 2021 , the recurring license and support or subscription contract value recognized as services revenue was$0.9 million . If a customer contract contains invoicing amounts that increase over the contract term, then ARR reflects the annualized invoicing amount outlined in the contract for the current reporting period. For example, given a contract with annual invoicing of$1.0 million at the beginning of year one,$2.0 million at the beginning of year two, and$3.0 million at the beginning of year three, and the reporting period is subsequent to year two invoicing and prior to year three invoicing, the reported ARR for that contract would be$2.0 million . 26 -------------------------------------------------------------------------------- Table of Contents As ofOctober 31, 2021 , ARR was$594 million , compared to$582 million as ofJuly 31, 2021 . ARR results for interim quarterly periods in fiscal year 2022 are measured on a constant currency basis, using the actual currency rates at the end of fiscal year 2021 throughout the year. Free Cash Flow We monitor our free cash flow, as a key measure of our overall business performance, which enables us to analyze our financial performance without the effects of certain non-cash items such as depreciation, amortization, and stock-based compensation expenses. Additionally, free cash flow takes into account the impact of changes in deferred revenue, which reflects the receipt of cash payment for products before they are recognized as revenue, and unbilled accounts receivable, which reflects revenue that has been recognized that has yet to be invoiced to our customers. Our net cash provided by (used in) operating activities is significantly impacted by the timing of invoicing and collections of accounts receivable, the timing and amount of annual bonus payments, as well as payroll and tax payments. Our capital expenditures consists of purchases of property and equipment, primarily computer hardware, software, and leasehold improvements, and capitalized software development costs. In the first quarter of fiscal year 2022, we paid the entire bonus amount for fiscal year 2021 along with accrued vacation for employees in countries where we adopted a non-accrued vacation policy effectiveSeptember 2021 . For a further discussion of our operating cash flows, see "Liquidity and Capital Resources - Cash Flows" in this Quarterly Report on Form 10-Q. Three
Ended months
2021 2020
Net cash provided by (used in) operating activities
Purchases of goods and equipment
(3,333) (1,907) Capitalized software development costs (3,783) (2,581) Free cash flow$ (114,158) $ (20,195)
Critical accounting conventions and estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP. Accounting policies, methods, and estimates are an integral part of the preparation of condensed consolidated financial statements in accordance with GAAP and, in part, are based upon management's current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods, and estimates are particularly sensitive because of their significance to the condensed consolidated financial statements and because of the possibility that future events affecting them may differ markedly from management's current judgments. While there are a number of significant accounting policies, methods, and estimates affecting our condensed consolidated financial statements, which are described in Note 1 "The Company and Summary of Significant Accounting Policies and Estimates" to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, our revenue recognition policies are critical to the periods presented. There have been no material changes to our significant and critical accounting policies as described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the fiscal year endedJuly 31, 2021 except for the addition of business combinations as a significant accounting policy described in Note 1 "The Company and Summary of Significant Accounting Policies and Estimates" to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Recent Accounting Pronouncements See Note 1 "The Company and Summary of Significant Accounting Policies and Estimates" to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, for a full description of recent accounting pronouncements adopted, including the dates of adoption, and recent account pronouncements not yet adopted. 27 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth our results of operations for the periods presented. The data has been derived from the condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly present the financial position and results of operations for the interim periods presented. The results of operations for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year endedJuly 31, 2021 . Three Months Ended October 31, As a % of As a % of 2021 total revenue 2020 total revenue (in thousands, except percentages)
Revenue: Subscription and support$ 78,990 48 %$ 57,966 35 % License 40,153 24 65,283 38 Services 46,791 28 46,553 27 Total revenue 165,934 100 169,802 100 Cost of revenue: Subscription and support 50,331 30 37,006 22 License 2,339 1 2,937 2 Services 50,509 30 51,024 30 Total cost of revenue 103,179 61 90,967 54 Gross profit: Subscription and support 28,659 17 20,960 13 License 37,814 23 62,346 36 Services (3,718) (2) (4,471) (3) Total gross profit 62,755 38 78,835 46 Operating expenses: Research and development 59,926 36 52,615 30 Sales and marketing 43,631 26 36,644 22 General and administrative 24,575 15 21,180 12 Total operating expenses 128,132 77 110,439 64 Income (loss) from operations (65,377) (39) (31,604) (18) Interest income 674 - 2,789 1 Interest expense (4,794) (3) (4,620) (3) Other income (expense), net 1,183 1 2,568 2
Profit (loss) before provision for (profit) income tax
(68,314) (41) (30,867) (18) Provision for (benefit from) income taxes (17,038) (10) (10,677) (6) Net income (loss)$ (51,276) (31) %$ (20,190) (12) % Revenue We derive our revenue primarily from delivering cloud-based services, licensing our software applications, providing support, and delivering professional services. Subscription and Support A growing portion of our revenue consists of fees for our subscription services, which are generally priced based on the amount of DWP that is managed by our subscription services. Subscription revenue is recognized ratably over the term of the arrangement, 28 -------------------------------------------------------------------------------- Table of Contents beginning at the point in time our provisioning process has been completed and access has been made available to the customer. The initial term of such arrangements is generally from three to five years. Subscription agreements contain optional annual renewals commencing upon the expiration of the initial contract term. A majority of our subscription customers are billed annually in advance. In some arrangements with multiple performance obligations, a portion of recurring subscription contract value may be allocated to license revenue or services revenue for revenue recognition purposes. For example, in arrangements with multiple performance obligations that include services at discounted rates, a portion of the total contract value related to subscription services will be allocated and recognized as services revenue. Our support revenue is generally recognized ratably over the committed support term of the licensed software. Our support fees are typically priced as a fixed percentage of the associated term license fees. We generally invoice support annually in advance. License A substantial majority of our license revenue consists of term license fees. Our term license revenue is primarily generated through license fees that are billed annually in advance during the term of the contract, including any renewals. Our term license fees are generally priced based on the amount of DWP that will be managed by our licensed software. Our term licenses have generally been sold under a two-year initial term with optional annual renewals after the initial term. However, we do enter into license arrangements that have an initial term of more than two years and renewal terms of more than one year. Term license revenue for the committed term of the customer agreement is generally fully recognized upon delivery of the software or at the beginning of the renewal term. In a limited number of cases, we license our software on a perpetual basis. Perpetual license revenue is generally recognized upon delivery. We invoice our perpetual license customers either in full at contract signing or on an installment basis. Services Our services revenue is primarily derived from implementation and migration services performed for our customers, reimbursable travel expenses, and training fees. A substantial majority of our services engagements are billed and revenue is recognized on a time and materials basis upon providing our services. Three Months Ended October 31, 2021 2020 Change As a % of total As a % of total Amount revenue Amount revenue ($) (%) (in thousands, except percentages)
Revenue: Subscription and support: Subscription$ 57,129 34 %$ 37,230 22 %$ 19,899 53 % Support 21,861 13 20,736 12 1,125 5 % License: Term license 40,105 24 65,225 38 (25,120) (39) % Perpetual license 48 - 58 - (10) (17) % Services 46,791 28 46,553 28 238 1 % Total revenue$ 165,934 99 %$ 169,802 100 %$ (3,868) (2) % Subscription and Support We anticipate subscriptions will continue to represent a majority of new arrangements, including customers migrating from existing term license arrangements to subscription services, in future periods. Due to the ratable recognition of subscription revenue, growth in subscription revenue will lag behind the growth of subscription orders and will impact the comparative growth of our reported revenue. If we complete a higher percentage of subscription arrangements in a given period, our short-term growth rates will be negatively impacted. Due to the seasonal nature of our business, the impact of new subscription orders in the fourth fiscal quarter, our historically largest quarter for new orders, is not reflected in revenues until the following fiscal year. Subscription revenue increased by$19.9 million during the three months endedOctober 31, 2021 compared to the same period a year ago, primarily due to the impact of new cloud transition agreements for InsuranceSuite via Guidewire Cloud entered into and provisioned sinceOctober 31, 2020 . Support revenue increased by$1.1 million during the three months endedOctober 31, 2021 compared to the same period a year ago, primarily due to an increase in extended support related to certain versions of our self-managed licenses of$0.8 million . Support 29 -------------------------------------------------------------------------------- Table of Contents related to subscription arrangements is included in subscription revenue, as support is not quoted or priced separately from the subscription services. As customers enter into a subscription agreement to migrate from an existing term license agreement, the timing and amount of revenue recognized will be impacted by allocations of the total contract value between the license, subscription, and support performance obligations. As a result, we expect the increase in subscription orders as a percentage of total new sales and customers migrating from term licenses to subscription services will continue to reduce the growth in, or result in lower, support revenue in the future.
Licence
Revenue related to new term licenses and multi-year term license renewals is generally recognized upfront and, as a result, no additional license revenue is recognized until after the committed term expires. As a customer enters into a subscription agreement to migrate from an existing term license agreement, the timing and amount of revenue recognition will be impacted by allocations of total contract value between license, subscription, and support performance obligations. License revenue growth will be negatively impacted as subscription sales increase as a percentage of total new sales and as customers migrate from term licenses to subscription services instead of renewing their term licenses. Term license revenue decreased by$25.1 million during the three months endedOctober 31, 2021 compared to the prior year period, primarily due to a large multi-year term license renewal in the three months endedOctober 31, 2020 . There was no impact of term license contracts with an initial term of greater than two years or a renewal term of greater than one year during the three months endedOctober 31, 2021 compared with$15.4 million in the prior year period. Perpetual license revenue accounted for less than 1% of total revenue during the three months endedOctober 31, 2021 . We expect perpetual license revenue to continue to represent a small percentage of our total license revenue. We also expect perpetual license revenue to potentially be volatile across quarters due to the large amount of perpetual revenue that may be generated from a single customer order.
Services
Services revenue increased by$0.2 million during the three months endedOctober 31, 2021 compared to the same period a year ago. The increase is primarily driven by higher training revenue, but services revenue overall continues to be impacted by contracts with lower average services billing rates and increased investments in customer implementations, including fixed fee or capped arrangements, to accelerate their transition to the cloud. In these arrangements when a project extends longer than originally anticipated, the average billing rate we recognize may decrease which can result in revenue adjustments and lower gross profit. We expect modestly higher levels of variability in our services revenue in future periods. As we successfully leverage our SI partners to lead more implementations, our services revenue could decrease further. We expect challenges related to COVID-19 will also continue to negatively impact services revenue. As we continue to expand into new markets and develop new services and products, we have, and may continue to, enter into contracts with lower average billing rates, make investments in customer implementation and migration engagements, and enter into fixed price contracts, which may impact services revenue and services margins. Cost of Revenue and Gross Profit Our cost of subscription and support revenue consists of personnel costs for our cloud operations and technical support teams, cloud infrastructure costs, development of online training curriculum, amortization of intangible assets, and royalty fees paid to third parties. Our cost of license revenue primarily consists of development of online training curriculum, royalty fees paid to third parties, and amortization of intangible assets. Our cost of services revenue primarily consists of personnel costs for our professional service employees, third-party consultants, and travel costs. In instances where we have primary responsibility for the delivery of services, subcontractor fees are expensed as cost of services revenue. In each case, personnel costs include salaries, bonuses, benefits, and stock-based compensation. We allocate overhead such as information technology support, information security, facilities, and other administrative costs to all functional departments based on headcount. As such, these general overhead expenses are reflected in cost of revenue and each functional operating expense. 30 -------------------------------------------------------------------------------- Table of Contents Cost of Revenue: Three Months Ended October 31, 2021 2020 Change Amount Amount ($) (%) (in thousands, except percentages) Cost of revenue: Subscription and support$ 50,331 $ 37,006 $ 13,325 36 % License 2,339 2,937 (598) (20) Services 50,509 51,024 (515) (1) Total cost of revenue$ 103,179 $ 90,967 $ 12,212 13
Includes stock-based compensation of:
Cost of subscription and support revenue$ 3,348 $ 2,602 $ 746 Cost of license revenue 182 251 (69) Cost of services revenue 5,637 5,543 94 Total$ 9,167 $ 8,396 $ 771 Cost of subscription and support revenue during the three months endedOctober 31, 2021 increased by$13.3 million compared to the same period a year ago. The increase is primarily due to increases in personnel costs of$8.2 million due to our continued investment in our cloud operations to increase operational efficiency and scale, cloud infrastructure expense of$6.5 million for our growing cloud customer base, higher amortization of previously capitalized software development costs of$0.5 million , and professional services expense of$0.4 million , partially offset by a net decrease in amortization of acquired intangibles of$2.3 million due to certain acquired intangible assets being fully amortized. Due to our continued investment in cloud-based operations, increase in new cloud-based customers, and increased usage from existing cloud-based customers, the costs to provide our subscription services has increased. We expect our cost of subscription revenue to increase as we continue to invest in our cloud operations and incur higher cloud infrastructure costs to support our growing cloud customer base, to improve efficiencies, and to continuously improve and maintain secure environments. However, we believe that the cost of subscription revenue will grow at a slower rate than subscription revenue in future years as we achieve economies of scale and other efficiencies. Cost of support revenue is expected to remain flat or slightly decrease over time as term license customers transition to the cloud. The short-term impact of these trends along with mix within subscription and support revenue may result in a decline in subscription and support gross margin even though subscription and support gross profit increases in absolute dollars. The cost of license revenue decreased by$0.6 million during the three months endedOctober 31, 2021 compared to the same period a year ago primarily due to decreases in amortization of acquired intangible assets due to certain acquired intangible assets being fully amortized and lower costs associated with the development of online training curriculum included with the latest releases of InsuranceSuite. We continue to anticipate lower cost of license revenue over time as our term license customers transition to cloud subscription agreements. The$0.5 million decrease in cost of services revenue during the three months endedOctober 31, 2021 compared to the same period a year ago was primarily attributable to a decrease of$1.6 million in personnel costs, partially offset by increases of$0.7 million in subcontractor expenses for InsuranceSuite implementation resources,$0.2 million in software subscription expenses, and$0.1 million in web hosting expenses. We had 634 cloud operations and technical support employees and 659 professional services employees atOctober 31, 2021 , compared to 475 cloud operations and technical support employees and 699 professional services employees atOctober 31, 2020 . 31 --------------------------------------------------------------------------------
Table of Contents Gross Profit: Three Months Ended October 31, 2021 2020 Change Amount Margin % Amount Margin % ($) (%) (in thousands, except percentages) Gross profit: Subscription and support$ 28,659 36 %$ 20,960 36 %$ 7,699 37 % License 37,814 94 62,346 96 (24,532) (39) Services (3,718) (8) (4,471) (10) 753 17 Total gross profit$ 62,755 38$ 78,835 46$ (16,080) (20) Our gross profit decreased$16.1 million during the three months endedOctober 31, 2021 compared to the same period a year ago. Gross profit was impacted by the decrease in term license revenue due to the impact of multi-year term license arrangements entered into in the first quarter of fiscal year 2022 being significantly lower than the impact of multi-year term license arrangements in the same period a year ago. Our gross margin decreased to 38% during the three months endedOctober 31, 2021 from 46% during the same period a year ago. Gross margin was primarily impacted by the increased percentage of subscription and support revenue to total revenue as subscription and support revenue has lower gross margin compared to license revenue. We expect subscription and support gross margins will fluctuate as our subscription revenue increases and we continue to invest in our cloud operations. However, as we gain efficiencies and increase the number of cloud customers, we expect subscription gross margins to improve over time. In addition to the impact of our investment in customer migrations and implementations, challenges related to COVID-19 may negatively impact services gross margin for at least the remainder of this fiscal year. We expect license gross margin will fluctuate based on changes in revenue due to the timing of delivery of new multi-year term licenses and the execution of multi-year term license renewals, as cost of license revenue is expected to be relatively consistent from period to period in the future. Overall, we expect gross margins to decline in the short-term primarily due to the mix between license revenue and subscription and support revenue. Operating Expenses Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest components of our operating expenses are personnel costs for our employees and, to a lesser extent, professional services. In each case, personnel costs include salaries, bonuses, commissions, benefits, and stock-based compensation. We allocate overhead such as information technology support, information security, facilities, and other administrative costs to all functional departments based on headcount. As a result, general overhead expenses are reflected in cost of revenue and each functional operating expense. Three Months Ended October 31, 2021 2020 Change As a % of Amount As a % of total revenue Amount total revenue ($) (%) (in thousands, except percentages) Operating expenses: Research and development$ 59,926 36%$ 52,615 30 %$ 7,311 14 % Sales and marketing 43,631 26 36,644 22 6,987 19 General and administrative 24,575 15 21,180 12 3,395 16 Total operating expenses$ 128,132 77$ 110,439 64$ 17,693 16
Includes stock-based compensation of:
Research and development$ 8,614 $ 7,247 $ 1,367 Sales and marketing 7,489 5,977 1,512 General and administrative 6,970 6,464 506 Total$ 23,073 $ 19,688 $ 3,385 32
-------------------------------------------------------------------------------- Table of Contents Research and Development Our research and development expenses primarily consist of personnel costs for our technical staff and consultants providing professional services. The$7.3 million increase in research and development expenses during the three months endedOctober 31, 2021 compared to the same period a year ago, was primarily due to increases of$4.6 million in personnel costs associated with higher headcount, inclusive of$0.7 million in acquisition consideration holdback costs relating to the Hazard Hub acquisition, and$2.0 million of cloud infrastructure costs for our development environments. Our research and development headcount was 871 atOctober 31, 2021 compared with 810 atOctober 31, 2020 . We expect our research and development expenses to increase in absolute dollars as we continue to hire and dedicate internal resources to develop, improve, and expand the functionality of our solutions and migrate our solutions to the cloud. Research and development expenses may also increase if we pursue additional acquisitions. Sales and Marketing Our sales and marketing expenses primarily consist of personnel costs for our sales and marketing employees. Included in our personnel costs are commissions, which are considered contract acquisition costs and are capitalized when earned and expensed over the anticipated period of time that goods and services are expected to be provided to a customer, which we estimate to be approximately five years. Sales and marketing expenses also includes travel expenses, professional services for marketing activities, and amortization of certain acquired intangibles. The$7.0 million increase in sales and marketing expenses during the three months endedOctober 31, 2021 compared to the same period a year ago was primarily attributable to increases of$7.2 million in personnel costs due to higher headcount to sell and market our services and products, including an increase of$0.9 million related to the net effect of the capitalization and amortization of contract acquisition costs (primarily commissions). These increases were partially offset by a decrease of$0.4 million in marketing and advertising expense due to costs associated with Connections Reimagined, our virtual annual sales conference in the first quarter of fiscal year 2021. Our annual sales conference in fiscal year 2022 was primarily an in-person event, supplemented with virtual content, held inNovember 2021 , the second quarter of fiscal year 2022. Our sales and marketing headcount was 457 atOctober 31, 2021 compared with 416 atOctober 31, 2020 . We expect our sales and marketing expenses to continue to increase in absolute dollars as we continue to invest in sales and marketing activities to support our business growth and objectives. General and Administrative Our general and administrative expenses include executive, finance, human resources, legal, and corporate development and strategy functions, and primarily consist of personnel costs, as well as professional services. The$3.4 million increase during the three months endedOctober 31, 2021 compared to the same period a year ago was primarily due to increases of$1.9 million in software and professional services to support our growth and$1.4 million in personnel costs due to higher headcount. Our general and administrative headcount was 410 atOctober 31, 2021 compared with 359 atOctober 31, 2020 . General and administrative headcount includes personnel in information technology support, information security, facilities, and recruiting whose expenses are allocated across all functional departments. We expect that our general and administrative expenses will increase in absolute dollars as we continue to invest in personnel, corporate infrastructure, and systems required to support our strategic initiatives, the growth of our business, and our compliance and reporting obligations. 33 --------------------------------------------------------------------------------
Table of Contents Other Income (Expense) Three Months Ended October 31, 2021 2020 Change Amount Amount ($) (%) (in thousands, except percentages) Interest income$ 674 $ 2,789 $ (2,115) (76) % Interest expense$ (4,794) $ (4,620) $ (174) 4 % Other income (expense), net$ 1,183 $ 2,568 $ (1,385) (54) % *Not meaningful Interest Income Interest income represents interest earned on our cash, cash equivalents, and investments. Interest income decreased$2.1 million during the three months endedOctober 31, 2021 compared to the same period a year ago, primarily due to lower yields on invested funds. Interest Expense Interest expense includes both stated interest and the amortization of debt discount and issuance costs associated with the$400.0 million aggregate principal amount of our Convertible Senior Notes. The amortization of debt discount and issuance costs are recognized on an effective interest basis. Stated interest expense is consistent in the comparative periods as the outstanding principal and stated interest rate have not changed. Interest expense for the three months endedOctober 31, 2021 and 2020 consists of non-cash interest expense related to the amortization of debt discount and issuance costs of$3.5 million and$3.3 million , respectively, and stated interest of$1.3 million in both periods. Other Income (Expense), Net Other income (expense), net includes foreign exchange gains and losses resulting from fluctuations in foreign exchange rates on monetary asset and monetary liability balances that are denominated in currencies other than the functional currency of the entity in which they are recorded. Our monetary assets and liabilities denominated in currencies other than the functional currency of the entity in which they are recorded consist primarily of trade accounts receivable, unbilled accounts receivable and intercompany receivables and payables. We currently have entities with a functional currency of the Argentine Peso, Australian Dollar, Brazilian Real, British Pound, Canadian Dollar, Chinese Yuan,Danish Krone , Euro, Hong Kong Dollar, Indian Rupee, Japanese Yen, Malaysian Ringgit, Mexican Peso, New Zealand Dollar, Polish Zloty, Russian Ruble, South African Rand, and Swiss Franc. Other income (expense), net during the three months endedOctober 31, 2021 was income of$1.2 million compared to$2.6 million during the same period a year ago. Due to fluctuations in exchange rates, the three months endedOctober 31, 2021 included realized and unrealized foreign currency gains of$1.2 million , while the three months endedOctober 31, 2020 included realized and unrealized foreign currency gains of$2.3 million . Provision for (benefit from) Income Taxes We are subject to taxes inthe United States as well as other tax jurisdictions and countries in which we conduct business. Earnings from our non-U.S. activities are subject to local country income tax and may also be subject toU.S. income tax. Three Months Ended October 31, 2021 2020 Change Amount Amount ($) (%) (in thousands, except percentages) Provision for (benefit from) income taxes$ (17,038) $ (10,677) $ (6,361) 60 % Effective tax rate 25 % 35 % 34
-------------------------------------------------------------------------------- Table of Contents We recognized an income tax benefit of$17.0 million and$10.7 million for the three months endedOctober 31, 2021 and 2020, respectively. The change in the amount of income taxes recorded for the three months endedOctober 31, 2021 compared to the same period a year ago was primarily due to the increase in the loss before taxes and research and development credits, offset by a tax status change of certain foreign subsidiaries forU.S. tax purposes and certain non-deductible expenses. The effective tax rate of 25% for the three months endedOctober 31, 2021 differs from the statutoryU.S. federal income tax rate of 21% due to permanent differences for stock-based compensation including excess tax benefits, research and development credits, and certain non-deductible expenses including executive compensation. During the three months endedOctober 31, 2021 , unrecognized tax benefits increased by$0.4 million . As ofOctober 31, 2021 , we had unrecognized tax benefits of$11.1 million that, if recognized, would affect our effective tax rate. Non-GAAP Financial Measures In addition to the key business metrics presented above, we believe that the following non-GAAP financial measures provide useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Management uses these non-GAAP measures to compare our performance to that of prior periods for trend analysis, for purposes of determining executive and senior management incentive compensation, and for budgeting and planning purposes. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing our financial results with other software companies because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, many of which present similar non-GAAP financial measures to investors. However, our management does not consider these non-GAAP measures in isolation or as an alternative to financial measures determined in accordance with GAAP. The non-GAAP financial information is presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled non-GAAP measures used by other companies. The principal limitation of these non-GAAP financial measures is that they exclude significant expenses and income that are required by GAAP to be recorded in our financial statements. In addition, they are subject to inherent limitations as they reflect the exercise of judgment by management about which expenses and income are excluded or included in determining these non-GAAP financial measures. We urge investors to review the reconciliation of non-GAAP financial measures to the comparable GAAP financial measures included herein and not to rely on any single financial measure to evaluate the Company's business. The following table reconciles the specific items excluded from GAAP in the calculation of non-GAAP financial measures for the periods indicated below. Three
Ended months
2021 2020 Gross profit reconciliation: GAAP gross profit $ 62,755$ 78,835 Non-GAAP adjustments: Stock-based compensation 9,167 8,396 Amortization of intangibles 1,944 4,526 Non-GAAP gross profit $ 73,866$ 91,757 Income (loss) from operations reconciliation: GAAP income (loss) from operations$ (65,377) $ (31,604) Non-GAAP adjustments: Stock-based compensation 32,240 28,084 Amortization of intangibles 3,754 6,323 Acquisition consideration holdback(1) 673 - Non-GAAP income (loss) from operations $
(28,710)
Net income (loss) reconciliation: GAAP net income (loss)$ (51,276) $ (20,190) Non-GAAP adjustments: Stock-based compensation 32,240 28,084 35
-------------------------------------------------------------------------------- Table of Contents Amortization of intangibles 3,754 6,323 Amortization of debt discount and issuance costs 3,524 3,335 Acquisition consideration holdback(1) 673 - Tax impact of non-GAAP adjustments(2) (6,966) (3,143) Non-GAAP net income (loss) $
(18,051)
Tax provision (benefit) reconciliation: GAAP tax provision (benefit)$ (17,038) $ (10,677) Non-GAAP adjustments: Stock-based compensation 11,548 (22,291) Amortization of intangibles 1,345 (5,019) Amortization of debt discount and issuance costs 1,262 (2,647) Acquisition consideration holdback(1) 241 - Tax impact of non-GAAP adjustments(2) (7,430) 33,100 Non-GAAP tax provision (benefit) $
(10,072)
Net income (loss) per share reconciliation: GAAP net income (loss) per share - diluted$ (0.62) $ (0.24) Non-GAAP adjustments: Stock-based compensation 0.39 0.34 Amortization of intangibles 0.05 0.08 Amortization of debt discount and issuance costs 0.04 0.04 Acquisition consideration holdback(1) 0.01 - Tax impact of non-GAAP adjustments(2) (0.08) (0.04)
Non-GAAP dilutive shares excluded from the calculation of net income (loss) per share in accordance with GAAP (3)
- (0.01) Non-GAAP net income (loss) per share - diluted $
(0.21) $ 0.17
Equities used in the calculation of non-GAAP income (loss) per share: average GAAP weighted stocks – diluted
83,225,743 83,613,287
Non-GAAP dilutive shares excluded from the calculation of earnings (loss) per share GAAP (3)
- 586,287 Pro forma weighted average shares - diluted 83,225,743 84,199,574 (1) Effective the first quarter of fiscal year 2022, the acquisition consideration holdback that is earned and recognized as expense over a post-acquisition service period is excluded from non-GAAP measures. Prior to the first quarter of fiscal year 2022, there was no acquisition consideration holdback in any periods presented. (2) Adjustments reflect the impact on the tax benefit (provision) from all non-GAAP adjustments. (3) Due to the occurrence of a net loss on a GAAP basis, potentially dilutive securities were excluded from the calculation of GAAP net income (loss) per share, as they would have an anti-dilutive effect. However, these shares have a dilutive effect on non-GAAP net income (loss) per share and, therefore, are included in the non-GAAP net income (loss) per share calculation. Liquidity and Capital Resources Our principal sources of liquidity are as follows (in thousands): October 31, 2021 July 31,
2021
Cash, cash equivalents and investments
Working capital
$ 876,498$ 1,054,971
Cash, cash equivalents and investments
Our cash and cash equivalents are comprised of cash and liquid investments with remaining maturities of 90 days or less from the date of purchase, primarily commercial paper and money market funds. Our investments primarily consist of corporate debt 36 -------------------------------------------------------------------------------- Table of Contents securities,U.S. government and agency debt securities, commercial paper, asset-backed securities, and non-U.S. government securities, which include state, municipal and foreign government securities. As ofOctober 31, 2021 , approximately$37.2 million of our cash and cash equivalents were domiciled in foreign jurisdictions. While we have no current plans to repatriate these funds tothe United States , we may repatriate foreign earnings in the future to the extent that the repatriation is not restricted by local laws or there are no substantial incremental costs associated with such repatriation. Share Repurchase Program InOctober 2020 , our board of directors authorized and approved a stock repurchase program of up to$200.0 million of our outstanding common stock. During the three months endedOctober 31, 2021 , we repurchased 226,172 shares of common stock at an average price of$116.12 per share, for an aggregate purchase price of$26.3 million . As ofOctober 31, 2021 ,$11.2 million remained available for future share repurchases. Cash Flows Our cash flows from operations are significantly impacted by timing of invoicing and collections of accounts receivable, annual bonus payments, as well as payments of payroll, commissions, payroll taxes and other taxes. We expect that we will continue to generate positive cash flows from operations on an annual basis, although this may fluctuate significantly on a quarterly basis. In particular, we typically use more cash during the first fiscal quarter endedOctober 31 , as we generally pay cash bonuses to our employees for the prior fiscal year and seasonally higher sales commissions from increased customer orders booked in our fourth fiscal quarter of the prior year. Additionally, our capital expenditures may fluctuate depending on future office build outs and development activities subject to capitalization. We believe that our existing cash and cash equivalents and sources of liquidity will be sufficient to fund our operations for at least the next 12 months. Our future cash requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of our spending to support our research and development efforts, investments in cloud infrastructure and operating costs, and expansion into other markets. We also may invest in or acquire complementary businesses, applications or technologies, or may expand our board-authorized stock repurchase program, which may require the use of significant cash resources and/or additional financing. The following summary of cash flows for the periods indicated has been derived from our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q (in thousands): Three
Ended months
2021 2020 Net cash provided by (used in) operating activities$ (107,042) $ (15,707) Net cash provided by (used in) investing activities$ 8,081 $ (53,399) Net cash provided by (used in) financing activities $
(26,245)
Cash Flows from Operating Activities Net cash used in operating activities was$107.0 million for the three months endedOctober 31, 2021 compared to net cash used in operating activities of$15.7 million during the three months endedOctober 31, 2020 . This$91.3 million increase in operating cash used was primarily attributable to$69.1 million from the payout of our fiscal year 2021 corporate bonus and accrued vacation balances in countries in which we adopted a non-accrual vacation policy, offset by$11.1 million in cash provided by other working capital activities, and a$33.3 million increase in net loss after excluding the impact of non-cash charges such as deferred taxes, stock-based compensation expense, depreciation and amortization expense, and other non-cash items. Cash Flows from Investing Activities Net cash provided by investing activities was$8.1 million for the three months endedOctober 31, 2021 compared to net cash used in investing activities of$53.4 million for the three months endedOctober 31, 2020 . The$61.5 million increase in cash provided by investing activities was primarily due to a$105.9 million decrease in net purchases of available-for-sale securities and a$2.0 million decrease in strategic investments, partially offset by$43.8 million paid as purchase consideration for the acquisition of HazardHub and a$2.6 million decrease in capital expenditures and capitalized software development costs. Cash Flows from Financing Activities Net cash used in financing activities for the three months endedOctober 31, 2021 was$26.2 million compared to$3.3 million net cash used in financing activities for the three months endedOctober 31, 2020 . This$23.0 million increase in cash used was primarily because we repurchased$21.3 million more of our common stock under our share repurchase program and, to a lesser extent, a decrease in proceeds from option exercises of$1.7 million . 37 -------------------------------------------------------------------------------- Table of Contents Commitments and Contractual Obligations Our estimated future obligations consist of leases, royalties, purchase obligations, debt, and unrecognized tax benefits as ofOctober 31, 2021 . Refer to Note 7 "Convertible Senior Notes," Note 8 "Leases," Note 9 "Commitments and Contingencies," and Note 11 "Income Taxes" to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. There has been no material change in our contractual obligations and commitments other than in the ordinary course of business since our fiscal year endedJuly 31, 2021 . See the Annual Report on Form 10-K for the fiscal year endedJuly 31, 2021 for additional information regarding the Company's contractual obligations. Off-Balance Sheet Arrangements ThroughOctober 31, 2021 , we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. ITEM 3. Quantitative and Qualitative Disclosures about Market Risk We are exposed to market risks in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.
Interest rate sensitivity
Our exposure to market risk for changes in interest rates relates primarily to our cash, cash equivalents, and investments. Our cash, cash equivalents, and investments as ofOctober 31, 2021 andJuly 31, 2021 were$1,139.6 million and$1,346.6 million , respectively, primarily consisting of cash, money market funds, corporate debt securities,U.S. government and agency debt securities, commercial paper, asset-backed securities, and non-U.S. government securities, which include state, municipal, and foreign government securities. Changes in interest rates, primarily inthe United States , affect the interest earned on our cash, cash equivalents, and investments, and their market value. A hypothetical 100 basis point increase in interest rates is estimated to result in a decrease of$6.1 million and$5.2 million in the market value of our available-for-sale securities as ofOctober 31, 2021 andJuly 31, 2021 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. Foreign Currency Exchange Risk Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Argentine Peso, Australian Dollar, Brazilian Real, British Pound, Canadian Dollar,Danish Kroner , Euro, Indian Rupee, Japanese Yen, Malaysian Ringgit, New Zealand Dollar, Polish Zloty, Russian Ruble, and Swiss Franc, the currency of the locations within which we currently operate. The volatility of exchange rates depends on many factors that we cannot forecast with reliable accuracy. We believe our operating activities act as a natural hedge for a substantial portion of our foreign currency exposure because we typically collect revenue and incur costs in the currency of the location in which we provide our services. However, our relationships with our customers are long-term in nature so it is difficult to predict if our operating activities will provide a natural hedge in the future. Additionally, changes in foreign currency exchange rates can affect our financial results due to transaction gains or losses related to revaluing certain monetary asset and monetary liability balances that are denominated in currencies other than the functional currency of the entity in which they are recorded. Our monetary assets and liabilities denominated in currencies other than the functional currency of the entity in which they are recorded consist primarily of trade accounts receivable, unbilled accounts receivable and intercompany receivables and payables. For the three months endedOctober 31, 2021 and 2020, we recorded foreign currency gains of$1.2 million and$2.6 million , respectively, in other income (expense) in our condensed consolidated statement of operations primarily due to currency exchange rate fluctuations. We will continue to experience fluctuations in foreign currency exchange rates. If a hypothetical ten percent change in foreign exchange rates were to occur in the future, the resulting transaction gain or loss is estimated to be approximately$18.6 million . As our international operations grow, we will continue to assess our approach to managing our risk relating to fluctuations in currency rates. Fair Value of Financial Instruments We do not have material exposure to market risk with respect to investments in financial instruments, as our investments primarily consist of high quality liquid investments purchased with a remaining maturity of three years or less. We do not use derivative financial instruments for speculative or trading purposes. However, this current position does not preclude our adoption of specific hedging strategies in the future. 38
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Table of Contents Our strategic investments in privately held securities are in various classes of equity and convertible debt. The particular securities we hold, and their rights and preferences relative to those of other securities within the capital structure, may impact the magnitude by which our investment value moves in relation to movements in the total enterprise value of the company in which we are invested. As a result, our investment in a specific company may move by more or less than any change in value of that overall company. In addition, the financial success of our investment in any company is typically dependent on a liquidity event, such as public offering, acquisition, or other favorable market event reflecting appreciation to the value of our investment. All of our investments, particularly those in privately held companies, are therefore subject to a risk of partial or total loss of invested capital.
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