The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes thereto included in Item 8 and the Risk Factors included in Item 1A of Part I of this Annual Report on Form 10-
K. Allinformation presented herein is based on our fiscal calendar. Unless otherwise stated, references in this Annual Report on Form 10-K 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. We have elected to omit discussion on the earliest of the three years covered by the consolidated financial statements presented. Refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in our Form 10-K for the fiscal year ended July 31, 2021, filed on September 24, 2021, for reference to discussion of the fiscal year ended July 31, 2020, the earliest of the three fiscal years presented.
Guidewire delivers a leading platform that property and casualty ("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 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. 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. InsuranceSuite Cloud is a highly configurable and scalable product, delivered as a service and primarily comprised of three core applications (PolicyCenter Cloud, BillingCenter Cloud, and ClaimCenter Cloud) 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 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 Cloud embeds digital and analytics capabilities natively into our platform. Most new sales and implementations are for InsuranceSuite Cloud.
InsuranceNow is a comprehensive cloud-based application that provides policy, billing and claims management functionality to insurers.
InsuranceSuite for Self-Managed Installations includes 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 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 thorough, which often results in an extended sales cycle. These evaluation periods can extend further if a customer purchases multiple services and products or is considering a move to a cloud-based subscription for the first time. Sales to new customers also involve extensive customer due diligence and reference checks. 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 are 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. A majority 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 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, business, 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 and securely 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, cybersecurity, implementation services, and sales and marketing.
Impact of COVID-19
March 2020, the World Health Organizationdeclared the outbreak of COVID-19 a pandemic, which has continued to spread throughout the United Statesand 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 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 extend our sales cycle, to delay the timing of new orders, and increase the time to complete 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, which has effected our annual recurring revenue ("ARR") growth rates, services revenue and margins, operating cash flow and expenses, potentially higher employee attrition, challenges in hiring necessary personnel, and the change in fair value of strategic investments. ARR growth rates and revenue, especially services revenue, continued to be impacted in fiscal year 2022 as a result of these challenges. Additionally, in recent quarters, inflation has reached levels that have not been seen for decades, which is impacting the global economy and magnifying the impact of these and other disruptions. Although vaccines have made progress against the COVID-19 pandemic in
the United Statesand 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. 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 been 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 inflation, 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.
We will continue to assess the nature and extent of the impact of COVID-19 on our business.
Key business indicators
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 Annual Report on Form 10-K.
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. In fiscal year 2022, the recurring license and support or subscription contract value recognized as services revenue was
$28.9 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 millionat the beginning of year one, $2.0 millionat the beginning of year two, and $3.0 millionat 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. As of July 31, 2022, ARR was $664 million, or $683 millionbased on currency exchange rates as of July 31, 2021. In March 2022, we announced that we will stop doing business and terminated all customer contracts in Russia. The impact of this decision resulted in the removal of $3.1 millionin ARR. We measure ARR on a constant currency basis during the fiscal year and revalue ARR at year end to current currency rates. ARR grew in fiscal year 2022 by 14%, or 17% on a constant currency basis.
Free movement of capital
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 services and 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 consist of purchases of property and equipment, primarily computer hardware, software, and leasehold improvements, and capitalized software development costs. Free cash flow in fiscal year 2022 was impacted by payments of
$69.1 millionrelated to our fiscal year 2021 corporate bonus and accrued vacation balances in countries in which we adopted a non-accrual vacation policy, which was $47.8 millionhigher than the bonus payment during fiscal year 2021. A portion of the fiscal year 2020 bonus in the amount of $9.9 million, which would have been paid in the first quarter of fiscal year 2021, was accelerated due to the COVID-19 pandemic and paid in fiscal year 2020, which correspondingly resulted in lower bonus payments in fiscal year 2021. This partial early bonus payout was approved by our board of directors in order to support our employees and, in turn, their local economies during the extraordinary situation created by the COVID-19 pandemic. The build out and furnishing of our new offices in Mississauga, Canadaand Dublin, Irelandimpacted free cash flow by a total of $15.6 millionfor the fiscal year 2021. For a further discussion of our operating cash flows, see "Liquidity and Capital Resources - Cash Flows." Fiscal years ended July 31, 20222021 (in thousands)
Net cash provided by (used in) operating activities
$ 111,587Purchases of property and equipment (9,510) (19,008) Capitalized software development costs (12,266) (9,846) Free cash flow $ (59,716) $ 82,733
Significant Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP. Accounting policies, methods, and estimates are an integral part of the preparation of our 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 our 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 consolidated financial statements, which are described in Note 1 "The Company and a Summary of Significant Accounting Policies and Estimates" to our consolidated financial statements included in this Annual Report on Form 10-K, our revenue recognition policies are critical to the periods presented. Revenue Recognition Revenue recognition requires judgment and the use of estimates, especially in identifying and evaluating the various non-standard terms and conditions in our contracts with customers as to their effect on reported revenue. Our revenue is derived from contracts with customers. The majority of our revenue is derived from subscriptions to our cloud services, licensing arrangements for our software, and implementation and other professional services arrangements. We account for revenue in accordance with Accounting Standards Codification 606, Revenue from Contracts with Customers ("ASC 606"). The core principle of ASC 606 is to recognize revenue upon the transfer of services or products to customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services or products. We apply a five-step framework to recognize revenue as described in our Revenue Recognition policy included in Note 1 of our consolidated financial statements included in this Annual Report on Form 10-K. Our customers have significant negotiating power during the sales process, which can and does result in terms and conditions that are different from our standard terms and conditions. When terms and conditions of our customer contracts are not standard, certain negotiated terms may require significant judgment in order to determine the appropriate revenue recognition in accordance with ASC 606.
Estimates and assumptions requiring significant judgment as part of our revenue policy in accordance with ASC 606 are as follows:
Allocation of the transaction price to the performance obligations of the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on its standalone selling price ("SSP") in relation to the total fair value of all performance obligations in the arrangement. Some of our performance obligations, such as support, implementation services, and training services, have observable inputs that are used to determine the SSP of those distinct performance obligations. Where SSP is not directly observable, we determine the SSP using information that may include market conditions and other observable inputs. In the circumstances when available information to determine SSP is highly variable or uncertain, such as for our term licenses, we will use the residual method. The majority of our contracts contain multiple performance obligations, such as when licenses are sold with support, implementation services or training services. As customers enter into a subscription agreement to migrate from an existing term license agreement, customers may be under contract for self-managed licenses and support, in addition to subscription services, for a period of time, which may require an allocation of the transaction price to each performance obligation. New and migration subscription agreements also typically include implementation, configuration, and training services, which may require an allocation of the transaction price to each performance obligation. Additionally, contract modifications for services and products that are distinct but are not priced commensurate with their SSP or are not distinct from the existing contract may affect the initial transaction price or the allocation of the transaction price to the performance obligations in the contract. In such cases, revenue recognized may be adjusted.
Modernization of Articles 101, 103 and 105 of the SK Regulation
SECissued Release No. 33-10825, "Modernization of Regulation S-K Items 101, 103, and 105," effective for annual periods beginning subsequent to November 2020. This release was adopted to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. Specifically, this release requires registrants to provide disclosures relating to their human capital resources and to restructure their risk factor
disclosures. In addition, the publication increases the threshold for disclosure of environmental proceedings to which the government is a party.
Management report, selected financial data and additional financial information
SECissued Release No. 33-10890 "Management's Discussion and Analysis, Selected Financial Data, Supplementary Financial Information" which became fully effective on August 9, 2021. This release was adopted to modernize, simplify, and enhance certain financial disclosure requirements in Regulation S-K. Specifically, the SECeliminated the requirement for selected financial data, only requiring quarterly disclosure when there are retrospective changes affecting comprehensive income, and amending the matters required to be presented under Management's Discussion and Analysis ("MD&A") to, among other things, eliminate the requirement of the contractual obligations table.
With the adoption of this version, we have eliminated from this document the elements discussed above which are no longer necessary. Information about our contractual obligations is always disclosed in narrative form in the “MD&A and Discussion of Financial Condition and Results of Operations” in Item 7 of Part II of this Annual Report on Form 10-K.
Recent accounting pronouncements
See Note 1 "The Company and Summary of Significant Accounting Policies and Estimates" to our consolidated financial statements included in this Annual Report on Form 10-K for a full description of recent accounting pronouncements adopted, including the dates of adoption, and recent accounting pronouncements not yet adopted.
The following table sets forth our results of operations for the years presented. The data has been derived from the consolidated financial statements contained in this Annual Report on Form 10-K. The results for any period should not be considered indicative of results for any future period.
Closed fiscal years
As a % of Total As a % of Total 2022 Revenue 2021 Revenue (in thousands except percentages) Revenue: Subscription and support
$ 343,70842 % $ 252,35834 % License 258,631 32 303,792 41 Services 210,275 26 187,117 25 Total revenue 812,614 100 743,267 100 Cost of revenue: Subscription and support 213,275 26 164,983 22 License 8,754 1 10,569 1 Services 238,365 29 199,502 27 Total cost of revenue 460,394 56 375,054 50 Gross profit: Subscription and support 130,433 16 87,375 12 License 249,877 31 293,223 39 Services (28,090) (3) (12,385) (2) Total gross profit 352,220 44 368,213 49 Operating expenses: Research and development 249,665 31 219,494 30 Sales and marketing 194,611 24 160,544 22 General and administrative 107,391 13 93,759 13 Total operating expenses 551,667 68 473,797 65 Income (loss) from operations (199,447) (24) (105,584) (16) Interest income 6,277 1 7,395 1 Interest expense (19,446) (2) (18,711) (3) Other income (expense), net (17,099) (2) 12,619 2 Income (loss) before provision for (benefit from) income taxes (229,715) (27) (104,281) (16) Provision for (benefit from) income taxes (49,284) (6) (37,774) (7) Net income (loss) $ (180,431)(21) % $ (66,507)(9) %
Comparison of the years ended
We derive our revenue primarily from the provision of cloud-based services, the licensing of our software applications, the provision of support and the provision of 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,
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. Additionally, agreements to migrate an existing term license customer to subscription services contain multiple performance obligations, including a provision to continue using the term license during the subscription service implementation period. Under these migration agreements, a portion of the total contract value related to subscription services could be allocated and recognized as term license and support revenue in the period renewed or delivered. 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 grant a perpetual license to our software. Revenue from perpetual licenses is generally recognized upon delivery. We invoice our customers with a perpetual license either in full at the signing of the contract, or in several instalments.
Our services revenue comes primarily from implementation and migration services performed for our customers, reimbursable travel expenses and training fees. The majority of our service commitments are billed and revenue recognized on a time and material basis when our services are provided.
Closed fiscal years
2022 2021 Change % of total % of total Amount revenue Amount revenue ($) (%) (in thousands, except percentages) Revenue: Subscription and support: Subscription
$ 259,23232 % $ 168,64923 % $ 90,58354 % Support 84,476 10 83,709 11 767 1 License: Term license 258,441 32 303,309 41 (44,868) (15) Perpetual license 190 - 483 - (293) (61) Services 210,275 26 187,117 25 23,158 12 Total revenue $ 812,614100 % $ 743,267100 % $ 69,3479 % 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 on a year-over-year basis. 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 fully reflected in revenues until the following fiscal year.
Subscription revenue increased by
$90.6 million, compared to the prior year, primarily due to the impact of cloud transition and new subscription agreements for InsuranceSuite Cloud entered into and provisioned since July 31, 2021. Support revenue was relatively flat compared to the prior year. Support 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.
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 has and 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
$44.9 million, compared to the prior year, primarily due to the impact of multi-year term license renewals and new deals in the same period a year ago, and, to a lesser extent, term license customers migrating to subscription services. The impact on term license revenue from contracts with an initial term of greater than two years or a renewal term of greater than one year was $2.5 millionduring fiscal year 2022 compared with $24.4 millionin the prior year. Perpetual license revenue decreased by $0.3 million, compared to the prior year, and accounted for less than 1% of total revenue in fiscal year 2022. We expect perpetual license revenue to continue to represent a small percentage of our total revenue. Perpetual license revenue may potentially be volatile across periods due to the large amount of perpetual revenue that may be generated from a single customer order. Services Revenue Services revenue increased $23.2 million, compared to the prior year. The increase is primarily driven by an increase in the number and size of subscription implementation and migration projects, 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 customer 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 some level 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. We expect challenges related to COVID-19, inflation, and our ability to hire additional services professionals 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.
Revenue cost and gross profit
Our cost of subscription and support revenue primarily 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 subcontractors or 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 costs such as IT support, information security, facilities and other administrative costs to all functional departments based on headcount. Thus, these overheads are reflected in the cost of products and in each functional operating expense.
Effective as of the beginning of fiscal year 2023, we are revising our allocation methodology to more closely reflect the way our business is managed and to be more comparable to other companies in our industry. The change will result in facilities expenses, information technology infrastructure and software expenses, and information security infrastructure and software expenses being
allocated to all functional departments based on headcount, while the remaining expenses will be recorded within general and administrative expenses. The expected impact is an increase in general and administrative expenses and a decrease in cost of revenue and other operating expense categories. Prior period amounts will be re-classified to reflect the revised methodology in our future consolidated financial statements and accompanying notes. Cost of Revenue: Fiscal years ended July 31, 2022 2021 Change % of total % of total Amount revenue Amount revenue ($) (%) (In thousands, except percentages) Cost of revenue: Subscription and support
$ 213,27526 % $ 164,98322 % $ 48,29229 % License 8,754 1 10,569 1 (1,815) (17) Services 238,365 29 199,502 27 38,863 19 Total cost of revenue $ 460,39456 % $ 375,05450 % $ 85,34023 % Includes stock-based compensation of: Cost of subscription and support revenue $ 14,614 $ 11,231 $ 3,383Cost of license revenue 692 770 (78) Cost of services revenue 22,951 21,809 1,142 Total $ 38,257 $ 33,810 $ 4,447Cost of subscription and support revenue increased by $48.3 millionprimarily due to increases in personnel costs of $27.9 millionas a result of our continued investment in our cloud operations to increase operational efficiency and scale, cloud infrastructure expense of $21.3 millionfor our growing cloud customer base, higher amortization of previously capitalized software development costs of $2.5 million, and higher royalties of $1.2 million. These increases were partially offset by a decrease in amortization of acquired intangible assets of $4.1 millionand a decrease in professional services of $0.6 million. 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 and support services increased. We expect our cost of subscription and support revenue to increase as we continue to invest in our cloud operations to improve efficiencies and to continuously improve and maintain secure environments, more customers migrate from term licenses to subscription services, and we incur higher cloud infrastructure costs as our cloud customer base and their usage grows. However, we believe that the cost of subscription and support revenue will grow at a slower rate than subscription and support revenue in future years as we achieve economies of scale and other efficiencies. 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 $1.8 milliondecrease in our cost of license revenue was primarily due to a decrease in amortization of acquired intangible assets of $1.5 milliondue to certain acquired intangible assets being fully amortized and lower personnel costs associated with the development of online training curriculum included with the latest releases of InsuranceSuite of $0.8 million. These decreases were partially offset by an increase in royalties of $0.5 million.
We continue to expect the cost of license revenue to decline over time as our term license customers transition to cloud subscription agreements.
$38.9 millionincrease in cost of services revenue was primarily due to an increase of $37.9 millionin subcontractor and personnel expenses for InsuranceSuite Cloud implementations and, to a lesser extent, increases of $0.6 millionin software subscriptions and $0.3 millionin web hosting services. We had 696 cloud operations and technical support employees and 755 professional service employees at July 31, 2022compared to 600 cloud operations and technical support employees and 657 professional services employees at July 31, 2021.
Table of Contents Gross Profit Fiscal years ended July 31, 2022 2021 Change Amount margin % Amount margin % ($) (%) (In thousands, except percentages) Gross profit: Subscription and support
$ 130,43338 % $ 87,37535 % $ 43,05849 % License 249,877 97 293,223 97 (43,346) (15) Services (28,090) (13) (12,385) (7) (15,705) 127 Total gross profit $ 352,22043 % $ 368,21350 % $ (15,993)(4) % Our gross profit decreased $16.0 millioncompared to the prior year. Gross profit was impacted by a decrease in term license revenue due to the impact of multi-year term license arrangements entered into in fiscal year 2022 being significantly lower than the impact of multi-year term license arrangements in the same period a year ago and, to a lesser extent, a decrease in services gross profit due to the investments that we are making in our customers' transition to subscription services. These decreases were partially offset by an increase in subscription and support gross profit due to the increase in subscription revenue, which has a lower gross margin compared to license revenue. Our gross margin decreased to 43% in fiscal year 2022, as compared to 50% in fiscal year 2021. Gross margin was primarily impacted by the increase as a percentage of total revenue of subscription and support revenue, which has a 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 the next several years. In addition, the impact of our investment in customer migrations and implementations, challenges related to COVID-19, and inflation may continue to negatively impact services gross margin going forward. 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.
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 costs such as IT support, information security, facilities and other administrative costs to all functional departments based on headcount. Therefore, overhead costs are reflected in the cost of products and in each functional operating expense.
Effective as of the beginning of fiscal year 2023, we are revising our allocation methodology to more closely reflect the way our business is managed and to be more comparable to other companies in our industry. The change will result in facilities expenses, information technology infrastructure and software expenses, and information security infrastructure and software expenses being allocated to all functional departments based on headcount, while the remaining expenses will be recorded within general and administrative expenses. The expected impact is an increase general and administrative expenses and a decrease in cost of revenue and other operating expense categories. Prior period amounts will be re-classified to reflect the revised methodology in our future consolidated financial statements and accompanying notes. Fiscal years ended July 31, 2022 2021 Change % of total % of total Amount revenue Amount revenue ($) (%) (In thousands, except percentages) Operating expenses: Research and development
$ 249,66531 % $ 219,49430 % $ 30,17114 % Sales and marketing 194,611 24 160,544 22 34,067 21 General and administrative 107,391 13 93,759 13 13,632 15 Total operating expenses $ 551,66768 % $ 473,79765 % $ 77,87016 % Includes stock-based compensation of: Research and development $ 36,134 $ 29,524 $ 6,610Sales and marketing 32,960 25,820 7,140 General and administrative 29,660 25,855 3,805 Total $ 98,754 $ 81,199 $ 17,555Research and Development
Our research and development expenses consist primarily of personnel costs for our technical staff and consultants providing professional services.
$30.2 millionincrease in research and development expenses was primarily due to increases of $21.7 millionin personnel costs associated with higher headcount, $4.3 millionin cloud infrastructure costs for our development environments, $3.1 millionin acquisition consideration holdback costs recognized over a service period relating to the HazardHub acquisition, and $1.2 millionin software subscription costs.
Our research and development workforce was 972 at
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
about five years. Selling and marketing expenses also include travel expenses, professional services for marketing activities and amortization of certain intangible assets acquired.
$34.1 millionincrease in sales and marketing expenses was primarily due to increases of $26.9 millionin personnel costs due to higher headcount to sell and market our services and products; $5.3 millionin travel expenses as in-person prospect and client interactions have resumed; $1.6 millionin marketing and advertising expense associated with Connections Reimagined, our annual sales conference which was a hybrid event held in November 2021, compared to two fully virtual events in fiscal year 2021; $0.3 millionin professional services; and $0.2 millionin web hosting costs. These increases were partially offset by a decrease of $0.4 milliondue to certain acquired intangible assets being fully amortized.
Our sales and marketing workforce was 475 at
We expect our sales and marketing expenses to continue to increase in absolute dollars as we continue to invest in sales and marketing activities and resume business travel to support our growth and objectives.
General and administrative
Our general and administrative expenses include management, finance, human resources, legal, development and corporate strategy functions, and consist primarily of personnel costs, as well as professional services.
$13.6 millionincrease in our general and administrative expenses was primarily due to increases of $9.6 millionin personnel costs due to higher headcount, $4.8 millionin software subscription and web hosting costs, and $3.0 millionof bad debt expense related to a contract termination as a result of United Statesgovernment sanctions on Russia. These increases were partially offset by a decrease of $3.7 millionin professional services.
Our general and administrative staff was 478 at
In addition to the impact of revising our allocation methodology mentioned above, we expect that our general and administrative expenses will increase in absolute dollars as we continue to invest in personnel, corporate infrastructure, and systems required to support our strategic initiatives, grow our business, and meet our compliance and reporting obligations. Other Income (Expense) Fiscal years ended July 31, 2022 2021 Change Amount Amount ($) (%) (In thousands, except percentages) Interest income
$ 6,277 $ 7,395 $ (1,118)(15) % Interest expense $ (19,446) $ (18,711) $ (735)4 % Other income (expense), net $ (17,099) $ 12,619 $ (29,718)(236) % Interest Income
Interest income represents interest earned on our cash, cash equivalents and investments.
Interest income decreased by
$1.1 millionin fiscal year 2022, primarily due to lower yields on invested funds and lower funds available for investment. This decrease was partially offset by imputed interest income realized upon the conversion of a strategic investment from convertible debt to preferred equity.
Interest expense includes both stated interest and the amortization of debt discount and issuance costs associated with 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 fiscal years 2022 and 2021 consist of non-cash interest expense related to the amortization of debt discount and issuance costs of
$14.4 millionand $13.6 million, respectively, and stated interest of $5.0 millionin both periods. Effective at the beginning of fiscal year 2023, we are adopting the FASB ASU No. 2020-06 (see Note 1 "The Company and Summary of Significant Accounting Policies and Estimates" to our consolidated financial statements included in this Annual Report
on Form 10-K) which will eliminate the equity component of our senior convertible bonds. This will reduce interest expense in future periods due to the elimination of debt discount amortization.
Other income (expenses), net
Other income (expense), net includes foreign exchange gains and losses resulting from fluctuations in foreign exchange rates on monetary asset and monetary liability balances that are denominated in currencies other than the functional currency of the entity in which they are recorded. Our monetary assets and liabilities denominated in currencies other than the functional currency of the entity in which they are recorded consist primarily of trade accounts receivable, unbilled accounts receivable, trade accounts payable, and intercompany receivables and payables. We currently are entering into transactions in the following currencies: the Argentine Peso, Australian Dollar, Brazilian Real, British Pound, Canadian Dollar, Chinese Yuan,
Danish Krone, Euro, Hong Kong Dollar, Indian Rupee, Japanese Yen, Malaysian Ringgit, Mexican Peso, New Zealand Dollar, Polish Zloty, Russian Ruble, South African Rand, and Swiss Franc.
Other income (expenses), net for fiscal year 2022, represented an expense of
Provision for (profit) income taxes
We are subject to taxes in
the United Statesas well as other tax jurisdictions and countries in which we conduct business. Earnings from our non- U.S.activities are subject to local country income tax and may also be subject to U.S.income tax. Fiscal years ended July 31, 2022 2021 Change Amount Amount ($) (%) (In thousands, except percentages) Provision for (benefit from) income taxes $ (49,284) $ (37,774) $ (11,510)30 % Effective tax rate 21 % 36 % We recognized an income tax benefit of $49.3 millionfor fiscal year 2022 compared to an income tax benefit of $37.8 millionfor fiscal year 2021. The increase in our income tax benefit for fiscal year 2022 was primarily due to an increase in pre-tax net loss, an increase in research and development credits, and a decrease in valuation allowance, partially offset by decreases in tax benefits such as tax deductions from stock-based compensation, the tax impact from the tax status change of certain foreign subsidiaries from prior year, and the release of uncertain tax positions from the prior year. As of July 31, 2022, we had unrecognized tax benefits of $11.8 millionthat, if recognized, would affect our effective tax rate, as certain unrecognized tax benefits have a valuation allowance. The effective tax rate could differ from the statutory U.S.Federal income tax rate of 21% mainly due to state taxes, tax deficiencies related to stock-based compensation, research and development credits, foreign earnings taxed in the U.S., change in valuation allowance and certain non-deductible expenses, including, but not limited to, executive compensation limitation.
Comparison of the years ended
Refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in our 10-K for the fiscal year ended
July 31, 2021, filed on September 24, 2021, for the discussion of the comparison of the fiscal year ended July 31, 2021to the fiscal year ended July 31, 2020, the earliest of the three fiscal years presented in the consolidated financial statements.
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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 specific items excluded from GAAP in the calculation of non-GAAP financial measures for the periods indicated below (in thousands, except per share and per share data):
Fiscal years ended July 31, 2022 2021 Gross profit reconciliation: GAAP gross profit
$ 352,220 $ 368,213Non-GAAP adjustments: Stock-based compensation 38,257 33,810 Amortization of intangibles 7,659 13,175 COVID-19 Canada Emergency Wage Subsidy benefit(1) - (1,975) Non-GAAP gross profit $
Income (loss) from operations reconciliation: GAAP income (loss) from operations
$ (199,447) $ (105,584)Non-GAAP adjustments: Stock-based compensation 137,011 115,009 Amortization of intangibles 14,081 19,965 COVID-19 Canada Emergency Wage Subsidy benefit(1) - (3,396) Acquisition consideration holdback (2) $ 3,067- Non-GAAP income (loss) from operations $
Net income (loss) reconciliation: GAAP net income (loss)
$ (180,431) $ (66,507)Non-GAAP adjustments: Stock-based compensation 137,011 115,009 Amortization of intangibles 14,081 19,965 COVID-19 Canada Emergency Wage Subsidy benefit(1) - (3,396) Acquisition consideration holdback(2) 3,067 - Amortization of debt discount and issuance costs 14,391 13,617 Changes in fair value of strategic investments (1,538) - Tax impact of non-GAAP adjustments (29,105) (37,379) Non-GAAP net income (loss) $
Tax provision (benefit) reconciliation: GAAP tax provision (benefit)
$ (49,284) $ (37,774)Non-GAAP adjustments:
Stock-based compensation 37,826 (20,979) Amortization of intangibles 3,936 (4,220) COVID-19 Canada Emergency Wage Subsidy benefit(1) - (135) Acquisition consideration holdback (2) 847 - Amortization of debt discount and issuance costs 4,049 (2,555) Changes in fair value of strategic investments (471) - Tax impact of non-GAAP adjustments (17,082) 65,268 Non-GAAP tax provision (benefit) $
(20,179) $ (395)
Net income (loss) per share reconciliation: GAAP net income (loss) per share - diluted
$ (2.16)$ (0.79) Non-GAAP adjustments: Stock-based compensation 1.63 1.39 Amortization of intangibles 0.16 0.25 COVID-19 Canada Emergency Wage Subsidy benefit(1) - (0.04) Acquisition consideration holdback (2) 0.03 - Amortization of debt discount and issuance costs 0.17 0.16 Changes in fair value of strategic investments 0.01 - Tax impact of non-GAAP adjustments (0.35) (0.45)
Dilutive non-GAAP shares excluded from the calculation of net earnings per share under GAAP
- (0.03) Non-GAAP net income (loss) per share - diluted $
Stocks Used in the Calculation of Non-GAAP Earnings (Loss) Per Share: GAAP Weighted Average Stocks – Diluted
Dilutive non-GAAP shares excluded from the calculation of income (loss) per share under GAAP
- 805,747 Pro forma weighted average shares - diluted 83,569,517 84,383,122 (1) Effective the second quarter of fiscal year 2021, the COVID-19
CanadaEmergency Wage Subsidy benefit has been included as a non-GAAP adjustment. Prior to the second quarter of fiscal year 2021, this program was unavailable. Beginning with the first quarter of fiscal year 2022, we have not and do not expect to receive a subsidy under the COVID-19 CanadaEmergency Wage Subsidy. (2) Effective the first quarter of fiscal year 2022, acquisition consideration holdback that is earned and recognized as expense over a post-acquisition service period has been included as a non-GAAP adjustment. Prior to the first quarter of fiscal year 2022, there was no acquisition consideration holdback in any periods presented.
Cash and capital resources
Our main sources of liquidity are as follows (in thousands):
July 31, 2022 July 31,
Cash, cash equivalents and investments
$ 915,185 $ 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 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 of July 31, 2022, approximately $44.9 millionof our cash and cash equivalents were domiciled in foreign jurisdictions. We may repatriate foreign earnings to the United Statesin 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 buyback program
October 2020, our board of directors authorized and approved a share repurchase program of up to $200.0 millionof our outstanding common stock. The share repurchase program was completed in the second quarter of fiscal year 2022. During the fiscal year ended July 31, 2022, we repurchased 322,545 shares of common stock at an average price of $116.11per share for an aggregate
purchase price of
$37.5 million. During the fiscal year ended July 31, 2021, we repurchased 1,488,991 shares of common stock at an average price of $109.17per share for an aggregate purchase price of $162.5 million.
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 generate positive cash flows from operations on an annual basis in the future, although this may fluctuate significantly on a quarterly basis. In particular, we typically use more cash during the first fiscal quarter, which ends
October 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, cybersecurity, and operating costs, and expansion into other markets. We also may invest in or acquire complementary businesses, applications or technologies, or may execute on a board-authorized share 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 consolidated financial statements included elsewhere in this Annual Report on Form 10-K (in thousands): Fiscal
Net cash provided by (used in) operating activities
Net cash provided by (used in) investing activities
Net cash provided by (used in) financing activities
Cash flow from operating activities
Net cash used in operating activities increased by
$149.5 millionin fiscal year 2022 as compared to fiscal year 2021. The increase in operating cash used was primarily attributable to a $110.9 millionincrease 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 along with an increase of $38.6 millionin cash used by working capital activities. Changes in working capital include payments of $69.1 millionrelated to our fiscal year 2021 corporate bonus and accrued vacation balances in countries in which we adopted a non-accrual vacation policy in the first quarter of fiscal year 2022, which was $47.8 millionhigher than the bonus payment during the same period a year ago. A portion of the fiscal year 2020 bonus, which would have been paid in the first quarter of fiscal year 2021, was accelerated due to the COVID-19 pandemic and paid in fiscal year 2020.
Cash flow from investing activities
Net cash provided by investing activities increased by
$248.0 millionin fiscal year 2022 as compared to fiscal year 2021. The increase in cash provided by investing activities was primarily due to decreased net purchases of available-for-sale securities of $293.9 millionand lower capital expenditures and capitalized software development costs of $7.1 million. These were offset by $43.8 millionpaid as purchase consideration for the acquisition of HazardHub and a $9.2 millionnet increase in amounts paid for strategic investments.
Cash flow from financing activities
Net cash used in financing activities decreased by
$122.1 millionin fiscal year 2022 as compared to fiscal year 2021. The decrease in cash used was primarily because our authorized share repurchase program was completed in the second quarter of fiscal year 2022, which resulted in our repurchase of $123.9 millionless of our common stock during fiscal year 2022 compared to the same period a year ago, and a decrease in proceeds from option exercises of $1.8 million.
Commitments and contractual obligations
Our estimated future obligations include leases, royalties, purchase obligations, debt and taxes at
Off-balance sheet arrangements
July 31, 2022, 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.
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