# Fastly, Inc. (FSLY) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Fastly, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1517413/000151741323000035/fsly-20221231.htm
Accession: 0001517413-23-000035
Filing date: 2023-02-27
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/FSLY/
All MD&A years: /company/FSLY/mda/
Previous year: /company/FSLY/mda/fy2021/ (FY 2021)
Next year: /company/FSLY/mda/fy2023/ (FY 2023)

ITEM 7.     Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current plans, expectations, and beliefs that involve risks and uncertainties. Actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and in other parts of this Annual Report on Form 10-K. Our fiscal year ends on December 31.

As used herein, "Fastly," "we," "our," "the Company" and similar terms include Fastly, Inc. and its subsidiaries, unless the context indicates otherwise.

Overview

Organizations around the world are more dependent on the quality of digital experiences they provide than ever before. At Fastly, we deliver an edge cloud platform capable of delivering fast, safe, and engaging digital experiences. By focusing holistically on edge cloud from developer inspiration to end-user experience, we have the opportunity to differentiate with our global footprint, dynamic infrastructure, and security solution. Performance, security, and building the most engaging applications are paramount to driving mission success for Fastly’s customers.

The edge cloud is an emerging category of Infrastructure as a Service ("IaaS") that enables developers to build, secure, and deliver digital experiences, at the edge of the Internet. This service represents the convergence of the Content Delivery Network ("CDN") with functionality that has been traditionally delivered by hardware-centric appliances such as Application Delivery Controllers ("ADC"), Web Application Firewalls ("WAF"), Bot Detection, Distributed Denial of Service ("DDoS") and observability solutions. It also includes the emergence of a new, but growing, edge computing market which aims to move compute power and logic as close to the end user as possible. When milliseconds matter, processing at the edge is an ideal way to handle highly dynamic and time-sensitive data. This has led to its acceptance and adoption by organizations who monetize or grow their user base with every millisecond saved. Organizations that want to improve their user experience, whether it’s faster loading websites or reduced shopping cart abandonment, can benefit from processing at the edge. The edge cloud complements data center, central cloud, and hybrid solutions.

Organizations must keep up with complex and ever-evolving end-user requirements. We help them surpass their end users’ expectations by powering fast, safe, and engaging digital experiences. We built a powerful edge cloud platform, designed from the ground up to be programmable and support agile software development. We believe that our platform gives our customers a significant competitive advantage, whether they were born into the digital age or are just embarking on their digital transformation journey.

Developers on the Fastly platform have a high degree of flexibility with granular control and real-time visibility, where they can write and deploy code in a serverless environment and push application logic to the edge. Our infrastructure is built for the software-defined future. Our network is powerful, efficient, and flexible, designed to enable us to rapidly scale to meet the needs of the most demanding customers. Our approach to scalable, secure reliability integrates security into multiple layers of development: architecture, engineering, and operations. That's why we invest in building security into the fabric of our platform, alongside performance. We provide developers and security operations teams with a fast and safe environment to create, build, and run modern applications.

We serve established enterprises, mid-market companies, and technology-savvy organizations. Our customers represent a diverse set of organizations across many industries with one thing in common: they care about delivering best in class digital experiences. With our edge cloud platform, our customers are disrupting existing industries and creating new ones. For example, several of our customers have reinvented digital publishing by connecting readers through subscription models to indispensable content. Fastly’s ability to dynamically manage content in real time enables readers to have instant access to the most up to date information.

Our customers’ ecommerce solutions use Fastly's edge compute functionality to deliver very low latency customer experiences, including providing better recommendations to their shoppers, converting more shopping carts into sales and executing fast and secure financial transactions. Content streaming organizations leverage Fastly's platform to deliver content to

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users around the world and those that livestream gain easy access to enormous edge compute resources for even greater reliability. The range of applications that developers build with our edge cloud platform continues to expand rapidly.

Our mission is to make the Internet a better place where all experiences are fast, safe, and engaging. We want all developers to have the ability to deliver the next transformative digital experience on a global scale. And because big ideas often start small, we love it when developers experiment and iterate on our platform, coming up with exciting new ways to solve today’s complex problems.

For the years ended December 31, 2022 and 2021, our revenue was $432.7 million and $354.3 million, respectively, an increase of 22%. Our 10 largest customers generated an aggregate of 35% and 33% of our revenue in the trailing 12 months ended December 31, 2022 and 2021, respectively. Our 5 largest customers generated an aggregate of 26% and 22% of our revenue in the trailing 12 months ended December 31, 2022 and 2021, respectively. Affiliated customers that are business units of a single company in the streaming entertainment space generated an aggregate of 11% of our revenue in both the trailing 12 months ended December 31, 2022 and 2021. We incurred a net loss of $190.8 million and $222.7 million in the years ended December 31, 2022 and 2021, respectively.

We focus our direct selling efforts on expanding our customer's use of our platform, which includes companies that are exhibiting significant growth. We engage with and support these customers with our field sales representatives, account managers, and technical account managers who focus on customer satisfaction and drive expansion of their usage of our platform and products. These teams work with technical and business leaders to help our customers’ end-users receive the best possible digital experience, while also lowering our customers’ total cost of ownership.

These direct selling efforts are reflected by our 493 enterprise customers as of December 31, 2022. These enterprise customers are defined as customers with revenue in excess of $100,000 over the previous 12-month period. Our enterprise customers generated 89% of our total revenue for the trailing 12 months ended December 31, 2022, up from 445 enterprise customers which generated 88% of our revenue for the trailing 12 months ended December 31, 2021.

Our Dollar-Based Net Expansion Rate ("DBNER"), Net Retention Rate ("NRR") and Last-Twelve Months Net Retention Rate ("LTM NRR") metrics measure the revenue growth from existing customers attributable to increased usage of our platform and features, and purchase of additional products and services. For additional details on our key metrics, refer to the "Key Business Metrics" section.

We believe that an annual cohort analysis of Fastly's customers, as depicted in the chart below, demonstrates the continued expansion of our customers' use of our platform. Once a customer begins to generate revenue for us, they tend to increase their usage of our platform, in particular in their second year. Customer accounts acquired in 2018, 2019, 2020, 2021 and 2022 are referred to as the 2018 Cohort, 2019 Cohort, 2020 Cohort, 2021 Cohort and 2022 Cohort, respectively. We calculate the Compound Annual Growth Rate (“CAGR”), which represents the rate of revenue return of our revenue cohorts, over a five year history from when they were first customers.

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    Summary of Revenue Generated by Customer Cohorts Over Time (in millions):

Our 2018 Cohort increased its revenue 3.1 times in fiscal 2019 and has grown at approximately a 60% CAGR over the next four years from fiscal 2019 to fiscal 2022.

We generate substantially all of our revenue from charging our customers based on their usage of our platform, and we generate a substantial majority of our revenue from customers that have negotiated contracts with us. Initially, customers typically choose to become platform customers, for which we charge fees based on their committed or actual use of our platform, as measured in gigabytes and requests. Many of our customers generate billings in excess of their minimum commitment. We also generate revenue from additional products as well as professional and other services, such as implementation, account management and enhanced customer support. We charge a flat one-time or recurring monthly fee depending on the additional products and services selected. Typically, the term of our contracts with customers is 12 months and includes a minimum monthly billing commitment in exchange for more favorable pricing terms. In addition, customers can sign up online by providing their credit card information and agreeing to a minimum monthly fee. We also offer subscriptions to access a unified security web application and application programming interface at a fixed rate.

The majority of our revenue is usage based and changes in usage by our largest customers can create volatility in our revenue. The length of our sales cycles, from initial evaluation to payment, can range from several months to well over a year and can vary substantially from customer to customer. Similarly, the onboarding and ramping process with new as well as existing enterprise customers with new business can take several months and can be subject to delays for unanticipated reasons. The timing of new revenue from our sales efforts and changes in usage by our largest customers can make revenue difficult to predict.

Factors Affecting Our Performance

Winning New Customers

We are focused on continuing to attract new customers, including those in new vertical markets, and expanding our relationship with existing customers, by enhancing our product experience, investing in technology,, and leveraging our partner ecosystem. Our customer base includes large, established enterprises that are undergoing digital transformation and emerging companies spanning a wide array of industries and verticals. Developers within these companies often use and advocate for the adoption of our platform by their companies and promotion across the broader developer community. We will continue to invest in our products and features and developer outreach, leveraging it as a cost-efficient approach to attracting new customers, and our sales and marketing programs, including various online marketing activities as well as targeted account-based advertising.

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We are continuing to bring a durable, consistent, and predictable pipeline of new innovations to our edge cloud platform and software-defined modern network architecture, and are seeing interest from customers in our existing product lines like Network Services and Security, and newer product lines like Compute and Observability. We will continue to build out a single, unified platform, simplify customer onboarding and service usage, and simplify our pricing and packaging. This will require us to dedicate significant resources to further develop the market for our platform and differentiate our platform from competitive products and services. We will also need to expand, retain, and motivate our sales and marketing personnel in order to target our sales efforts at larger enterprises and senior management of these potential customers.

Many jurisdictions have enacted laws on data localization and cross-border data transfers, and the evolving enforcement and interpretation of such laws has created uncertainty regarding data stored abroad and transferred across borders, which could impact customer growth and acquisition for customers and potential customers conducting business in Europe and elsewhere outside of the United States. For additional details, refer to the section titled "Risk Factors."

Expanding into New Vertical Markets and within Our Existing Customer Base

We aim to continue to add customers from a diverse set of industry verticals through our differentiated platform that offers a broad range of capabilities. By focusing on performance and security, we have the opportunity to continue to add customers from a diverse set of industries.

We emphasize retaining our customers and expanding their usage of our platform and adoption of our other products. Customers often begin with smaller deployments of one of our products and then expand their usage over time. Our platform includes a variety of offerings across Network Services, Security, Compute and Observability product lines. As our customers mature, we assist them in expanding their use of our platform, including the use of additional offerings beyond edge cloud delivery or security. As enterprises grow and experience increased traffic, their needs evolve, leading them to find additional use cases for our platform and expand their usage accordingly. In addition, given that customer acquisition costs are incurred largely for acquiring and initial onboarding, we may gain operating leverage to the extent that existing customers expand their use of our platform and products.

Our ability to retain customers and expand their usage could be impaired for a variety of reasons, including a customer moving to another provider or reducing usage within the term of their contract to their minimum usage commitment. Even if our customers expand their usage of our platform, we cannot guarantee that they will maintain those usage levels for any meaningful period of time or that they will renew their commitments. The data localization and cross-border data transfer issues described above also impact current customers' usage of our products and services.

In addition, we cannot be certain what actions the United States or another country's government may take with respect to certain of our customers that may adversely affect our ability to do business with our customers that operate in China, target China as a market or that have strong business ties to China.

International Expansion

We intend to continue expanding our efforts to attract customers outside of the United States by augmenting our sales teams and strategically increasing our presence in the number of markets in select international locations. As of December 31, 2022, our edge network spanned across 58 markets and 34 countries that are outside of the United States. As of December 31, 2021, our edge network spanned across 51 markets and 31 countries that are outside of the United States.

Our international expansion, including our global sales efforts, continues to add increased complexity and cost to our business. This requires us to expand our sales and marketing capabilities outside of the United States, as well as increase the number of markets we have a presence in around the world to support our customers. Managing the administrative aspects of a global organization places a strain on our business and culture.

We are closely monitoring the unfolding events of the Russian invasion of Ukraine and its global impacts. While the conflict is still evolving and the outcome remains highly uncertain, we do not believe the Russia-Ukraine conflict will have a material impact on our business and results of operation. However, some threat actors now engage and are expected to continue to engage in cyber-attacks, including without limitation nation-state actors for geopolitical reasons and in conjunction with military conflicts and defense activities. During times of war and other major conflicts, we, the third parties upon which we rely, and our customers may be vulnerable to a heightened risk of these attacks, including retaliatory cyber-attacks, that could materially disrupt our systems and operations, supply chain, and ability to produce, sell and distribute our goods and services. If the Russia-Ukraine conflict continues or worsens, leading to greater global economic disruptions and uncertainty, our business

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and results of operations could be materially impacted. Our customers in Russia represented an immaterial portion of our net assets and total consolidated revenue as of December 31, 2022 and 2021.

Investing in Sales and Marketing

Our customers have been pivotal in driving brand awareness and broadening our reach. While we continue to leverage the self-service approach to drive adoption by developers, we will continue to expand our sales and marketing efforts, with an increased focus on sales to enterprises globally. Utilizing our direct sales force, we have multiple selling points within organizations to acquire new customers and increase usage from our existing customers. We will continue to increase our discretionary marketing spend, including account-based and brand spend, to drive the effectiveness of our sales teams. As a result, we expect our total operating expenses to increase as we continue to expand. Our investments in sales and marketing teams are intended to help accelerate our sales, onboarding, and ramp cycles.

These efforts will require us to continue to invest in sales and marketing resources. Furthermore, we believe that there is significant competition for sales personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, training, and retaining sufficient numbers of sales personnel to support our growth.

Continued Investment in Our Platform and Network Infrastructure

We must continue to invest in our platform and network infrastructure to maintain our position in the market. We expect our revenue growth to be dependent on an expanding customer base and continued adoption of our edge cloud delivery, security, and other products and services. In anticipation of winning new customers and staying ahead of our customers’ needs, we plan to continue to invest in order to expand the scale and capacity of our software-defined modern network. This could result in increased network service provider fees, which could adversely affect our gross margins if we are unable to offset these costs with revenue from new customers and increase revenue from existing customers. Our customers require constant innovation within their own organizations and expect the same from us. Therefore, we will continue to invest in resources to enhance our development capabilities and introduce new products and features on our platform. We believe that investment in research and development will contribute to our long-term growth but may also negatively impact our short-term profitability. For the years ended December 31, 2022 and 2021, our research and development expenses as a percentage of revenue were 36% and 36%, respectively. We may also seek to acquire or invest in businesses, products, or technologies that we believe could complement or expand our platform, enhance our technical capabilities, or otherwise offer growth opportunities. For example, in May 2022, we acquired Glitch, a software company specializing in developer project management tools to bolster our existing product offerings, by making it easier to innovate at a layer in the Fastly software stack.

Developers use our platform to build custom applications and require a state-of-the-art infrastructure to test and run these applications. We will continue to invest in our network infrastructure by strategically increasing our POPs. We also anticipate making investments in upgrading our technology and hardware to continue providing our customers a fast and secure platform. Our gross margins and operating results are impacted by these investments. As of December 31, 2022, our global network is located in 79 markets across 35 countries.

In the event that there are errors in software, failures of hardware, damages to a facility or misconfigurations of any of our services—whether caused by our own error, security breaches, third-party error, or natural disasters—we could experience lengthy interruptions in our platform as well as delays and additional expenses in arranging new facilities and services. In addition, there can be no assurance that we are adequately prepared for unexpected increases in bandwidth demands by our customers, particularly when customers experience cyber-attacks. The bandwidth we have contracted to purchase may become unavailable for a variety of reasons, including service outages, payment disputes, network providers going out of business, natural disasters, networks imposing traffic limits, or governments adopting regulations that impact network operations.

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Key Business Metrics

We use the following key metrics presented in the table below, to evaluate our business, measure our performance, identify trends affecting our business, prepare financial projections, and make strategic decisions. The calculation of these key metrics below may differ from other similarly titled metrics used by other companies, securities analysts, or investors.

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Number of Customers

We believe that the number of customers is an important indicator of the adoption of our platform. Our definition of a customer consists of identifiable operating entities with which we have a billing relationship in good standing, from which we recognized revenue during the period. An identifiable operating entity is defined as a company, a government entity, or a distinct business unit of a larger company that has a relationship with us through direct sale or through one of our reseller partners where charges are identified on an end-customer basis. We may treat separate subsidiaries, segments, divisions, or business units of a single organization that use our platform as unique customers where they have distinct account identifiers. In cases where charges are identified through a reseller partner rather than on an end-customer basis, we would count the reseller as a single customer in our customer count. Our customer groupings may be impacted by changes to our customers’ business, including any impact from acquisition activities, internal business reorganizations leading to operational and decision making changes, and corporate structure changes such as subsidiary consolidation and reorganization that may arise in the future.

In addition to our paying customers, we also have trial, developer, nonprofit and open source programs, and other non-paying accounts that are excluded from our customer count metric. We operate globally and as a result, the success of our ability to retain our customers is also affected by general economic and market conditions around the world. As of December 31, 2022 and 2021, we had 2,958 and 2,804 customers, respectively.

Number of Enterprise Customers

Historically our revenue has been driven primarily by a subset of customers who have leveraged our platform substantially from a usage standpoint. These enterprise customers are defined as customers with revenue in excess of $100,000 over the previous 12-month period. As of December 31, 2022, we had 493 enterprise customers which generated 89% of our revenue for the trailing 12 months ended December 31, 2022. As of December 31, 2021, we had 445 enterprise customers which generated 88% of our revenue for the trailing 12 months ended December 31, 2021. We believe that the recruitment and cultivation of enterprise customers is critical to our long-term success.

Average Enterprise Customer Spend

Our enterprise customers continue to leverage our platform, increasing their spend on our platform and driving our revenue growth year over year. Average enterprise customer spend is calculated by taking the sum of the trailing 12-month revenue contributed by enterprise customers existing as of December 31, 2022, and dividing that by the number of enterprise customers as of December 31, 2022. As of December 31, 2022, our average enterprise customer spend was $782 thousand, as compared to $704 thousand as of December 31, 2021. The continued retention and growth of our enterprise customer spend is key to our long-term growth strategy.

Dollar-Based Net Expansion Rate ("DBNER")

Our ability to generate and increase our revenue is dependent upon our ability to increase the number of new customers and usage of our edge cloud delivery platform, security, and other products and services by our existing customers. We track

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our growth, in part, by measuring DBNER. Our DBNER increases when customers increase their usage of our platform or purchase additional products, and declines when they reduce their usage, benefit from lower pricing on their existing usage, or curtail their purchases of additional products. We believe that DBNER is a key metric in measuring the long-term value of our customer relationships and our ability to grow our revenue through increased usage of our edge cloud delivery platform, security, and purchase of additional products and services by our existing customers. However, our calculation of DBNER indicates only expansion among continuing customers and does not indicate any decrease in revenue attributable to former customers, which may differ from similar metrics of other companies.

We calculate DBNER by dividing the revenue for a given period from customers who remained customers as of the last day of the given period ("current period") by the revenue from the same customers for the same period measured one year prior ("base period"). The revenue included in the current period excludes revenue from (i) customers that churned after the end of the base period and (ii) new customers that entered into a customer agreement after the end of the base period. For example, to calculate our DBNER for the trailing 12 months ended December 31, 2022, we divide (i) revenue, for the trailing 12 months ended December 31, 2022, from customers that entered into a customer agreement on or before December 31, 2022, and that remained customers as of December 31, 2022, by (ii) revenue for the trailing 12 months ended December 31, 2021 from the same set of customers.

For the trailing 12 months ended December 31, 2022 and 2021 our DBNER was 122.7% and 120.9%, respectively. DBNER may fluctuate from quarter to quarter based on, among other things, the timing associated with new customer accounts. We expect our DBNER for individual cohorts to decrease once customers in that cohort have used our platform for more than two years and become a larger portion of both our overall customer base and the revenue that we use to calculate DBNER.

We separately monitor customer retention and churn on an annual basis by measuring our annual revenue retention rate, which we calculate by multiplying the final full month of revenue from a customer that terminated its contract with us (a "Churned Customer") by the number of months remaining in the same calendar year ("Annual Revenue Churn"). The quotient of the Annual Revenue Churn from all of our Churned Customers divided by our annual revenue of the same calendar year is then subtracted from 100% to determine our annual revenue retention rate. We believe this calculation is helpful in that it is based on the amount of revenue that we would expect to have received in the remaining portion of a particular period had a customer not terminated its contract with us. It is not indicative of the actual revenue contribution from churned customers in past periods. By comparing this amount to actual revenue for the period, we are able to assess our ability to replace terminated revenue by generating revenue from new and continuing customers. Our annual revenue retention rate for both of the years ended December 31, 2022 and 2021 was 99.2%.

Net Retention Rate ("NRR") and Last-Twelve Months Net Retention Rate ("LTM NRR")

Our ability to generate and increase our revenue is also dependent upon our ability to retain our existing customers. In addition to measuring expansion using DBNER, NRR and LTM NRR also allow us to track customer retention which demonstrates the stickiness of our edge cloud platform.

Our NRR measures the net change in monthly revenue from existing customers in the last month of the period (the “current" period month) compared to the last month of the same period one year prior (the “prior" period month) and includes revenue contraction due to billing decreases or customer churn, revenue expansion due to billing increases, but excludes revenue from new customers. We calculate Net Retention Rate by dividing the revenue from the current period month by the revenue in the prior period month. For the last month of the years ended December 31, 2022 and 2021 our NRR was 110.7% and 106.6%, respectively.

Our LTM NRR removes some of the volatility that is inherent in a usage-based business model from the measurement of the NRR metric. We calculate LTM NRR by dividing the total customer revenue for the prior twelve-month period (“prior 12-month period”) ending at the beginning of the last twelve-month period (“LTM period”) minus revenue contraction due to billing decreases or customer churn, plus revenue expansion due to billing increases during the LTM period from the same customers by the total prior 12-month period revenue. For the trailing twelve months ended December 31, 2022 and 2021 our LTM NRR was 119.1% and 117.6%, respectively.

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Key Components of Statement of Operations

Revenue

We derive our revenue primarily from usage-based fees earned from customers using our platform. We also earn fixed-rate recurring revenue from security and other products and services.

Our usage-based fees earned from customers using our platform are generally billed in arrears. Our security products are primarily annual subscriptions that are billed in advance. Many customers have tiered usage pricing which reflects discounted rates as usage increases. For most contracts, usage charges are determined on a monthly basis based on actual usage within the month and do not impact usage charges within any other month. Our larger customers often enter into contracts that contain minimum billing commitments and reflect discounted pricing associated with such usage levels.

We define United States revenue as revenue from customers that have a billing address in the United States, and we define international revenue as revenue from customers that have a billing address outside of the United States.

Cost of Revenue and Gross Margin

Cost of revenue consists primarily of fees paid to network providers for bandwidth and to third-party network data centers for housing servers, also known as colocation costs. Cost of revenue also includes employee costs for network operation, build-out and support and services delivery, network storage costs, cost of managed services and software-as-a-service, depreciation of network equipment used to deliver services, and amortization of network-related internal-use software. Our arrangements with network service providers require us to pay fees based on bandwidth use, in some cases subject to minimum commitments, which may be underutilized. Over the long term we expect cost of revenue to decrease as a percentage of revenue as we continue to drive efficiencies in our operations. However, our cost of revenue may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

Our gross margin has been and will continue to be affected by a number of factors, including utilization of our network, the timing of our investments in the expansion of our network, which can increase depreciation and colocation costs in advance of expected demand, our ability to manage our network service providers and cloud infrastructure-related fees, the timing of amortization of capitalized software development costs, changes in personnel costs to provide customer support and operate the network, and customer pricing. Over the long term we expect gross margin to increase as we continue to drive efficiencies in our operations. However, our gross margin may fluctuate from period to period.

Research and Development

Research and development expenses consist primarily of personnel costs, including salaries, benefits, bonuses, and stock-based compensation. Research and development expenses also include cloud infrastructure fees for development and testing, and an allocation of our general overhead expenses. We capitalize the portion of our software development costs that meet the criteria for capitalization.

We continue to focus our research and development efforts on adding new features and products including new use cases, improving the efficiency and performance of our network, and increasing the functionality of our existing products. Over the long term we expect our research and development expenses to decrease as a percentage of our revenue. However, our research and development expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

Sales and Marketing

Sales and marketing expenses consist primarily of personnel costs, including commissions for our sales employees, salaries, benefits, bonuses, and stock-based compensation. Sales and marketing expenses also include expenditures related to advertising, marketing, our brand awareness activities, bandwidth and co-location costs for free trial users, costs related to our customer conferences, including our Altitude conference, professional services fees and amortization of our intangible assets, and an allocation of our general overhead expenses.

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We focus our sales and marketing efforts on generating awareness of our platform and products, creating sales leads, and establishing and promoting our brand, both domestically and internationally. Over the long term, we expect our sales and marketing expenses to decrease as a percentage of our revenue. However, our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

General and Administrative

General and administrative expenses consist primarily of personnel costs, including salaries, benefits, bonuses, and stock-based compensation for our administrative support personnel. General and administrative expenses also include costs related to legal and other professional services fees, SaaS costs, an allocation of our general overhead expenses, credit losses and acquisition-related costs.

Our general and administrative expenses also include sales and other tax expenses to which we are subject to based on the manner we sell and deliver our products. Historically, we have not collected such taxes from our customers and have therefore recorded such taxes as general and administrative expenses. We expect that these expenses will decline in future years as we continue to implement our sales tax collection mechanisms and start collecting these taxes from our customers.

In the near term, we expect to continue to incur costs associated with supporting the growth of our business, including international expansion, but expect these costs to decrease as a percentage of our revenue over the long term as we continue to drive efficiencies in our operations. However, our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

Income Taxes

Our income tax expense consists primarily of income taxes in certain foreign jurisdictions where we conduct business and state minimum income taxes in the United States. We have a valuation allowance for deferred tax assets, including net operating loss carryforwards. We expect to maintain this valuation allowance for the foreseeable future.

Net Gain on Extinguishment of Debt

Our net gain on extinguishment of debt relates to the partial repurchase of our outstanding senior convertible notes at a discount in May 2022.

Other Income and Expenses

Our interest income consists primarily of interest earned on our cash, cash equivalents and investments. Our interest expense consists primarily of the interest expense on our finance leases and amortization of discount and debt issuance costs associated with our debt obligations. Our other income (expense), net, consists primarily of foreign currency transaction gains and losses.

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Results of Operations

In this section, we discuss the results of our operations for the year ended December 31, 2022 compared to the year ended December 31, 2021. For a discussion of the year ended December 31, 2021 compared to the year ended December 31, 2020, please refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2021.

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[[/GREPCENT_TABLE]]

__________

*    Columns may not add up to 100% due to rounding.

73

Revenue

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Revenue","","$","432,725","","","$","354,330","","","$","78,395","","","22","%"]]
[[/GREPCENT_TABLE]]

Revenue was $432.7 million for the year ended December 31, 2022 compared to $354.3 million for the year ended December 31, 2021, an increase of $78.4 million, or 22%. Revenue growth was driven by the further adoption of our edge platform and products as well as a $17.4 million increase in revenue related to security products acquired from the acquisition of Signal Sciences.

We had 2,958 customers and 493 enterprise customers as of December 31, 2022. We had 2,804 customers and 445 enterprise customers as of December 31, 2021. This represents an increase of 154, or 5%, in customers and 48, or 11%, in enterprise customers from December 31, 2021.

Approximately 94% of our revenue in the year ended December 31, 2022 was driven by usage on our platform, primarily from existing customers, as revenue from new customers contributed less than 10% of our revenue. The proportion of the revenue contribution between new and existing customers is consistent with prior periods and typical customer behavior as customers tend to contribute more revenue over time as their use of the platform increases. The remainder of our revenue was generated by other products and services.

U.S. revenue was $316.1 million and 73% of revenue for the year ended December 31, 2022, and $260.4 million and 73% of revenue for the year ended December 31, 2021. This represents an increase of $55.8 million, or 21%. International revenue was $116.6 million and 27% of revenue for the year ended December 31, 2022, and $93.9 million and 27% of revenue for the year ended December 31, 2021. This represents an increase of $22.6 million, or 24%.

We had 2,074 domestic customers and 884 international customers as of December 31, 2022, and 2,111 domestic customers and 691 international customer as of December 31, 2021. There was a decrease in domestic customers of 37, or 2%, and an increase in international customers of 193, or 28%, compared to December 31, 2021.

Cost of Revenue

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Cost of revenue","","$","222,944","","","$","167,002","","","$","55,942","","","33","%"]]
[[/GREPCENT_TABLE]]

Cost of revenue was $222.9 million for the year ended December 31, 2022 compared to $167.0 million for the year ended December 31, 2021, an increase of $55.9 million, or 33%. The increase in cost of revenue is a result of an increase in bandwidth costs of $17.4 million, colocation costs of $8.5 million, hosting services of $4.9 million and other network costs of $2.0 million. Depreciation and amortization expense increased by $10.8 million as a result of increased investments in our platform. There was also a $8.9 million increase in personnel related costs due to an increase in headcount and equity awards granted to employees supporting the growth of our business. There was also a one-time charge of $2.0 million related to cancellation of a commitment. Lastly, there was a $0.6 million increase in employee travel expenses due to the increase in work-related travel with the easing of travel-related restrictions associated with the COVID-19 pandemic.

74

Gross Profit and Gross Margin

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Gross profit","","$","209,781","","","$","187,328","","","$","22,453","","","12","%"],["Gross margin","","48","%","","53","%","","","","(4)","%"]]
[[/GREPCENT_TABLE]]

Gross profit was $209.8 million for the year ended December 31, 2022 compared to $187.3 million for the year ended December 31, 2021, an increase of $22.5 million, or 12%. Gross margin was 48% for the year ended December 31, 2022 compared to 53% for the year ended December 31, 2021, a decrease of 4%. The decrease in gross margin was driven by increases in bandwidth, colocation, hosting services and other network costs, an increase in depreciation expense associated with our network equipment and an increase in travel and personnel-related costs, as part of our continued investment in infrastructure and capacity to build out our platform to support future customer traffic.

Operating Expenses

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Research and development","","$","155,308","","","$","126,859","","","$","28,449","","","22","%"],["Sales and marketing","","179,869","","","152,645","","","$","27,224","","","18","%"],["General and administrative","","120,803","","","126,845","","","$","(6,042)","","","(5)","%"],["Total operating expenses","","$","455,980","","","$","406,349","","","$","49,631","","","12","%"],["Percentage of revenue:"],["Research and development","","36","%","","36","%","","","","\u2014","%"],["Sales and marketing","","42","%","","43","%","","","","(1)","%"],["General and administrative","","28","%","","36","%","","","","(8)","%"]]
[[/GREPCENT_TABLE]]

Research and development

Research and development expenses were $155.3 million for the year ended December 31, 2022 compared to $126.9 million for the year ended December 31, 2021, an increase of $28.4 million, or 22%. This is primarily due to an increase of $21.1 million of personnel-related costs, such as salaries, benefits, bonuses, and stock-based compensation due to an increase in headcount and equity awards granted to employees supporting our research and development efforts. There was also an increase of $2.4 million in hosting services and $1.7 million in SaaS costs as we continue to develop new products and features for our next-generation edge computing solutions. There was also a $1.4 million increase in employee travel expenses due to the increase in work-related travel with the easing of travel-related restrictions associated with the COVID-19 pandemic. There was also an increase in professional fees of $0.9 million primarily related to temporary agency costs to support our internal development efforts.

Sales and marketing

Sales and marketing expenses were $179.9 million for the year ended December 31, 2022 compared to $152.6 million for the year ended December 31, 2021, an increase of $27.2 million, or 18%. This is primarily due to a $15.6 million increase in personnel related costs, such as salaries, sales commissions, benefits, and stock-based compensation, due to an increase in headcount and equity awards granted to employees supporting our sales and marketing efforts. There was also an increase of $5.9 million related to employee travel expenses due to increase in work-related travel with the easing of travel-related restrictions associated with the COVID-19 pandemic. There was also a $2.7 million increase in marketing spend associated with brand campaign and advertising and an increase of $2.3 million in spending related to the software and hosting services costs used in our sales generation efforts.

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General and administrative

General and administrative costs were $120.8 million for the year ended December 31, 2022 compared to $126.8 million for the year ended December 31, 2021, a decrease of $6.0 million, or 5%. The net decrease is primarily due to a $18.9 million decrease in stock-based compensation expenses attributed to the function, offset by increases of $4.4 million in personnel related costs, such as salaries and benefits. The decrease was partially offset by an increase of $2.9 million in professional services such as legal and accounting services, an increase of $2.2 million in increase in the allowance for credit losses due the increase in revenue in the period, an increase of $2.1 million due to impairment of leased assets and a $1.3 million increase in SaaS costs to support the growth of our operations.

Net Gain on Extinguishment of Debt

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Net gain on extinguishment of debt","","$","54,391","","","$","\u2014","","","$","54,391","","","100","%"]]
[[/GREPCENT_TABLE]]

We recognized a net gain on debt extinguishment of $54.4 million for the year ended December 31, 2022 relating to our repurchase at a discount in May 2022 of approximately $235 million aggregate principal amount of our outstanding 0% convertible senior unsecured notes due in 2026.

Other Income and Expense

Interest Income

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Interest income","","$","7,044","","","$","1,282","","","$","5,762","","","449","%"]]
[[/GREPCENT_TABLE]]

Interest income was $7.0 million for the year ended December 31, 2022 compared to $1.3 million for the year ended December 31, 2021, an increase of $5.8 million, or 449%. This increase is due to an increase in interest rates on our cash balances and investments portfolio.

Interest Expense

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Interest expense","","$","(5,887)","","","$","(5,245)","","","$","(642)","","","12","%"]]
[[/GREPCENT_TABLE]]

Interest expense was $5.9 million for the year ended December 31, 2022 compared to $5.2 million for the year ended December 31, 2021, an increase of $0.6 million, or 12%. This increase is primarily due to the amortization of debt issuance costs related to the convertible debt and revolving credit facility.

Other income(expense), net

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Other income (expense), net","","$","(29)","","","$","356","","","$","(385)","","","(108)","%"]]
[[/GREPCENT_TABLE]]

Other expense, net was $0.0 million for the year ended December 31, 2022 compared to other income, net, of $0.4 million for the year ended December 31, 2021, a decrease of $0.4 million, or (108)%. The increase is mainly driven by our foreign currency transaction gains and losses between the periods.

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Income Tax Expense

[[GREPCENT_TABLE]]
[["","","Year ended December 31,","","Change"],["","","2022","","2021","","$ Change","","% Change"],["","","(in thousands)"],["Income tax expense","","$","94","","","$","69","","","$","25","","","36","%"]]
[[/GREPCENT_TABLE]]

Income tax expense was $0.1 million both for the year ended December 31, 2022 and for the year ended December 31, 2021. . The Company continues to maintain a full valuation allowance and the tax expense for the periods were primarily due to foreign tax expense.

Liquidity and Capital Resources

As of December 31, 2022, we had cash, cash equivalents, and marketable securities and restricted cash totaling $683.1 million. Our cash, cash equivalents, and marketable securities primarily consisted of bank deposits, money market funds, investment-grade commercial paper, corporate notes and bonds, U.S. treasury securities, municipal securities, foreign government and supranational securities and asset-backed securities held at major financial institutions. As of December 31, 2022, our marketable securities balance includes $165.1 million of marketable securities that were classified as non-current.

To date, we have financed our operations primarily through equity issuances, payments received from customers, the net proceeds we received through sales of our debt securities, and proceeds from our convertible notes. Our principal uses of cash in the near term have primarily been around funding our operations, our capital expenditures, business acquisitions, investments and fulfilling our debt and contractual commitments. We have also entered into longer term commitments to support our operations, including arrangements to directly lease and operate our infrastructure assets and colocation facilities. We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.

We believe that our cash and cash equivalents balances, and available borrowing capacity under our credit facility, and the cash flows generated by our operations, net of the cash outflows used in our operations, will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. We have generated losses from operations in the past and expect to continue to incur operating losses for the foreseeable future due to the investments and strategic initiatives we intend to make to grow our business. Our uses of cash beyond the next 12 months will depend on many factors, including the general economic environment in which we operate and our ability to generate cash flow from operations, which are uncertain. We may also use our cash to buy back any outstanding debt on our convertible notes or on any future equity issuances.

Senior Secured Credit Facilities Agreement

On February 16, 2021, we entered into a Senior Secured Credit Facilities Agreement ("Credit Agreement") with Silicon Valley Bank for an aggregate commitment amount of $100.0 million, with a maturity date of February 16, 2024. The Credit Agreement bears interest at a rate per annum equal to the sum of LIBOR for the applicable interest period plus 1.75% to 2.00%, depending on the average daily outstanding balance of all loans and letters of credit under the Credit Agreement. Interest payments on outstanding borrowings are due on the last day of each interest period. The Credit Agreement has a commitment fee on the unused portion of the borrowing commitment, which is payable on the last day of each calendar quarter at a rate per annum of 0.20% to 0.25% depending on the average daily outstanding balance of all loans and letters of credit under the Credit Agreement. The agreement allows for an alternative interest rate to be used. The Credit Agreement contains a financial covenant that requires us to maintain a consolidated adjusted quick ratio of at least 1:25 to 1:00 tested on a quarterly basis as well as a springing revenue growth covenant for certain periods if our consolidated adjusted quick ratio falls below 1.75 to 1:00 on the last day of any fiscal quarter. As of December 31, 2022, we were in compliance with the covenant and we expect to continue to be in compliance for at least the next 12 months. During the year ended December 31, 2022and 2021, no amounts were drawn down on the Credit Agreement.

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Convertible Senior Notes

In March 2021, we issued approximately $948.8 million aggregate principal amount of 0% convertible senior unsecured notes due in 2026 (the "Notes") in a private placement to qualified institutional buyers pursuant to Rule144A under the Securities Act. On May 25, 2022, we entered into separate, privately negotiated transactions with certain holders of the Notes to repurchase (the "Repurchases") approximately $235.0 million aggregate outstanding principal amount of the Notes for an aggregate cash repurchase price of approximately $176.4 million. The Repurchases closed on May 31, 2022. The remaining Notes will mature on March 15, 2026, unless earlier converted, redeemed or repurchased.

Cash Flows

The following table summarizes our cash flows for the period indicated:

[[GREPCENT_TABLE]]
[["","","Year ended December 31,"],["","","2022","","2021","","2020"],["","","(in thousands)"],["Cash used in operating activities","","$","(69,632)","","","$","(38,482)","","","$","(19,916)"],["Cash provided by (used in) investing activities","","235,751","","","(794,511)","","","(275,023)"],["Cash provided by (used in) financing activities","","(189,149)","","","936,551","","","272,739"]]
[[/GREPCENT_TABLE]]

Cash Flows from Operating Activities

For the year ended December 31, 2022, cash used in operating activities consisted primarily of our net loss of $190.8 million, adjusted for non-cash items of $207.3 million, and net cash flows used in operating assets and liabilities of $86.2 million. The main drivers of the changes in operating assets and liabilities were an increase in other assets of $35.4 million related to deferred contract costs, an increase in accounts receivable of $27.4 million, primarily due to an increase in revenue and the timing of cash receipts from certain of our larger customers and an increase of $6.8 million in prepaid expenses and other assets due to pre-payments for hosting services and software licenses. We also had $27.0 million of operating lease payments. There were also increases of $8.3 million in accrued expenses and $2.1 million in accounts payable and other liabilities due to timing of payments.

For the year ended December 31, 2021, cash used in operating activities consisted primarily of our net loss of $222.7 million adjusted for non-cash items of $227.3 million. With respect to changes in operating assets and liabilities, there was an increase in accounts receivable of $14.6 million, primarily due to an increase in revenue and the timing of cash receipts from certain of our larger customers and an increase of $15.2 million in prepaid expenses and other assets due to pre-payments for software licenses. We also had $26.4 million of operating lease payments. This was partially offset by increases of $4.3 million in accrued expenses and $8.9 million in other liabilities due to timing of payments.

For the year ended December 31, 2020, cash used in operating activities consisted primarily of our net loss of $95.9 million adjusted for non-cash items of $104.3 million. With respect to changes in operating assets and liabilities, there was a decrease in accounts receivable of $9.3 million, primarily due to increased collections due to the growth of our business and the timing of cash receipts from certain of our larger customers, and $22.7 million in prepaid expenses and other assets due to pre-payments for software licenses. We also had $18.3 million of operating lease payments. This was partially offset by an increase of $22.0 million in accounts payable, accrued expenses, and other liabilities due to timing of payments.

Cash Flows from Investing Activities

For the year ended December 31, 2022, cash provided by investing activities was $235.8 million, primarily consisting of $697.0 million of maturities and sales of marketable securities. This was offset by $355.5 million in purchases of marketable securities, $42.2 million of advanced payments and $20.0 million of payments related to purchases of property and equipment to expand our network, $26.0 million related to business acquisitions and $18.1 million of additions to capitalized internal-use software.

For the year ended December 31, 2021, cash used in investing activities was $794.5 million, primarily consisting of $928.2 million in purchases of marketable securities, $34.8 million of payments related to purchases of property and equipment

78

to expand our network, and $13.5 million of additions to capitalized internal-use software. This was partially offset by $184.6 million of maturities and sales of marketable securities.

For the year ended December 31, 2020, cash used in investing activities was $275.0 million, primarily consisting of $269.1 million in purchases of marketable securities, $201.0 million of business acquisitions, net of cash acquired, $29.6 million of payments related to purchases of property and equipment to expand our network, $6.1 million of additions to capitalized internal-use software, and $1.8 million of purchases of intangible assets. This was offset by $232.0 million of maturities and sales of marketable securities.

Cash Flows from Financing Activities

For the year ended December 31, 2022, cash used in financing activities was $189.1 million, primarily consisting of $177.1 million used for the partial repurchase of our convertible debt and $22.5 million of finance lease liabilities repayments. This was partially offset by $4.8 million in proceeds from the employee stock purchase plan ("ESPP") and $5.7 million in proceeds from stock option exercises by our employees and directors.

For the year ended December 31, 2021, cash provided by financing activities was $936.6 million, primarily consisting of $930.8 million of proceeds from the issuance of the Notes, net of issuance costs, $8.1 million in proceeds from the employee stock purchase plan ("ESPP") and $12.6 million in proceeds from stock option exercises by our employees and directors. This was partially offset by $13.6 million of finance lease liabilities repayments.

For the year ended December 31, 2020, cash provided by financing activities was $272.7 million, primarily consisting of $274.9 million in proceeds from our follow-on public offering, net of underwriting fees, $9.3 million in proceeds from the ESPP, and $15.3 million in proceeds from stock option exercises by our employees and directors. This was partially offset by $20.3 million of debt repayments, $5.8 million of finance lease liabilities repayments, and $0.7 million of payments of costs related to our follow-on public offering.

Contractual Obligations and Other Commitments

The following table summarizes our non-cancelable contractual obligations as of December 31, 2022:

[[GREPCENT_TABLE]]
[["","","Less than 1 Year","","1-3 Years","","3-5 Years","","More than 5 Years","","Total"],["","","(in thousands)"],["Purchase obligations - non-equipment(1)","","$","59,896","","","$","15,525","","","$","243","","","$","14","","","$","75,678"],["Purchase obligations - equipment (2)","","4,370","","","11,120","","","\u2014","","","\u2014","","","15,490"],["Operating lease obligations(3)","","27,410","","","39,145","","","26,961","","","2,928","","","96,444"],["Finance lease obligations(4)","","30,285","","","15,898","","","\u2014","","","\u2014","","","46,183"],["Debt obligation(5)","","\u2014","","","\u2014","","","713,753","","","\u2014","","","713,753"],["Total","","$","121,961","","","$","81,688","","","$","740,957","","","$","2,942","","","$","947,548"]]
[[/GREPCENT_TABLE]]

__________

(1)    Purchase obligations-non equipment represent total future minimum payments under contracts with our cloud infrastructure providers, network service providers, and other vendors. Purchase obligations exclude agreements that are cancellable without penalty. Our purchase obligations exclude our operating lease commitments associated with our colocation arrangements which have been separately disclosed under our operating lease obligations.

(2)     Purchase obligations-equipment represent total future minimum payments under contracts for capital expenditures.

(3)     Operating lease obligations represent total future minimum rent payments under non-cancelable operating lease agreements, such as our facilities and colocation (i.e. data center) leases.

(4)    Finance lease obligations represents principal and interest payments under our networking equipment leases.

(5)    Debt obligation aggregate principal amount of our 0% convertible senior notes due on March 15, 2026.

These commitments will generally be settled with existing cash on hand, cash generated from operations and our current or any future financing arrangements.

79

Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with U.S. GAAP. The preparation of our consolidated financial statements requires us to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenue, costs, expenses, and related disclosures. Actual results and outcomes could differ significantly from our estimates, judgments, and assumptions. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected.

Revenue recognition

We recognize revenue in accordance with ASC 606, where revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. The processing and recording of certain revenue requires a manual process, which uses a complex set of procedures to generate complete and accurate data to record these revenue transactions. We enter into contracts that can include various combinations of products and services, each of which are distinct and accounted for as separate performance obligations.

Our performance obligations generally represent stand-ready obligations that are satisfied over time as the customer simultaneously receives and consumes the benefits provided by us. These obligations can be network services, security, compute, professional services, support, and other edge cloud platform services. For contracts with multiple performance obligations that are delivered over different time periods, we allocate the contract transaction price to each performance obligation using the estimated standalone selling price ("SSP") of each distinct good or service in the contract. Judgment is required to determine the SSP for each distinct performance obligation. We analyze separate sales of our products and services or the discounted list price per our approved price list as a basis for estimating the SSP of these products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information, such as geographic region and distribution channel, in determining the SSP.

Stock-based Compensation Fair Value determination

We recognize compensation expense related to stock options based on the fair value of stock-based awards on the date of grant. We determine the grant date fair value of the awards using the Black-Scholes option-pricing model. The related stock-based compensation expense is recognized on a straight-line basis over the period in which an employee is required to provide service in exchange for the stock-based award, which is generally four years. Our stock price volatility and expected option life involve management's best estimates, both of which impact the fair value of the option calculated under the Black-Scholes option pricing model and, ultimately, the expense that will be recognized over the life of the option.

We recognize stock-based compensation expense related to market-based performance stock awards based on the grant-date fair value of the awards. We determine the grant date fair value of the awards using the Monte Carlo simulation valuation model. The related stock-based compensation expense is recognized on an accelerated attribution method over the derived service period. The expected volatility was a blended volatility rate which incorporated both our observed equity volatility and the relevant guideline company volatility. The derived service period and the expected volatility involve management's best estimates, both of which impact the fair value of the option calculated under the Monte Carlo simulation valuation model and, ultimately, the expense that will be recognized over the life of the option.

Valuation of Goodwill and Other Acquired Intangible Assets in Business Combinations

We account for our acquisitions using the acquisition method of accounting, which requires, among other things, allocation of the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date. The excess of the fair value of purchase consideration over the values of these identifiable assets and liabilities is recorded as goodwill.

Determining the fair value of assets acquired and liabilities assumed requires significant judgment and estimates including the selection of valuation methodologies, future expected cash flows, discount rates, and useful lives. Our estimates of fair value are based on assumptions believed to be reasonable, but which are inherently uncertain and, as a result, actual results may

80

differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed with a corresponding offset to goodwill to reflect new information obtained about facts and circumstances that existed as of the acquisition date. At the conclusion of the measurement period, or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are reflected in the consolidated statements of operations.

Goodwill Impairment

Goodwill represents the excess of the purchase price of an acquired business over the fair value of the net tangible and identifiable intangible assets acquired. The carrying amount of goodwill is reviewed for impairment at least annually, in the fourth quarter, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We have a single operating segment and reporting unit structure for all of the periods presented.

To test for goodwill impairment, we compare the carrying value of our reporting unit with its fair value. If the carrying value of the goodwill is considered impaired, a loss is measured as the excess of the reporting unit’s carrying value over the fair value. As of October 31, 2022, our annual goodwill impairment assessment date, the estimated fair value of our one single reporting unit has substantially exceeded its carrying value.

Recent Accounting Pronouncements

Please refer to Note 2—Summary of Significant Accounting Policies included in the Notes to Consolidated Financial Statements.

81