# Toast, Inc. (TOST) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Toast, Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1650164/000165016422000009/tost-20211231.htm
Accession: 0001650164-22-000009
Filing date: 2022-03-01
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/TOST/
All MD&A years: /company/TOST/mda/
Next year: /company/TOST/mda/fy2022/ (FY 2022)

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 our consolidated financial statements and the related notes appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks, uncertainties and assumptions. You should read the “Special Note Regarding Forward-Looking Statements” and “Risk Factors” sections of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

The Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, describes principal factors affecting the results of our operations, financial condition and liquidity, as well as our critical accounting policies and estimates that require significant judgment and thus have the most significant potential impact on our Consolidated Financial Statements included elsewhere in this Form 10-K. Our MD&A is organized as follows:

•Overview. This section provides a general description of our business, recent developments, and key business metrics.

•Results of Operations. This section provides an overview and analysis of our financial results for the year ended December 31, 2021 compared to the year ended December 31, 2020 and for the year ended December 31, 2020 compared to the year ended December 31, 2019.

•Liquidity and Capital Resources. This section provides an analysis of our liquidity and changes in cash flows, as well as a discussion of available borrowings and contractual commitments.

•Critical Accounting Policies and Estimates. This section discusses accounting policies and estimates that require us to exercise subjective or complex judgments in their application. We believe these accounting policies and estimates are important to understanding the assumptions and judgments incorporated in our reported financial results.

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OVERVIEW

Toast is a cloud-based, all-in-one digital technology platform purpose-built for the entire restaurant community. Our platform provides a comprehensive suite of SaaS products, financial technology solutions including integrated payment processing, restaurant-grade hardware, and a broad ecosystem of third-party partners. We serve as the restaurant operating system, connecting front of house and back of house operations across dine-in, takeout, and delivery channels. As of December 31, 2021, our customers processed over $57 billion of gross payment volume in the trailing 12 months, partnered with Toast to optimize operations, increase sales, engage guests, and maintain happy employees.

By enabling these capabilities through a single, integrated platform, Toast improves experiences across the restaurant ecosystem:

•Restaurant operators. We arm restaurants with a wide range of products and capabilities to address their specific needs regardless of size, location, or business model. As a result, restaurants using Toast often see higher sales and greater operational efficiency.

•Guests. We are laser focused on helping our customers deliver memorable guest experiences at scale. Guests can place orders easily, safely, and accurately across web, mobile, and in-person channels for dine-in, takeout, or delivery. In addition, our platform empowers restaurants to utilize their guest data to deliver targeted and personalized experiences with loyalty programs and marketing solutions.

•Employees. Our easy-to-learn and easy-to-use technology improves the experience of restaurant employees across Toast customers. Employees are core to delivering great hospitality, and it is critical for restaurants to engage and retain employees in an increasingly competitive labor market. Our products enable new employees to learn quickly through guided workflows, facilitate faster table turns and safer, streamlined operations, and provide greater transparency around, and timely access to, employees’ wages.

The benefits to all stakeholders using the Toast platform create a powerful, virtuous cycle that amplifies our impact on restaurants. Guest satisfaction generates loyalty to restaurants, driving repeat sales, word-of-mouth referrals, and larger checks and tips. This promotes employee satisfaction, helping reduce turnover and motivating employees to continue to raise the bar on the guest experience. In addition, our integrated software and payments platform consolidates data on restaurant sales and operations, which enables our reporting and analytics as well as financial technology solutions, such as working capital loans, to further support our customers’ success.

Since our founding, we have translated our love for restaurants into a commitment to innovation and digital transformation for the restaurant industry. As we have expanded our platform, launched new products, and added new partners over time, we have rapidly grown the number of restaurant locations on the Toast platform.

On September 24, 2021, we completed our initial public offering, or IPO, in which we issued and sold 25,000,000 shares of our Class A common stock at the public offering price of $40.00 per share, which included the full exercise of the underwriters’ option to purchase additional 3,260,869 shares. We received net proceeds of $944 million after deducting $47 million of underwriting discounts and commissions and $7 million of other offering costs. Immediately prior to the completion of the IPO, all of the outstanding shares of our convertible preferred stock and our common stock were automatically converted into an aggregate of 477,593,550 shares of Class B common stock on a one-for-one basis.

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Impact of COVID-19

Since early 2020, changes in consumers' behavior and government-imposed restrictions because of the COVID-19 pandemic have impacted restaurants in various ways, including limiting service to takeout orders for a period of time or reducing capacity to accommodate social distancing recommendations. Though the exact long-term circumstances are difficult to predict, we believe that the COVID-19 pandemic will result in a lasting shift in consumer demand towards omnichannel consumption and increased guest demand for digital solutions such as Order & Pay. Depending on the extent to which the prevalence of takeout and delivery orders persists, our financial results may be impacted in a number of ways.

In light of the evolving nature of the COVID-19 pandemic and the uncertainty it has produced around the world, it is not possible to predict the cumulative and ultimate impact of the pandemic on our future business operations, results of operations, financial position, liquidity, and cash flows despite progress in vaccination efforts. The extent of the impact of the pandemic on our business and financial results will depend largely on future developments that cannot be accurately predicted at this time, including the duration of the spread of the pandemic both globally and within the United States, the introduction and severity of new variants of the virus and their resistance to currently approved vaccines, the impact on capital, foreign currency exchange, and financial markets, the impact of governmental or regulatory orders that impact our business, and the effect on global supply chains, all of which are highly uncertain and cannot be predicted.

Key Business Metrics

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","As of December 31,","","2021 to 2020","","2020 to 2019"],["(dollars in millions)","2021","","2020","","2019","","% Growth","","% Growth"],["Annualized Recurring Run-Rate (ARR)","$","568","","","$","326","","","$","184","","","74","%","","77","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","As of December 31,","","2021 to 2020","","2020 to 2019"],["","2021","","2020","","2019","","% Change","","% Change"],["Net Retention Rate (NRR)","135","%","","114","%","","110","%","","21","%","","4","%"]]
[[/GREPCENT_TABLE]]

Gross Payment Volume (GPV)1

Gross Payment Volume represents the sum of total dollars processed through the Toast payments platform across all restaurant locations in a given period. GPV is a key measure of the scale of our platform, which in turn drives our financial performance. As our customers generate more sales and therefore more GPV, we generally see higher financial technology solutions revenue.

1 Please note that numbers may not tie due to rounding to the nearest hundred million.

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Annualized Recurring Run-Rate (ARR)

We monitor Annualized Recurring Run-Rate as a key operational measure of the scale of our subscription and payment processing services for both new and existing customers. To calculate this metric, we first calculate recurring run-rate on a monthly basis. Monthly Recurring Run-Rate, or MRR, is measured on the final day of each month for all restaurant locations live on our platform as the sum of (i) our monthly subscription services fees, which we refer to as the subscription component of MRR, and (ii) our in-month adjusted payments services fees, exclusive of estimated transaction-based costs, which we refer to as the payments component of MRR. MRR does not include fees derived from Toast Capital or related costs. MRR is also not burdened by the impact of SaaS credits offered.

ARR is determined by taking the sum of (i) twelve times the subscription component of MRR and (ii) four times the trailing-three-month cumulative payments component of MRR. We believe this approach provides an indication of our scale, while also controlling for short-term fluctuations in payments volume. Our ARR may decline or fluctuate as a result of a number of factors, including customers’ satisfaction with our platform, pricing, competitive offerings, economic conditions, or overall changes in our customers’ and their guests’ spending levels. ARR is an operational measure, does not reflect our revenue or gross profit determined in accordance with GAAP, and should be viewed independently of, and not combined with or substituted for, our revenue, gross profit, and other financial information determined in accordance with GAAP. Further, ARR is not a forecast of future revenue and investors should not place undue reliance on ARR as an indicator of our future or expected results.

Net Retention Rate (NRR)

To calculate our Net Retention Rate, or NRR, we first identify a cohort of customers, or the Base Customers, in a particular month, or the Base Month. For this purpose, we do not consider a customer as a Base Customer unless there is at least one location live on the Toast platform for the entirety of the Base Month. We then divide MRR for the Base Customers in the same month of the subsequent year, or the Comparison Month, by MRR in the Base Month to derive a monthly NRR. MRR in the Comparison Month includes the impact of any churn or contraction of the Base Customers, and by definition does not include any customers added to the Toast platform between the Base Month and Comparison Month. We measure the annual NRR by taking a weighted average of the monthly NRR over the trailing twelve months.

Components of Results of Operations

Revenue

We generate revenue from four main sources that are further described below: (1) subscription services, (2) financial technology solutions, (3) hardware, and (4) professional services.

Our total revenue consists of the following:

Subscription services. We generate subscription services revenue from fees charged to customers for access to our software applications, generally over a term ranging from 12 to 36 months. Our subscription services revenue is primarily based on a rate per location, and this rate varies depending on the number of software products purchased, hardware configuration, and employee count at each location.

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Financial technology solutions. Revenue from financial technology solutions consists primarily of transaction-based fees paid by customers to facilitate their payment transactions, which are generally calculated as a percentage of the total transaction amount processed plus a per-transaction fee. The transaction fees collected are recognized as revenue on a gross basis. Financial technology solutions revenue also includes fees earned from marketing and servicing working capital loans to our customers through Toast Capital that are originated by a third-party bank. In these arrangements, Toast Capital’s bank partner originates all loans, and Toast Capital then services the loans using Toast’s payments infrastructure to remit a fixed percentage of daily sales until the loan is paid back. Toast Capital is responsible for purchasing from our bank partner loans in default (or that have been or are scheduled to be charged off) until the aggregate principal amount of such purchased loans equals 15% (or 30% in the case of a limited program offered during the winter of 2020-2021 related to the COVID-19 pandemic) of the total originated amount for each quarterly loan cohort. Toast Capital earns a servicing fee as well as a credit performance fee that is tied to the portfolio performance.

Hardware. We generate hardware revenue from the sale of terminals, tablets, handhelds, and related devices and accessories, net of estimated returns.

Professional services. We generate professional services revenue from fees charged to customers for installation services, including business process mapping, configuration, and training. These services can be delivered on-site, remotely, or on a self-guided basis.

Costs of Revenue

Costs of revenue consists of expenses that are directly related or closely correlated to revenue generation, including, but not limited to, employee-related costs for customer support and certain operational roles as well as allocated overhead. Employee-related costs consist of salaries, benefits, bonuses, and stock-based compensation expense. Allocated overhead includes certain facilities costs, depreciation expense, and amortization costs associated with internally developed software. Below are descriptions of the types of costs classified within each component of costs of revenue:

Subscription services. Subscription services costs consist of customer support and associated employee-related costs, hosting costs, professional services costs, other software costs to support our cloud-based platform, and amortization costs associated with internally developed software.

Financial technology solutions. Financial technology solutions costs consist primarily of transaction-based costs, which are mostly fees and costs paid to issuers and card networks as well as other related fees associated with third-party payment processors and fraud management.

Hardware. Hardware costs consist of raw materials and the cost of manufacturing and shipping hardware sold to customers, including terminals, tablets, handhelds, card readers, printers, and other accessories. Included in the manufacturing and shipping costs are employee-related costs, professional services costs, and allocated overhead associated with our supply chain and fulfillment teams.

Professional services. Professional services costs consist primarily of employee-related costs and allocated overhead associated with our onboarding team, along with fees paid to third-party service providers engaged to perform installations and other services.

Amortization of acquired technology. Amortization of acquired technology costs is related to technologies acquired through acquisitions that have the capability of producing revenue.

Operating Expenses

During the year ended December 31, 2020, we incurred certain costs, including severance, lease exit costs, and impairment of property and equipment, in connection with a reduction in workforce resulting from changes to our operations as a result of the COVID-19 pandemic.

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Our operating expenses consist of the following:

Sales and marketing. Sales and marketing expenses consist primarily of employee-related costs incurred to acquire new customers and increase product adoption across our existing customer base. Marketing expenses also include fees incurred to generate demand through various advertising channels.

We expect that sales and marketing expenses will increase on an absolute dollar basis as we invest to grow our field-based sales team, increase demand generation, and enhance our brand awareness. We expect sales and marketing expenses as a percentage of revenue will vary from period-to-period over the short-term and decrease over the long-term.

Research and development. Research and development expenses consist primarily of employee- related costs associated with improvements to our platform and the development of new product offerings, as well as allocated overhead and expenses associated with the use of third-party software directly related to development of our products and services.

We plan to continue to hire employees to support our research and development efforts to expand the capabilities and scope of our platform and related products and services. As a result, we expect that research and development expenses will increase on an absolute dollar basis as we continue to invest to support these activities and innovate over the long-term.

General and administrative. General and administrative expenses consist primarily of expenses related to operations, finance, legal, human resources, information technology, and administrative personnel. General and administrative expenses also include costs related to fees paid for certain professional services, including legal, information technology, tax and accounting services, and credit loss expenses.

We expect that general and administrative expenses will increase on an absolute dollar basis as we add personnel and enhance our systems, processes, and controls to support the growth of our business as well as our increased compliance and reporting requirements as a public company. We expect general and administrative expenses as a percentage of revenue will vary from period-to-period over the short-term and decrease over the long-term.

Other Income (Expense)

Our other income and expenses consist of the following:

Interest income. Interest income consists of interest earned from cash held in money market accounts and interest earned on our marketable securities.

Interest expense. Interest expense represents interest incurred on our convertible notes, which were issued in June 2020 and repaid in June 2021.

Change in fair value of warrant liability. Represents the change in the fair value of our warrant liability related to warrants issued to purchase shares of our convertible preferred stock and our common stock. The warrant liability is remeasured at fair value at each reporting date which could have a significant effect on other income (expense) and our results of operations during each period. The fair value is based on the trading price of our Class A common stock, as well as other relevant valuation inputs, including volatility of our Class A common stock, strike price, relevant risk-free interest rates, and time to expiration of the warrants.

Change in fair value of derivative liability. Represents the change in fair value of derivative liability related to the conversion option provided for in the convertible notes which were repaid in June 2021.

Loss on debt extinguishment. Represents the loss on settlement of our convertible notes which were repaid in June 2021.

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Other income (expense), net. Represents foreign currency transaction gains and losses, changes in fair value of our marketable securities, refundable research and development tax credits, and other items.

Income Tax Benefit (Expense)

Income tax benefit (expense). Consists of U.S. federal and state income tax as well as international taxes in Ireland and India for the year ended December 31, 2021. Our effective tax rate fluctuates from period to period due to changes in the mix of income and losses in jurisdictions with a wide range of tax rates, the effect of acquisitions, changes resulting from the amount of recorded valuation allowance, and permanent differences between U.S. generally accepted accounting principles and local tax laws.

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RESULTS OF OPERATIONS

Comparison of the Years Ended December 31, 2021, 2020, and 2019

Discussions related to year-over-year comparisons between 2020 and 2019 are included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” our final prospectus dated September 21, 2021 as filed with the SEC on September 22, 2021 pursuant to Rule 424(b) under the Securities Act of 1933, as amended, or the Securities Act, and incorporated herein by reference.

The following table summarizes our results of operations for the years ended December 31, 2021, 2020, and 2019:

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[[/GREPCENT_TABLE]]

(1)Includes stock-based compensation expense recognized for the years ended December 31, 2021, 2020, and 2019 as follows:

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[[/GREPCENT_TABLE]]

Revenue

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

Total revenue increased 107% to $1,705 million for the year ended December 31, 2021 from $823 million for the year ended December 31, 2020.

Revenue from subscription services increased 67% to $169 million for the year ended December 31, 2021 from $101 million for the year ended December 31, 2020. The increase was attributable to growth in number of restaurant locations on the Toast platform and the continued upsell of products to existing customers.

Revenue from financial technology solutions increased 118% to $1,406 million for the year ended December 31, 2021 from $644 million for the year ended December 31, 2020 due to an increase in GPV resulting from more processing locations.

Revenue from hardware increased 75% to $112 million for the year ended December 31, 2021 from $64 million for the year ended December 31, 2020 largely driven by the growth in locations.

Revenue from professional services increased 29% to $18 million for the year ended December 31, 2021 from $14 million for the year ended December 31, 2020, primarily due to the increase in the number of restaurant locations going live, partially offset by a shift towards self-guided installations, which are more favorably priced for customers.

Costs of Revenue

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[[/GREPCENT_TABLE]]

Total costs of revenue increased 104% to $1,391 million for the year ended December 31, 2021 from $683 million for the year ended December 31, 2020.

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Costs associated with subscription services increased 58% to $63 million for the year ended December 31, 2021 from $40 million for the year ended December 31, 2020. This increase was due to $10 million in employee-related expenses of which $2 million was stock-based compensation expense, due to increased headcount, and $6 million in contractor services, both of which were required to support our growth. Hosting and other infrastructure costs increased by $7 million to support growth in our customer locations and employees.

Costs associated with financial technology solutions increased 120% to $1,120 million for the year ended December 31, 2021 from $509 million for the year ended December 31, 2020, due to an increase in GPV.

Hardware costs increased 79% to $152 million for the year ended December 31, 2021 from $85 million for the year ended December 31, 2020. The increase was primarily attributed to higher shipment volume as a result of growth in locations and to a lesser extent, higher costs per shipment due to increased freight charges and product costs.

Professional services costs increased 16% to $52 million for the year ended December 31, 2021 from $45 million for the year ended December 31, 2020. This increase was due to a $5 million increase in third-party contractors as we shifted our mix of servicing resources and a $2 million increase in employee-related and overhead costs due to increased headcount, of which $1 million was stock-based compensation expense, to support our growth.

Amortization of acquired technology and customer assets reflected the acquisition of xtra CHEF Inc., or xtraCHEF, in 2021 and StratEx HoldCo, LLC, or StratEx, in 2020.

Operating Expenses

Stock-based compensation expense increased 65% to $130 million for the year ended December 31, 2021 from $79 million for the year ended December 31, 2020. This increase was primarily attributable to expense recognition for awards with an IPO-related vesting condition, and to a lesser extent, certain secondary sale transactions conducted in 2021.

Sales and Marketing

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

Sales and marketing expenses increased 38% to $190 million for the year ended December 31, 2021 from $138 million for the year ended December 31, 2020 due to a $24 million increase in employee-related and overhead costs, of which $8 million was stock-based compensation expense, $12 million increase in amortization of capitalized commissions due to increased sales, and $10 million increase in advertising and related spend due to an increase in online paid advertising and brand awareness efforts. The increase in employee-related costs was driven by increased employee headcount.

Research and Development

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

Research and development expenses increased 50% to $163 million for the year ended December 31, 2021 from $109 million for the year ended December 31, 2020 due to a $49 million increase in employee-related costs, of which $18 million was stock-based compensation expense, resulting from increased headcount.

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General and Administrative

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2021 to 2020 Change","","2020 to 2019 Change"],["(dollars in millions)","2021","","2020","","2019","","Amount","","%","","Amount","","%"],["General and administrative","$","189","","","$","113","","","$","83","","","$","76","","","67","%","","$","30","","","36","%"]]
[[/GREPCENT_TABLE]]

General and administrative expenses increased 67% to $189 million for the year ended December 31, 2021 from $113 million for the year ended December 31, 2020 due to a $34 million increase in employee-related and overhead costs, of which $26 million was stock-based compensation expense, driven by increased headcount, $19 million increase in charitable contributions, and $14 million increase in professional services. The increase in charitable contribution expense is the result of our first donation in December 2021 of Class A common stock, consistent with our pledge to reserve and donate an aggregate of 1% of our equity through Class A common stock over ten years to further our social impact. These increases were partially offset by a $18 million reduction in facilities expenses as we exited leases in 2020.

Interest Income

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

The decrease in interest income in 2021 as compared to 2020 was primarily attributable to premium amortization on marketable securities which partially offset interest income generated on our investments.

Interest Expense

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

Interest expense remained consistent in 2021 as compared to 2020, because the debt was outstanding for a part of each year.

Change in Fair Value of Warrant Liability

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2021 to 2020 Change","","2020 to 2019 Change"],["(dollars in millions)","2021","","2020","","2019","","Amount","","%","","Amount","","%"],["Change in fair value of warrant liability","$","(97)","","","$","(8)","","","$","(1)","","","$","(89)","","","1113","%","","$","(7)","","","700","%"]]
[[/GREPCENT_TABLE]]

The increase in expense associated with the change in fair value of warrant liability was due to higher value of our common stock underlying the warrants in each period, as well as the issuance of additional common stock warrants in 2021. As of December 31, 2021, fair value of the liability related to warrants issued to purchase our Class A common stock was $181 million. The actual change in fair value of warrant liability in subsequent periods will depend in part on the future trading price of our Class A common stock, as well as other relevant valuation inputs, including volatility of our Class A common stock, relevant risk-free interest rates, and time to expiration of the warrants.

Change in Fair Value of Derivative Liability

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[[/GREPCENT_TABLE]]

The increase in expense associated with the change in fair value of derivative liability in 2021 and 2020 was the result of an increase in our stock price and repayment of our convertible notes in June 2021 and the resolution of the corresponding liability.

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Loss on Debt Extinguishment

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

The loss on debt extinguishment for the year ended December 31, 2021 was due to the repayment of our convertible notes in June 2021.

Other Income (Expense), Net

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2021 to 2020 Change","","2020 to 2019 Change"],["(dollars in millions)","2021","","2020","","2019","","Amount","","%","","Amount","","%"],["Other income (expense), net","$","\u2014","","","$","(1)","","","$","\u2014","","","$","1","","","(100)","%","","$","(1)","","","(100)","%"]]
[[/GREPCENT_TABLE]]

Other income (expense), net remained materially consistent in 2021 as compared to 2020.

Income Tax Benefit

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2021 to 2020 Change","","2020 to 2019 Change"],["(dollars in millions)","2021","","2020","","2019","","Amount","","%","","Amount","","%"],["Benefit for income taxes","$","3","","","$","\u2014","","","$","3","","","$","3","","","100","%","","$","(3)","","","(100)","%"]]
[[/GREPCENT_TABLE]]

The income tax benefit (expense) recorded for the tax years ended December 31, 2021 and 2019 was due to deferred tax benefit associated with the partial release of our pre-existing valuation allowance. The valuation allowance release arose from deferred tax liabilities that were brought on through the acquisitions of xtraCHEF and StratEx, that served as a new sources of income.

81

Non-GAAP Financial Measures

We use certain non-GAAP financial measures described below to supplement our consolidated financial statements prepared and presented in accordance with U.S. Generally Accepted Accounting Principles, or GAAP, and to understand and evaluate our core operating performance. These non-GAAP financial measures, which may be different than similarly titled measures used by other companies, are presented to enhance investors’ overall understanding of our financial performance and should not be considered substitutes for, or superior to, the financial information prepared and presented in accordance with GAAP.

We believe that these non-GAAP financial measures provide useful information about our financial performance, enhance the overall understanding of our past performance and future prospects, and allow for greater transparency with respect to important metrics used by our management for financial and operational decision-making. We are presenting these non-GAAP metrics to provide investors insight to the information used by our management to evaluate our business and financial performance. We believe that these measures provide investors increased comparability of our core financial performance over multiple periods with other companies in our industry.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions)","2021","","2020","","2019"],["Adjusted EBITDA","$","(42)","","","$","(94)","","","$","(172)"],["Free Cash Flow","$","(17)","","","$","(161)","","","$","(141)"]]
[[/GREPCENT_TABLE]]

Adjusted EBITDA

Adjusted EBITDA is defined as net income (loss), adjusted to exclude stock-based compensation expense and related payroll tax expense, depreciation and amortization expense, interest income, interest expense, other income (expense) net, acquisition expenses, fair value adjustments on warrant and derivative liabilities, expenses related to COVID-19 pandemic initiatives resulting from a reduction of workforce in 2020, early termination of leases, loss on debt extinguishment, charitable contribution stock-based expense, and income taxes. We have provided below a reconciliation of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.

We believe Adjusted EBITDA is useful for investors in comparing our financial performance to other companies and from period to period. Adjusted EBITDA is widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as depreciation and amortization, interest expense, and interest income, which can vary substantially from company to company depending on their financing and capital structures and the method by which their assets were acquired. In addition, Adjusted EBITDA eliminates the impact of certain items that may obscure trends in the underlying performance of our business. Adjusted EBITDA also has limitations as an analytical tool, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. For example, although depreciation expense is a non-cash charge, the assets being depreciated may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new asset acquisitions. In addition, Adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy. Adjusted EBITDA also does not reflect changes in, or cash requirements for, our working capital needs; interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces the cash available to us; or tax payments that may represent a reduction in cash available to us. The expenses and other items which are excluded from the calculation of Adjusted EBITDA may differ from the expenses and other items that other companies may exclude from Adjusted EBITDA when they report their financial results.

The following table reflects the reconciliation of net loss to Adjusted EBITDA for each of the periods presented:

82

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions)","2021","","2020","","2019"],["Net loss","$","(487)","","","$","(248)","","","$","(209)"],["Stock-based compensation expense and related payroll tax","144","","","86","","","33"],["Depreciation and amortization","21","","","27","","","6"],["Interest income","\u2014","","","(1)","","","(2)"],["Interest expense","12","","","13","","","\u2014"],["Other (income) expense, net","\u2014","","","1","","","1"],["Acquisition expenses","1","","","\u2014","","","1"],["Change in fair value of warrant liability","97","","","8","","","1"],["Change in fair value of derivative liability","103","","","7","","","\u2014"],["Reduction of workforce","\u2014","","","10","","","\u2014"],["Termination of leases","1","","","3","","","\u2014"],["Loss on debt extinguishment","50","","","\u2014","","","\u2014"],["Charitable contribution stock-based expense","19","","","\u2014","","","\u2014"],["Income tax benefit","(3)","","","\u2014","","","(3)"],["Adjusted EBITDA","$","(42)","","","$","(94)","","","$","(172)"]]
[[/GREPCENT_TABLE]]

Free Cash Flow

Free cash flow is defined as net cash provided by (used in) operating activities reduced by purchases of property and equipment and capitalization of internal-use software costs. We believe that free cash flow is a meaningful indicator of liquidity that provides information to management and investors about the amount of cash generated from operations and used for purchases of property and equipment, capitalization of software costs, and investments in our business. Once our business needs and obligations are met, cash can be used to maintain a strong balance sheet and invest in future growth.

Free cash flow has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Other companies may calculate free cash flow or similarly titled non-GAAP measures differently, which could reduce the usefulness of free cash flow as a tool for comparison. In addition, free cash flow does not reflect mandatory debt service and other non-discretionary expenditures that are required to be made under contractual commitments and does not represent the total increase or decrease in our cash balance for any given period.

The following table presents a reconciliation of free cash flow to the net cash provided by (used in) operating activities for each of the periods presented:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions)","2021","","2020","","2019"],["Net cash provided by (used in) operating activities","$","2","","","$","(125)","","","$","(126)"],["Purchase of property and equipment","(12)","","","(28)","","","(9)"],["Capitalized software","(7)","","","(8)","","","(6)"],["Free cash flow","$","(17)","","","$","(161)","","","$","(141)"]]
[[/GREPCENT_TABLE]]

LIQUIDITY AND CAPITAL RESOURCES

Upon completion of the IPO, we received net proceeds of $950 million after deducting underwriting discounts and commissions and invested them into interest-generating marketable securities and money market accounts.

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Our principal sources of liquidity are cash and cash equivalents and marketable securities. As of December 31, 2021, we had cash and cash equivalents of $809 million, excluding cash held on behalf of customers and restricted cash of $42 million, marketable securities of $457 million, and $330 million available under our revolving credit facility. Cash and cash equivalents consist of highly liquid investments with original maturities of 90 days or less at the time of purchase, other than those held for sale in the ordinary course of business. Marketable securities consisted of commercial paper, corporate bonds, U.S. government agency securities, and U.S. Treasury securities.

We believe that our existing cash and cash equivalents, along with our available borrowing capacity under our credit facility, will be sufficient to meet our working capital needs for at least the next 12 months, including planned capital expenditures, strategic transactions, and investment commitments that we may enter into from time to time. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth under “Risk Factors”.

In the event that additional financing is required from outside sources, we cannot be sure that any additional financing will be available to us on acceptable terms, if at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition could be adversely affected.

Cash Flows

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

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions)","2021","","2020","","2019"],["Net cash provided by (used in) operating activities","$","2","","","$","(125)","","","$","(126)"],["Net cash used in investing activities","(503)","","","(36)","","","(47)"],["Net cash provided by financing activities","759","","","594","","","256"],["Net increase in cash, cash equivalents and restricted cash","$","258","","","$","433","","","$","83"]]
[[/GREPCENT_TABLE]]

Operating Activities

For the year ended December 31, 2021, net cash provided by operating activities was $2 million. The increase in cash provided by operations resulted from net sources of cash from a change in operating assets and liabilities of $11 million and adjustments for non-cash charges of $478 million offset by a net loss of $487 million. The non-cash charges were related to the changes in fair values of derivative and warrant liabilities of $200 million, stock-based compensation expense of $140 million, loss on debt extinguishment of $50 million, amortization of deferred costs of $30 million, depreciation and amortization of $21 million, charitable contribution stock-based expense of $19 million, and other items amounting to $18 million. The net sources of cash from changes in operating assets and liabilities primarily related to increases in accrued expenses and other current liabilities of $145 million and accounts payable of $15 million, as well as decreases in operating right-of-use assets of $16 million. These changes were partially offset by increases in deferred costs of $56 million, prepaid expenses and other current assets of $45 million, accounts receivable of $23 million, and inventories of $23 million, as well as a decrease in operating lease liabilities of $16 million.

For the year ended December 31, 2020, net cash used in operating activities was $125 million. This use of cash resulted from our net loss of $248 million and net use of cash from changes in operating assets and liabilities of $28 million, partially offset by adjustments for non-cash charges of $151 million. The non-cash adjustments relate to stock-based compensation expense of $86 million, depreciation and amortization of $27 million, changes in fair value related to derivative and warrant liabilities of $15 million, amortization of deferred costs of $15 million, and non-cash interest on convertible notes of $8 million. The net use of cash from changes in operating assets and liabilities primarily related to increases in accounts receivables of $13 million, deferred costs of $25 million and inventories of $4 million, and decreases in deferred revenue of $8 million, accounts payable of $6 million, and accrued expenses and other current liabilities of $3 million, partially offset by decreases in prepaid expenses and other current assets of $18 million, merchant cash advances of $9 million, and an increase in other assets and liabilities of $4 million.

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Investing Activities

For the year ended December 31, 2021, cash used in investing activities was $503 million, which was the result of purchases of marketable securities of $469 million, cash paid for a business combination of $26 million, purchases of property and equipment of $12 million, and cash outflows for capitalized software of $7 million. These cash outflows were partially offset by proceeds from sales and maturities of marketable securities of $10 million and $1 million of other items.

For the year ended December 31, 2020, cash used in investing activities was $36 million, which consisted of purchases of property and equipment of $28 million and cash outflows for capitalized software of $8 million.

Financing Activities

For the year ended December 31, 2021, cash provided by financing activities was $759 million, which consisted of proceeds from our IPO of $950 million, payment of previously deferred offering costs of $5 million, changes in customer funds obligations of $24 million, proceeds from the exercises of stock options and common stock warrants of $21 million and $3 million, respectively, proceeds received from early exercise of stock options and corresponding issuance of restricted stock of $10 million, and proceeds from other financing activities of $1 million, partially offset by the repayment of our convertible notes of $245 million.

For the year ended December 31, 2020, cash provided by financing activities was $594 million, which consisted of proceeds from the issuance of Series F convertible preferred stock, net of issuance costs, of $402 million, proceeds from the issuance of convertible notes of $195 million, $3 million from the exercise of stock options, and the change in customer funds obligations of $4 million, partially offset by repayments of secured borrowings of $9 million, and the redemption of Series B convertible preferred stock of $1 million.

Debt

Credit Facilities

In March 2019, we entered into a senior secured credit facility, or the 2019 Facility, which included a revolving line of credit equal to $100 million. Loans under this agreement accrued interest at a per annum rate of, at our election, LIBOR plus 3.00% or the base rate plus 2.00%. Interest was payable in arrears quarterly, in the case of base rate loans, and at the end of the applicable interest period (but not less frequently than three months) in the case of LIBOR loans. The 2019 Facility was subject to certain financial covenants, including maximum total net debt to recurring revenue ratio, maximum senior net debt to recurring revenue ratio, minimum liquidity and minimum last quarter annualized recurring revenue. As of December 31, 2020, no amount was drawn and outstanding under this credit facility; however, $14 million of letters of credit were outstanding, which reduced the amount available under this credit facility to $86 million. On June 8, 2021, the 2019 Facility and all commitments thereunder were terminated. There were no amounts outstanding under the 2019 Facility.

On June 8, 2021, we entered into a senior secured credit facility, or the 2021 Facility, which includes a revolving line of credit equal to $330 million. Interest on outstanding loans under the revolving line of credit is determined based on loan type and accrues at an annual rate, as defined in the agreement, of: (a) LIBO Rate multiplied by the Statutory Reserve Rate, plus 1.50% per annum; or 0.5% per annum plus the highest of: (i) the Prime Rate, (ii) the Federal Reserve Bank of New York Rate plus 0.5%, or (iii) the Adjusted LIBO Rate plus 1.00%. Subsequent to December 31, 2021, interest on outstanding loans will be accrued based on Secured Overnight Financing Rate, or SOFR. The 2021 Facility is subject to a minimum liquidity covenant of $250 million. As of December 31, 2021, no amount was drawn and outstanding under the 2021 Facility which had $330 million available for borrowings. As of December 31, 2021, there were $13 million of letters of credit outstanding.

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Convertible Notes

On June 19, 2020, we issued $200 million in aggregate principal amount of senior unsecured convertible promissory notes, or the convertible notes, pursuant to the Senior Unsecured Convertible Promissory Note Purchase Agreement between us and investors party thereto. We received net proceeds of $195 million, net of a $5 million original issue discount and certain legal fees. The convertible notes bore interest at a rate of 8.5% per annum, 50% of which was payable in cash and the other 50% of which was payable in kind. Unless earlier converted or redeemed, the convertible notes were scheduled to mature on June 19, 2027.

As a result of entering into the 2021 Facility, we became obligated to prepay or redeem the convertible notes, which were prepaid on June 21, 2021. We prepaid all of the outstanding convertible notes with a carrying amount of $183 million, including principal and accrued interest, net of an unamortized discount, for an aggregate cash amount of $249 million, or the Optional Prepayment, which included an applicable redemption premium. In connection with the Optional Prepayment, we issued warrants to purchase 8,113,585 shares of our Class B common stock to the registered holders of the convertible notes, with an exercise price of $17.51 per share.

Contractual Obligations and Commitments and Off-Balance Sheet Arrangements

As of December 31, 2021, our contractual obligations consisted of: (i) operating lease commitments of $108 million, of which $22 million is due in 2022 and $86 million is due thereafter, and (ii) purchase commitments of $315 million, a majority of which are due in 2022. Please refer to Note 12, "Lessee Arrangements" and Note 23, "Commitments and Contingencies" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for a discussion on our lease and purchase commitments.

Please refer to Note 9, "Loan Servicing Activities" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for discussion of credit exposure related to our financial guarantees as of December 31, 2021.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the balance sheet date, as well as reported amounts of revenue and expenses during the reporting period. Our most significant estimates and judgments are related to revenue recognition, allowance for credit losses, allowances for uncollectible loans, loan servicing assets, business combinations and other acquired intangible assets, stock-based compensation expense, and common stock and derivative liabilities valuation. Actual results may differ from these estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected.

We believe that the accounting policies described below involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical in fully understanding and evaluating our financial condition and results of operations. For further information, see Note 2, "Summary of Significant Accounting Policies" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K.

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Revenue Recognition

Effective on January 1, 2020, we adopted ASU 2014-09, Revenue from Contracts with Customers, or ASC 606, or Topic 606, using the modified retrospective method of transition. Modified retrospective adoption requires entities to apply the standard retrospectively to the most current period presented in the financial statements, requiring the cumulative effect of the retrospective application as an adjustment to the opening balance of retained earnings at the date of initial application. Accordingly, results for reporting periods beginning after January 1, 2020 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic revenue recognition methodology under ASC 605, Revenue Recognition.

We applied ASC 606 to all contracts that were effective and not complete as of January 1, 2020. Under the guidance of ASC 606, revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In order to achieve this core principle, we applied the following five steps:

1.Identify the contract(s) with a customer.

2.Identify the performance obligations in the contract.

3.Determine the transaction price.

4.Allocate the transaction price to the performance obligations in the contract.

5.Recognize revenue as the entity satisfies a performance obligation.

During the years ended December 31, 2021, 2020, and 2019, we generated revenue through four revenue streams, including: (1) subscription services, (2) financial technology solutions, (3) hardware, and (4) professional services. Our contracts often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately as opposed to being combined may require significant judgment. We allocate total arrangement consideration at the inception of an arrangement to each performance obligation using the relative selling price allocation method based on each distinct performance obligation’s standalone selling price, or SSP. Judgment is required to determine the SSP for each distinct performance obligation. We determined the SSP for hardware and professional services revenue using an adjusted market assessment approach which analyzes discounts provided to similar customers based on customer category and size. SSP for subscription services revenue was established using the adjusted market approach considering relevant information, such as current and new customer pricing, renewal pricing, competitor information, market trends, and market share for similar services. SSP for financial technology solutions revenue was determined using our own standalone sales data.

Business Combinations

The purchase price of an acquisition is allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition dates. The excess of total consideration over the fair values of the assets acquired and the liabilities assumed is recorded as goodwill. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever occurs first, any subsequent adjustments would be recorded in the Consolidated Statements of Operations.

87

Stock-Based Compensation Expense

We grant equity awards, including stock options which vest upon the satisfaction of a service condition and restricted stock units, or RSUs, which vest upon the satisfaction of a performance condition and/or a service condition. We account for stock-based compensation expense related to equity awards in accordance with ASC 718, Compensation—Stock Compensation. Stock-based awards are measured at fair value on the grant date and compensation cost recognized over the service period, net of estimated forfeitures. Compensation cost is recognized on a straight-line basis for stock options and RSUs, and on an accelerated attribution basis for awards with a performance condition for each separately vesting portion of the award over the applicable vesting period. We use the Black-Scholes option-pricing model to determine the estimated fair value of stock option awards. We estimate a forfeiture rate to calculate the stock-based compensation expense for the awards based on an analysis of actual historical experience and expected employee attrition rates.

Our stock option program allows for early exercise of all granted options before vesting requirements have been satisfied. Shares acquired through the early exercise of options which have not vested at the time of an employee’s termination may be purchased by us at the lower of the original exercise price or the then current fair value.

Fair Value of Common Stock

Prior to our IPO, the fair value of our common stock was determined by our Board of Directors, with the assistance of management, as there was no public market for the underlying common stock. Our Board of Directors determined the fair value of our common stock by considering a number of objective and subjective factors, such as contemporaneous third-party valuations of our common stock, the valuation of comparable companies, sales of our common and redeemable convertible preferred stock to outside investors in arms-length transactions, our operating and financial performance, the lack of marketability, and the general and industry specific economic outlook, amongst other factors. After the completion of the IPO, the fair value of our Class A common stock is determined based on the New York Stock Exchange, or NYSE, closing price on the date of grant.

There is inherent uncertainty in these estimates and, if we had made different assumptions than those described, the fair value of the underlying common stock and amount of our stock-based compensation expense, net loss, and net loss per share amounts would have differed.

Goodwill and Intangible Assets

Goodwill represents the excess of purchase price over the fair value of net tangible and identifiable intangible assets of the businesses acquired by us. Goodwill is tested for impairment annually or more often if impairment indicators are present. We determined we are comprised of one reporting unit as of December 31, 2021 and 2020. We performed our annual quantitative goodwill impairment test as of December 31, 2021 and determined that no adjustment to goodwill was necessary because the reporting unit’s fair value significantly exceeded its book value. There were no goodwill impairment losses recognized during the years ended December 31, 2021, 2020 and 2019.

Our intangible assets consist of finite-lived acquired technology, trade names, and customer relationships assets. Intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods deemed appropriate for the type of intangible asset acquired, and reported net of accumulated amortization, separately from goodwill. All intangible assets are amortized over their estimated useful lives. We evaluate on an ongoing basis the remaining estimated useful life of the intangible assets being amortized to determine whether events and circumstances warrant a revision to the remaining amortization period. The amortization periods for acquired technology, customer relationships intangible assets, and acquired trade names are 3 to 10 years, 6 years, and 1.5 years, respectively.

88

Operating Leases

We enter into operating lease arrangements for real estate office space. We determine at contact inception whether an arrangement represents or contains a lease by evaluating various factors, including whether the arrangement conveys the right to control the use of the identified asset in exchange for consideration. Lease classification is determined at the lease commencement date, which is the date the leased assets are made available for use. Operating leases are included in "Operating lease right-of-use-assets" (ROU assets), "Operating lease liabilities," and "Operating lease liabilities, non-current" in the Consolidated Balance Sheets.

ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. Right of use assets are recorded net of any lease incentives received from a lessor. Lease liabilities are calculated as the present value of fixed payments over the lease term, including periodic fixed rent increases and excluding any lease incentives paid or payable to us by a lessor. Lease payments are discounted to present value using our estimated incremental borrowing rate, because a readily determinable implicit rate is not available. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. We account for lease components and non-lease components as a single lease component for each class of underlying assets. Variable payments consist primarily of payments for maintenance, utilities, and management fees. Variable payments included in lease arrangements are expensed as incurred and excluded from the right of use assets and lease liabilities.

Lease term includes the non-cancelable term, renewal options that extend the lease and are reasonably certain to be exercised, and options to terminate the lease before the end of its non-cancelable term that are not reasonably certain to be exercised. We do not record right-of-use assets and lease liabilities for leases with an initial term of 12 months or less and recognize lease expense on a straight-line basis over the lease term.

Convertible Notes

Upon the issuance of the convertible notes in June 2020, we identified and assessed the embedded features in accordance with the accounting guidance for debt with conversion and other options. We concluded that certain features including conversion and redemption features and contingently issuable warrants, were not clearly and closely related to the convertible notes and met the definition of a derivative. Therefore, we bifurcated and separately accounted for these features. We estimated the fair value of the derivative liability on the issuance date and deducted the fair value from the carrying value of the convertible notes. The fair value of the derivative was recorded in Long-term liabilities in the Consolidated Balance Sheets.

We allocated the transaction costs related to the convertible notes and bifurcated derivatives using the same proportion as the allocation of the related proceeds. The transaction costs attributable to the convertible notes were recorded as a direct deduction from the debt liability along with original issue discount and amortized to interest expense over the term of the convertible notes. The transaction costs attributable to the bifurcated derivatives were expensed as incurred. We were accreting the carrying value of the convertible notes to the principal amount along with the 15% exit fee payable at maturity as interest expense using the effective interest method over the term of the convertible notes. On June 21, 2021, we prepaid all of the then outstanding convertible notes, including principal and accrued interest, net of an unamortized discount, as an optional prepayment for an aggregate cash amount of $249 million which included an applicable redemption premium. The bifurcated derivative liability and contingently issuable warrants were adjusted to their then fair value at each reporting period and on the convertible notes’ settlement date with the change in the fair value recorded in "Change in fair value of derivative liability" in the Consolidated Statements of Operations.

89

Recent Accounting Pronouncements

Refer to the sections titled “Basis of Presentation” in Note 1 and “Recently Adopted Accounting Pronouncements” and “Recently Issued Accounting Pronouncements” in Note 2 of the Notes to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for more information.