# Toast, Inc. (TOST) FY 2022 MD&A

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

SEC filing source: https://www.sec.gov/Archives/edgar/data/1650164/000165016423000069/tost-20221231.htm
Accession: 0001650164-23-000069
Filing date: 2023-03-01
Report date: 2022-12-31
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/
Previous year: /company/TOST/mda/fy2021/ (FY 2021)
Next year: /company/TOST/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 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, 2022 compared to the year ended December 31, 2021 and for the year ended December 31, 2021 compared to the year ended December 31, 2020.

•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.

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, 2022, approximately 79,000 restaurant locations, processing approximately $92 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.

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•Suppliers. Our supplier management and accounting products give restaurants the tools to optimize their back-office operations. Managing supplier networks and procurement, and having high visibility into costs, are critical to efficiently operating a restaurant. Our products enable customers to automate manual billing processes, manage inventory, and improve profitability with real-time cost insights on menu items. The seamless integration across our end-to-end platform gives our customers the rich data and reporting capabilities to efficiently operate and manage their restaurants.

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 underwriting discounts, commissions, and other offering costs.

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Recent Developments in Macroeconomic Environment

Global events and macroeconomic conditions such as inflation and its potential impact on consumer spending, rising interest rates, global supply chain issues and the COVID-19 pandemic have impacted and may continue to impact our business. While our business results remain positive, it is difficult to predict the potential impact these factors may have on our future business results because of the uncertainty they have produced or will produce among consumers and the restaurant industry.

Key Business Metrics

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","As of December 31,","","2022 to 2021","","2021 to 2020"],["(dollars in millions)","2022","","2021","","2020","","% Growth","","% Growth"],["Annualized Recurring Run-Rate (ARR)","$","901","","","$","568","","","$","326","","","59","%","","74","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","As of December 31,","","2022 to 2021","","2021 to 2020"],["","2022","","2021","","2020","","% Change","","% Change"],["Net Retention Rate (NRR)","118","%","","135","%","","114","%","","(17)","%","","21","%"]]
[[/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 billings of 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.

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% 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.

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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, and related devices and 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 intangible assets. Amortization of acquired intangible assets 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 accelerated depreciation 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.

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.

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.

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General and administrative. General and administrative expenses consist primarily of expenses related to management and administrative functions, including finance, legal, human resources, and information technology. General and administrative expenses also include costs related to fees paid for certain professional services, including legal, information technology, and tax and accounting services, as well as bad debt and credit related expenses.

Other Income (Expenses)

Our other income and expenses consist of the following:

Interest income (expense), net. Consists of interest earned from cash held in money market accounts, interest earned on our marketable securities, offset by 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 estimated volatility of our Class A common stock, strike price, relevant risk-free interest rates, and time to expiration of the warrants, and may fluctuate in subsequent periods.

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.

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 various foreign jurisdictions for the year ended December 31, 2022. 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, 2022, 2021, and 2020

Discussions related to year-over-year comparisons between 2021 and 2020 are included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on March 1, 2022, and incorporated herein by reference.

The following table summarizes our results of operations for the years ended December 31, 2022, 2021, and 2020:

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[[/GREPCENT_TABLE]]

(1)Includes stock-based compensation expense recognized for the years ended December 31, 2022, 2021, and 2020 as follows:

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[[/GREPCENT_TABLE]]

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Revenue

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2022 to 2021 Change","","2021 to 2020 Change"],["(dollars in millions)","2022","","2021","","2020","","Amount","","%","","Amount","","%"],["Subscription services","$","324","","","$","169","","","$","101","","","$","155","","","92","%","","$","68","","","67","%"],["Financial technology solutions","2,268","","","1,406","","","644","","","862","","","61","%","","762","","","118","%"],["Hardware","113","","","112","","","64","","","1","","","1","%","","48","","","75","%"],["Professional services","26","","","18","","","14","","","8","","","44","%","","4","","","29","%"],["Total revenue","$","2,731","","","$","1,705","","","$","823","","","$","1,026","","","60","%","","$","882","","","107","%"]]
[[/GREPCENT_TABLE]]

The increase in subscription services revenue during the year ended December 31, 2022 was attributed to growth in live restaurant locations and the continued increase in the number of products adopted by both new and existing customers.

The increase in financial technology solutions revenue during the year ended December 31, 2022 was attributable to the increase in live restaurant locations and the increase in GPV per processing location, which was due to both higher consumer demand and higher average transaction values.

Hardware revenue increased slightly during the year ended December 31, 2022, primarily due to an increase in hardware sales to new locations and upsell sales to existing locations, mostly offset by the impact of pricing and packaging related to bundled sales. Pricing and packaging of bundled sales benefited revenue in the prior year compared to a negative impact in the current year.

The increase in professional services revenue during the year ended December 31, 2022 was primarily driven by the increase in new live locations.

Costs of Revenue

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[[/GREPCENT_TABLE]]

The increase in subscription services costs during the year ended December 31, 2022 was primarily attributable to an increase in employee-related and overhead costs and contractor services as well as stock-based compensation expense. Higher employee-related costs were driven primarily by increased employee headcount.

The increase in financial technology solutions costs during the year ended December 31, 2022 was due to an increase in GPV.

The increase in hardware costs during the year ended December 31, 2022 was attributable to higher shipment volume as a result of growth in new restaurant locations and higher product costs.

The increase in professional services costs during the year ended December 31, 2022 was primarily due to an increase in employee-related and overhead costs and contractor services as well as stock-based compensation expense.

We utilize our hardware and related professional services as customer acquisition tools and price them competitively to reduce barriers to entry for new locations.

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Operating Expenses

Sales and Marketing

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

The increase in sales and marketing expenses during the year ended December 31, 2022 was primarily attributable to a $77 million increase in employee-related and overhead costs and a $26 million increase in stock-based compensation. Higher employee-related costs were driven primarily by increased employee headcount.

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

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

The increase in research and development expenses during the year ended December 31, 2022 was primarily attributable to a $75 million increase in employee-related and overhead costs and a $24 million increase in stock-based compensation. Higher employee-related costs and stock-based compensation was driven by increased employee headcount.

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

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2022 to 2021 Change","","2021 to 2020 Change"],["(dollars in millions)","2022","","2021","","2020","","Amount","","%","","Amount","","%"],["General and administrative","$","294","","","$","189","","","$","113","","","$","105","","","56","%","","$","76","","","67","%"]]
[[/GREPCENT_TABLE]]

The increase in general and administrative expenses during the year ended December 31, 2022 was primarily attributable to employee-related and overhead costs and stock-based-compensation due to increased headcount, as well as bad debt and credit related expenses mainly due to growth in our Toast Capital product offering. Employee-related and overhead costs, stock-based compensation, and bad debt and credit related expenses increased $48 million, $15 million, and $34 million, respectively.

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.

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Interest Income (expense), net

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

The increase in interest income (expense), net in 2022 as compared to 2021 was attributable to higher interest income generated on our investments in marketable securities, as well as decreases in interest expense due to the repayment of convertible notes in 2021. We made our initial investment in marketable securities in October 2021.

Change in Fair Value of Warrant Liability

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","2022 to 2021 Change","","2021 to 2020 Change"],["(dollars in millions)","2022","","2021","","2020","","Amount","","%","","Amount","","%"],["Change in fair value of warrant liability","$","95","","","$","(97)","","","$","(8)","","","$","192","","","(198)","%","","$","(89)","","","1113","%"]]
[[/GREPCENT_TABLE]]

The change in fair value of warrant liability in 2022 was primarily attributable to a lower value of common stock underlying outstanding warrants at the end of the period compared to the beginning of the period.

Change in Fair Value of Derivative Liability

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

The decrease in expense associated with the change in fair value of derivative liability for the year ended December 31, 2022 was due to the repayment of our convertible notes in June 2021 and the extinguishment of the corresponding liability.

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]]
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[[/GREPCENT_TABLE]]

Other income (expense), net remained materially consistent in 2022 as compared to 2021.

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Benefit from Income Taxes

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[[/GREPCENT_TABLE]]

The income tax benefit for the years ended December 31, 2022 and 2021 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 Sling and xtraCHEF, that served as new sources of income.

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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.

Net Loss (GAAP) and Adjusted EBITDA (Non-GAAP)

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 (expense) net, 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, expenses related to 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.

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

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions)","2022","","2021","","2020"],["Net loss","$","(275)","","","$","(487)","","","$","(248)"],["Stock-based compensation expense and related payroll tax","232","","","144","","","86"],["Depreciation and amortization","24","","","21","","","27"],["Interest (income) expense, net","(11)","","","12","","","12"],["Other (income) expense, net","1","","","\u2014","","","1"],["Acquisition expenses","2","","","1","","","\u2014"],["Change in fair value of warrant liability","(95)","","","97","","","8"],["Change in fair value of derivative liability","\u2014","","","103","","","7"],["Reduction of workforce","\u2014","","","\u2014","","","10"],["Termination of leases","(1)","","","1","","","3"],["Loss on debt extinguishment","\u2014","","","50","","","\u2014"],["Charitable contribution stock-based expense","10","","","19","","","\u2014"],["Income tax benefit","(2)","","","(3)","","","\u2014"],["Adjusted EBITDA","$","(115)","","","$","(42)","","","$","(94)"]]
[[/GREPCENT_TABLE]]

Net Cash (Used in) Provided by Operating Activities (GAAP) and Free Cash Flow (Non-GAAP)

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)","2022","","2021","","2020"],["Net cash (used in) provided by operating activities","$","(156)","","","$","2","","","$","(125)"],["Purchase of property and equipment","(16)","","","(12)","","","(28)"],["Capitalized software","(17)","","","(7)","","","(8)"],["Free cash flow","$","(189)","","","$","(17)","","","$","(161)"]]
[[/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, 2022, we had cash and cash equivalents of $547 million, excluding cash held on behalf of customers of $60 million, restricted cash of $28 million, marketable securities of $474 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, certificates of deposit, corporate bonds, U.S. government agency securities, asset-backed 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)","2022","","2021","","2020"],["Net cash (used in) provided by operating activities","$","(156)","","","$","2","","","$","(125)"],["Net cash used in investing activities","(98)","","","(503)","","","(36)"],["Net cash provided by financing activities","38","","","759","","","594"],["Net (decrease) increase in cash, cash equivalents and restricted cash","$","(216)","","","$","258","","","$","433"]]
[[/GREPCENT_TABLE]]

Operating Activities

For the year ended December 31, 2022, net cash used in operating activities was $156 million as a result of our net loss for the period, adjusted for certain non-cash items, such as stock-based compensation, the change in fair value of our warrant liabilities, depreciation and amortization, as well as a use of cash for working capital. The change in working capital was primarily driven by higher inventory balances, in part due to the opening of a new facility, as well as higher deferred costs, partially offset by higher accrued expenses and other current liabilities related to our growth in GPV.

For the year ended December 31, 2021, net cash provided by operating activities was $2 million. This resulted from our net loss for the period, adjusted for certain non-cash items, such as stock-based compensation, the change in fair value of derivative liability, the change in fair value of warrant liabilities, loss on debt extinguishment, depreciation and amortization, as well as a use of cash for working capital. The change in working capital was primarily driven by higher deferred costs mostly related to sales compensation and higher prepaid expenses as a result of hardware purchases, partially offset by higher accrued expenses and other current liabilities related to our growth in GPV.

Investing Activities

For the year ended December 31, 2022, cash used in investing activities was $98 million, which consisted primarily of cash paid for purchases of marketable securities and cash paid for an acquisition, partially offset by proceeds from sales and maturities of marketable securities.

For the year ended December 31, 2021, cash used in investing activities was $503 million, which consisted primarily of cash paid for purchases of marketable securities, cash paid for an acquisition, purchases of property and equipment and cash paid for capitalized software.

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Financing Activities

For the year ended December 31, 2022, cash provided by financing activities was $38 million, which consisted primarily of an increase in customer funds obligations and proceeds from the exercise of stock options.

For the year ended December 31, 2021, cash provided by financing activities was $759 million, which consisted of proceeds from our IPO, a change in customer funds obligations, proceeds from the exercise of stock options, and proceeds from the issuance of restricted stock, partially offset by repayments of our convertible notes.

Debt

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, 2022, 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, 2022, no amount was drawn and outstanding under the 2021 Facility which had $330 million available for borrowings. As of December 31, 2022 and 2021, there were $8 million and $13 million of letters of credit outstanding, respectively.

As a result of entering into the 2021 Facility, we became obligated to prepay or redeem convertible notes issued in June 2020. 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, which included an applicable redemption premium. Please refer to Note 9, "Debt" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for further information on this transaction.

Contractual Obligations and Commitments and Off-Balance Sheet Arrangements

As of December 31, 2022, our contractual obligations consisted of: (i) operating lease commitments of $112 million, of which $17 million is due in 2023 and $95 million is due thereafter, and (ii) purchase commitments of $231 million, a majority of which are due in 2023. Please refer to Note 8, "Lessee Arrangements" and Note 18, "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 6, "Loan Servicing Activities and Acquired Loans Receivable, Net" 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, 2022.

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, business combinations and other acquired intangible assets, and stock-based compensation expense. 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.

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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.

Revenue Recognition

We recognize revenue in accordance with ASC 606, Revenue from Contracts with Customers, or ASC 606, 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.

During the years ended December 31, 2022, 2021, and 2020, 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 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 determine 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, sales channel, 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.

Determining whether to recognize revenue on a gross or net basis requires judgment in evaluating whether we are the principal or agent in contracts with customers. We have concluded that we are the principal in providing a managed payment solution because we control the payment processing services before the customer receives them, perform authorization and fraud check procedures prior to submitting transactions for processing in the payment network, have sole discretion over which third-party acquiring payment processors we will use, and are ultimately responsible to the customers for amounts owed if those acquiring payment processors do not fulfill their obligations. Based upon this evaluation, we recognize transaction fees for payment-processing on a gross basis.

Business Combinations

The acquisition purchase price is allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values on the acquisition dates. The excess of total consideration over the fair values of the assets acquired and the liabilities assumed is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, we make significant estimates and assumptions, especially with respect to intangible assets. Our estimates of fair value are based upon assumptions believed to be reasonable, which are inherently uncertain and unpredictable, and as such, actual results may differ from estimates. 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 within our results of operations.

Our intangible assets consist of finite-lived acquired technology and customer relationships assets which are amortized over their estimated useful lives. We evaluate on an ongoing basis the remaining estimated useful life of the intangible assets to determine whether events and circumstances warrant a revision to the remaining amortization period. Such estimates are inherently uncertain since unanticipated events and circumstances may occur which may materially impact these estimates and our actual results. The amortization periods for acquired technology and customer relationships intangible assets is between three years and ten years, respectively.

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Stock-Based Compensation Expense

Stock-based compensation expense for stock options and RSUs is recognized over the service period based on the fair value of equity awards on the grant date, net of estimated forfeitures. For RSUs, fair value is based on the New York Stock Exchange, or NYSE, closing price of our Class A common stock on the grant date.

We use the Black-Scholes option-pricing model to determine the estimated fair value of stock option awards. We have limited historical stock option activity and therefore estimate the expected term of stock options granted using the simplified method, which represents the average of the contractual term of the stock option and its weighted-average vesting period. The expected volatility of stock options is based upon the average historical volatility of a number of publicly traded companies in a similar industry. 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.

We will continue to use judgment in evaluating the expected volatility, expected term and forfeiture rate utilized in our stock-based compensation expense calculation on a prospective basis. As we continue to accumulate additional data related to our Class A common stock and forfeiture rates, we may adjust our estimates, which could materially impact our future stock-based compensation expense.

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.

Right-of-use assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term which are discounted 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, which requires judgment and may impact the reported amounts of Right-of-use assets and lease liabilities.

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Recent Accounting Pronouncements

Refer to the sections titled “Recently Adopted 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.