Upstart Holdings, Inc. (UPST) FY 2022 MD&A

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

Upstart’s revenues are primarily earned in exchange for the use of our platform and for borrower referral services provided to our lending partners through our lending marketplace. Fees for these services can be either fixed or based on a variable price per unit, depending on the contractual arrangement. Platform services result in loan originations by our lending partners using our platform and referral services result in a referral of a borrower obtaining a loan from our lending partners. These fees are combined for accounting purposes as they represent a single performance obligation. We do not charge the borrowers on our platform any referral, platform or other similar fees for our loan matching services.

We also charge the holder of the loan (either a lending partner or institutional investor) a servicing fee based on the outstanding principal over the lifetime of the loan for ongoing servicing of the loan. In addition, we earn a smaller portion of our revenue from interest income for loans held on our balance sheet and gain or (loss) generated through our capital markets programs.

Loans on our platform today are predominantly sourced from Upstart.com. For these loans, we incur variable costs in the form of borrower acquisition costs and borrower verification and servicing costs. Borrower acquisition, verification and servicing costs are highly correlated with Transaction Volume, which fluctuates on a quarter by quarter basis. We continue to focus on improvements to our level of automation and Conversion Rate (as defined below) through our increasingly sophisticated risk models and our evolving channel mix which have contributed to improving our loan unit economics over time.

Factors Affecting Our Performance

Continued Improvements to Our AI Models

Much of our historical growth has been driven by improvements to our AI models. These models benefit over time from a flywheel effect that is characteristic of machine learning systems: accumulation of repayment data leads to improved accuracy of risk and fraud predictions, which results in higher approval rates and lower interest rates, leading to increased volume, and consequently greater accumulation of repayment data. This virtuous cycle describes an important mechanism by which our business grows simply through model learning and recalibration. We expect to continue to invest significantly in the development of our AI models and platform functionalities.

Beyond the ongoing accumulation of repayment data used to train our models, we also frequently make discrete improvements to model accuracy by upgrading algorithms and incorporating new variables, both of which have historically resulted in higher approval rates, more competitive loan offers, increased automation, and faster growth. As a second order effect, the impact of these improvements on our conversion funnel also allows us to unlock new marketing channels over time that have previously been unprofitable.

While the credit performance of Upstart-powered loans can be impacted by a variety of macroeconomic and other factors, we consider credit performance to be one of the most important measures of the effectiveness of our AI models. We focus on credit performance compared to the expectations set by us at the time of origination. Since 2018 through to the end of 2021, all quarterly vintages of loans retained by our lending partners, to date are currently forecasted to meet or exceed the target returns set at the time of loan origination. For loans purchased by institutional investors, all vintages from 2018 through 2020 are forecasted to deliver returns at or in excess of the targets such institutional investors were expecting to receive, while our 2021 through mid-2022 vintages have underperformed relative to target returns.

We believe that ongoing improvements to our technology in this manner will allow us to further expand access and lower rates for creditworthy borrowers, which will continue to fuel our growth. Should the pace of these improvements slow down or cease, or should we discover forms of model upgrades which improve accuracy at the expense of volume, our growth rates could be adversely affected.

Impact of Macroeconomic Environment

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(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

In an economic downturn, we believe consumer lending will generally contract. Lending partners and institutional investors will generally require higher rates of return, which in turn increases the interest rates offered to borrowers, leading to lower borrower demand. Macroeconomic factors can also cause fluctuations of available capital in our lending marketplace due to shifts in the risk preferences of our lending partners and institutional investors. We expect these dynamics would generally invert in an economic upswing.

Loan funding provided by institutional investors started to become constrained in the second quarter of 2022 and has remained constrained, largely due to concerns about the macroeconomic environment. In response to inflationary pressure, the U.S. Federal Reserve has raised, and may continue to raise, interest rates, leading to more expensive loan offers across borrower categories. At the same time, macroeconomic uncertainty had generally made institutional investors more cautious and caused them to reduce the amount of capital available to fund Upstart-powered loans. As a result, in the fourth quarter of 2022, our Transaction Volume, Dollars decreased by 17% in comparison to the third quarter of 2022. In response to this challenging macroeconomic environment where many lenders and credit investors have significantly reduced or paused investments in Upstart-powered loans, we announced reductions in force in November 2022 and January 2023 that resulted in the termination of approximately 7% and 20% of our workforce, respectively. These steps were designed to reduce operating costs, streamline operations and return Upstart to profitability. We have completed the November 2022 reduction in workforce and expect to substantially complete the January 2023 reduction in workforce by March 31, 2023.

Further, several of our lending partners have paused or reduced loan originations in order to limit their exposure in the current macroeconomic environment. In order to create greater stability for our business, we are planning to secure committed capital from lending partners and institutional investors that will contribute loan funding consistently throughout macroeconomic cycles. In the interim period, we expect to utilize our balance sheet to support loan funding. While our goal remains to operate as a marketplace for credit, we will continue to leverage our balance sheet in the short term as we evaluate opportunities to implement a committed capital structure.

In addition, the COVID-19 pandemic has had, and continues to have, a significant impact on the U.S. economy and markets in which we operate. Starting in the second half of March 2020, the COVID-19 pandemic impacted origination volumes on our platform. The rapid rise in unemployment in the United States led to a reduction in originations by lending partners and a temporary pause in loan funding from institutional investors and capital markets. The level of government assistance that was made available to consumers starting in the second quarter of 2020 was unprecedented, driving significant reduction in loan default rates and resulting in strong credit performance of Upstart-powered loans from the second quarter of 2020 through the third quarter of 2021. Since then, most government assistance programs have expired, which has led to the credit risk of borrowers who benefited from these government assistance programs surpassing pre-pandemic levels and led to borrower default rates above historical norms.

We measure the performance of our loans primarily by comparing actual loan defaults to defaults projected by our AI models upon loan origination. Projected performance is a critical component of our loan pricing, and the accuracy of loan default projections is determined by how close the actual return will be to the level expected by our lending partners and institutional investors. The expiration of the government assistance programs had the greatest impact on higher risk borrowers, resulting in a greater increase in default rates for these groups as compared to other less risky borrowers.

We have adjusted our AI models by incorporating different types of economic data, such as unemployment levels and inflation rates, that we receive from third party sources. These adjustments impact interest rates for loans offered on our platform and, as a result, affect borrower acceptance rates of these loans. Recently, this resulted in higher interest rates for the loans being offered through our platform and lower borrower acceptance rates of such loans. But while these economic data help our AI models take into account the current macroeconomic environment, we focus on the ability of our AI models to separate high and low risk borrowers which demonstrates the resilience in the performance of our AI models and Upstart-powered loans during downward shifts in economic cycles relative

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

to general consumer credit. If we do it successfully, it could strengthen our competitive positioning when we emerge from such downturns.

We continuously monitor the direct and indirect impacts of the current macroeconomic conditions on our business, financial condition, and results of operations.

Lending Partner and Market Adoption

Lending partners play two key roles in Upstart’s ecosystem: funding loans and acquiring new customers. Traditional lenders, such as banks, tend to enjoy among the most efficient sources of funding due to their expansive base of deposits. As they adopt our technology and fund a growing proportion of our marketplace transactions, offers made to borrowers will typically improve, generally leading to higher conversion rates and faster growth for our platform.

New lending partners also represent additional acquisition channels through which we can reach and source prospective new borrowers, as these lending partners develop and implement their own digital and in-branch campaigns to drive traffic from their existing customer base to our platform. We view this emerging growth channel to be additive to the marketing acquisition programs we currently run at Upstart.

To provide funding support beyond our lending partners, we have built, and continue to expand, a broad network of institutional investors that can fund Upstart-powered loans through secondary loan purchasing and issuance of pass-through certificates and asset-backed securitizations. This diverse network of capital helps to minimize our reliance on any one funding source. However, any trend towards reduced participation by lending partners will generally erode the overall competitiveness of the offers on our platform, and any declining trend in the participation of broader institutional investment markets with respect to funding availability for Upstart-powered loans will adversely affect our business.

We believe that continued focus on improving our AI models and demonstrating strong performance of Upstart-powered loans over time will allow us to further diversify our sources of capital for our lending marketplace and mitigate the volatility in our loan funding supply.

Product Expansion and Innovation

We believe that significant growth opportunities exist to apply our evolving AI technology to additional segments of credit, and we continue to invest in research and development of our products. In the second quarter of 2022, we introduced a new offering of personal loans for borrowers interested in small dollar loans. We may incur expenses to support the launch of new products and fund early loan originations. Monetization prospects for new products are uncertain, and costs associated with integrating, developing and marketing new products might not be recovered, which could weigh on our top-line growth and profitability.

In the third quarter of 2020, we announced our entry into the auto lending market and in April 2021, we acquired Prodigy Software, Inc. or Prodigy, a leader in automotive commerce software solutions. Prodigy provides a modern multi-channel car buying experience, helping dealerships serve consumers with a holistic software solution that integrates legacy systems. In addition to modernizing the car buying experience, Prodigy is helping bring Upstart's AI enabled auto loans to dealerships across the country where the vast majority of auto loans are transacted. In October 2021, we announced the launch of Upstart Auto Retail software, a cloud-based solution that enables dealerships to provide consumers with access to Upstart-powered auto loans by combining Prodigy Software and Upstart intellectual property.

Key Operating and Non-GAAP Financial Metrics

We focus on several key operating and Non-GAAP financial metrics to measure the performance of our business and help determine strategic direction. The following presents our key operating and financial metrics:

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

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(1)Represents a non-GAAP financial measure. See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for further information.

Transaction Volume

We define Transaction Volume, Dollars as the total principal of loans transacted on our platform between a borrower and the originating lending partner during the period presented. We define Transaction Volume, Number of Loans as the number of loans facilitated on our platform between a borrower and the originating lending partner during the period presented. Transaction Volume is primarily driven by improvements in our AI models and technology, including our ability to streamline and automate the loan application and origination process. Increases in Transaction Volume are dependent on our loan funding programs having sufficient access to capital. Decreases in the availability of funding due to factors such as volatility in the capital markets and macroeconomic conditions will generally cause a decline in Transaction Volume. Transaction Volume can also be driven by borrower acceptance rates and their sensitivity to the interest rates offered through our platform. We believe these metrics are good proxies for our overall scale and reach as a marketplace.

Conversion Rate

We define Conversion Rate as the Transaction Volume, Number of Loans in a period divided by the number of rate inquiries received that we estimate to be legitimate, which we record when a borrower requests a loan offer on our platform. We track this metric to understand the impact of improvements to the efficiency of our borrower funnel on our overall growth. Historically, our Conversion Rate has benefited from improvements to our technology, which have made our evaluation of risk more accurate and our verification process more automated, or from the addition of lending partners that have made our offers more competitive. However, our Conversion Rate can be impacted by a variety of internal factors such as changes in the amount of origination fees that we charge or changes in the rate of returns we target for our lending partners and institutional investors. External factors, including shifts in macroeconomic conditions, also impact our Conversion Rate. For example, as the U.S. Federal Reserve raises interest rates, the average interest rates charged to borrowers for Upstart-powered loans also increase, which results in decreases to our Conversion Rate. Our ability to continue to improve our Conversion Rate depends in part on our ability to continue to improve our AI models and Percentage of Loans Fully Automated and the mix of marketing channels in any given period.

Percentage of Loans Fully Automated

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

A driver of our Contribution Margin and operating efficiency is the Percentage of Loans Fully Automated, which is defined as the total number of loans in a given period originated end-to-end (from initial rate request to final funding) with no human involvement divided by the Transaction Volume, Number of Loans in the same period. We have been successful in increasing the level of loan automation on the platform over the past few years while simultaneously holding fraud rates constant and at very low levels. We believe our growth over the last several years has been driven in part by our ability to rapidly streamline and automate the loan application and origination process on our platform. We expect growth of the percentage of loans fully automated to subside in the near term. However, the expansion of our loan offerings may cause it to fluctuate from period to period depending on the loan offering mix and other external factors.

Contribution Profit and Contribution Margin

To derive Contribution Profit, we subtract from revenue from fees, net from our borrower acquisition costs as well as our borrower verification and servicing costs. To calculate Contribution Margin we divide Contribution Profit by revenue from fees, net.

The following table provides a calculation of Contribution Profit and Contribution Margin:

_______

(1)Borrower acquisition costs consist of our sales and marketing expenses adjusted to exclude costs not directly attributable to attracting a new borrower, such as payroll-related expenses for our business development and marketing teams, as well as other operational, brand awareness and marketing activities.

(2)Borrower verification and servicing costs consist of payroll and other personnel-related expenses for personnel engaged in loan onboarding, verification and servicing, as well as servicing system costs. It excludes payroll and personnel-related expenses and stock-based compensation for certain members of our customer operations team whose work is not directly attributable to onboarding and servicing loans.

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of income from operations to Contribution Profit.

Adjusted EBITDA and Adjusted EBITDA Margin

We calculate Adjusted EBITDA as net income (loss) attributable to Upstart Holdings, Inc. common stockholders adjusted to exclude stock-based compensation expense and certain payroll tax expenses, depreciation and amortization, expense on convertible notes, provision for income taxes and acquisition-related costs. We calculate Adjusted EBITDA Margin as Adjusted EBITDA divided by total revenue. Adjusted EBITDA and Adjusted EBITDA Margin includes interest expense from corporate debt and warehouse credit facilities which is incurred in the course of earning corresponding interest income. See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of net income (loss) attributable to Upstart Holdings, Inc. common stockholders to Adjusted EBITDA and Adjusted EBITDA Margin.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

Adjusted Net Income and Adjusted Net Income Per Share

We define Adjusted Net Income as net income (loss) attributable to Upstart Holdings, Inc. common stockholders exclusive of stock-based compensation expense and certain payroll tax expenses and acquisition-related costs. Adjusted Net Income Per Share is calculated by dividing Adjusted Net Income Per Share by the weighted-average common shares outstanding. See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of net income (loss) attributable to Upstart Holdings, Inc. common stockholders to Adjusted Net Income and Adjusted Net Income per Share.

Components of Results of Operations

Revenue from Fees, Net

Platform and Referral Fees, Net

We charge our lending partners platform fees in exchange for usage of our AI lending marketplace, which includes collection of loan application data, underwriting of credit risk, verification and fraud detection, and the delivery of electronic loan offers and associated documentation. We also charge referral fees to our lending partners in exchange for the referral of borrowers from Upstart.com. Referral fees are charged to lending partners on a per borrower basis upon origination of a loan. These fees are charged net of any fees the lending partner charges Upstart. Upstart pays these lending partners a one-time loan premium fee upon completion of the minimum holding periods. Upstart also pays lending partners monthly loan trailing fees based on the amount and timing of principal and interest payments made by borrowers of the underlying loans. See “Note 2. Revenue” to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for more information about loan premium fees and trailing fees.

Servicing and Other Fees, Net

Servicing fees are calculated as a percentage of outstanding principal and are charged monthly to any entities holding loans facilitated through our marketplace, to compensate us for activities we perform throughout the loan term, including collection, processing and reconciliations of payments received, institutional investor reporting and borrower customer support. Servicing fees are recorded net of any gains, losses or changes to fair value recognized in the underlying servicing rights and obligations, which are carried as assets and liabilities on our consolidated balance sheets. Upstart currently acts as loan-servicer for substantially all outstanding loans facilitated through the Upstart marketplace. Borrower payment collections for loans that are more than 30 days past due or charged off are generally outsourced to third-party collection agencies. Upstart charges lending partners and institutional investors for collection agency fees related to their outstanding loan portfolio. Upstart also receives certain ancillary fees on a per transaction basis inclusive of late payment fees and ACH fail fees.

Interest Income and Fair Value Adjustments, Net

Interest income and fair value adjustments, net is comprised of interest income, interest expense and net changes in the fair value of financial instruments held on our consolidated balance sheets as part of our ongoing operating activities, excluding loan servicing assets and liabilities. Interest income and fair value adjustments, net also includes income from our capital market programs and realized gain (loss) on the sale of loans. Interest income and fair value adjustments, net can fluctuate based on the fair value of financial instruments held on our consolidated balance sheets. This amount has historically been a small percentage of our total revenue, and we do not manage our business with a focus on growing this component of revenue.

Sales and Marketing

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Sales and marketing expenses primarily consist of costs incurred across various advertising channels, including expenses for partnerships with third parties providing borrower referrals, direct mail and digital advertising campaigns, as well as other expenses associated with building overall brand awareness and experiential marketing costs. Sales and marketing expenses also include payroll and other personnel-related costs, including stock-based compensation expense. These costs are recognized in the period incurred. We expect that our sales and marketing expenses will generally increase in absolute dollars and may fluctuate as a percentage of our total revenue from period to period as we hire additional sales and marketing personnel, increase our marketing activities and build greater brand awareness.

Customer Operations

Customer operations expenses include payroll and other personnel-related expenses, including stock-based compensation expense, for personnel engaged in borrower onboarding, loan servicing, customer support and other operational teams. These costs also include systems, third-party services and tools we use as part of loan servicing, information verification, fraud detection and payment processing activities. These costs are recognized in the period incurred. We expect that our customer operations expenses will increase in absolute dollars and may fluctuate as a percentage of our total revenue over time, as we expand our portfolio.

Engineering and Product Development

Engineering and product development expenses primarily consist of payroll and other personnel-related expenses, including stock-based compensation expense, for the engineering and product development teams as well as the costs of systems and tools used by these teams. These costs are recognized in the period incurred. We expect that our engineering and product development expenses will increase in absolute dollars and may increase as a percentage of our total revenue over time, as we expand our engineering and product development team to continue to improve our AI models and develop new products and product enhancements.

General, Administrative and Other

General, administrative and other expenses consist primarily of payroll and other personnel-related expenses, including stock-based compensation expense, for legal and compliance, finance and accounting, human resources and facilities teams, as well as depreciation and amortization of property, equipment, software, and intangibles, professional services fees, facilities and travel expenses. These costs are recognized in the period incurred. We expect to increase the size of our general and administrative function to support the further growth of our business. As a result, we expect that our general, administrative and other expenses will increase in absolute dollars but may fluctuate as a percentage of our total revenue from period to period.

Other Income (Expense), Net

Other income (expense), net consists of funds received under the Paycheck Protection Program, or PPP, during the year ended December 31, 2021 and our voluntary repayment of the funds during the year ended December 31, 2021. During the year ended December 31, 2022 other income (expense), net primarily consists of dividend income earned on our unrestricted cash balances.

Expense on Warrants and Convertible Notes, Net

Expense on warrants and convertible notes, net is primarily comprised of the net changes in the fair value of our common and convertible preferred stock warrant liabilities for the year ended December 31, 2020 and interest expense on our convertible notes for the year ended December 31, 2021 and 2022.

Results of Operations

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(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

The following table summarizes our historical consolidated statements of operations data:

________

(1)Includes stock-based compensation expense as follows:

Revenue

Revenue from Fees, Net

The following table sets forth our revenue from fees, net in the years presented:

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Revenue from fees, net increased $106.0 million, or 13%, in the year ended December 31, 2022, compared to the prior year, which included an increase of $99.9 million in servicing and other fees, net and an increase of $6.1 million in revenue from platform and referral fees, net. The increase in the servicing and other fees, net was primarily due to a 58% increase in the outstanding principal of serviced loans.

Interest Income and Fair Value Adjustments, Net

For the year ended December 31, 2022, interest income and fair value adjustments, net decreased $112.1 million, or 237%, compared to the prior year. The decrease was driven by a $189.5 million decrease in fair value adjustments, net partially offset by a $84.9 million increase in interest income due to an increase in unpaid principal balance of loans held on the consolidated balance sheets. The negative fair value adjustments were attributable to a $101.4 million unfavorable change in the fair value of our loan portfolio and increasing charge-offs as well as a $(58.1) million of realized loss on the sale of loans compared $28.1 million gain on loan sales in the prior year, primarily due to the rising interest rate environment and higher loan delinquency rates.

Operating Expenses

Sales and Marketing

Sales and marketing expenses increased by $12.3 million, or 4%, in the year ended December 31, 2022 compared to the prior year. The increase was primarily due to a $12.2 million increase in payroll and other personnel-related expenses driven by increased headcount. As a percentage of total revenue, sales and marketing expenses increased from 39% to 41%.

Customer Operations

Customer operations expenses increased by $70.4 million, or 60%, in the year ended December 31, 2022, compared to the prior year. The increase was primarily due to an increase of $46.7 million in payroll and other personnel-related expenses due to a higher average headcount in 2022 compared to 2021, and a $18.9 million

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increase in servicing expenses. As a percentage of total revenue, customer operations expenses increased from 14% to 22%.

Engineering and Product Development

Engineering and product development expenses increased by $103.2 million, or 77%, for the year ended December 31, 2022, compared to the prior year. The increase was primarily due to an increase of $76.4 million in payroll and other personnel-related expenses driven by an increase in headcount, as well as a $25.5 million increase in spending on consultants and other engineering support services. As a percentage of total revenue, engineering and product development expenses increased from 16% to 28%.

General, Administrative, and Other

General, administrative, and other expenses increased by $62.6 million, or 51%, for the year ended December 31, 2022, compared to the prior year. The increase was primarily due to an increase of $38.1 million in payroll and personnel-related costs as a result of increased headcount, an increase of $10.4 million in office rent and other facility expenses, and a $6.0 million increase in depreciation expense. As a percentage of total revenue, general, administrative, and other expenses increased from 14% to 22%.

Other Income (Expense), Net

In the year ended December 31, 2022, other income (expense), net increased by $14.6 million, or 283%, compared to the prior year. The increase was primarily due to and increase of $7.2 million in dividend income as yields on sweep investments have increased due to rising interest rates. Also, in 2021, we voluntary repaid $5.2 million of proceeds received from the Paycheck Protection Program received in 2020.

Expense on Warrants and Convertible Notes, Net

Expense on warrants and convertible notes, net increased by $2.7 million, or 137%, in the year ended December 31, 2022, compared to the prior year. The increase was a result of a $2.7 million increase in interest expense in convertible notes in the year ended December 31, 2022.

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Reconciliation of Non-GAAP Financial Measures

To supplement our consolidated financial statements prepared and presented in accordance with GAAP, we use the non-GAAP financial measures of Contribution Profit, Contribution Margin, Adjusted EBITDA, Adjusted EBITDA Margin, and Adjusted Net Income and Adjusted Net Income Per Share to provide investors with additional information about our financial performance and to enhance the overall understanding of our past performance and future prospects. We are presenting these non-GAAP financial measures because we believe they provide an additional tool for investors to use in comparing our core financial performance over multiple periods with the performance of other companies.

However, non-GAAP financial measures have limitations in their usefulness to investors because they have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, non-GAAP financial measures may be calculated differently from, and therefore may not be directly comparable to, similarly titled measures used by other companies. As a result, non-GAAP financial measures should be viewed as supplementing, and not as an alternative or substitute for, our consolidated financial statements prepared and presented in accordance with GAAP.

To address these limitations, we provide a reconciliation of Contribution Profit, Contribution Margin, Adjusted EBITDA, Adjusted EBITDA Margin, and Adjusted Net Income and Adjusted Net Income Per Share to income (loss) from operations and net income (loss) attributable to Upstart Holdings, Inc. common stockholders, respectively. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure and to view Contribution Profit, Contribution Margin, Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net Income, and Adjusted Net Income Per Share in conjunction with their respective related GAAP financial measures.

Contribution Profit and Contribution Margin

We use Contribution Profit and Contribution Margin as part of our overall assessment of performance, including the preparation of our annual operating budget and quarterly forecasts, to evaluate the effectiveness of our business strategies, and to communicate with our Board of Directors concerning our financial performance. We believe Contribution Profit and Contribution Margin are useful to investors for period-to-period comparisons of our business and in evaluating and understanding our operating results and ability to scale. Contribution Profit and Contribution Margin are also useful to investors because our management uses Contribution Profit and Contribution Margin, in conjunction with financial measures prepared in accordance with GAAP, to evaluate our operating results and financial performance and the effectiveness of our strategies.

Contribution Profit and Contribution Margin have 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. Contribution Profit and Contribution Margin are not GAAP financial measures of, nor do they imply, profitability. Even if our revenue exceeds variable expenses over time, we may not be able to achieve or maintain profitability, and the relationship of revenue to variable expenses is not necessarily indicative of future performance. Contribution Profit and Contribution Margin do not reflect all of our variable expenses and involve some judgment and discretion around what costs vary directly with loan volume. Other companies that present Contribution Profit and Contribution Margin may calculate it differently and, therefore, similarly titled measures presented by other companies may not be directly comparable to ours.

The following table presents a reconciliation of income (loss) from operations to Contribution Profit and Contribution Margin. We define Operating Margin as our income (loss) from operations divided by revenue from fees, net.

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_________

(1)Borrower acquisition costs were $91.7 million, $307.6 million and $302.7 million for the year ended December 31, 2020, 2021 and 2022 respectively. Borrower acquisition costs consist of our sales and marketing expenses adjusted to exclude costs not directly attributable to attracting a new borrower, such as payroll-related expenses for our business development and marketing teams, as well as other operational, brand awareness and marketing activities.

(2)Borrower verification and servicing costs were $31.8 million, $95.8 million and $157.8 million for the year ended December 31, 2020, 2021 and 2022, respectively. Borrower verification and servicing costs consist of payroll and other personnel-related expenses for personnel engaged in loan onboarding, verification and servicing, as well as servicing system costs. It excludes payroll and personnel-related expenses and stock-based compensation for certain members of our customer operations team whose work is not directly attributable to onboarding and servicing loans.

Adjusted EBITDA and Adjusted EBITDA Margin

We believe that Adjusted EBITDA and Adjusted EBITDA Margin are useful for investors to use in comparing our financial performance with the performance of other companies for the following reasons:

•Adjusted EBITDA and Adjusted EBITDA Margin are widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as depreciation, and interest expense, that can vary substantially from company to company depending upon their financing and capital structures, and the method by which assets were acquired; and

•Adjusted EBITDA and Adjusted EBITDA Margin eliminate the impact of certain items such as stock-based compensation expense and certain payroll tax expense, warrant expense and acquisition-related costs that may obscure trends in the underlying performance of our business; and

•Adjusted EBITDA and Adjusted EBITDA Margin provide consistency and comparability with our past financial performance, and facilitate comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results.

Our use of Adjusted EBITDA and Adjusted EBITDA Margin has limitations as an analytical tool, and these measures should not be considered in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of these limitations are as follows:

•Although depreciation expense is a non-cash charge, the assets being depreciated may have to be replaced in the future, and Adjusted EBITDA and Adjusted EBITDA Margin does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;

•Adjusted EBITDA and Adjusted EBITDA Margin exclude stock-based compensation expense and certain employer payroll taxes on employee stock transactions. Stock-based compensation expense 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. The amount of employer payroll tax-related expense on employee stock transactions is dependent on our stock price and other factors that are beyond our control and which not correlate to the operation of the business;

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect: (1) changes in, or cash requirements for, our working capital needs; (2) interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us; or (3) tax payments that may represent a reduction in cash available to us; and

•the expenses and other items that we exclude in our calculation of Adjusted EBITDA and Adjusted EBITDA Margin may differ from the expenses and other items, if any, that other companies may exclude from Adjusted EBITDA and Adjusted EBITDA Margin when they report their operating results.

Because of these limitations, Adjusted EBITDA and Adjusted EBITDA Margin should be considered along with other operating and financial performance measures presented in accordance with GAAP. The following table provides a reconciliation of net income (loss) attributable to Upstart Holdings, Inc. common stockholders and net income (loss) attributable to Upstart Holdings, Inc. common stockholders margin to Adjusted EBITDA Margin. We define Net Income (Loss) Margin as net income (loss) attributable to Upstart Holdings, Inc. common stockholders divided by total revenue.

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(1)Payroll tax expenses include the employer payroll tax-related expense on employee stock transactions, as the amount is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of our business.

Adjusted Net Income and Adjusted Net Income Per Share

We define Adjusted Net Income as net income (loss) attributable to Upstart Holdings, Inc. common stockholders exclusive of stock-based compensation expense and certain payroll tax expense and acquisition-related costs. Adjusted Net Income Per Share is calculated by dividing Adjusted Net Income Per Share by the weighted-average common shares outstanding. We believe Adjusted Net Income and Adjusted Net Income Per Share are useful measures for investors in evaluating our ability to generate earnings, more readily compare between past and future periods, and provide comparability of our performance with the performance of other companies.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

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(1)Payroll tax expenses includes the amount of employer payroll tax-related expense on employee stock transactions, as the amount is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of our business.

Liquidity and Capital Resources

Sources and Uses of Cash

Since inception, we have financed our operations, corporate investments, and capital expenditures primarily through the sale of convertible preferred stock, convertible promissory notes, term loans and draws on our revolving credit facilities, and cash generated from operations.

In December 2020, we completed our Initial Public Offering (“IPO”) which resulted in $167.4 million of proceeds, net of underwriting discounts and commissions, and before deducting deferred offering costs of $7.9 million. In April 2021, we completed a follow-on offering, in which 2,300,000 shares of common stock (including the exercise in full of the underwriters option to purchase 300,000 shares) were issued and sold at $120.00 per share. We received net proceeds of $263.9 million after deducting underwriting discounts and commissions of $11.0 million and offering expenses of $1.0 million. In August 2021, we issued $661.3 million aggregate principal amount of 0.25% convertible senior notes due 2026, or the Notes, (including the exercise in full of the initial purchasers’ option of an additional $86.3 million aggregate principal of additional Notes) in a private placement to qualified institutional buyers. The net proceeds from the sale of the Notes were $645.5 million after deducting debt issuance costs.

As of December 31, 2022, our primary source of liquidity was cash of $422.4 million. We also held $5.0 million of investments in certificates of deposit with maturities greater than three months as of December 31, 2022. Certificates of deposit provide a secondary source of liquidity since they can be converted into cash in a timely manner. Changes in the balance of cash are generally a result of working capital fluctuations and the timing of purchases and sales of loans facilitated through our marketplace. To finance purchases of certain loans facilitated through our lending marketplace, we rely on our warehouse credit facilities through the special-purpose trusts, or the warehouse trusts and corporate cash.

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(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

Our convertible senior notes have a principal balance of $661.3 million and bear interest at a rate of 0.25% per year, payable semiannually in arrears on February 15 and August 15 of each year. The Notes mature on August 15, 2026 unless earlier converted, redeemed, or repurchased in accordance with their terms. See “Note 8. Borrowings” in Part II, Item 8 of this Form 10-K for further details on our Notes.

Our warehouse credit facilities, which mature in 2024, allow us to borrow up to borrow up to $175.0 million under the ULT Credit Facility to purchase unsecured personal loans and up to $200.0 million under the UAWT Credit Facility to purchase secured auto loans. As of December 31, 2022, we have drawn an aggregate of $336.5 million on our warehouse credit facilities. See “Note 8. Borrowings” in Part II, Item 8 of this Form 10-K for further details on our warehouse credit facilities.

We lease office facilities under operating lease agreements which expire between 2027 and 2032. Our cash requirements related to these lease agreements are $120.3 million, of which $15.1 million is expected to be paid within the next 12 months. See “Note 10. Leases” in Part II, Item 8 of this Form 10-K for further details on our operating lease obligations.

We have committed to purchase loans from certain lending partners at the conclusion of the required holding period, which is generally equal to three business days. As of December 31, 2022, the total loan purchase commitment was $17.8 million. See “Note 11. Commitments and Contingencies” in Part II, Item 8 of this Form 10-K for further details on our loan purchase obligations.

While we believe that our cash on hand and our cash flow from operations will be sufficient to meet our liquidity needs for at least the next 12 months, our future capital requirements will depend on multiple factors, including our revenue growth, working capital requirements, volume of loan purchases for product development purposes or during market downturns, and our capital expenditures. We may decide to raise additional capital through the sale of equity, equity-linked or debt securities or other debt financing arrangements. If we raise additional funds by issuing equity or equity-linked securities, our stockholders may experience dilution. Future debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt or equity financing that we raise may contain terms that are not favorable to us or our stockholders. Further, if we are unable to raise additional capital when our cash balances and cash generated by operations are insufficient to satisfy liquidity needs, our results of operations and financial condition would be materially and adversely impacted.

Cash Flows

The following table summarizes our cash flows during the years indicated:

Net Cash from Operating Activities

Our main sources of cash provided by operating activities are our revenue from fees earned under contracts with lending partners and institutional investors and interest income we receive for loans held on our balance sheet.

Our main uses of cash in our operating activities include payments to marketing partners, vendor payments, payroll and other personnel-related expenses, payments for facilities, and other general business expenditures.

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(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

Net cash used in operating activities was $674.7 million for the year ended December 31, 2022, which primarily consisted of a decrease of $848.7 million in net operating assets and liabilities, adjustments for non-cash items of $282.6 million, and net loss of $108.7 million. The decrease in net operating assets and liabilities was primarily related to $7,807.4 million in purchases of loans held-for-sale, partially offset by $6,828.6 million in proceeds from the sale of loans classified as held-for-sale and $152.0 million in principal payments received for loans held-for-sale.

Net Cash from Investing Activities

Net cash used in investing activities was $114.1 million for the year ended December 31, 2022 as a result of $149.3 million purchases of loans held-for-investment and $14.1 million in capitalized software, partially offset by $43.3 million in principal payments received for loans held-for-investment, and $14.3 million in proceeds from sale of loans held-for-investment.

Net Cash from Financing Activities

Net cash provided by financing activities was $130.0 million for the year ended December 31, 2022 as a result of $688.8 million proceeds from borrowings, partially offset by $400.9 million in payments on borrowings and $177.9 million in repurchases of common stock.

Composition of Retained Loan Portfolio

As of December 31, 2022, we held $1,010.4 million of loans on our consolidated balance sheet. $492.1 million of these loans were originated for research and development purposes, primarily in support of our auto lending products and expansion of our unsecured personal loan product to new categories of borrowers. We also held $518.3 million of core personal loans which would otherwise be immediately purchased by institutional investors. We will continue to utilize our capital to support research and development activities and, at times, as a funding source for core personal loans during periods of marketplace funding constraints. The extent and timing of utilizing our capital as a funding source for loans will largely depend on the availability of capital in our marketplace relative to the demand from qualified borrowers and our business priorities. We plan to sell retained loans to institutional investors over time in the form of secondary sales or securitizations.

Off-Balance Sheet Arrangements

In the ordinary course of business, we engage in activities that are not reflected on our consolidated balance sheets, generally referred to as off-balance sheet arrangements. These activities involve transactions with unconsolidated VIEs, including our sponsored and co-sponsored securitization transactions, which we contractually service. We use these transactions to provide a source of liquidity to finance our business and to diversify our institutional investor base. If we are the retaining sponsor, we are required by law to retain at least 5% of the credit risk of the securities issued in these securitizations. We provide additional information regarding transactions with unconsolidated VIEs in “Note 3. Variable Interest Entities” in Part II, Item 8 of this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our 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. Our significant accounting policies are described in “Note 1. Description of Business and Significant Accounting Policies” in Part II, Item 8 of this Annual Report on Form 10-K.

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(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)

Fair Value

We have elected the fair value option for loans, notes receivable and residual certificates. We believe the estimate of fair value of these financial instruments requires significant judgment. We use a discounted cash flow model to estimate the fair value of these financial instruments based on the present value of estimated future cash flows. This model uses both observable and unobservable inputs and reflects our best estimates of the assumptions a market participant would use to calculate fair value. Primary inputs that require significant judgment include discount rates, credit risk rates and expected prepayment rates. These inputs are based on historical performance of loans facilitated through our platform, as well as the consideration of market participant requirements.

We have also elected the fair value option for servicing assets and liabilities. We record servicing assets and liabilities at estimated fair value when we transfer loans which qualify as sales under Topic 860, Transfers and Servicing. We use a discounted cash flow model to estimate the fair value of loan servicing assets and liabilities. The cash flows in the valuation model represent the difference between the servicing fees charged to institutional investors and an estimated market servicing fee. Since servicing fees are generally based on the monthly unpaid principal balance of the underlying loans, the expected cash flows in the model incorporate estimated credit risk and expected prepayments on the loans. For further information on fair value measurement refer to “Note 4. Fair Value Measurement” in Part II, Item 8 of this Annual Report on Form 10-K.

Evaluation for Impairment of Goodwill and Acquired Intangible Assets

Assets acquired and liabilities assumed in a business combination are recognized at their estimated fair value as of the acquisition date. The excess purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. The allocation of fair values may be subject to adjustment after the initial allocation for up to a one-year period, with the corresponding offset to goodwill. For further information on business combinations refer to “Note 5. Acquisitions” in Part II, Item 8 of this Annual Report on Form 10-K.

Goodwill is reviewed for impairment annually, or more frequently if an event or a change in circumstances indicates that goodwill may be impaired. For further information on goodwill, refer to “Note 1. Description of Business and Significant Accounting Policies” and “Note 6. Goodwill and Intangible Assets” in Part II, Item 8 of this Annual Report on Form 10-K.

Stock-Based Compensation

The determination of the amount of stock-based compensation expense to be recorded requires us to develop estimates to be used in the calculation of the grant date fair value of stock options and purchase rights granted under our employee stock purchase plan. We estimate the grant date fair value of stock options and employee purchase rights using the Black-Scholes option-pricing model. Performance-based restricted stock units are initially measured at fair value using a Monte Carlo simulation. The use of the Black-Scholes model and Monte Carlo simulation requires us to make key assumptions such as expected option term and volatility to determine the fair value of a stock option. We estimate the expected term based on the simplified method, which is the weighted-average time to vesting and the contractual maturity. Volatility is estimated based on the average volatility for comparable publicly-traded companies, over a period equal to the expected term of the award grants. For further information on stock-based compensation refer to “Note 9. Stockholders' Equity” in Part II, Item 8 of this Annual Report on Form 10-K.

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