Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks, uncertainties and assumptions. You should read the “Special Note Regarding Forward-Looking Statements” and “Risk Factors” sections of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
The Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, describes principal factors affecting the results of our operations, financial condition and liquidity, as well as our critical accounting policies and estimates that require significant judgment and thus have the most significant potential impact on our Consolidated Financial Statements included elsewhere in this Form 10-K. Our MD&A is organized as follows:
•Overview. This section provides a general description of our business, recent developments, and key business metrics.
•Results of Operations. This section provides an overview and analysis of our financial results for the year ended December 31, 2021 compared to the year ended December 31, 2020 and for the year ended December 31, 2020 compared to the year ended December 31, 2019.
•Liquidity and Capital Resources. This section provides an analysis of our liquidity and changes in cash flows, as well as a discussion of available borrowings and contractual commitments.
•Critical Accounting Policies and Estimates. This section discusses accounting policies and estimates that require us to exercise subjective or complex judgments in their application. We believe these accounting policies and estimates are important to understanding the assumptions and judgments incorporated in our reported financial results.
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OVERVIEW
Toast is a cloud-based, all-in-one digital technology platform purpose-built for the entire restaurant community. Our platform provides a comprehensive suite of SaaS products, financial technology solutions including integrated payment processing, restaurant-grade hardware, and a broad ecosystem of third-party partners. We serve as the restaurant operating system, connecting front of house and back of house operations across dine-in, takeout, and delivery channels. As of December 31, 2021, our customers processed over $57 billion of gross payment volume in the trailing 12 months, partnered with Toast to optimize operations, increase sales, engage guests, and maintain happy employees.
By enabling these capabilities through a single, integrated platform, Toast improves experiences across the restaurant ecosystem:
•Restaurant operators. We arm restaurants with a wide range of products and capabilities to address their specific needs regardless of size, location, or business model. As a result, restaurants using Toast often see higher sales and greater operational efficiency.
•Guests. We are laser focused on helping our customers deliver memorable guest experiences at scale. Guests can place orders easily, safely, and accurately across web, mobile, and in-person channels for dine-in, takeout, or delivery. In addition, our platform empowers restaurants to utilize their guest data to deliver targeted and personalized experiences with loyalty programs and marketing solutions.
•Employees. Our easy-to-learn and easy-to-use technology improves the experience of restaurant employees across Toast customers. Employees are core to delivering great hospitality, and it is critical for restaurants to engage and retain employees in an increasingly competitive labor market. Our products enable new employees to learn quickly through guided workflows, facilitate faster table turns and safer, streamlined operations, and provide greater transparency around, and timely access to, employees’ wages.
The benefits to all stakeholders using the Toast platform create a powerful, virtuous cycle that amplifies our impact on restaurants. Guest satisfaction generates loyalty to restaurants, driving repeat sales, word-of-mouth referrals, and larger checks and tips. This promotes employee satisfaction, helping reduce turnover and motivating employees to continue to raise the bar on the guest experience. In addition, our integrated software and payments platform consolidates data on restaurant sales and operations, which enables our reporting and analytics as well as financial technology solutions, such as working capital loans, to further support our customers’ success.
Since our founding, we have translated our love for restaurants into a commitment to innovation and digital transformation for the restaurant industry. As we have expanded our platform, launched new products, and added new partners over time, we have rapidly grown the number of restaurant locations on the Toast platform.
On September 24, 2021, we completed our initial public offering, or IPO, in which we issued and sold 25,000,000 shares of our Class A common stock at the public offering price of $40.00 per share, which included the full exercise of the underwriters’ option to purchase additional 3,260,869 shares. We received net proceeds of $944 million after deducting $47 million of underwriting discounts and commissions and $7 million of other offering costs. Immediately prior to the completion of the IPO, all of the outstanding shares of our convertible preferred stock and our common stock were automatically converted into an aggregate of 477,593,550 shares of Class B common stock on a one-for-one basis.
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Impact of COVID-19
Since early 2020, changes in consumers' behavior and government-imposed restrictions because of the COVID-19 pandemic have impacted restaurants in various ways, including limiting service to takeout orders for a period of time or reducing capacity to accommodate social distancing recommendations. Though the exact long-term circumstances are difficult to predict, we believe that the COVID-19 pandemic will result in a lasting shift in consumer demand towards omnichannel consumption and increased guest demand for digital solutions such as Order & Pay. Depending on the extent to which the prevalence of takeout and delivery orders persists, our financial results may be impacted in a number of ways.
In light of the evolving nature of the COVID-19 pandemic and the uncertainty it has produced around the world, it is not possible to predict the cumulative and ultimate impact of the pandemic on our future business operations, results of operations, financial position, liquidity, and cash flows despite progress in vaccination efforts. The extent of the impact of the pandemic on our business and financial results will depend largely on future developments that cannot be accurately predicted at this time, including the duration of the spread of the pandemic both globally and within the United States, the introduction and severity of new variants of the virus and their resistance to currently approved vaccines, the impact on capital, foreign currency exchange, and financial markets, the impact of governmental or regulatory orders that impact our business, and the effect on global supply chains, all of which are highly uncertain and cannot be predicted.
Key Business Metrics
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.
1Please note that numbers may not tie due to rounding to the nearest hundred million.
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Annualized Recurring Run-Rate (ARR)
We monitor Annualized Recurring Run-Rate as a key operational measure of the scale of our subscription and payment processing services for both new and existing customers. To calculate this metric, we first calculate recurring run-rate on a monthly basis. Monthly Recurring Run-Rate, or MRR, is measured on the final day of each month for all restaurant locations live on our platform as the sum of (i) our monthly subscription services fees, which we refer to as the subscription component of MRR, and (ii) our in-month adjusted payments services fees, exclusive of estimated transaction-based costs, which we refer to as the payments component of MRR. MRR does not include fees derived from Toast Capital or related costs. MRR is also not burdened by the impact of SaaS credits offered.
ARR is determined by taking the sum of (i) twelve times the subscription component of MRR and (ii) four times the trailing-three-month cumulative payments component of MRR. We believe this approach provides an indication of our scale, while also controlling for short-term fluctuations in payments volume. Our ARR may decline or fluctuate as a result of a number of factors, including customers’ satisfaction with our platform, pricing, competitive offerings, economic conditions, or overall changes in our customers’ and their guests’ spending levels. ARR is an operational measure, does not reflect our revenue or gross profit determined in accordance with GAAP, and should be viewed independently of, and not combined with or substituted for, our revenue, gross profit, and other financial information determined in accordance with GAAP. Further, ARR is not a forecast of future revenue and investors should not place undue reliance on ARR as an indicator of our future or expected results.
Net Retention Rate (NRR)
To calculate our Net Retention Rate, or NRR, we first identify a cohort of customers, or the Base Customers, in a particular month, or the Base Month. For this purpose, we do not consider a customer as a Base Customer unless there is at least one location live on the Toast platform for the entirety of the Base Month. We then divide MRR for the Base Customers in the same month of the subsequent year, or the Comparison Month, by MRR in the Base Month to derive a monthly NRR. MRR in the Comparison Month includes the impact of any churn or contraction of the Base Customers, and by definition does not include any customers added to the Toast platform between the Base Month and Comparison Month. We measure the annual NRR by taking a weighted average of the monthly NRR over the trailing twelve months.
Components of Results of Operations
Revenue
We generate revenue from four main sources that are further described below: (1) subscription services, (2) financial technology solutions, (3) hardware, and (4) professional services.
Our total revenue consists of the following:
Subscription services. We generate subscription services revenue from fees charged to customers for access to our software applications, generally over a term ranging from 12 to 36 months. Our subscription services revenue is primarily based on a rate per location, and this rate varies depending on the number of software products purchased, hardware configuration, and employee count at each location.
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Financial technology solutions. Revenue from financial technology solutions consists primarily of transaction-based fees paid by customers to facilitate their payment transactions, which are generally calculated as a percentage of the total transaction amount processed plus a per-transaction fee. The transaction fees collected are recognized as revenue on a gross basis. Financial technology solutions revenue also includes fees earned from marketing and servicing working capital loans to our customers through Toast Capital that are originated by a third-party bank. In these arrangements, Toast Capital’s bank partner originates all loans, and Toast Capital then services the loans using Toast’s payments infrastructure to remit a fixed percentage of daily sales until the loan is paid back. Toast Capital is responsible for purchasing from our bank partner loans in default (or that have been or are scheduled to be charged off) until the aggregate principal amount of such purchased loans equals 15% (or 30% in the case of a limited program offered during the winter of 2020-2021 related to the COVID-19 pandemic) of the total originated amount for each quarterly loan cohort. Toast Capital earns a servicing fee as well as a credit performance fee that is tied to the portfolio performance.
Hardware. We generate hardware revenue from the sale of terminals, tablets, handhelds, and related devices and accessories, net of estimated returns.
Professional services. We generate professional services revenue from fees charged to customers for installation services, including business process mapping, configuration, and training. These services can be delivered on-site, remotely, or on a self-guided basis.
Costs of Revenue
Costs of revenue consists of expenses that are directly related or closely correlated to revenue generation, including, but not limited to, employee-related costs for customer support and certain operational roles as well as allocated overhead. Employee-related costs consist of salaries, benefits, bonuses, and stock-based compensation expense. Allocated overhead includes certain facilities costs, depreciation expense, and amortization costs associated with internally developed software. Below are descriptions of the types of costs classified within each component of costs of revenue:
Subscription services. Subscription services costs consist of customer support and associated employee-related costs, hosting costs, professional services costs, other software costs to support our cloud-based platform, and amortization costs associated with internally developed software.
Financial technology solutions. Financial technology solutions costs consist primarily of transaction-based costs, which are mostly fees and costs paid to issuers and card networks as well as other related fees associated with third-party payment processors and fraud management.
Hardware. Hardware costs consist of raw materials and the cost of manufacturing and shipping hardware sold to customers, including terminals, tablets, handhelds, card readers, printers, and other accessories. Included in the manufacturing and shipping costs are employee-related costs, professional services costs, and allocated overhead associated with our supply chain and fulfillment teams.
Professional services. Professional services costs consist primarily of employee-related costs and allocated overhead associated with our onboarding team, along with fees paid to third-party service providers engaged to perform installations and other services.
Amortization of acquired technology. Amortization of acquired technology costs is related to technologies acquired through acquisitions that have the capability of producing revenue.
Operating Expenses
During the year ended December 31, 2020, we incurred certain costs, including severance, lease exit costs, and impairment of property and equipment, in connection with a reduction in workforce resulting from changes to our operations as a result of the COVID-19 pandemic.
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Our operating expenses consist of the following:
Sales and marketing. Sales and marketing expenses consist primarily of employee-related costs incurred to acquire new customers and increase product adoption across our existing customer base. Marketing expenses also include fees incurred to generate demand through various advertising channels.
We expect that sales and marketing expenses will increase on an absolute dollar basis as we invest to grow our field-based sales team, increase demand generation, and enhance our brand awareness. We expect sales and marketing expenses as a percentage of revenue will vary from period-to-period over the short-term and decrease over the long-term.
Research and development. Research and development expenses consist primarily of employee- related costs associated with improvements to our platform and the development of new product offerings, as well as allocated overhead and expenses associated with the use of third-party software directly related to development of our products and services.
We plan to continue to hire employees to support our research and development efforts to expand the capabilities and scope of our platform and related products and services. As a result, we expect that research and development expenses will increase on an absolute dollar basis as we continue to invest to support these activities and innovate over the long-term.
General and administrative. General and administrative expenses consist primarily of expenses related to operations, finance, legal, human resources, information technology, and administrative personnel. General and administrative expenses also include costs related to fees paid for certain professional services, including legal, information technology, tax and accounting services, and credit loss expenses.
We expect that general and administrative expenses will increase on an absolute dollar basis as we add personnel and enhance our systems, processes, and controls to support the growth of our business as well as our increased compliance and reporting requirements as a public company. We expect general and administrative expenses as a percentage of revenue will vary from period-to-period over the short-term and decrease over the long-term.
Other Income (Expense)
Our other income and expenses consist of the following:
Interest income. Interest income consists of interest earned from cash held in money market accounts and interest earned on our marketable securities.
Interest expense. Interest expense represents interest incurred on our convertible notes, which were issued in June 2020 and repaid in June 2021.
Change in fair value of warrant liability. Represents the change in the fair value of our warrant liability related to warrants issued to purchase shares of our convertible preferred stock and our common stock. The warrant liability is remeasured at fair value at each reporting date which could have a significant effect on other income (expense) and our results of operations during each period. The fair value is based on the trading price of our Class A common stock, as well as other relevant valuation inputs, including volatility of our Class A common stock, strike price, relevant risk-free interest rates, and time to expiration of the warrants.
Change in fair value of derivative liability. Represents the change in fair value of derivative liability related to the conversion option provided for in the convertible notes which were repaid in June 2021.
Loss on debt extinguishment. Represents the loss on settlement of our convertible notes which were repaid in June 2021.
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Other income (expense), net. Represents foreign currency transaction gains and losses, changes in fair value of our marketable securities, refundable research and development tax credits, and other items.
Income Tax Benefit (Expense)
Income tax benefit (expense). Consists of U.S. federal and state income tax as well as international taxes in Ireland and India for the year ended December 31, 2021. Our effective tax rate fluctuates from period to period due to changes in the mix of income and losses in jurisdictions with a wide range of tax rates, the effect of acquisitions, changes resulting from the amount of recorded valuation allowance, and permanent differences between U.S. generally accepted accounting principles and local tax laws.
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RESULTS OF OPERATIONS
Comparison of the Years Ended December 31, 2021, 2020, and 2019
Discussions related to year-over-year comparisons between 2020 and 2019 are included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” our final prospectus dated September 21, 2021 as filed with the SEC on September 22, 2021 pursuant to Rule 424(b) under the Securities Act of 1933, as amended, or the Securities Act, and incorporated herein by reference.
The following table summarizes our results of operations for the years ended December 31, 2021, 2020, and 2019:
Year Ended December 31,
Revenue:
Costs of revenue:
Amortization of acquired technology and customer assets 4 4 2
Operating expenses:
Other income (expense):
Interest income — 1 2
Interest expense (12) (13) —
Change in fair value of warrant liability (97) (8) (1)
Change in fair value of derivative liability (103) (7) —
Loss on debt extinguishment (50) — —
Other income (expense), net — (1) —
Income taxes benefit 3 — 3
(1)Includes stock-based compensation expense recognized for the years ended December 31, 2021, 2020, and 2019 as follows:
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Year Ended December 31,
Costs of revenue $ 12 $ 7 $ 1
Sales and marketing 24 16 1
Research and development 48 30 3
General and administrative 58 33 29
Total stock-based compensation expense $ 142 $ 86 $ 34
Revenue
Total revenue increased 107% to $1,705 million for the year ended December 31, 2021 from $823 million for the year ended December 31, 2020.
Revenue from subscription services increased 67% to $169 million for the year ended December 31, 2021 from $101 million for the year ended December 31, 2020. The increase was attributable to growth in number of restaurant locations on the Toast platform and the continued upsell of products to existing customers.
Revenue from financial technology solutions increased 118% to $1,406 million for the year ended December 31, 2021 from $644 million for the year ended December 31, 2020 due to an increase in GPV resulting from more processing locations.
Revenue from hardware increased 75% to $112 million for the year ended December 31, 2021 from $64 million for the year ended December 31, 2020 largely driven by the growth in locations.
Revenue from professional services increased 29% to $18 million for the year ended December 31, 2021 from $14 million for the year ended December 31, 2020, primarily due to the increase in the number of restaurant locations going live, partially offset by a shift towards self-guided installations, which are more favorably priced for customers.
Costs of Revenue
Amortization of acquired technology and customer assets 4 4 2 — — % 2 100 %
Total costs of revenue increased 104% to $1,391 million for the year ended December 31, 2021 from $683 million for the year ended December 31, 2020.
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Costs associated with subscription services increased 58% to $63 million for the year ended December 31, 2021 from $40 million for the year ended December 31, 2020. This increase was due to $10 million in employee-related expenses of which $2 million was stock-based compensation expense, due to increased headcount, and $6 million in contractor services, both of which were required to support our growth. Hosting and other infrastructure costs increased by $7 million to support growth in our customer locations and employees.
Costs associated with financial technology solutions increased 120% to $1,120 million for the year ended December 31, 2021 from $509 million for the year ended December 31, 2020, due to an increase in GPV.
Hardware costs increased 79% to $152 million for the year ended December 31, 2021 from $85 million for the year ended December 31, 2020. The increase was primarily attributed to higher shipment volume as a result of growth in locations and to a lesser extent, higher costs per shipment due to increased freight charges and product costs.
Professional services costs increased 16% to $52 million for the year ended December 31, 2021 from $45 million for the year ended December 31, 2020. This increase was due to a $5 million increase in third-party contractors as we shifted our mix of servicing resources and a $2 million increase in employee-related and overhead costs due to increased headcount, of which $1 million was stock-based compensation expense, to support our growth.
Amortization of acquired technology and customer assets reflected the acquisition of xtra CHEF Inc., or xtraCHEF, in 2021 and StratEx HoldCo, LLC, or StratEx, in 2020.
Operating Expenses
Stock-based compensation expense increased 65% to $130 million for the year ended December 31, 2021 from $79 million for the year ended December 31, 2020. This increase was primarily attributable to expense recognition for awards with an IPO-related vesting condition, and to a lesser extent, certain secondary sale transactions conducted in 2021.
Sales and Marketing
Sales and marketing expenses increased 38% to $190 million for the year ended December 31, 2021 from $138 million for the year ended December 31, 2020 due to a $24 million increase in employee-related and overhead costs, of which $8 million was stock-based compensation expense, $12 million increase in amortization of capitalized commissions due to increased sales, and $10 million increase in advertising and related spend due to an increase in online paid advertising and brand awareness efforts. The increase in employee-related costs was driven by increased employee headcount.
Research and Development
Research and development expenses increased 50% to $163 million for the year ended December 31, 2021 from $109 million for the year ended December 31, 2020 due to a $49 million increase in employee-related costs, of which $18 million was stock-based compensation expense, resulting from increased headcount.
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General and Administrative
General and administrative expenses increased 67% to $189 million for the year ended December 31, 2021 from $113 million for the year ended December 31, 2020 due to a $34 million increase in employee-related and overhead costs, of which $26 million was stock-based compensation expense, driven by increased headcount, $19 million increase in charitable contributions, and $14 million increase in professional services. The increase in charitable contribution expense is the result of our first donation in December 2021 of Class A common stock, consistent with our pledge to reserve and donate an aggregate of 1% of our equity through Class A common stock over ten years to further our social impact. These increases were partially offset by a $18 million reduction in facilities expenses as we exited leases in 2020.
Interest Income
Interest income $ — $ 1 $ 2 $ (1) (100) % $ (1) (50) %
The decrease in interest income in 2021 as compared to 2020 was primarily attributable to premium amortization on marketable securities which partially offset interest income generated on our investments.
Interest Expense
Interest expense $ (12) $ (13) $ — $ 1 (8) % $ (13) (100) %
Interest expense remained consistent in 2021 as compared to 2020, because the debt was outstanding for a part of each year.
Change in Fair Value of Warrant Liability
The increase in expense associated with the change in fair value of warrant liability was due to higher value of our common stock underlying the warrants in each period, as well as the issuance of additional common stock warrants in 2021. As of December 31, 2021, fair value of the liability related to warrants issued to purchase our Class A common stock was $181 million. The actual change in fair value of warrant liability in subsequent periods will depend in part on the future trading price of our Class A common stock, as well as other relevant valuation inputs, including volatility of our Class A common stock, relevant risk-free interest rates, and time to expiration of the warrants.
Change in Fair Value of Derivative Liability
The increase in expense associated with the change in fair value of derivative liability in 2021 and 2020 was the result of an increase in our stock price and repayment of our convertible notes in June 2021 and the resolution of the corresponding liability.
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Loss on Debt Extinguishment
Loss on debt extinguishment $ (50) $ — $ — $ (50) — % $ — (100) %
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
Other income (expense), net $ — $ (1) $ — $ 1 (100) % $ (1) (100) %
Other income (expense), net remained materially consistent in 2021 as compared to 2020.
Income Tax Benefit
Benefit for income taxes $ 3 $ — $ 3 $ 3 100 % $ (3) (100) %
The income tax benefit (expense) recorded for the tax years ended December 31, 2021 and 2019 was due to deferred tax benefit associated with the partial release of our pre-existing valuation allowance. The valuation allowance release arose from deferred tax liabilities that were brought on through the acquisitions of xtraCHEF and StratEx, that served as a new sources of income.
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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.
Year Ended December 31,
Adjusted EBITDA $ (42) $ (94) $ (172)
Adjusted EBITDA
Adjusted EBITDA is defined as net income (loss), adjusted to exclude stock-based compensation expense and related payroll tax expense, depreciation and amortization expense, interest income, interest expense, other income (expense) net, acquisition expenses, fair value adjustments on warrant and derivative liabilities, expenses related to COVID-19 pandemic initiatives resulting from a reduction of workforce in 2020, early termination of leases, loss on debt extinguishment, charitable contribution stock-based expense, and income taxes. We have provided below a reconciliation of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.
We believe Adjusted EBITDA is useful for investors in comparing our financial performance to other companies and from period to period. Adjusted EBITDA is widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as depreciation and amortization, interest expense, and interest income, which can vary substantially from company to company depending on their financing and capital structures and the method by which their assets were acquired. In addition, Adjusted EBITDA eliminates the impact of certain items that may obscure trends in the underlying performance of our business. Adjusted EBITDA also has limitations as an analytical tool, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. For example, although depreciation expense is a non-cash charge, the assets being depreciated may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new asset acquisitions. In addition, Adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy. Adjusted EBITDA also does not reflect changes in, or cash requirements for, our working capital needs; interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces the cash available to us; or tax payments that may represent a reduction in cash available to us. The expenses and other items which are excluded from the calculation of Adjusted EBITDA may differ from the expenses and other items that other companies may exclude from Adjusted EBITDA when they report their financial results.
The following table reflects the reconciliation of net loss to Adjusted EBITDA for each of the periods presented:
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Year Ended December 31,
Stock-based compensation expense and related payroll tax 144 86 33
Depreciation and amortization 21 27 6
Interest income — (1) (2)
Interest expense 12 13 —
Other (income) expense, net — 1 1
Acquisition expenses 1 — 1
Change in fair value of warrant liability 97 8 1
Change in fair value of derivative liability 103 7 —
Reduction of workforce — 10 —
Termination of leases 1 3 —
Loss on debt extinguishment 50 — —
Charitable contribution stock-based expense 19 — —
Income tax benefit (3) — (3)
Adjusted EBITDA $ (42) $ (94) $ (172)
Free Cash Flow
Free cash flow is defined as net cash provided by (used in) operating activities reduced by purchases of property and equipment and capitalization of internal-use software costs. We believe that free cash flow is a meaningful indicator of liquidity that provides information to management and investors about the amount of cash generated from operations and used for purchases of property and equipment, capitalization of software costs, and investments in our business. Once our business needs and obligations are met, cash can be used to maintain a strong balance sheet and invest in future growth.
Free cash flow has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Other companies may calculate free cash flow or similarly titled non-GAAP measures differently, which could reduce the usefulness of free cash flow as a tool for comparison. In addition, free cash flow does not reflect mandatory debt service and other non-discretionary expenditures that are required to be made under contractual commitments and does not represent the total increase or decrease in our cash balance for any given period.
The following table presents a reconciliation of free cash flow to the net cash provided by (used in) operating activities for each of the periods presented:
Year Ended December 31,
Net cash provided by (used in) operating activities $ 2 $ (125) $ (126)
Purchase of property and equipment (12) (28) (9)
Capitalized software (7) (8) (6)
LIQUIDITY AND CAPITAL RESOURCES
Upon completion of the IPO, we received net proceeds of $950 million after deducting underwriting discounts and commissions and invested them into interest-generating marketable securities and money market accounts.
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Our principal sources of liquidity are cash and cash equivalents and marketable securities. As of December 31, 2021, we had cash and cash equivalents of $809 million, excluding cash held on behalf of customers and restricted cash of $42 million, marketable securities of $457 million, and $330 million available under our revolving credit facility. Cash and cash equivalents consist of highly liquid investments with original maturities of 90 days or less at the time of purchase, other than those held for sale in the ordinary course of business. Marketable securities consisted of commercial paper, corporate bonds, U.S. government agency securities, and U.S. Treasury securities.
We believe that our existing cash and cash equivalents, along with our available borrowing capacity under our credit facility, will be sufficient to meet our working capital needs for at least the next 12 months, including planned capital expenditures, strategic transactions, and investment commitments that we may enter into from time to time. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth under “Risk Factors”.
In the event that additional financing is required from outside sources, we cannot be sure that any additional financing will be available to us on acceptable terms, if at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition could be adversely affected.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
Year Ended December 31,
Net cash provided by (used in) operating activities $ 2 $ (125) $ (126)
Net cash used in investing activities (503) (36) (47)
Net cash provided by financing activities 759 594 256
Net increase in cash, cash equivalents and restricted cash $ 258 $ 433 $ 83
Operating Activities
For the year ended December 31, 2021, net cash provided by operating activities was $2 million. The increase in cash provided by operations resulted from net sources of cash from a change in operating assets and liabilities of $11 million and adjustments for non-cash charges of $478 million offset by a net loss of $487 million. The non-cash charges were related to the changes in fair values of derivative and warrant liabilities of $200 million, stock-based compensation expense of $140 million, loss on debt extinguishment of $50 million, amortization of deferred costs of $30 million, depreciation and amortization of $21 million, charitable contribution stock-based expense of $19 million, and other items amounting to $18 million. The net sources of cash from changes in operating assets and liabilities primarily related to increases in accrued expenses and other current liabilities of $145 million and accounts payable of $15 million, as well as decreases in operating right-of-use assets of $16 million. These changes were partially offset by increases in deferred costs of $56 million, prepaid expenses and other current assets of $45 million, accounts receivable of $23 million, and inventories of $23 million, as well as a decrease in operating lease liabilities of $16 million.
For the year ended December 31, 2020, net cash used in operating activities was $125 million. This use of cash resulted from our net loss of $248 million and net use of cash from changes in operating assets and liabilities of $28 million, partially offset by adjustments for non-cash charges of $151 million. The non-cash adjustments relate to stock-based compensation expense of $86 million, depreciation and amortization of $27 million, changes in fair value related to derivative and warrant liabilities of $15 million, amortization of deferred costs of $15 million, and non-cash interest on convertible notes of $8 million. The net use of cash from changes in operating assets and liabilities primarily related to increases in accounts receivables of $13 million, deferred costs of $25 million and inventories of $4 million, and decreases in deferred revenue of $8 million, accounts payable of $6 million, and accrued expenses and other current liabilities of $3 million, partially offset by decreases in prepaid expenses and other current assets of $18 million, merchant cash advances of $9 million, and an increase in other assets and liabilities of $4 million.
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Investing Activities
For the year ended December 31, 2021, cash used in investing activities was $503 million, which was the result of purchases of marketable securities of $469 million, cash paid for a business combination of $26 million, purchases of property and equipment of $12 million, and cash outflows for capitalized software of $7 million. These cash outflows were partially offset by proceeds from sales and maturities of marketable securities of $10 million and $1 million of other items.
For the year ended December 31, 2020, cash used in investing activities was $36 million, which consisted of purchases of property and equipment of $28 million and cash outflows for capitalized software of $8 million.
Financing Activities
For the year ended December 31, 2021, cash provided by financing activities was $759 million, which consisted of proceeds from our IPO of $950 million, payment of previously deferred offering costs of $5 million, changes in customer funds obligations of $24 million, proceeds from the exercises of stock options and common stock warrants of $21 million and $3 million, respectively, proceeds received from early exercise of stock options and corresponding issuance of restricted stock of $10 million, and proceeds from other financing activities of $1 million, partially offset by the repayment of our convertible notes of $245 million.
For the year ended December 31, 2020, cash provided by financing activities was $594 million, which consisted of proceeds from the issuance of Series F convertible preferred stock, net of issuance costs, of $402 million, proceeds from the issuance of convertible notes of $195 million, $3 million from the exercise of stock options, and the change in customer funds obligations of $4 million, partially offset by repayments of secured borrowings of $9 million, and the redemption of Series B convertible preferred stock of $1 million.
Debt
Credit Facilities
In March 2019, we entered into a senior secured credit facility, or the 2019 Facility, which included a revolving line of credit equal to $100 million. Loans under this agreement accrued interest at a per annum rate of, at our election, LIBOR plus 3.00% or the base rate plus 2.00%. Interest was payable in arrears quarterly, in the case of base rate loans, and at the end of the applicable interest period (but not less frequently than three months) in the case of LIBOR loans. The 2019 Facility was subject to certain financial covenants, including maximum total net debt to recurring revenue ratio, maximum senior net debt to recurring revenue ratio, minimum liquidity and minimum last quarter annualized recurring revenue. As of December 31, 2020, no amount was drawn and outstanding under this credit facility; however, $14 million of letters of credit were outstanding, which reduced the amount available under this credit facility to $86 million. On June 8, 2021, the 2019 Facility and all commitments thereunder were terminated. There were no amounts outstanding under the 2019 Facility.
On June 8, 2021, we entered into a senior secured credit facility, or the 2021 Facility, which includes a revolving line of credit equal to $330 million. Interest on outstanding loans under the revolving line of credit is determined based on loan type and accrues at an annual rate, as defined in the agreement, of: (a) LIBO Rate multiplied by the Statutory Reserve Rate, plus 1.50% per annum; or 0.5% per annum plus the highest of: (i) the Prime Rate, (ii) the Federal Reserve Bank of New York Rate plus 0.5%, or (iii) the Adjusted LIBO Rate plus 1.00%. Subsequent to December 31, 2021, interest on outstanding loans will be accrued based on Secured Overnight Financing Rate, or SOFR. The 2021 Facility is subject to a minimum liquidity covenant of $250 million. As of December 31, 2021, no amount was drawn and outstanding under the 2021 Facility which had $330 million available for borrowings. As of December 31, 2021, there were $13 million of letters of credit outstanding.
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Convertible Notes
On June 19, 2020, we issued $200 million in aggregate principal amount of senior unsecured convertible promissory notes, or the convertible notes, pursuant to the Senior Unsecured Convertible Promissory Note Purchase Agreement between us and investors party thereto. We received net proceeds of $195 million, net of a $5 million original issue discount and certain legal fees. The convertible notes bore interest at a rate of 8.5% per annum, 50% of which was payable in cash and the other 50% of which was payable in kind. Unless earlier converted or redeemed, the convertible notes were scheduled to mature on June 19, 2027.
As a result of entering into the 2021 Facility, we became obligated to prepay or redeem the convertible notes, which were prepaid on June 21, 2021. We prepaid all of the outstanding convertible notes with a carrying amount of $183 million, including principal and accrued interest, net of an unamortized discount, for an aggregate cash amount of $249 million, or the Optional Prepayment, which included an applicable redemption premium. In connection with the Optional Prepayment, we issued warrants to purchase 8,113,585 shares of our Class B common stock to the registered holders of the convertible notes, with an exercise price of $17.51 per share.
Contractual Obligations and Commitments and Off-Balance Sheet Arrangements
As of December 31, 2021, our contractual obligations consisted of: (i) operating lease commitments of $108 million, of which $22 million is due in 2022 and $86 million is due thereafter, and (ii) purchase commitments of $315 million, a majority of which are due in 2022. Please refer to Note 12, "Lessee Arrangements" and Note 23, "Commitments and Contingencies" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for a discussion on our lease and purchase commitments.
Please refer to Note 9, "Loan Servicing Activities" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for discussion of credit exposure related to our financial guarantees as of December 31, 2021.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the balance sheet date, as well as reported amounts of revenue and expenses during the reporting period. Our most significant estimates and judgments are related to revenue recognition, allowance for credit losses, allowances for uncollectible loans, loan servicing assets, business combinations and other acquired intangible assets, stock-based compensation expense, and common stock and derivative liabilities valuation. Actual results may differ from these estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected.
We believe that the accounting policies described below involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical in fully understanding and evaluating our financial condition and results of operations. For further information, see Note 2, "Summary of Significant Accounting Policies" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K.
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Revenue Recognition
Effective on January 1, 2020, we adopted ASU 2014-09, Revenue from Contracts with Customers, or ASC 606, or Topic 606, using the modified retrospective method of transition. Modified retrospective adoption requires entities to apply the standard retrospectively to the most current period presented in the financial statements, requiring the cumulative effect of the retrospective application as an adjustment to the opening balance of retained earnings at the date of initial application. Accordingly, results for reporting periods beginning after January 1, 2020 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic revenue recognition methodology under ASC 605, Revenue Recognition.
We applied ASC 606 to all contracts that were effective and not complete as of January 1, 2020. Under the guidance of ASC 606, revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In order to achieve this core principle, we applied the following five steps:
1.Identify the contract(s) with a customer.
2.Identify the performance obligations in the contract.
3.Determine the transaction price.
4.Allocate the transaction price to the performance obligations in the contract.
5.Recognize revenue as the entity satisfies a performance obligation.
During the years ended December 31, 2021, 2020, and 2019, we generated revenue through four revenue streams, including: (1) subscription services, (2) financial technology solutions, (3) hardware, and (4) professional services. Our contracts often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately as opposed to being combined may require significant judgment. We allocate total arrangement consideration at the inception of an arrangement to each performance obligation using the relative selling price allocation method based on each distinct performance obligation’s standalone selling price, or SSP. Judgment is required to determine the SSP for each distinct performance obligation. We determined the SSP for hardware and professional services revenue using an adjusted market assessment approach which analyzes discounts provided to similar customers based on customer category and size. SSP for subscription services revenue was established using the adjusted market approach considering relevant information, such as current and new customer pricing, renewal pricing, competitor information, market trends, and market share for similar services. SSP for financial technology solutions revenue was determined using our own standalone sales data.
Business Combinations
The purchase price of an acquisition is allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition dates. The excess of total consideration over the fair values of the assets acquired and the liabilities assumed is recorded as goodwill. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever occurs first, any subsequent adjustments would be recorded in the Consolidated Statements of Operations.
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Stock-Based Compensation Expense
We grant equity awards, including stock options which vest upon the satisfaction of a service condition and restricted stock units, or RSUs, which vest upon the satisfaction of a performance condition and/or a service condition. We account for stock-based compensation expense related to equity awards in accordance with ASC 718, Compensation—Stock Compensation.Stock-based awards are measured at fair value on the grant date and compensation cost recognized over the service period, net of estimated forfeitures.Compensation cost is recognized on a straight-line basis for stock options and RSUs, and on an accelerated attribution basis for awards with a performance condition for each separately vesting portion of the award over the applicable vesting period. We use the Black-Scholes option-pricing model to determine the estimated fair value of stock option awards. We estimate a forfeiture rate to calculate the stock-based compensation expense for the awards based on an analysis of actual historical experience and expected employee attrition rates.
Our stock option program allows for early exercise of all granted options before vesting requirements have been satisfied. Shares acquired through the early exercise of options which have not vested at the time of an employee’s termination may be purchased by us at the lower of the original exercise price or the then current fair value.
Fair Value of Common Stock
Prior to our IPO, the fair value of our common stock was determined by our Board of Directors, with the assistance of management, as there was no public market for the underlying common stock. Our Board of Directors determined the fair value of our common stock by considering a number of objective and subjective factors, such as contemporaneous third-party valuations of our common stock, the valuation of comparable companies, sales of our common and redeemable convertible preferred stock to outside investors in arms-length transactions, our operating and financial performance, the lack of marketability, and the general and industry specific economic outlook, amongst other factors. After the completion of the IPO, the fair value of our Class A common stock is determined based on the New York Stock Exchange, or NYSE, closing price on the date of grant.
There is inherent uncertainty in these estimates and, if we had made different assumptions than those described, the fair value of the underlying common stock and amount of our stock-based compensation expense, net loss, and net loss per share amounts would have differed.
Goodwill and Intangible Assets
Goodwill represents the excess of purchase price over the fair value of net tangible and identifiable intangible assets of the businesses acquired by us. Goodwill is tested for impairment annually or more often if impairment indicators are present. We determined we are comprised of one reporting unit as of December 31, 2021 and 2020. We performed our annual quantitative goodwill impairment test as of December 31, 2021 and determined that no adjustment to goodwill was necessary because the reporting unit’s fair value significantly exceeded its book value. There were no goodwill impairment losses recognized during the years ended December 31, 2021, 2020 and 2019.
Our intangible assets consist of finite-lived acquired technology, trade names, and customer relationships assets. Intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods deemed appropriate for the type of intangible asset acquired, and reported net of accumulated amortization, separately from goodwill. All intangible assets are amortized over their estimated useful lives. We evaluate on an ongoing basis the remaining estimated useful life of the intangible assets being amortized to determine whether events and circumstances warrant a revision to the remaining amortization period. The amortization periods for acquired technology, customer relationships intangible assets, and acquired trade names are 3 to 10 years, 6 years, and 1.5 years, respectively.
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Operating Leases
We enter into operating lease arrangements for real estate office space. We determine at contact inception whether an arrangement represents or contains a lease by evaluating various factors, including whether the arrangement conveys the right to control the use of the identified asset in exchange for consideration. Lease classification is determined at the lease commencement date, which is the date the leased assets are made available for use. Operating leases are included in "Operating lease right-of-use-assets" (ROU assets), "Operating lease liabilities," and "Operating lease liabilities, non-current" in the Consolidated Balance Sheets.
ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. Right of use assets are recorded net of any lease incentives received from a lessor. Lease liabilities are calculated as the present value of fixed payments over the lease term, including periodic fixed rent increases and excluding any lease incentives paid or payable to us by a lessor. Lease payments are discounted to present value using our estimated incremental borrowing rate, because a readily determinable implicit rate is not available. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. We account for lease components and non-lease components as a single lease component for each class of underlying assets. Variable payments consist primarily of payments for maintenance, utilities, and management fees. Variable payments included in lease arrangements are expensed as incurred and excluded from the right of use assets and lease liabilities.
Lease term includes the non-cancelable term, renewal options that extend the lease and are reasonably certain to be exercised, and options to terminate the lease before the end of its non-cancelable term that are not reasonably certain to be exercised. We do not record right-of-use assets and lease liabilities for leases with an initial term of 12 months or less and recognize lease expense on a straight-line basis over the lease term.
Convertible Notes
Upon the issuance of the convertible notes in June 2020, we identified and assessed the embedded features in accordance with the accounting guidance for debt with conversion and other options. We concluded that certain features including conversion and redemption features and contingently issuable warrants, were not clearly and closely related to the convertible notes and met the definition of a derivative. Therefore, we bifurcated and separately accounted for these features. We estimated the fair value of the derivative liability on the issuance date and deducted the fair value from the carrying value of the convertible notes. The fair value of the derivative was recorded in Long-term liabilities in the Consolidated Balance Sheets.
We allocated the transaction costs related to the convertible notes and bifurcated derivatives using the same proportion as the allocation of the related proceeds. The transaction costs attributable to the convertible notes were recorded as a direct deduction from the debt liability along with original issue discount and amortized to interest expense over the term of the convertible notes. The transaction costs attributable to the bifurcated derivatives were expensed as incurred. We were accreting the carrying value of the convertible notes to the principal amount along with the 15% exit fee payable at maturity as interest expense using the effective interest method over the term of the convertible notes. On June 21, 2021, we prepaid all of the then outstanding convertible notes, including principal and accrued interest, net of an unamortized discount, as an optional prepayment for an aggregate cash amount of $249 million which included an applicable redemption premium. The bifurcated derivative liability and contingently issuable warrants were adjusted to their then fair value at each reporting period and on the convertible notes’ settlement date with the change in the fair value recorded in "Change in fair value of derivative liability" in the Consolidated Statements of Operations.
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Recent Accounting Pronouncements
Refer to the sections titled “Basis of Presentation” in Note 1 and “Recently Adopted Accounting Pronouncements” and “Recently Issued Accounting Pronouncements” in Note 2 of the Notes to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for more information.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We have operations in the United States, Ireland, India, and we are exposed to market risks in the ordinary course of our business. These risks primarily include interest rate and foreign currency exchange risks.
Interest Rate Sensitivity
We are exposed to interest rate risk related primarily to our investment portfolio. Changes in interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the fair value of those securities. We had cash and cash equivalents of $809 million and marketable securities of $457 million as of December 31, 2021. Our cash and cash equivalents are held primarily in cash deposits and money market funds, and the securities are considered investment-grade debt securities and classified as available-for-sale. The securities are recorded at fair value in the Consolidated Balance Sheets with unrealized gains or losses, net of tax, reported as a separate component of stockholders' equity (deficit) within "Accumulated other comprehensive loss." The primary objective of our investment activities is to preserve capital and meet liquidity requirements without significantly increasing risk. We do not enter into investments for trading or speculative purposes.
Based on our investment portfolio balance as of December 31, 2021, a hypothetical 100 basis point increase in interest rates would not have materially affected our financial position. We do not expect that any change in prevailing interest rates will have a material impact on our results of operations.
Foreign Currency Risk
Most of our sales and operating expenses are denominated in U.S. dollars, and therefore, neither our revenue nor operating expenses are currently subject to significant foreign currency risk. A portion of our operating expenses are denominated in Euros and Indian rupee and may be subject to fluctuations due to changes in foreign currency exchange rates. Fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our results of operations. To date, foreign currency transaction gains and losses have not been material to our results of operations, and we have not engaged in any foreign currency hedging transactions.
Credit Risk
We are exposed to credit risk on accounts receivable and our loan servicing activities. This risk is mitigated due to our diverse customer base, dispersed over various geographic regions. During the years ended December 31, 2021, 2020, and 2019, we had no customers that accounted for more than 10% of our total revenue. No customers accounted for more than 10% of our total receivables at December 31, 2021 and 2020. We maintain provisions for potential credit losses and evaluate on an ongoing basis the solvency of our customers and the impact of current and future conditions to determine if additional allowances for credit losses need to be recorded.
Inflation Risk
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the lack of precise estimates, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial. We cannot assure you our business will not be affected in the future by inflation.
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Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Page
Report of Independent Registered Public Accounting Firm 92
Consolidated Financial Statements
Consolidated Balance Sheets for the years ended December 31, 2021 and 2020 94
Notes to Consolidated Financial Statements 102
Financial Statement Schedule
91
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Toast, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Toast, Inc. (the Company) as of December 31, 2021 and 2020, the related consolidated statements of operations, comprehensive loss, convertible preferred stock and stockholders’ deficit and cash flows for the years then ended, and the related notes and financial statement schedule listed in Item 15(b) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021, 2020 and 2019, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
Adoption of New Accounting Standard
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for leases in 2021.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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Stock-Based Compensation Expense
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2019.
Boston, Massachusetts
March 1, 2022
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TOAST, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except shares and per share values)
December 31,
Assets:
Current Assets:
Cash and cash equivalents $ 809 $ 582
Marketable securities 457 —
Accounts receivable, net 55 33
Deferred costs, net 30 17
Prepaid expenses and other current assets 92 22
Property and equipment, net 41 44
Operating lease right-of-use assets 79 —
Intangible assets 16 7
Restricted cash 8 1
Deferred costs, non-current 25 12
Security deposits 1 2
Other non-current assets 6 1
Total non-current assets 250 103
Liabilities, Convertible Preferred Stock and Stockholders’ Deficit
Current liabilities:
Accounts payable $ 40 $ 30
Operating lease liabilities 22 —
Deferred revenue 44 43
Accrued expenses and other current liabilities 246 63
Total current liabilities 352 136
Long-term debt — 172
Derivative liabilities — 37
Warrants to purchase preferred stock — 11
Warrants to purchase common stock 181 —
Deferred revenue, non-current 12 16
Operating lease liabilities, non-current 77 —
Deferred rent, non-current — 19
Other long-term liabilities 22 7
Commitments and Contingencies (Note 23)
Stockholders’ Equity (Deficit):
94
Accumulated other comprehensive loss (1) —
Additional paid-in capital 2,194 145
Total stockholders’ equity (deficit) 1,091 (471)
The accompanying notes are an integral part of these consolidated financial statements.
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TOAST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except shares and per share amounts)
Year Ended December 31,
Revenue:
Costs of revenue:
Amortization of acquired technology and customer assets 4 4 2
Operating expenses:
Other income (expense):
Interest income — 1 2
Interest expense (12) (13) —
Change in fair value of warrant liability (97) (8) (1)
Change in fair value of derivative liability (103) (7) —
Loss on debt extinguishment (50) — —
Other income (expense), net — (1) —
Loss before income taxes benefit (490) (248) (212)
Benefit from income taxes 3 — 3
Redemption of Series B Preferred — (1) —
Net loss attributable to common stockholders $ (487) $ (249) $ (209)
The accompanying notes are an integral part of these consolidated financial statements.
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TOAST, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in millions)
Year Ended December 31,
Other comprehensive loss:
Unrealized losses on marketable securities, net of tax effect of $0 (1) — —
Total other comprehensive loss (1) — —
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TOAST, INC.
CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)
(in millions, except shares)
Shares Amount Shares Amount Shares Amount
Repurchase of common stock — — (111,375) — — — — — — —
Issuance of Series E preferred stock 45,788,025 250 — — — — — — — —
Exercise of common stock options — — 17,459,435 — — — 1 — — 1
Stock-based compensation expense — — — — — — 33 — — 33
Net loss — — — — — — — (209) — (209)
Cumulative adjustment due to adoption of ASC 606 — — — — — — — 18 — 18
Repurchase of common stock — — (1,011,880) — 25,000 — — — — —
Redemption of Series B preferred stock (77,270) — — — — — (1) — — (1)
Issuance of Series F preferred Stock 44,301,220 403 — — — — — — — —
Issuance cost of Series F preferred stock — (1) — — — — — — — —
Exercise of common stock options — — 5,865,910 — — — 4 — — 4
Stock-based compensation expense — — — — — — 86 — — 86
Net loss — — — — — — — (248) — (248)
98
Shares Amount Shares Amount Shares Amount
Cumulative adjustment due to adoption of ASC 842 and ASC 326 — — — — — — — 1 — 1
Repurchase of common stock — — (35,665) — — — — — — —
Exercise of common stock options — — 6,307,785 — — — 7 — — 7
Vesting of restricted stock — — — — — — 4 — — 4
Stock-based compensation expense (1) — — — — — — 141 — — 141
Charitable contribution stock-based expense — — 546,889 — — — 19 — — 19
Unrealized loss on marketable securities — — — — — — — — (1) (1)
Net loss — — — — — — — (487) — (487)
The accompanying notes are an integral part of these consolidated financial statements.
(1)During the year ended December 31, 2021, stock-based compensation expense recorded within additional paid-in capital does not include $2 of expense recognized as a result of the acquisition of xtraCHEF due to accelerated vesting of acquiree option awards on the acquisition date (see Note 3).
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TOAST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Year Ended December 31,
Cash flows from operating activities:
Depreciation and amortization 21 27 7
Stock-based compensation expense 140 86 34
Amortization of deferred costs 30 15 —
Change in fair value of derivative liability 103 7 —
Change in fair value of warrant liability 97 8 1
Change in deferred income taxes (3) — (3)
Loss on debt extinguishment 50 — —
Credit loss expense 4 — —
Non-cash interest on convertible notes 12 8 —
Charitable contribution stock-based expense 19 — —
Change in fair value of contingent consideration 3 — —
Other non-cash items 2 — —
Changes in operating assets and liabilities:
Account receivable, net (23) (13) (4)
Merchant cash advances made — — (22)
Merchant cash advances repaid 1 9 13
Prepaid expenses and other current assets (45) 18 (24)
Deferred costs, net (56) (25) —
Inventories (23) (4) (7)
Operating lease right-of-use assets 16 — —
Accounts payable 15 (6) 15
Accrued expenses and other current liabilities 145 (3) 22
Deferred revenue (2) (8) 23
Operating lease liabilities (16) — —
Other assets and liabilities (1) 4 28
Net cash provided by (used in) operating activities 2 (125) (126)
Cash flows from investing activities:
Cash paid for acquisition, net of customer funds obligations assumed (26) — (41)
Customer funds obligations assumed in acquisition — — 8
Capitalized software (7) (8) (6)
Purchases of property and equipment (12) (28) (9)
Purchase of marketable securities (469) — —
Proceeds from the sale of marketable securities 5 — —
Maturities of marketable securities 5 — —
Other 1 — 1
Net cash used in investing activities (503) (36) (47)
Cash flows from financing activities:
Payment of deferred offering costs (5) — —
Proceeds from secured borrowings — — 10
Repayments of secured borrowings — (9) (3)
Extinguishment of convertible notes (245) — —
Change in customer funds obligations, net 24 4 (2)
Proceeds from issuance of long-term debt — 195 —
Proceeds from exercise of stock options 21 3 —
Proceeds from issuance of restricted stock 10 — 1
Proceeds from issuance of Series E and Series F Preferred — 402 250
Redemption of Series B Preferred — (1) —
100
Proceeds from exercise of common stock warrants 3 — —
Other proceeds from financing activities 1 — —
Net cash provided by financing activities 759 594 256
Cash held on behalf of customers 34 11 7
Restricted cash 8 1 2
Supplemental disclosure of cash flow information
Cash paid for interest $ 13 $ 5 $ —
Supplemental disclosure of non-cash investing and financing activities:
Common stock issued in acquisition 15 — 3
Contingent consideration for acquisition included in purchase price 2 — —
Deferred payment included in purchase price 5 — —
Issuance of Class B common stock upon exercise of common stock warrants 56 — —
Issuance of common stock warrants upon debt extinguishment 125 — —
Deferred offering costs included in accounts payable and accrued expenses 1 — —
Stock-based compensation expense included in capitalized software 1 — —
The accompanying notes are an integral part of these consolidated financial statements.
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TOAST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in millions, except share and per share amounts)
1.Description of Business and Basis of Presentation
Toast ("we," or the “Company”), is a cloud-based all-in-one digital technology platform purpose-built for the entire restaurant community. Our platform provides a comprehensive suite of software as a service, or 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.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP, and the rules and regulations of the Securities and Exchange Commission, or SEC. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
As a result of our Initial Public Offering, or IPO, exemptions previously available to us as an Emerging Growth Company as defined in the Jumpstart Our Business Startups Act were no longer available as of December 31, 2021. Accordingly, we adopted Accounting Standards Update, or ASU, 2016-02, Leases, or ASC 842, and ASU 2016-13, 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, or ASC 326 retroactive to January 1, 2021. Our Consolidated Financial Statements for comparative periods have not been recast.
Additionally, we adopted ASU 2014-09, Revenue from Contracts with Customers, or ASC 606, on a modified retrospective basis effective January 1, 2020.
Risks and Uncertainties
We are subject to a number of risks common to emerging, technology-based companies, including a limited operating history; dependence on key individuals; rapid technological changes; competition from substitute products and larger companies; the successful development, marketing, and outsourced manufacturing of our products and services, as well as the impact of the novel coronavirus disease, or COVID-19, on the restaurant industry.
Initial Public Offering
On September 24, 2021, we completed our IPO where we 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 an additional 3,260,869 shares. We received net proceeds of $944 after deducting underwriting discounts and commissions and other offering costs.
Immediately prior to the completion of our IPO, 253,832,025 shares of convertible preferred stock were automatically converted into an equal number of shares of Class B common stock, and 1,002,035 warrants to purchase shares of Series B and Series C convertible preferred stock were automatically exchanged or became exercisable for the same number of shares of Class B common stock.
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In connection with and on the date of the IPO, we filed an amended and restated certificate of incorporation (the “Restated Certificate”) with the Secretary of State of the State of Delaware. The Restated Certificate amended and restated our certificate of incorporation in its entirety, and, among other things: (i) authorized 7,000,000,000 shares of Class A common stock; (ii) authorized 700,000,000 shares of Class B common stock; (iii) authorized 100,000,000 shares of undesignated preferred stock that may be issued from time to time by the Board of Directors, or the Board, in one or more series; and (iv) eliminated all references to the previously-existing series of preferred stock. Upon completion of our IPO, each share of issued and outstanding common stock automatically converted into one share of Class B common stock.
Each share of Class A common stock entitles the holder to one vote per share and each share of Class B common stock entitles the holder to ten votes per share on all matters submitted to a vote of stockholders. Holders of Class A common stock and Class B common stock are entitled to receive dividends, when and if declared by the Board. In addition, each share of Class B common stock will convert automatically into a share of Class A common stock on the earlier of (i) seven years from the date of the filing of the Restated Certificate, or (ii) the date the holders of at least two-thirds of our outstanding Class B common stock elect to convert the Class B common stock to Class A common stock.
Stock Split
On September 9, 2021, our Board and stockholders approved a 5-for-1 stock-split of our common stock and convertible preferred stock which became effective shortly thereafter. Accordingly, all shares of common stock and per share amounts, the conversion ratio of the then outstanding convertible preferred stock, the number of shares of common stock into which each outstanding option and warrant to purchase common stock is exercisable, the exercise prices of each option and warrant, as well as the number of shares of common stock that will be issued when each outstanding RSU vests have been proportionately adjusted on a 5-for-1 basis. All share and per share data shown in the accompanying consolidated financial statements and related notes have been retroactively revised to reflect the stock split.
Impact of COVID-19
Since early 2020, changes in consumers' behavior and government-imposed restrictions because of the COVID-19 pandemic have impacted restaurants in various ways, including limiting service to takeout orders for a period of time or reducing capacity to accommodate social distancing recommendations. The extent of the impact of the COVID-19 pandemic over the longer term remain uncertain and will depend largely on future developments that cannot be accurately predicted at this time, including the duration and the spread of the pandemic both globally and within the United States, the introduction and severity of new variants of the virus and their resistance to currently approved vaccines, as well as the potential negative impact these and other factors may have on the restaurant industry and our business.
We considered the potential effects of the COVID-19 pandemic on our consolidated financial statements and the carrying amounts of assets or liabilities as of December 31, 2021 and 2020. During the year ended December 31, 2021, we partially terminated the lease for one of our office facilities. The lease termination penalty of $3 is payable in monthly installments through 2029. We recognized a loss of $1 resulting from the lease termination and $1 of write offs on certain leasehold improvements and other property as a result of exiting the leased space.
During 2020, we terminated leases for two office facilities and recognized a liability of $17 for lease termination costs, resulting in a loss of $3. Lease termination costs of $10 were paid up front, with the remaining balance payable in monthly installments through 2026. A liability related to lease termination fees was $7 as of December 31, 2020. In addition, we recognized $16 of accelerated depreciation on certain leasehold improvements and other property and equipment as a result of exiting the leased space. Depreciation expense was accelerated prospectively for the year ended December 31, 2020 based on the new remaining useful life of the related assets.
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Additionally, during 2020 we completed a significant reduction in workforce, pursuant to which we incurred severance costs of $10 and stock-based compensation expense of $3 in connection with the modification of previously issued employee stock option awards. In addition to the restructuring liabilities described above, we also engaged in efforts to reduce operating expenses and took other measures to reduce discretionary spending while conditions remained uncertain for the restaurant industry.
Reclassifications
Certain amounts in prior period financial statements have been reclassified to conform to the current period presentation. None of the reclassifications materially affected previously reported amounts.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates, judgements and assumptions that can affect the reported amounts of assets and liabilities, and disclosure of contingent liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the result of which forms the basis for making judgments.
Estimates, judgments, and assumptions in these consolidated financial statements include, but are not limited to, those related to revenue recognition, allowance for credit losses, liabilities associated with financial guarantees (contingent liabilities for credit losses and non-contingent stand-ready liabilities), negative allowances for expected recoveries on repurchased loans, allowances for uncollectible loans, allowance for excessive and obsolete inventory, reserves for warranties on hardware sold, incremental borrowing rates applied in valuation of lease liabilities, reserves for sales returns, fair values of assets acquired and liabilities assumed through business combinations, useful lives of assets acquired in business combinations, stock-based compensation expense, warrants, convertible debt, debt derivatives and common stock valuation, as well as amortization period for deferred contract acquisition costs.
Fair Value Measurements
Certain assets and liabilities are carried at fair value under U.S. GAAP. These include cash and cash equivalents, marketable securities, warrants to purchase common and preferred stock, contingent consideration liability, non-contingent stand-ready liabilities, and convertible debt-related derivative liabilities. Assets and liabilities measured at fair value on a nonrecurring basis include assets acquired and liabilities assumed in business combinations. Other financial assets and liabilities are carried at cost with fair value disclosed, if required.
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:
•Level 1—Quoted prices in active markets for identical assets or liabilities.
•Level 2—Observable inputs (other than Level 1 quoted prices), such as quoted prices in active markets for similar assets or liabilities, quoted prices in markets that are not active for identical or similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data.
•Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to determining the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques.
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Fair values of our warrants to purchase common and preferred stock, convertible debt-related derivative liabilities, and contingent consideration liability related to our acquisition of xtraCHEF are determined using Level 3 inputs in the fair value hierarchy described above. The fair value of our marketable securities is determined based on quoted market prices of similar assets and classified as Level 2 within the fair value hierarchy. (See Note 4). The carrying values of accounts receivable, merchant cash advances receivable, accounts payable, and accrued expenses approximate their fair values due to their short-term nature.
We record a non-contingent liability which represents a financial guarantee related to our obligation to stand-ready to repurchase delinquent or defaulted loans which we service through the Toast Capital loan program (please refer to Note 9, “Loan Servicing Activities,” for further information). A non-contingent liability is recorded at fair value as loans are originated and amortized on a straight-line basis over the expected obligation term, which ranges from 90 to 270 days, or derecognized into results of operations if we repurchase the loan. The fair value of the non-contingent liability is measured based on a discounted cash flow model under the income approach. The fair value of the non-contingent liability reflects various inputs and assumptions, including the probability and amount of payments to be made under the guarantee based on probabilities of loan defaults and delinquency, as well as associated losses, and a discount rate reflecting our credit risk as the guarantor. The fair value measurement of the non-contingent liability is based on significant inputs not observable in the market and thus represents a Level 3 measurement within the fair value hierarchy.
Foreign Currency Translation
The functional currency of our foreign subsidiaries is the local currency. The assets and liabilities of foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at the Consolidated Balance Sheet date. Revenue and expenses are translated using the average exchange rates during the period. Equity transactions are translated using historical exchange rates. Exchange-rate differences resulting from translation adjustments are accounted for as a component of accumulated other comprehensive loss. Foreign currency transaction gains and losses are included in "Other income (expense), net" in the Consolidated Statements of Operations for the period.
Concentration of Credit Risk and Significant Customers
Financial instruments that subject us to significant concentrations of credit risk primarily consist of cash deposits and cash equivalents, marketable securities, and accounts receivable. We maintain substantially all of our cash deposits and cash equivalents with primarily one financial institution, which, at times, may exceed federally insured limits. We have not incurred any losses associated with this concentration of deposits. Marketable securities consist of highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate debt securities, mortgage-backed securities, and asset-backed securities. Our investment policy provides guidelines and limits regarding investment type, concentration, credit quality, and maturity aimed at maintaining sufficient liquidity to satisfy operating and working capital requirements along with strategic initiatives, preserving capital, and minimizing risk of capital loss while generating returns on our investments.
Accounts receivable are typically unsecured. We regularly monitor the creditworthiness of our customers and believe that we have adequately provided for exposure to potential credit losses. During the years ended December 31, 2021, 2020, and 2019, we had no customers that accounted for more than 10% of our total revenue. No customers accounted for more than 10% of our total receivables as of December 31, 2021 or 2020.
We have third-party automated clearing houses acquiring processors that represented substantially all deposits in transit as of December 31, 2021 and 2020.
Segment Information
Our operations constitute a single operating segment. Operating segments are defined as components of an enterprise for which discrete financial information is available and is evaluated regularly by the chief operating decision maker, or CODM, in deciding how to allocate resources and assess performance. Our CODM is our Chief Executive Officer who reviews financial information presented on a consolidated basis for the purposes of allocating resources and evaluating financial performance.
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Revenue Recognition
During the years ended December 31, 2021, 2020, and 2019, we generated four types of revenue, including: (1) subscription services from our SaaS products, (2) financial technology solutions, including loan servicing activities, (3) hardware, and (4) professional services. Our contracts often include promises to transfer multiple products and services to a customer.
Determining whether products and services are considered distinct performance obligations that should be accounted for separately as opposed to being combined may require significant judgment. We allocate total arrangement consideration at the inception of an arrangement to each performance obligation using the relative selling price allocation method based on each distinct performance obligation’s standalone selling price, or SSP. Judgment is required to determine the SSP for each distinct performance obligation. We 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 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. We allocate all variable fees earned from financial technology services revenue to that distinct performance obligation on the basis that pricing practices for that performance obligation are consistent with the allocation objective under ASC 606.
Customer credits are estimated based on historical experience. The provision for these estimates is recorded as a reduction of revenue and an increase to liabilities at the time that the related revenue is recognized.
We facilitate customers receiving financing from third-party financing firms for hardware, professional services, and the initial SaaS subscription services term. We have partnerships with these third-party financing firms that ultimately decide whether to extend credit to the customers. We pay the equivalent of an early payment discount to the third-party financing partners and recognize the payment as a reduction of revenue, as we believe these costs represent a customer sales incentive. Under our arrangements with the financing firms, we also assume a limited portion of the risk of customer defaults, which prior to the adoption of ASC 326 were accrued upon origination of the financing agreements under ASC 460, Guarantees (ASC 460). Upon adopting ASC 326 effective January 1, 2021, we recognize a contingent guarantee liability for expected credit losses and a non-contingent stand-ready liability related to the financial guarantees in accordance with ASC 460 along with a corresponding non-cash charge recorded as "General and administrative" expense in the Consolidated Statements of Operations. Costs incurred to date under such guarantees have not been material.
Subscription Services
Subscription services revenue is generated from fees charged to customers for access to our software applications. 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. The performance obligation is satisfied ratably over the contract period as the service is provided, commencing when the subscription service is made available to the customer. Our contracts with customers are generally for a term ranging from 12 to 36 months. Amounts invoiced in excess of revenue recognized represent deferred revenue.
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Financial Technology Solutions
Financial technology solutions revenue includes transaction-based payment processing services for customers which are charged a transaction fee for payment-processing. This transaction fee is generally calculated as a percentage of the total transaction amount processed plus a fixed per-transaction fee, which is earned as transactions are authorized and submitted for processing. We incur costs of interchange and network assessment fees, processing fees, and bank settlement fees to the third-party payment processors and financial institutions involved in settlement, which are recorded as costs of revenues. We satisfy our payment processing performance obligations and recognize the transaction fees as revenue upon authorization by the issuing bank and submission for processing. The transaction fees collected are recognized as revenue on a gross basis as we are the principal in the delivery of the managed payments solutions to the customers.
We have concluded that we are the principal in this performance obligation to provide 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. We generally have full discretion in setting prices charged to the customers. Additionally, we are obligated to comply with certain payment card network operating rules and contractual obligations under the terms of out registration as a payment facilitator and as a master merchant under our third-party acquiring payment processor agreements which make us liable for the costs of processing the transactions for our customers and chargebacks and other financial losses if such amounts cannot be recovered from the restaurant.
Financial technology solutions revenue is recorded net of refunds and reversals initiated by the restaurant and are recognized upon authorization by the issuing bank and submission for processing. We allocate all variable fees earned from transaction-based revenue to this performance obligation on the basis that it is consistent with the ASC 606 allocation objectives.
Financial technology solutions revenue also includes fees earned from marketing and servicing working capital loans to customers through our wholly-owned subsidiary, Toast Capital, that are originated by a third-party banking partner. We believe Toast Capital is uniquely qualified to underwrite and competitively price loans that range from $5 thousand to $250 thousand to eligible Toast customers by using patented systems for loan origination that incorporate historical POS data and payment processing volume. 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 to our bank partner until the loan is paid back. Toast Capital earns fees for the underwriting and marketing of loans, which are recognized upon origination of the loan, and loan servicing fees, based on a percentage of each outstanding loan, which are recognized as servicing revenue as the servicing is delivered in accordance with ASC 860, Transfers and Servicing. Servicing revenue is adjusted for the amortization of servicing rights carried at amortized cost. The marketing and facilitation fees earned upon execution of these loan agreements with its customers are recognized as revenue on a gross basis. Similar to the limited guarantee we provide in third-party financing arrangements described above, we also provide limited guarantees to our bank partner for customer defaults. We recognize a contingent guarantee liability for expected credit losses and a non-contingent stand-ready liability related to this financial guarantee in accordance with ASC 460 along with a corresponding non-cash charge recorded as "General and administrative" expense in the Consolidated Statements of Operations.
Hardware
Hardware revenue is generated from the sale of terminals, tablets, handhelds, and related devices and accessories, net of estimated returns. We invoice end-user customers upon shipment of the products. Revenue for hardware sales is recognized at the point in time at which the transfer of control occurs in accordance with agreed upon shipping terms, satisfying the performance obligation. We accept returns for hardware sales and recognize them at the time of the sale as a reduction of transaction price based on historical experience.
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Professional Services
Professional services revenue is generated from fees charged to customers for installation services, including business process mapping, configuration, and training. Professional services are sold separately. Amounts invoiced in advance are recorded as deferred revenue. The duration of providing professional services to the customer is relatively short and completed in a matter of days. The performance obligation for professional services is considered to be satisfied upon the completion of the installation.
Cash, Cash Equivalents, Cash Held on Behalf of Customers and Restricted Cash
We define cash and cash equivalents as highly liquid investments with original maturities of 90 days or less at the time of purchase that are readily convertible to known amounts of cash. As of December 31, 2021 and 2020, our cash and cash equivalents consisted primarily of cash held in checking and money market accounts as well as marketable securities with an original maturities of 90 days or less.
Cash held on behalf of customers represents an asset that is restricted for the purpose of satisfying obligations to remit funds to various tax authorities to satisfy customers’ payroll, tax and other obligations. Cash held on behalf of customers is included within "Prepaid expenses and other current assets," and the corresponding customer funds obligation is included within "Accrued expenses and other current liabilities" on our Consolidated Balance Sheets.
Restricted cash represents cash held with commercial lending institutions. The restrictions are related to cash collateralized letters of credit to cover potential customer defaults on third-party financing arrangements, and cash held as collateral pursuant to an agreement with the originating third-party bank for the working capital loans serviced by Toast Capital (See Note 9).
Cash and cash equivalents and restricted cash consisted of the following:
December 31,
Cash and cash equivalents $ 809 $ 582
Cash held on behalf of customers 34 11
Restricted cash 8 1
Marketable Securities
Our marketable securities are classified as available-for-sale. We classify our marketable securities as current assets, including those with maturities greater than 12 months, as they are available for use in current operations or to satisfy other liquidity requirements.
Marketable securities are carried at fair value, and we report unrealized gains and losses as a component of accumulated other comprehensive income, net of tax, until the security is sold or matures, except for changes in allowance for expected credit losses, which are recorded in our results of operations. Gains or losses realized from sales of marketable securities are computed based on the specific identification method and recognized as a component of "Other income (expense), net" in the accompanying Consolidated Statements of Operations.
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Accounts Receivable, net
Accounts receivable, net consisted of the following:
December 31,
Accounts receivable $ 20 $ 5
Unbilled receivables 39 32
Less: Allowance for credit losses (4) (4)
Accounts receivable, net $ 55 $ 33
Our allowance for credit losses was comprised of the following:
Amount
Additions (5)
Write offs 6
Balance as of December 31, 2020 $ (4)
Additions (1)
Write offs 3
Balance as of December 31, 2021 $ (4)
Accounts receivable, net consists of trade accounts receivable and unbilled receivables (which we collectively refer to as accounts receivable), net of an allowance for credit losses. Unbilled receivables represent revenue recognized on a contract in excess of billings. Our payment terms for trade accounts receivable vary by the type of customer and the products or services offered. The term between invoicing and when payment is due is not significant.
We record an allowance for expected credit losses for Accounts Receivable upon the initial recognition of an Accounts Receivable balance in accordance with ASC 326. The allowance for credit losses represents the best estimate of lifetime expected credit losses, based on customer-specific information, historical loss rates and the impact of current and future conditions, including an assessment of customer creditworthiness, historical payment experience and the age of outstanding receivables, Accounts Receivable balances are written off against the allowance for credit losses when we determine that the balances are not recoverable. Provisions for the allowance for expected credit losses are recorded in "General and administrative" expenses in the Consolidated Statements of Operations. We evaluate the allowance for credit losses for the entire portfolio of Accounts Receivable on an aggregate basis due to similar risk characteristics of its customers based on similar industry and historical loss patterns.
Inventory
Inventory, which consists of tablets, printers, and networking equipment, are stated at the lower of cost or net realizable value and are accounted for using the average cost method. We evaluate ending inventory for estimated excess and obsolete inventory based primarily on historical sales levels by product and projections of future demand, as well as the impact of changing product design and technology. We recognize freight, handling costs, and damaged inventory as current-period costs. We recorded provisions for excess and obsolete inventory for the years ended December 31, 2021 and 2020, of $3 and $5, respectively.
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Assets and Liabilities Recorded with Loan Servicing Activities
Capitalized servicing rights are recorded as a component of "Prepaid expenses and other current assets" in the accompanying Consolidated Balance Sheets, and represent rights associated with servicing loans originated by our industrial bank partner to merchant customers. A servicing asset is recognized when benefits of servicing are expected to be greater than adequate compensation for performing servicing by us. No servicing rights are recorded if the amounts earned represent adequate compensation. In determining adequate compensation, we compare its level of compensation to the level of compensation demanded by current market prices.
Servicing rights are initially recorded at fair value. Initial measurement is based on an analysis of discounted cash flows based on assumptions that market participants use to estimate fair value. Subsequently, servicing rights are amortized over the expected period of estimated net servicing income and assessed for impairment.
Amortization of servicing rights is recorded in proportion to and over the period of estimated net servicing income. Resulting amortization expense is recorded as an adjustment to net "Financial technology solutions" revenue on the Consolidated Statements of Operations.
Impairment is recognized through a valuation allowance and a charge to current period earnings if it is considered to be temporary. If circumstances indicate that the likelihood of future recovery of the impaired assets or liability is remote, we directly write-down such assets and relieve the valuation account.
Under the terms of our agreement with our industrial bank partner, we are obligated to repurchase certain loans originated by our industrial banking partner to our customers in cases where the customer's payments on the loan are delayed for a defined period of time, and the loan is considered delinquent.Our obligation is limited to a specified percentage of the total loans originated, measured on a quarterly basis. To the extent we make a repurchase, our obligation with respect to the quarterly cohort of loans from which the defaulted loan originated is reduced. Please refer to "Acquired Loans Receivable, Net" section within this note for information on our accounting for repurchased loans.
This obligation represents a financial guarantee with two aspects: a contingent liability accounted for under ASC 326 related to our contingent obligation to purchase defaulted loans, and a non-contingent liability accounted for under ASC 460related to our obligation to stand-ready to perform under the obligation. As noted above, we adopted ASC 326 effective January 1, 2021 which applies to the contingent component of the guarantee arrangement. We measure a contingent liability for expected credit losses which is based on historical lifetime loss data, as well as macroeconomic forecasts applied to the loan portfolio. Probability of default curves are generated using historical default data for portfolios of guaranteed loans with similar risk characteristics. Loss severity estimates are generated using historical collections data for the loans repurchased by us. Additionally, we apply macroeconomic factors, such as forecasted trends in unemployment rates, which are sourced externally, using a single scenario that we believe is most appropriate to the economic conditions applicable to a particular period. Projected loss rates, inclusive of historical loss data and macroeconomic factors, are applied to the outstanding principal amounts of the guaranteed loans. We may also include qualitative adjustments that incorporate incremental information not captured in the quantitative estimates of its current expected credit losses. The expected term of the loans guaranteed by us typically range from 90 to 270 days, and the reasonable and supportable forecast period we haveincluded in our projected loss rates is approximately 12 months based on externally sourced data.
Contingent liabilities for expected credit losses are recorded as new guaranteed loans get originated, along with a corresponding non-cash charge recorded within "General and administrative" expense in the Consolidated Statements of Operations. We remeasure these contingent liabilities each reporting period and reverse the liability upon loan purchase or upon the expiration of the obligation. We record a non-contingent liability at fair value as loans are originated, with a corresponding charge recorded within "General and administrative" expense in the accompanying Consolidated Statements of Operations. Subsequently, the liability is amortized on a straight-line basis over the expected obligation term, which ranges from 90 to 270 days, and derecognized upon loan repurchase against "General and administrative" expense in the Consolidated Statements of Operations.
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Prior to January 1, 2021, we estimated a single liability related to the financial guarantees which was accounted for as a guarantee under ASC 460 and was recorded as a reduction of net revenue at the time the loans were originated and trued up over the period of repayment.
Please refer to the "Recently Adopted Accounting Pronouncements" section within this note related to the adoption of ASC 326, Note 6, “Merchant Cash Advances Receivable and Acquired Loans Receivable, Net” for additional information on acquired loans receivable, as well as Note 9, “Loan Servicing Activities” for additional information on the liabilities related to the financial guarantees.
Acquired Loans Receivable, Net
As described above, we are obligated to purchase delinquent loans from our industrial bank partner. Such purchases, net of expected recoveries, are recorded as a reduction to our potential liability with respect to the quarterly cohort of loans from which the defaulted loan originated (please see Note 9, "Loan Servicing Activities").
Effective January 1, 2021, we adopted ASC 326, and as a result account for purchased loans in accordance with the guidance for purchased credit deteriorated, or PCD, assets as the loans experienced credit quality deterioration between their origination and purchase.
Because we have an expectation of collecting cash flows at the portfolio level, a negative allowance is established for expected recoveries. We estimate a negative allowance on an undiscounted basis using historical collections data for loans purchased by us and qualitative adjustments that incorporate incremental information not captured in the quantitative estimates of our current expected recoveries. Cash collections related to Acquired Loans Receivable are first applied to the negative allowance balance, and when recoveries received exceed the negative allowance, we recognize amounts within operating expenses in the Consolidated Statements of Operations. The negative allowance is recorded as an asset and presented within "Accounts receivable, net" on our Consolidated Balance Sheets. Changes in the negative allowance are recorded as an operating expense in the Consolidated Statements of Operations.
Prior to January 1, 2021, Acquired Loans Receivable were carried at their amortized cost, fully offset by an allowance for loan losses.
Please refer to "Recently Adopted Accounting Pronouncements" in Note 2 for discussion related to ASC 326 adoption, Note 6, "Merchant Cash Advances Receivable and Acquired Loans Receivable, Net” for additional information on acquired loans receivable, and Note 9, "Loan Servicing Activities" for additional information on the liabilities related to financial guarantees.
Property and Equipment, Intangible Assets and Impairment of Long-lived Assets
Property and equipment are stated at cost, net of accumulated depreciation, and are depreciated using the straight-line method over their estimated lives, as follows:
Property and Equipment Estimated Useful Life
Computer and other equipment 3 years
Office furniture and fixtures 3 years
Tooling 3 years
Capitalized software 2 years
Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining terms of the respective leases. Repair and maintenance costs are expensed as incurred, whereas major improvements are capitalized as additions to property and equipment.
We account for our internal use software and website development costs in accordance with the guidance in ASC 350-40, Internal-Use Software. The costs incurred prior to the application development stage and post implementation are expensed as incurred. Direct and incremental internal and external costs incurred during the application development stage, are capitalized until the application is substantially complete and ready for its intended use, at which point amortization begins. Training and data conversion costs are expensed as incurred.
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When assets are retired or disposed of, cost and associated accumulated depreciation are derecognized, and any resulting gain or loss is included in our Consolidated Statements of Operations.
Operating Leases
We adopted ASC 842 effective January 1, 2021. We determine if an arrangement is or contains a lease at contract inception. Lease agreements generally contain lease and non-lease components, which we elect to combine for all asset classes as a single lease component. Payments under lease arrangements are primarily fixed. Variable payments typically represent non-lease components, which consist primarily of payments for maintenance, utilities, and management fees. Variable payments included in lease arrangements are expensed as incurred and excluded from the right of use assets and lease liabilities.
Right-of-use assets and lease liabilities for operating leases are initially measured on the lease commencement date based on a present value of lease payments over the lease term. Right of use assets are recorded net of any lease incentives received from a lessor. Lease liabilities are calculated as the present value of fixed payments over the lease term, including periodic fixed rent increases and excluding any lease incentives paid or payable to us by a lessor. Lease payments are discounted to present value using our estimated incremental borrowing rate, because a readily determinable implicit rate is not available. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located.The weighted average discount rate for operating leases was 2.62% as of December 31, 2021.
Lease term includes the non-cancelable term, renewal options that extend the lease and are reasonably certain to be exercised, and options to terminate the lease before the end of its non-cancelable term that are not reasonably certain to be exercised.
We do not record right-of-use assets and lease liabilities for leases with an initial term of 12 months or less and recognize lease expense on a straight-line basis over the lease term.
Our consolidated financial statements and related disclosures for the reporting periods prior to January 1, 2021 have not been adjusted and continue to be reported under Topic 840.
Business Combinations
We account for acquisitions using the acquisition method of accounting. Assets acquired and liabilities assumed are recorded at their respective fair values at the acquisition date. The fair value of the consideration transferred in a business combination, including any contingent consideration, is allocated to the assets acquired and liabilities assumed based on their respective fair values. The excess of the consideration transferred over the fair values of the assets acquired and the liabilities assumed is recorded as goodwill. During the measurement period, which may be up to one year from the acquisition date or upon a final determination of asset and liability fair values, whichever occurs first, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Any subsequent adjustments are recorded on the Consolidated Statements of Operations.
Intangible Assets
Intangible assets consist of finite-lived acquired technology, customer relationships, and acquired trade names. Finite-lived intangible assets are valued based on estimated future cash flows and amortized on a straight-line basis over their estimated useful lives. We evaluate the remaining estimated useful life of its intangible assets being amortized on an ongoing basis to determine whether events and circumstances warrant a revision to the remaining amortization period.
Acquired technology is amortized over its useful life on a straight-line basis within costs of revenue. Customer relationships are amortized over their useful life on a straight-line basis within Amortization of acquired technology and customer assets.
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The estimated useful lives for acquired technology, customer relationship intangible assets and acquired trade names are as follows:
Estimated Useful Life
Acquired technology 3 - 10 years
Customer acquired intangible assets 6 years
Trade names 1.5 years
We evaluate the recoverability of property and equipment and finite lived intangible assets for impairment whenever events or circumstances indicate that the carrying amounts of such assets may not be recoverable. For purposes of this assessment, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability is measured by comparing the carrying amount of an asset group to the estimated future undiscounted future net cash flows expected to be generated from their use and eventual disposal. If the carrying amount is not recoverable, the carrying amount is reduced to fair value and impairment loss is recognized. We did not identify any events or circumstances that indicated the carrying amounts of our long-lived assets may not be recoverable and did not recognize any impairment during the year ended December 31, 2021.
Goodwill