Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks, uncertainties and assumptions. You should read the “Special Note Regarding Forward-Looking Statements” and “Risk Factors” sections of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
The Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, describes principal factors affecting the results of our operations, financial condition and liquidity, as well as our critical accounting policies and estimates that require significant judgment and thus have the most significant potential impact on our Consolidated Financial Statements included elsewhere in this Form 10-K. Our MD&A is organized as follows:
•Overview. This section provides a general description of our business, recent developments, and key business metrics.
•Results of Operations. This section provides an overview and analysis of our financial results for the year ended December 31, 2022 compared to the year ended December 31, 2021 and for the year ended December 31, 2021 compared to the year ended December 31, 2020.
•Liquidity and Capital Resources. This section provides an analysis of our liquidity and changes in cash flows, as well as a discussion of available borrowings and contractual commitments.
•Critical Accounting Policies and Estimates. This section discusses accounting policies and estimates that require us to exercise subjective or complex judgments in their application. We believe these accounting policies and estimates are important to understanding the assumptions and judgments incorporated in our reported financial results.
OVERVIEW
Toast is a cloud-based, all-in-one digital technology platform purpose-built for the entire restaurant community. Our platform provides a comprehensive suite of SaaS products, financial technology solutions including integrated payment processing, restaurant-grade hardware, and a broad ecosystem of third-party partners. We serve as the restaurant operating system, connecting front of house and back of house operations across dine-in, takeout, and delivery channels. As of December 31, 2022, approximately 79,000 restaurant locations, processing approximately $92 billion of gross payment volume in the trailing 12 months, partnered with Toast to optimize operations, increase sales, engage guests, and maintain happy employees.
By enabling these capabilities through a single, integrated platform, Toast improves experiences across the restaurant ecosystem:
•Restaurant operators. We arm restaurants with a wide range of products and capabilities to address their specific needs regardless of size, location, or business model. As a result, restaurants using Toast often see higher sales and greater operational efficiency.
•Guests. We are laser focused on helping our customers deliver memorable guest experiences at scale. Guests can place orders easily, safely, and accurately across web, mobile, and in-person channels for dine-in, takeout, or delivery. In addition, our platform empowers restaurants to utilize their guest data to deliver targeted and personalized experiences with loyalty programs and marketing solutions.
•Employees. Our easy-to-learn and easy-to-use technology improves the experience of restaurant employees across Toast customers. Employees are core to delivering great hospitality, and it is critical for restaurants to engage and retain employees in an increasingly competitive labor market. Our products enable new employees to learn quickly through guided workflows, facilitate faster table turns and safer, streamlined operations, and provide greater transparency around, and timely access to, employees’ wages.
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•Suppliers. Our supplier management and accounting products give restaurants the tools to optimize their back-office operations. Managing supplier networks and procurement, and having high visibility into costs, are critical to efficiently operating a restaurant. Our products enable customers to automate manual billing processes, manage inventory, and improve profitability with real-time cost insights on menu items. The seamless integration across our end-to-end platform gives our customers the rich data and reporting capabilities to efficiently operate and manage their restaurants.
The benefits to all stakeholders using the Toast platform create a powerful, virtuous cycle that amplifies our impact on restaurants. Guest satisfaction generates loyalty to restaurants, driving repeat sales, word-of-mouth referrals, and larger checks and tips. This promotes employee satisfaction, helping reduce turnover and motivating employees to continue to raise the bar on the guest experience. In addition, our integrated software and payments platform consolidates data on restaurant sales and operations, which enables our reporting and analytics as well as financial technology solutions, such as working capital loans, to further support our customers’ success.
Since our founding, we have translated our love for restaurants into a commitment to innovation and digital transformation for the restaurant industry. As we have expanded our platform, launched new products, and added new partners over time, we have rapidly grown the number of restaurant locations on the Toast platform.
On September 24, 2021, we completed our initial public offering, or IPO, in which we issued and sold 25,000,000 shares of our Class A common stock at the public offering price of $40.00 per share, which included the full exercise of the underwriters’ option to purchase additional 3,260,869 shares. We received net proceeds of $944 million after deducting underwriting discounts, commissions, and other offering costs.
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Recent Developments in Macroeconomic Environment
Global events and macroeconomic conditions such as inflation and its potential impact on consumer spending, rising interest rates, global supply chain issues and the COVID-19 pandemic have impacted and may continue to impact our business. While our business results remain positive, it is difficult to predict the potential impact these factors may have on our future business results because of the uncertainty they have produced or will produce among consumers and the restaurant industry.
Key Business Metrics
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 billings of subscription services fees, which we refer to as the subscription component of MRR, and (ii) our in-month adjusted payments services fees, exclusive of estimated transaction-based costs, which we refer to as the payments component of MRR. MRR does not include fees derived from Toast Capital or related costs. MRR is also not burdened by the impact of SaaS credits offered.
ARR is determined by taking the sum of (i) twelve times the subscription component of MRR and (ii) four times the trailing-three-month cumulative payments component of MRR. We believe this approach provides an indication of our scale, while also controlling for short-term fluctuations in payments volume. Our ARR may decline or fluctuate as a result of a number of factors, including customers’ satisfaction with our platform, pricing, competitive offerings, economic conditions, or overall changes in our customers’ and their guests’ spending levels. ARR is an operational measure, does not reflect our revenue or gross profit determined in accordance with GAAP, and should be viewed independently of, and not combined with or substituted for, our revenue, gross profit, and other financial information determined in accordance with GAAP. Further, ARR is not a forecast of future revenue and investors should not place undue reliance on ARR as an indicator of our future or expected results.
Net Retention Rate (NRR)
To calculate our Net Retention Rate, or NRR, we first identify a cohort of customers, or the Base Customers, in a particular month, or the Base Month. For this purpose, we do not consider a customer as a Base Customer unless there is at least one location live on the Toast platform for the entirety of the Base Month. We then divide MRR for the Base Customers in the same month of the subsequent year, or the Comparison Month, by MRR in the Base Month to derive a monthly NRR. MRR in the Comparison Month includes the impact of any churn or contraction of the Base Customers, and by definition does not include any customers added to the Toast platform between the Base Month and Comparison Month. We measure the annual NRR by taking a weighted average of the monthly NRR over the trailing twelve months.
Components of Results of Operations
Revenue
We generate revenue from four main sources that are further described below: (1) subscription services, (2) financial technology solutions, (3) hardware, and (4) professional services.
Our total revenue consists of the following:
Subscription services. We generate subscription services revenue from fees charged to customers for access to our software applications, generally over a term ranging from 12 to 36 months. Our subscription services revenue is primarily based on a rate per location, and this rate varies depending on the number of software products purchased, hardware configuration, and employee count at each location.
Financial technology solutions. Revenue from financial technology solutions consists primarily of transaction-based fees paid by customers to facilitate their payment transactions, which are generally calculated as a percentage of the total transaction amount processed plus a per-transaction fee. The transaction fees collected are recognized as revenue on a gross basis. Financial technology solutions revenue also includes fees earned from marketing and servicing working capital loans to our customers through Toast Capital that are originated by a third-party bank. In these arrangements, Toast Capital’s bank partner originates all loans, and Toast Capital then services the loans using Toast’s payments infrastructure to remit a fixed percentage of daily sales until the loan is paid back. Toast Capital is responsible for purchasing from our bank partner loans in default (or that have been or are scheduled to be charged off) until the aggregate principal amount of such purchased loans equals 15% of the total originated amount for each quarterly loan cohort. Toast Capital earns a servicing fee as well as a credit performance fee that is tied to the portfolio performance.
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Hardware. We generate hardware revenue from the sale of terminals, tablets, handhelds, and related devices and accessories, net of estimated returns.
Professional services. We generate professional services revenue from fees charged to customers for installation services, including business process mapping, configuration, and training. These services can be delivered on-site, remotely, or on a self-guided basis.
Costs of Revenue
Costs of revenue consists of expenses that are directly related or closely correlated to revenue generation, including, but not limited to, employee-related costs for customer support and certain operational roles as well as allocated overhead. Employee-related costs consist of salaries, benefits, bonuses, and stock-based compensation expense. Allocated overhead includes certain facilities costs, depreciation expense, and amortization costs associated with internally developed software. Below are descriptions of the types of costs classified within each component of costs of revenue:
Subscription services. Subscription services costs consist of customer support and associated employee-related costs, hosting costs, professional services costs, other software costs to support our cloud-based platform, and amortization costs associated with internally developed software.
Financial technology solutions. Financial technology solutions costs consist primarily of transaction-based costs, which are mostly fees and costs paid to issuers and card networks as well as other related fees associated with third-party payment processors and fraud management.
Hardware. Hardware costs consist of raw materials and the cost of manufacturing and shipping hardware sold to customers, including terminals, tablets, handhelds, and related devices and accessories. Included in the manufacturing and shipping costs are employee-related costs, professional services costs, and allocated overhead associated with our supply chain and fulfillment teams.
Professional services. Professional services costs consist primarily of employee-related costs and allocated overhead associated with our onboarding team, along with fees paid to third-party service providers engaged to perform installations and other services.
Amortization of acquired intangible assets. Amortization of acquired intangible assets is related to technologies acquired through acquisitions that have the capability of producing revenue.
Operating Expenses
During the year ended December 31, 2020, we incurred certain costs, including severance, lease exit costs, and accelerated depreciation of property and equipment, in connection with a reduction in workforce resulting from changes to our operations as a result of the COVID-19 pandemic.
Our operating expenses consist of the following:
Sales and marketing. Sales and marketing expenses consist primarily of employee-related costs incurred to acquire new customers and increase product adoption across our existing customer base. Marketing expenses also include fees incurred to generate demand through various advertising channels.
Research and development. Research and development expenses consist primarily of employee-related costs associated with improvements to our platform and the development of new product offerings, as well as allocated overhead and expenses associated with the use of third-party software directly related to development of our products and services.
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General and administrative. General and administrative expenses consist primarily of expenses related to management and administrative functions, including finance, legal, human resources, and information technology. General and administrative expenses also include costs related to fees paid for certain professional services, including legal, information technology, and tax and accounting services, as well as bad debt and credit related expenses.
Other Income (Expenses)
Our other income and expenses consist of the following:
Interest income (expense), net. Consists of interest earned from cash held in money market accounts, interest earned on our marketable securities, offset by interest incurred on our convertible notes, which were issued in June 2020 and repaid in June 2021.
Change in fair value of warrant liability. Represents the change in the fair value of our warrant liability related to warrants issued to purchase shares of our convertible preferred stock and our common stock. The warrant liability is remeasured at fair value at each reporting date which could have a significant effect on other income (expense) and our results of operations during each period. The fair value is based on the trading price of our Class A common stock, as well as other relevant valuation inputs, including estimated volatility of our Class A common stock, strike price, relevant risk-free interest rates, and time to expiration of the warrants, and may fluctuate in subsequent periods.
Change in fair value of derivative liability. Represents the change in fair value of derivative liability related to the conversion option provided for in the convertible notes which were repaid in June 2021.
Loss on debt extinguishment. Represents the loss on settlement of our convertible notes which were repaid in June 2021.
Other income (expense), net. Represents foreign currency transaction gains and losses, changes in fair value of our marketable securities, refundable research and development tax credits, and other items.
Income Tax Benefit (Expense)
Income tax benefit (expense). Consists of U.S. federal and state income tax as well as international taxes in various foreign jurisdictions for the year ended December 31, 2022. Our effective tax rate fluctuates from period to period due to changes in the mix of income and losses in jurisdictions with a wide range of tax rates, the effect of acquisitions, changes resulting from the amount of recorded valuation allowance, and permanent differences between U.S. generally accepted accounting principles and local tax laws.
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RESULTS OF OPERATIONS
Comparison of the Years Ended December 31, 2022, 2021, and 2020
Discussions related to year-over-year comparisons between 2021 and 2020 are included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on March 1, 2022, and incorporated herein by reference.
The following table summarizes our results of operations for the years ended December 31, 2022, 2021, and 2020:
Year Ended December 31,
Revenue:
Costs of revenue:
Amortization of acquired intangible assets 5 4 4
Operating expenses:
Other income (expenses):
Interest income (expense), net 11 (12) (12)
Change in fair value of warrant liability 95 (97) (8)
Change in fair value of derivative liability — (103) (7)
Loss on debt extinguishment — (50) —
Other income (expense), net 1 — (1)
Loss before benefit from income taxes (277) (490) (248)
Benefit from income taxes 2 3 —
(1)Includes stock-based compensation expense recognized for the years ended December 31, 2022, 2021, and 2020 as follows:
Year Ended December 31,
Costs of revenue $ 33 $ 12 $ 7
Research and development 72 48 30
General and administrative 73 58 33
Total stock-based compensation expense $ 228 $ 142 $ 86
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Revenue
The increase in subscription services revenue during the year ended December 31, 2022 was attributed to growth in live restaurant locations and the continued increase in the number of products adopted by both new and existing customers.
The increase in financial technology solutions revenue during the year ended December 31, 2022 was attributable to the increase in live restaurant locations and the increase in GPV per processing location, which was due to both higher consumer demand and higher average transaction values.
Hardware revenue increased slightly during the year ended December 31, 2022, primarily due to an increase in hardware sales to new locations and upsell sales to existing locations, mostly offset by the impact of pricing and packaging related to bundled sales. Pricing and packaging of bundled sales benefited revenue in the prior year compared to a negative impact in the current year.
The increase in professional services revenue during the year ended December 31, 2022 was primarily driven by the increase in new live locations.
Costs of Revenue
Amortization of acquired intangible assets 5 4 4 1 25 % — — %
The increase in subscription services costs during the year ended December 31, 2022 was primarily attributable to an increase in employee-related and overhead costs and contractor services as well as stock-based compensation expense. Higher employee-related costs were driven primarily by increased employee headcount.
The increase in financial technology solutions costs during the year ended December 31, 2022 was due to an increase in GPV.
The increase in hardware costs during the year ended December 31, 2022 was attributable to higher shipment volume as a result of growth in new restaurant locations and higher product costs.
The increase in professional services costs during the year ended December 31, 2022 was primarily due to an increase in employee-related and overhead costs and contractor services as well as stock-based compensation expense.
We utilize our hardware and related professional services as customer acquisition tools and price them competitively to reduce barriers to entry for new locations.
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Operating Expenses
Sales and Marketing
The increase in sales and marketing expenses during the year ended December 31, 2022 was primarily attributable to a $77 million increase in employee-related and overhead costs and a $26 million increase in stock-based compensation. Higher employee-related costs were driven primarily by increased employee headcount.
We expect that sales and marketing expenses will increase on an absolute dollar basis as we invest to grow our field-based sales team, increase demand generation, and enhance our brand awareness. We expect sales and marketing expenses as a percentage of revenue will vary from period-to-period over the short-term and decrease over the long-term.
Research and Development
The increase in research and development expenses during the year ended December 31, 2022 was primarily attributable to a $75 million increase in employee-related and overhead costs and a $24 million increase in stock-based compensation. Higher employee-related costs and stock-based compensation was driven by increased employee headcount.
We plan to continue to hire employees to support our research and development efforts to expand the capabilities and scope of our platform and related products and services. As a result, we expect that research and development expenses will increase on an absolute dollar basis as we continue to invest to support these activities and innovate over the long-term.
General and Administrative
The increase in general and administrative expenses during the year ended December 31, 2022 was primarily attributable to employee-related and overhead costs and stock-based-compensation due to increased headcount, as well as bad debt and credit related expenses mainly due to growth in our Toast Capital product offering. Employee-related and overhead costs, stock-based compensation, and bad debt and credit related expenses increased $48 million, $15 million, and $34 million, respectively.
We expect that general and administrative expenses will increase on an absolute dollar basis as we add personnel and enhance our systems, processes, and controls to support the growth of our business as well as our increased compliance and reporting requirements as a public company. We expect general and administrative expenses as a percentage of revenue will vary from period-to-period over the short-term and decrease over the long-term.
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Interest Income (expense), net
The increase in interest income (expense), net in 2022 as compared to 2021 was attributable to higher interest income generated on our investments in marketable securities, as well as decreases in interest expense due to the repayment of convertible notes in 2021. We made our initial investment in marketable securities in October 2021.
Change in Fair Value of Warrant Liability
The change in fair value of warrant liability in 2022 was primarily attributable to a lower value of common stock underlying outstanding warrants at the end of the period compared to the beginning of the period.
Change in Fair Value of Derivative Liability
The decrease in expense associated with the change in fair value of derivative liability for the year ended December 31, 2022 was due to the repayment of our convertible notes in June 2021 and the extinguishment of the corresponding liability.
Loss on Debt Extinguishment
Loss on debt extinguishment $ — $ (50) $ — $ 50 (100) % $ (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) $ 1 100 % $ 1 (100) %
Other income (expense), net remained materially consistent in 2022 as compared to 2021.
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Benefit from Income Taxes
Benefit from income taxes $ 2 $ 3 $ — $ (1) (33) % $ 3 (100) %
The income tax benefit for the years ended December 31, 2022 and 2021 was due to deferred tax benefit associated with the partial release of our pre-existing valuation allowance. The valuation allowance release arose from deferred tax liabilities that were brought on through the acquisitions of Sling and xtraCHEF, that served as new sources of income.
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Non-GAAP Financial Measures
We use certain non-GAAP financial measures described below to supplement our consolidated financial statements prepared and presented in accordance with U.S. Generally Accepted Accounting Principles, or GAAP, and to understand and evaluate our core operating performance. These non-GAAP financial measures, which may be different than similarly titled measures used by other companies, are presented to enhance investors’ overall understanding of our financial performance and should not be considered substitutes for, or superior to, the financial information prepared and presented in accordance with GAAP.
We believe that these non-GAAP financial measures provide useful information about our financial performance, enhance the overall understanding of our past performance and future prospects, and allow for greater transparency with respect to important metrics used by our management for financial and operational decision-making. We are presenting these non-GAAP metrics to provide investors insight to the information used by our management to evaluate our business and financial performance. We believe that these measures provide investors increased comparability of our core financial performance over multiple periods with other companies in our industry.
Net Loss (GAAP) and Adjusted EBITDA (Non-GAAP)
Adjusted EBITDA is defined as net income (loss), adjusted to exclude stock-based compensation expense and related payroll tax expense, depreciation and amortization expense, interest income (expense) net, other income (expense), net, acquisition expenses, fair value adjustments on warrant and derivative liabilities, expenses related to COVID-19 pandemic initiatives resulting from a reduction of workforce in 2020, expenses related to early termination of leases, loss on debt extinguishment, charitable contribution stock-based expense, and income taxes. We have provided below a reconciliation of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.
We believe Adjusted EBITDA is useful for investors in comparing our financial performance to other companies and from period to period. Adjusted EBITDA is widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as depreciation and amortization, interest expense, and interest income, which can vary substantially from company to company depending on their financing and capital structures and the method by which their assets were acquired. In addition, Adjusted EBITDA eliminates the impact of certain items that may obscure trends in the underlying performance of our business. Adjusted EBITDA also has limitations as an analytical tool, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. For example, although depreciation expense is a non-cash charge, the assets being depreciated may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new asset acquisitions. In addition, Adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy. Adjusted EBITDA also does not reflect changes in, or cash requirements for, our working capital needs; interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces the cash available to us; or tax payments that may represent a reduction in cash available to us. The expenses and other items which are excluded from the calculation of Adjusted EBITDA may differ from the expenses and other items that other companies may exclude from Adjusted EBITDA when they report their financial results.
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The following table reflects the reconciliation of net loss to Adjusted EBITDA for each of the periods presented:
Year Ended December 31,
Stock-based compensation expense and related payroll tax 232 144 86
Depreciation and amortization 24 21 27
Interest (income) expense, net (11) 12 12
Other (income) expense, net 1 — 1
Acquisition expenses 2 1 —
Change in fair value of warrant liability (95) 97 8
Change in fair value of derivative liability — 103 7
Reduction of workforce — — 10
Termination of leases (1) 1 3
Loss on debt extinguishment — 50 —
Charitable contribution stock-based expense 10 19 —
Income tax benefit (2) (3) —
Adjusted EBITDA $ (115) $ (42) $ (94)
Net Cash (Used in) Provided by Operating Activities (GAAP) and Free Cash Flow (Non-GAAP)
Free cash flow is defined as net cash provided by (used in) operating activities reduced by purchases of property and equipment and capitalization of internal-use software costs. We believe that free cash flow is a meaningful indicator of liquidity that provides information to management and investors about the amount of cash generated from operations and used for purchases of property and equipment, capitalization of software costs, and investments in our business. Once our business needs and obligations are met, cash can be used to maintain a strong balance sheet and invest in future growth.
Free cash flow has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Other companies may calculate free cash flow or similarly titled non-GAAP measures differently, which could reduce the usefulness of free cash flow as a tool for comparison. In addition, free cash flow does not reflect mandatory debt service and other non-discretionary expenditures that are required to be made under contractual commitments and does not represent the total increase or decrease in our cash balance for any given period.
The following table presents a reconciliation of free cash flow to the net cash provided by (used in) operating activities for each of the periods presented:
Year Ended December 31,
Net cash (used in) provided by operating activities $ (156) $ 2 $ (125)
Purchase of property and equipment (16) (12) (28)
Capitalized software (17) (7) (8)
LIQUIDITY AND CAPITAL RESOURCES
Upon completion of the IPO, we received net proceeds of $950 million after deducting underwriting discounts and commissions and invested them into interest-generating marketable securities and money market accounts.
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Our principal sources of liquidity are cash and cash equivalents and marketable securities. As of December 31, 2022, we had cash and cash equivalents of $547 million, excluding cash held on behalf of customers of $60 million, restricted cash of $28 million, marketable securities of $474 million, and $330 million available under our revolving credit facility. Cash and cash equivalents consist of highly liquid investments with original maturities of 90 days or less at the time of purchase, other than those held for sale in the ordinary course of business. Marketable securities consisted of commercial paper, certificates of deposit, corporate bonds, U.S. government agency securities, asset-backed securities and U.S. Treasury securities.
We believe that our existing cash and cash equivalents, along with our available borrowing capacity under our credit facility, will be sufficient to meet our working capital needs for at least the next 12 months, including planned capital expenditures, strategic transactions, and investment commitments that we may enter into from time to time. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth under “Risk Factors”.
In the event that additional financing is required from outside sources, we cannot be sure that any additional financing will be available to us on acceptable terms, if at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition could be adversely affected.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
Year Ended December 31,
Net cash (used in) provided by operating activities $ (156) $ 2 $ (125)
Net cash used in investing activities (98) (503) (36)
Net cash provided by financing activities 38 759 594
Operating Activities
For the year ended December 31, 2022, net cash used in operating activities was $156 million as a result of our net loss for the period, adjusted for certain non-cash items, such as stock-based compensation, the change in fair value of our warrant liabilities, depreciation and amortization, as well as a use of cash for working capital. The change in working capital was primarily driven by higher inventory balances, in part due to the opening of a new facility, as well as higher deferred costs, partially offset by higher accrued expenses and other current liabilities related to our growth in GPV.
For the year ended December 31, 2021, net cash provided by operating activities was $2 million. This resulted from our net loss for the period, adjusted for certain non-cash items, such as stock-based compensation, the change in fair value of derivative liability, the change in fair value of warrant liabilities, loss on debt extinguishment, depreciation and amortization, as well as a use of cash for working capital. The change in working capital was primarily driven by higher deferred costs mostly related to sales compensation and higher prepaid expenses as a result of hardware purchases, partially offset by higher accrued expenses and other current liabilities related to our growth in GPV.
Investing Activities
For the year ended December 31, 2022, cash used in investing activities was $98 million, which consisted primarily of cash paid for purchases of marketable securities and cash paid for an acquisition, partially offset by proceeds from sales and maturities of marketable securities.
For the year ended December 31, 2021, cash used in investing activities was $503 million, which consisted primarily of cash paid for purchases of marketable securities, cash paid for an acquisition, purchases of property and equipment and cash paid for capitalized software.
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Financing Activities
For the year ended December 31, 2022, cash provided by financing activities was $38 million, which consisted primarily of an increase in customer funds obligations and proceeds from the exercise of stock options.
For the year ended December 31, 2021, cash provided by financing activities was $759 million, which consisted of proceeds from our IPO, a change in customer funds obligations, proceeds from the exercise of stock options, and proceeds from the issuance of restricted stock, partially offset by repayments of our convertible notes.
Debt
On June 8, 2021, we entered into a senior secured credit facility, or the 2021 Facility, which includes a revolving line of credit equal to $330 million. Interest on outstanding loans under the revolving line of credit is determined based on loan type and accrues at an annual rate, as defined in the agreement, of: (a) LIBO Rate multiplied by the Statutory Reserve Rate, plus 1.50% per annum; or 0.5% per annum plus the highest of: (i) the Prime Rate, (ii) the Federal Reserve Bank of New York Rate plus 0.5%, or (iii) the Adjusted LIBO Rate plus 1.00%. Subsequent to December 31, 2022, interest on outstanding loans will be accrued based on Secured Overnight Financing Rate, or SOFR. The 2021 Facility is subject to a minimum liquidity covenant of $250 million. As of December 31, 2022, no amount was drawn and outstanding under the 2021 Facility which had $330 million available for borrowings. As of December 31, 2022 and 2021, there were $8 million and $13 million of letters of credit outstanding, respectively.
As a result of entering into the 2021 Facility, we became obligated to prepay or redeem convertible notes issued in June 2020. On June 21, 2021, we prepaid all of the outstanding convertible notes with a carrying amount of $183 million, including principal and accrued interest, net of an unamortized discount, for an aggregate cash amount of $249 million, which included an applicable redemption premium. Please refer to Note 9, "Debt" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for further information on this transaction.
Contractual Obligations and Commitments and Off-Balance Sheet Arrangements
As of December 31, 2022, our contractual obligations consisted of: (i) operating lease commitments of $112 million, of which $17 million is due in 2023 and $95 million is due thereafter, and (ii) purchase commitments of $231 million, a majority of which are due in 2023. Please refer to Note 8, "Lessee Arrangements" and Note 18, "Commitments and Contingencies" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for a discussion on our lease and purchase commitments.
Please refer to Note 6, "Loan Servicing Activities and Acquired Loans Receivable, Net" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for discussion of credit exposure related to our financial guarantees as of December 31, 2022.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the balance sheet date, as well as reported amounts of revenue and expenses during the reporting period. Our most significant estimates and judgments are related to revenue recognition, business combinations and other acquired intangible assets, and stock-based compensation expense. Actual results may differ from these estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected.
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We believe that the accounting policies described below involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical in fully understanding and evaluating our financial condition and results of operations. For further information, see Note 2, "Summary of Significant Accounting Policies" to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K.
Revenue Recognition
We recognize revenue in accordance with ASC 606, Revenue from Contracts with Customers, or ASC 606, when a customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services.
During the years ended December 31, 2022, 2021, and 2020, we generated revenue through four revenue streams, including: (1) subscription services, (2) financial technology solutions, (3) hardware, and (4) professional services. Our contracts often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately as opposed to being combined may require judgment. We allocate total arrangement consideration at the inception of an arrangement to each performance obligation using the relative selling price allocation method based on each distinct performance obligation’s standalone selling price, or SSP. Judgment is required to determine the SSP for each distinct performance obligation. We determine the SSP for hardware and professional services revenue using an adjusted market assessment approach which analyzes discounts provided to similar customers based on customer category, sales channel, and size. SSP for subscription services revenue was established using the adjusted market approach considering relevant information, such as current and new customer pricing, renewal pricing, competitor information, market trends, and market share for similar services. SSP for financial technology solutions revenue was determined using our own standalone sales data.
Determining whether to recognize revenue on a gross or net basis requires judgment in evaluating whether we are the principal or agent in contracts with customers. We have concluded that we are the principal in providing a managed payment solution because we control the payment processing services before the customer receives them, perform authorization and fraud check procedures prior to submitting transactions for processing in the payment network, have sole discretion over which third-party acquiring payment processors we will use, and are ultimately responsible to the customers for amounts owed if those acquiring payment processors do not fulfill their obligations. Based upon this evaluation, we recognize transaction fees for payment-processing on a gross basis.
Business Combinations
The acquisition purchase price is allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values on the acquisition dates. The excess of total consideration over the fair values of the assets acquired and the liabilities assumed is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, we make significant estimates and assumptions, especially with respect to intangible assets. Our estimates of fair value are based upon assumptions believed to be reasonable, which are inherently uncertain and unpredictable, and as such, actual results may differ from estimates. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever occurs first, any subsequent adjustments would be recorded within our results of operations.
Our intangible assets consist of finite-lived acquired technology and customer relationships assets which are amortized over their estimated useful lives. We evaluate on an ongoing basis the remaining estimated useful life of the intangible assets to determine whether events and circumstances warrant a revision to the remaining amortization period. Such estimates are inherently uncertain since unanticipated events and circumstances may occur which may materially impact these estimates and our actual results. The amortization periods for acquired technology and customer relationships intangible assets is between three years and ten years, respectively.
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Stock-Based Compensation Expense
Stock-based compensation expense for stock options and RSUs is recognized over the service period based on the fair value of equity awards on the grant date, net of estimated forfeitures. For RSUs, fair value is based on the New York Stock Exchange, or NYSE, closing price of our Class A common stock on the grant date.
We use the Black-Scholes option-pricing model to determine the estimated fair value of stock option awards. We have limited historical stock option activity and therefore estimate the expected term of stock options granted using the simplified method, which represents the average of the contractual term of the stock option and its weighted-average vesting period. The expected volatility of stock options is based upon the average historical volatility of a number of publicly traded companies in a similar industry. We estimate a forfeiture rate to calculate the stock-based compensation expense for the awards based on an analysis of actual historical experience and expected employee attrition rates.
We will continue to use judgment in evaluating the expected volatility, expected term and forfeiture rate utilized in our stock-based compensation expense calculation on a prospective basis. As we continue to accumulate additional data related to our Class A common stock and forfeiture rates, we may adjust our estimates, which could materially impact our future stock-based compensation expense.
Operating Leases
We enter into operating lease arrangements for real estate office space. We determine at contact inception whether an arrangement represents or contains a lease by evaluating various factors, including whether the arrangement conveys the right to control the use of the identified asset in exchange for consideration.
Right-of-use assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term which are discounted using our estimated incremental borrowing rate because a readily determinable implicit rate is not available. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located, which requires judgment and may impact the reported amounts of Right-of-use assets and lease liabilities.
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Recent Accounting Pronouncements
Refer to the sections titled “Recently Adopted Accounting Pronouncements” in Note 2 of the Notes to our Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for more information.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We have operations in North America, Europe and Asia, 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 $547 million and marketable securities of $474 million as of December 31, 2022. 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 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 speculative purposes.
Based on our investment portfolio balance as of December 31, 2022, a hypothetical 100 basis point increase or decrease 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, Canadian dollars, Indian rupees and other currencies and may be subject to fluctuations due to changes in foreign currency exchange rates and result in transaction gains and losses that we may need to recognize 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, 2022, 2021, and 2020, 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, 2022 and 2021. 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
Reports of Independent Registered Public Accounting Firm 89
Consolidated Financial Statements
Consolidated Balance Sheets for the years ended December 31, 2022 and 2021 93
Notes to Consolidated Financial Statements 101
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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, 2022 and 2021, the related consolidated statements of operations, comprehensive loss, convertible preferred stock and stockholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (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, 2022 and 2021 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated March 1, 2023 expressed an adverse opinion thereon.
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 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.
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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Valuation of Acquired Developed Technology
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2019.
Boston, Massachusetts
March 1, 2023
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Toast, Inc.
Opinion on Internal Control Over Financial Reporting
We have audited Toast, Inc.’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, because of the effect of the material weakness described below on the achievement of the objectives of the control criteria, Toast, Inc. (the Company) has not maintained effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. Management identified a material weakness in internal control related to ineffective information technology general controls, or ITGCs, in the area of user access over certain information technology, or IT, systems that support the Company’s revenue financial reporting processes.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive loss, convertible preferred stock and stockholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2022 consolidated financial statements, and this report does not affect our report dated March 1, 2023, which expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the 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 audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Boston, Massachusetts
March 1, 2023
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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 $ 547 $ 809
Accounts receivable, net 77 55
Deferred costs, net 44 30
Prepaid expenses and other current assets 155 92
Property and equipment, net 61 41
Operating lease right-of-use assets 77 79
Intangible assets, net 29 16
Restricted cash 28 8
Deferred costs, non-current 38 25
Other non-current assets 14 7
Total non-current assets 354 250
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable $ 30 $ 40
Operating lease liabilities 14 22
Deferred revenue 39 44
Accrued expenses and other current liabilities 413 246
Total current liabilities 496 352
Warrants to purchase common stock 68 181
Deferred revenue, non-current 7 12
Operating lease liabilities, non-current 80 77
Other long-term liabilities 12 22
Commitments and Contingencies (Note 18)
Stockholders’ Equity:
Accumulated other comprehensive loss (2) (1)
Total liabilities and stockholders’ equity $ 1,761 $ 1,735
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 intangible assets 5 4 4
Operating expenses:
Other income (expenses):
Interest income (expense), net 11 (12) (12)
Change in fair value of warrant liability 95 (97) (8)
Change in fair value of derivative liability — (103) (7)
Loss on debt extinguishment — (50) —
Other income (expense), net 1 — (1)
Loss before benefit from income taxes (277) (490) (248)
Benefit from income taxes 2 3 —
Redemption of Series B Preferred Stock — — (1)
Net loss attributable to common stockholders $ (275) $ (487) $ (249)
Net loss per share attributable to common stockholders:
Weighted average shares used in computing net loss per share:
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) (1) —
Total other comprehensive loss (1) (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
Repurchase of common stock (33,475) — — — — — — —
Stock-based compensation expense — — — — 235 — — 235
Vesting of restricted stock — — — — 4 — — 4
Charitable contribution stock-based expense 546,889 — — — 10 — — 10
Cumulative translation adjustment — — — — — — — —
Unrealized loss on marketable securities — — — — — — (1) (1)
Net loss — — — — — (275) — (275)
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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) — — — — — — —
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, "Business Combinations").
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Shares Amount Shares Amount Shares Amount
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) — — — — — — — —
Stock-based compensation expense — — — — — — 86 — — 86
Net loss — — — — — — — (248) — (248)
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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 24 21 27
Stock-based compensation expense 228 140 86
Amortization of deferred costs 44 30 15
Change in fair value of derivative liability — 103 7
Change in fair value of warrant liability (95) 97 8
Change in deferred income taxes (5) (3) —
Loss on debt extinguishment — 50 —
Credit loss expense 34 4 —
Non-cash interest on convertible notes — 12 8
Charitable contribution stock-based expense 10 19 —
Change in fair value of contingent consideration 3 3 —
Other non-cash items 5 2 —
Changes in operating assets and liabilities:
Account receivable, net (35) (23) (13)
Acquired loans and merchant cash advances repaid 4 1 9
Prepaid expenses and other current assets (40) (45) 18
Deferred costs, net (71) (56) (25)
Inventories, net (68) (23) (4)
Operating lease right-of-use assets (4) 16 —
Accounts payable (11) 15 (6)
Accrued expenses and other current liabilities 116 145 (3)
Deferred revenue (11) (2) (8)
Operating lease liabilities 4 (16) —
Other assets and liabilities (13) (1) 4
Net cash (used in) provided by operating activities (156) 2 (125)
Cash flows from investing activities:
Cash paid for acquisition, net of cash acquired (46) (26) —
Capitalized software (17) (7) (8)
Purchases of property and equipment (16) (12) (28)
Purchases of marketable securities (434) (469) —
Proceeds from the sale of marketable securities 46 5 —
Maturities of marketable securities 369 5 —
Other — 1 —
Net cash used in investing activities (98) (503) (36)
Cash flows from financing activities:
Proceeds from initial public offering, net — 950 —
Payment of deferred offering costs — (5) —
Payment of contingent consideration (2) — —
Repayments of secured borrowings — — (9)
Extinguishment of convertible notes — (245) —
Change in customer funds obligations, net 26 24 4
Proceeds from issuance of long-term debt — — 195
Proceeds from exercise of stock options 15 21 3
Proceeds from issuance of restricted stock — 10 —
Proceeds from issuance of Series E and Series F Preferred — — 402
Redemption of Series B Preferred — — (1)
Proceeds from exercise of common stock warrants — 3 —
Other financing activities (1) 1 —
Net cash provided by financing activities 38 759 594
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Cash held on behalf of customers 60 34 11
Restricted cash 28 8 1
Supplemental disclosure of cash flow information
Cash paid for interest $ — $ 13 $ 5
Cash paid for income taxes $ 1 $ — $ —
Supplemental disclosure of non-cash investing and financing activities:
Stock-based compensation included in capitalized software 7 1 —
Issuance of Class B common stock upon exercise of common stock warrants 18 56 —
Issuance of Class B common stock for payment of contingent consideration 1 — —
Common stock issued for acquisition — 15 —
Deferred offering costs included in accounts payable and accrued expenses — 1 —
Issuance of common stock warrants upon debt extinguishment — 125 —
Deferred payments included in purchase price 2 5 —
Contingent consideration included in purchase price — 2 —
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.
Initial Public Offering and Stock Split
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. The holders of our convertible preferred stock had certain voting, conversion, dividend, and redemption rights, as well as liquidation preferences and conversion privileges in respect of the convertible preferred stock which were terminated upon IPO. 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 of Directors, or the Board.
Risks and Uncertainties
We are subject to a number of risks and uncertainties, including global events and macroeconomic conditions such as inflation and its potential impact on consumer spending, rising interest rates, global supply chain issues, and any public health concerns, which may also impact consumer behavior, the restaurant industry, and our business.
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.
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.
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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.
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 related to loan repurchase activities, incremental borrowing rates applied in valuation of lease liabilities, fair values and useful lives of assets acquired and liabilities assumed through 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.
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, “Fair Value of Financial Instruments”). The carrying values of accounts receivable, accounts payable, and accrued expenses approximate their fair values due to their short-term nature.
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.
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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 a large portion 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. 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, 2022, 2021, and 2020, 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, 2022 or 2021.
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.
Revenue Recognition
During the years ended December 31, 2022, 2021, and 2020, 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.
Determining whether products and services are considered distinct performance obligations that should be accounted for separately as opposed to being combined requires 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 SSP for hardware and professional services revenue using an adjusted market assessment approach which analyzes discounts provided to similar customers based on customer category, sales channel, and size. SSP for subscription services revenue was established using the adjusted market approach considering relevant information, such as current and new customer pricing, renewal pricing, competitor information, market trends and market share for similar services. SSP for financial technology solutions revenue was determined using our own standalone sales data. We allocate variable fees earned from financial technology services revenue to those distinct performance obligations where pricing practices are consistent with the allocation objective under ASC 606.
Customer credits represent variable consideration which is estimated based on historical experience and accounted for as a reduction of transaction price. 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. Sales taxes collected from customers and remitted to government authorities are excluded from revenue and deferred revenue.
We also facilitate customers receiving financing from third-party financing firms for hardware, professional services, and the initial SaaS subscription services term. 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.
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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.
Financial Technology Solutions
Financial technology solutions revenue includes transaction-based payment processing services for customers who 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 our 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 is recognized upon authorization by the issuing bank and submission for processing.
Financial technology solutions revenue also includes fees earned from marketing and servicing loans to customers through our wholly-owned subsidiary, Toast Capital, that are originated by a third-party banking partner. 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 repaid. 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.
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 when the transfer of control occurs, which is upon product shipment. 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. 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 cash deposits, money market funds, and 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.
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 held as collateral pursuant to an agreement with the originating third-party bank for the working capital loans serviced by Toast Capital (See Note 6, "Loan Servicing Activities and Acquired Loans Receivable, Net").
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 loss, 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.
Accounts Receivable, net
Accounts receivable, net consisted of the following:
December 31,
Accounts receivable $ 45 $ 20
Unbilled receivables 44 39
Less: Allowance for credit losses (12) (4)
Accounts receivable, net $ 77 $ 55
Our allowance for credit losses was comprised of the following:
Twelve Months Ended December 31,
Beginning balance $ (4) $ (4)
Impact of adopting ASU 2016-13 — (2)
Additions (13) (1)
Write offs 5 3
Ending balance $ (12) $ (4)
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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.
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 our 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. Substantially all inventory consists of finished goods. 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 outbound freight, handling costs, and damaged inventory as current-period costs. We recorded provisions for excess and obsolete inventory of $13 and $3, respectively, within "Costs of Revenue" for the years ended December 31, 2022 and 2021.
Assets and Liabilities Recorded with Loan Servicing Activities
We perform loan servicing activities through the Toast Capital loan program, where we partner with an industrial bank to provide working capital loans to qualified Toast customers based on the customer’s current payment processing and point of sale data. Under the program, our bank partner originates the loans and we market and service the loans and facilitate the loan application and origination process. These loans provide eligible customers with access to financing up to $300 thousand, and loan repayment occurs automatically through a fixed percentage of every payment transaction processed on Toast’s platform.
Under the terms of our agreement with our industrial bank partner, we are obligated to repurchase certain loans originated by our industrial banking partner in cases where the customer's payments on the loan are missing or delayed for a defined period of time, and the loan is considered defaulted or delinquent (ineligible).Our obligation is limited to a specified percentage of the total loans originated, measured on a quarterly basis. The loan repurchase, net of expected recoveries, reduces our potential liability with respect to the quarterly cohort of loans from which the ineligible loan originated. 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 ineligible loans, and a non-contingent liability accounted for under ASC 460related to our obligation to stand-ready to perform under the obligation, both of which are included in “Accrued Expenses and other current liabilities” in the Consolidated Balance Sheets. 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 360 days, and the reasonable and supportable forecast period we haveincluded in our projected loss rates is approximately 12 months based on externally sourced data.
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Contingent liabilities for expected credit losses are recorded as loans are originated, along with a corresponding non-cash charge recorded within "General and administrative" expense in the Consolidated Statements of Operations. We remeasure 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 average expected obligation term, which ranges from 90 to 360 days, and derecognized upon loan repurchase. Fair value of a non-contingent liability is measured based on a discounted cash flow model under the income approach which 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.
Please refer to Note 6, “Loan Servicing Activities and Acquired Loans Receivable, Net” for additional information on the liabilities related to the financial guarantees.
We facilitate customers receiving financing from third-party financing firms for hardware, professional services, and the initial SaaS subscription services term and assume a limited portion of the risk of customer defaults under our arrangements. 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.
Acquired Loans Receivable, Net
We are obligated to purchase delinquent loans from our industrial bank partner. Such purchases, net of expected recoveries, are recorded as a reduction of contingent liabilities with respect to the quarterly cohort of loans from which the defaulted loan originated. We 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, and write off their unpaid principal balance at the time of purchase as collectability is not probable. However, when we have an expectation of collecting cash flows, a negative allowance is established for repurchased loans based on our historical experience of expected recoveries across our portfolio. As of December 31, 2022 and 2021, we have established a negative allowance for expected recoveries which is included within "Prepaid expenses and other current assets" in the Consolidated Balance Sheets. We had $13 and $2 of acquired loans outstanding as of December 31, 2022 and 2021.
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 as reductions of operating expenses in the Consolidated Statements of Operations. Please refer to Note 6, "Loan Servicing Activities and Acquired Loans Receivable, Net" for additional information on the liabilities related to loan financial guarantees and negative allowance.
Deferred Costs, Net
Based on ASC 340-40, Other Assets and Deferred Costs, we capitalize and amortize incremental costs of obtaining a contract, such as sales commissions and related payroll taxes, over the period we expect to derive benefits from the contract, which we have determined to be three years. The period of benefit for commissions paid for the acquisition of initial subscription services is determined by taking into consideration the initial estimated customer life and the technological life of our subscription services platform and related significant features. We adjust the carrying value of the deferred commissions assets periodically to account for customer churn, which occurs when customers have ceased operations or otherwise discontinued using our subscription services and financial technology solutions. Amortization expense is included in "Sales and marketing" expense in the Consolidated Statements of Operations.
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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 and equipment 3-7 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.
Operating Leases
We adopted ASU 2016-02, Leases, or 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, net of any lease incentives received by the 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.
Lease term includes the non-cancelable term, unless it is reasonably certain that a renewal or termination option will 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.
Business Combinations and Goodwill
We account for business combinations using the acquisition method of accounting in accordance with which assets acquired and liabilities assumed are recorded at their respective fair values on 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.
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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 during the fourth quarter or more often if impairment indicators are present, based on events and circumstances indicating that it is more likely than not that the fair value of the reporting unit is below its carrying value. There were no goodwill impairment losses recognized during the years ended December 31, 2022, 2021, and 2020. We performed our annual quantitative goodwill impairment test as of December 31, 2022 and 2021 and determined that no adjustment to goodwill was necessary because the reporting unit's fair value significantly exceeded its book value.
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 our intangible assets on an ongoing basis to determine whether events and circumstances warrant a revision to the remaining amortization period.
Acquired technology and customer relationships amortization is recorded within "Costs of revenue" and “Sales and marketing” expenses, respectively, within the Consolidated Statements of Operations and amounted to $5, $4 and $4, respectively, during the years ended December 31, 2022, 2021, and 2020.
The estimated useful lives for acquired technology and customer relationship intangible assets are as follows:
Estimated Useful Life
Acquired technology 3 - 10 years
Customer acquired intangible assets 5 - 6 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 losses during the years ended December 31, 2022, 2021 and 2020.
Deferred Revenue
Deferred revenue represents our obligation to transfer products or services to customers for which consideration has been received and consists of amounts deferred from subscription services contracts, professional service engagements, and customer deposits received in advance. Amounts deferred under subscription service contracts are recognized ratably over the respective term of the customer contract.
Costs of Revenue
Costs of revenue primarily consists of costs associated with payment processing, personnel, and related infrastructure for operation of our cloud-based platform, data center operations, customer support, loan servicing and allocated overhead. Hardware costs consist of all product and shipping costs associated with tablets, printers, and other peripherals. Employee-related costs consist of salaries, benefits, bonuses, and stock-based compensation expense. Overhead consists of certain facilities costs, depreciation expense, and amortization costs associated with internally developed software.
Payment processing costs include interchange fees, network assessment fees and fees paid to the acquiring payment processors.
Stock-Based Compensation Expense
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We grant equity awards, including stock options which vest upon the satisfaction of service conditions and restricted stock units, or RSUs, which vest upon the satisfaction of performance conditions and/or service conditions. 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 is recognized over the service period, net of estimated forfeitures. We estimate a forfeiture rate to calculate the stock-based compensation expense for all awards based on an analysis of actual historical experience and expected employee attrition rates.