UPWORK, INC 10-K

Item 8. Financial Statements and Supplementary Data. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm—PCAOB ID: 238 66 Consolidated Balance Sheets as of December 31, 2022 and 2021 69 Consolidated Statements of Operations and Comprehensive Loss for the Years ended December 31, 2022, 2021, and 2020 70 Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2022, 2021, and 2020 71 Consolidated Statements of Cash Flows for the Years ended December 31, 2022, 2021, and 2020 72 Notes to Consolidated Financial Statements 73 The supplementary financial information required by this item is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 65 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Upwork Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Upwork Inc. and its subsidiaries (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of operations and comprehensive loss, of stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2022, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of 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 accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated 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 consolidated 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 consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. 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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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. 66 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. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters 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. Revenue Recognition – Estimation of Standalone Selling Price of the Talent Material Rights and the Period of Time Over Which to Defer and Recognize the Consideration Allocated to the Material Rights As described in Notes 2 and 12 to the consolidated financial statements, the Company charges talent a service fee as a percentage of talent billings primarily using a tiered service fee model based on cumulative lifetime billings by talent to each client. The Company recorded total revenue of $618.3 million for the year ended December 31, 2022, of which $334.7 million related to revenue from talent. Certain of the Company’s contracts with talent contain multiple performance obligations in the event management determines a material right exists. Specifically, the arrangements with talent subject to tiered service fees include contract renewal options that represent a material right. For such arrangements, management allocates revenue to each performance obligation based on its relative standalone selling price by applying the portfolio approach practical expedient under Topic 606. Standalone selling prices for offerings subject to tiered service fees are estimated based on observable transactions when these services are sold on a standalone basis. Standalone selling price for a material right is estimated by determining the discount that the talent would obtain when exercising the option, adjusted for the likelihood that the option will be exercised. Management applies significant judgment in the application of the portfolio approach practical expedient, which includes estimating the standalone selling price of the material rights and the period of time over which to defer and recognize the consideration allocated to the material rights. Specifically, management applied significant judgment in assessing the appropriateness of the model for the estimates, which includes assessing the appropriateness of the methodology and relevant data inputs to (i) estimate the standalone selling price of the material rights, which includes the standalone selling price of the services when sold separately and the likelihood of exercise of the material rights, and (ii) estimate the period of time over which to defer and recognize the consideration allocated to the material rights. Management utilized historical user transaction data in developing the estimates. The Company recognizes revenue related to the material rights based on management’s estimate of when the material rights are exercised. The principal considerations for our determination that performing procedures relating to revenue recognition, specifically the estimation of standalone selling price of the talent material rights and the period of time over which to defer and recognize the consideration allocated to the material rights, is a critical audit matter are the significant judgment by management in assessing the appropriateness of the model, methodology and relevant data inputs to estimate the standalone selling price of the material rights, and the period of time over which to defer and recognize the consideration allocated to the material rights. This in turn led to significant auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence related to management’s determination of the standalone selling price of the services when sold separately, the likelihood of exercise of the material rights, and the period of time over which to defer and recognize the consideration allocated to the material rights. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including the assessment of the appropriateness of the model, methodology and relevant data inputs to estimate the material rights standalone selling price and the period of time over which to defer and recognize the consideration allocated to the material rights. These procedures also included, among others, (i) evaluating the appropriateness of management’s model used in developing the estimates, the reasonableness of the selected methodology and relevant data inputs used in determining the standalone selling price of the services when sold separately and the likelihood of exercise of the material rights, and the period of time over which to defer and recognize the consideration allocated to the material rights, (ii) testing the completeness and accuracy of data inputs, and (iii) testing the mathematical accuracy of the model’s calculations and the amounts recorded for the material rights in the consolidated financial statements. 67 /s/ PricewaterhouseCoopers LLP San Jose, California February 16, 2023 We have served as the Company’s auditor since 2016. 68 UPWORK INC. CONSOLIDATED BALANCE SHEETS As of December 31, 2022 and 2021 (In thousands, except share and per share data) 2022 2021 ASSETS Current assets Cash and cash equivalents $ 129,384 $ 187,205 Marketable securities 557,230 497,566 Funds held in escrow, including funds in transit 161,457 160,813 Trade and client receivables – net of allowance of $ 12,464 and $ 3,410 as of December 31, 2022 and 2021, respectively 64,888 66,826 Prepaid expenses and other current assets 17,947 17,243 Total current assets 930,906 929,653 Property and equipment, net 22,063 21,329 Goodwill 118,219 118,219 Operating lease asset 7,603 10,682 Other assets, noncurrent 1,454 1,178 Total assets $ 1,080,245 $ 1,081,061 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities Accounts payable $ 7,549 $ 4,996 Escrow funds payable 161,457 160,813 Accrued expenses and other current liabilities 53,611 45,742 Deferred revenue 25,075 22,083 Total current liabilities 247,692 233,634 Debt, noncurrent 564,261 561,299 Operating lease liability, noncurrent 11,177 16,753 Other liabilities, noncurrent 8,236 9,858 Total liabilities 831,366 821,544 Commitments and contingencies (Note 6) Stockholders’ equity Common stock, $ 0.0001 par value; 490,000,000 shares authorized as of December 31, 2022 and 2021; 132,368,265 and 129,130,478 shares issued and outstanding as of December 31, 2022 and 2021, respectively 13 13 Additional paid-in capital 592,900 511,096 Accumulated other comprehensive loss ( 3,085 ) ( 528 ) Accumulated deficit ( 340,949 ) ( 251,064 ) Total stockholders’ equity 248,879 259,517 Total liabilities and stockholders’ equity $ 1,080,245 $ 1,081,061 The accompanying notes are an integral part of these consolidated financial statements. 69 UPWORK INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS For the Years Ended December 31, 2022, 2021, and 2020 (In thousands, except per share data) 2022 2021 2020 Revenue $ 618,318 $ 502,797 $ 373,628 Cost of revenue 160,402 135,508 104,267 Gross profit 457,916 367,289 269,361 Operating expenses Research and development 154,553 119,083 83,471 Sales and marketing 246,882 183,294 133,225 General and administrative 123,952 113,081 71,518 Provision for transaction losses 25,153 6,048 3,555 Total operating expenses 550,540 421,506 291,769 Loss from operations ( 92,624 ) ( 54,217 ) ( 22,408 ) Interest expense 4,483 2,180 778 Other income, net ( 7,758 ) ( 279 ) ( 469 ) Loss before income taxes ( 89,349 ) ( 56,118 ) ( 22,717 ) Income tax provision ( 536 ) ( 122 ) ( 150 ) Net loss $ ( 89,885 ) $ ( 56,240 ) $ ( 22,867 ) Net loss per share, basic and diluted $ ( 0.69 ) $ ( 0.44 ) $ ( 0.19 ) Weighted-average shares used to compute net loss per share, basic and diluted 130,518 127,164 118,699 Other comprehensive loss, net of tax: Net unrealized holding loss on marketable securities, net $ ( 2,557 ) $ ( 547 ) $ ( 18 ) Total comprehensive loss $ ( 92,442 ) $ ( 56,787 ) $ ( 22,885 ) The accompanying notes are an integral part of these consolidated financial statements. 70 UPWORK INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY For the Years Ended December 31, 2022, 2021, and 2020 Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Loss Accumulated Deficit Total Stockholders’ Equity (In thousands, except share amounts) Shares Amount Balances as of December 31, 2019 113,604,398 $ 11 $ 431,333 $ 37 $ ( 171,957 ) $ 259,424 Issuance of common stock upon exercise of stock options and common stock warrants 9,115,947 1 31,027 — — 31,028 Stock-based compensation expense — — 25,677 — — 25,677 Issuance of common stock for settlement of RSUs 1,590,225 — — — — — Tides Foundation common stock warrant expense and other — — 1,153 — — 1,153 Issuance of common stock in connection with employee stock purchase plan 484,652 — 4,913 — — 4,913 Unrealized loss on marketable securities — — — ( 18 ) — ( 18 ) Net loss — — — — ( 22,867 ) ( 22,867 ) Balances as of December 31, 2020 124,795,222 12 494,103 19 ( 194,824 ) 299,310 Issuance of common stock upon exercise of stock options and common stock warrants 2,085,698 1 7,176 — — 7,177 Stock-based compensation expense — — 53,671 — — 53,671 Issuance of common stock for settlement of RSUs 1,865,444 — 1 — — 1 Tides Foundation common stock warrant expense and other — — 749 — — 749 Issuance of common stock in connection with employee stock purchase plan 384,114 — 4,789 — — 4,789 Purchase of capped calls related to convertible senior notes — — ( 49,393 ) — — ( 49,393 ) Unrealized loss on marketable securities — — ( 547 ) — ( 547 ) Net loss — — — — ( 56,240 ) ( 56,240 ) Balances as of December 31, 2021 129,130,478 13 511,096 ( 528 ) ( 251,064 ) 259,517 Issuance of common stock upon exercise of stock options 412,171 — 1,642 — — 1,642 Stock-based compensation expense — — 75,618 — — 75,618 Issuance of common stock for settlement of RSUs 2,553,300 — — — — — Tides Foundation common stock warrant expense and other — — 750 — — 750 Issuance of common stock in connection with employee stock purchase plan 272,316 — 3,794 — — 3,794 Unrealized loss on marketable securities — — — ( 2,557 ) — ( 2,557 ) Net loss — — — — ( 89,885 ) ( 89,885 ) Balances as of December 31, 2022 132,368,265 $ 13 $ 592,900 $ — $ ( 3,085 ) $ ( 340,949 ) $ 248,879 The accompanying notes are an integral part of these consolidated financial statements. 71 UPWORK INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2022, 2021, and 2020 (In thousands) 2022 2021 2020 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ ( 89,885 ) $ ( 56,240 ) $ ( 22,867 ) Adjustments to reconcile net loss to net cash provided by operating activities: Provision for transaction losses 23,306 5,178 2,919 Depreciation and amortization 8,057 10,261 10,172 Amortization of debt issuance costs 2,961 1,182 61 Amortization of premium (accretion of discount) of purchases of marketable securities, net ( 1,486 ) 298 ( 320 ) Amortization of operating lease asset 3,079 3,545 3,860 Tides Foundation common stock warrant expense 750 750 750 Stock-based compensation expense 75,501 53,592 25,508 Impairment expense — 8,741 — Loss on disposal of fixed assets — — 44 Changes in operating assets and liabilities: Trade and client receivables ( 20,230 ) ( 24,610 ) ( 20,000 ) Prepaid expenses and other assets ( 630 ) ( 6,960 ) ( 1,198 ) Operating lease liability ( 5,389 ) ( 1,163 ) ( 1,851 ) Accounts payable 2,579 ( 1,445 ) 5,822 Accrued expenses and other liabilities 3,689 10,253 15,438 Deferred revenue 4,257 7,454 4,027 Net cash provided by operating activities 6,559 10,836 22,365 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of marketable securities ( 581,887 ) ( 525,343 ) ( 107,281 ) Proceeds from maturities of marketable securities 521,152 102,500 117,500 Purchases of property and equipment ( 1,248 ) ( 1,027 ) ( 6,320 ) Internal-use software and platform development costs ( 7,485 ) ( 5,110 ) ( 8,045 ) Net cash used in investing activities ( 69,468 ) ( 428,980 ) ( 4,146 ) CASH FLOWS FROM FINANCING ACTIVITIES: Changes in escrow funds payable 645 25,771 26,321 Proceeds from exercises of stock options and common stock warrant 1,643 7,177 31,028 Proceeds from employee stock purchase plan 3,794 4,789 4,913 Proceeds from borrowings on debt — — 18,000 Repayment of debt — ( 10,750 ) ( 25,621 ) Proceeds from issuance of convertible senior notes — 575,000 — Payment of debt issuance costs — ( 14,855 ) — Purchases of capped calls related to convertible senior notes — ( 49,393 ) — Net cash provided by financing activities 6,082 537,739 54,641 NET CHANGE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH ( 56,827 ) 119,595 72,860 Cash, cash equivalents, and restricted cash—beginning of year 352,058 232,463 159,603 Cash, cash equivalents, and restricted cash—end of year $ 295,231 $ 352,058 $ 232,463 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 1,541 $ 373 $ 764 SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Property and equipment purchased but not yet paid — 22 37 Internal-use software and platform development costs incurred but not yet paid 73 106 286 The accompanying notes are an integral part of these consolidated financial statements. 72 UPWORK INC. Notes to Consolidated Financial Statements Note 1— Organization and Description of Business Upwork Inc., which is referred to as the Company or Upwork, operates a work marketplace that connects businesses, which are referred to as clients, with independent talent. Independent talent on the Company’s work marketplace, which are referred to as talent, and, together with clients, as users, include independent professionals and agencies of varying sizes and are an increasingly sought-after, critical, and expanding segment of the global workforce. The Company was originally incorporated in the state of Delaware in December 2013 prior to and in connection with the combination, which is referred to as the Elance-oDesk Combination, of Elance, Inc., which is referred to as Elance, and oDesk Corporation, which is referred to as oDesk. The Company changed its name to Elance-oDesk, Inc. shortly before the Elance-oDesk Combination in March 2014, and later to Upwork Inc. The Company is currently headquartered in San Francisco, California. Unless otherwise expressly stated or the context otherwise requires, the terms “Upwork” and the “Company” in these notes to the consolidated financial statements refer to Upwork and its wholly-owned subsidiaries. Note 2— Basis of Presentation and Summary of Significant Accounting Policies Basis of Presentation and Principles of Consolidation The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States, which is referred to as U.S. GAAP, and include the accounts of Upwork Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Use of Estimates The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the periods presented. Such estimates include, but are not limited to: the useful lives of assets; assessment of the recoverability of long-lived assets; goodwill impairment; standalone selling price of material rights and the period of time over which to defer and recognize the consideration allocated to the material rights; allowance for expected credit losses; liabilities relating to transaction losses; stock-based compensation; and accounting for income taxes. Management bases its estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. The Company evaluates its estimates, assumptions, and judgments on an ongoing basis using historical experience and other factors and revises them when facts and circumstances dictate. The Company is not aware of any specific event or circumstance that would require an update to its estimates or judgments or a revision of the carrying value of its assets or liabilities. These estimates may change as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions. Cash and Cash Equivalents The Company classifies as cash and cash equivalents its cash held in checking and interest-bearing accounts and investments in money market funds, U.S. government securities, and debt securities with maturities of 90 days or less from the date of purchase. Restricted Cash As of December 31, 2022 and 2021, the Company maintained restricted cash of $ 4.4 million and $ 4.0 million, respectively, related to cash reserve requirements under the escrow laws and regulations of the California Department of Financial Protection and Innovation and collateral for letters of credit issued in conjunction with operating leases. Short-term restricted cash included in prepaid expenses and other current assets was $ 3.6 million and $ 3.2 million as of December 31, 2022 and 2021, respectively, and long-term restricted cash included in other assets, noncurrent was $ 0.8 million and $ 0.8 million as of December 31, 2022 and 2021, respectively. Funds Held in Escrow, Including Funds in Transit The Company maintains its users’ funds held in escrow in demand or checking accounts at U.S. financial institutions, as well as two California licensed money transmitters. The balance in these accounts was in excess of 73 UPWORK INC. Notes to Consolidated Financial Statements—Continued federally insured limits as of December 31, 2022 and 2021. Users’ funds held in escrow are denominated exclusively in U.S. dollars. The Company is an internet escrow agent and is therefore required to hold its users’ escrowed funds and escrow funds in transit in trust as an asset and record a corresponding liability for escrow funds payable on its consolidated balance sheets. For this reason, funds held in escrow, including funds in transit, are restricted cash. Escrow funds in transit arise due to the time it takes to clear transactions through external payment networks. When clients fund their escrow account using credit cards, there is a clearing period before the cash is received and settled. Accordingly, the funds are treated as escrow funds in transit until the transaction is settled to the escrow trust bank account or, in the case of international credit card settlements, to the Company’s bank accounts. Escrow regulations require the Company to fund the trust with its own operating cash if there is ever a shortage due to the timing of cash receipts from clients for completed hourly billings. As of December 31, 2022 and 2021, the Company recorded $ 161.5 million and $ 160.8 million, respectively, as funds held in escrow, including funds in transit. The below table reconciles cash, cash equivalents, and restricted cash as reported in the consolidated balance sheets to the total of the same amounts shown in the consolidated statements of cash flows for the years ended December 31, 2022, 2021, and 2020: (In thousands) 2022 2021 2020 Cash and cash equivalents $ 129,384 $ 187,205 $ 94,081 Restricted cash 4,390 4,040 3,340 Funds held in escrow, including funds in transit 161,457 160,813 135,042 Total cash, cash equivalents, and restricted cash as shown in the consolidated statement of cash flows $ 295,231 $ 352,058 $ 232,463 Marketable Securities The Company's marketable securities consist of money market funds, commercial paper, treasury bills, corporate bonds, U.S. government securities, asset-backed securities, and other types of fixed income securities issued by foreign governments or entities and denominated in U.S. dollars, all of which have contractual maturities within 24 months from the date of purchase. The marketable securities are available for current operations and are classified as available-for-sale. These marketable securities are carried at estimated fair value with unrealized gains and losses, net of taxes, included within the stockholders’ equity section of the Company’s consolidated balance sheet. The Company periodically assesses its portfolio of debt investments for impairment. For debt securities in an unrealized loss position, this assessment first takes into account the Company’s intent to sell, or whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If either of these criteria are met, the debt security’s amortized cost basis is written down to fair value through other (income) expense, net. For debt securities in an unrealized loss position that do not meet the aforementioned criteria, the Company assesses whether the decline in fair value below the amortized cost basis resulted from a credit loss or other factors. In making this assessment, the Company considers factors such as the extent to which fair value is less than the amortized cost basis, the financial condition of the issuer, any changes to the rating of the security by a rating agency, and any adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss may exist, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses will be recorded through other (income) expense, net, limited by the amount that the fair v alue is less than the amortized cost basis. Any additional impairment not recorded through an allowance for credit losses is recognized in other comprehensive loss. Cha nges in the allowance for credit losses are reflected as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when management believes the uncollectability of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell are met. These changes are recorded in other income, net. The Company determines realized gains or losses from the sale of marketable securities on a specific identification method and records such gains or losses as other (income) expense, net within the Company’s consolidated statements of operations and comprehensive loss. Escrow Funds Payable Escrow funds payable represent user funds that are held in escrow by the Company on behalf of both talent and clients. Escrow funds payable to talent are comprised primarily of funds available to be withdrawn by talent for work performed and paid by clients. Escrow funds payable to clients primarily represent deposits received from certain 74 UPWORK INC. Notes to Consolidated Financial Statements—Continued clients to set up an account or to apply toward future payments to talent upon completion of the project defined and agreed between the client and talent. Concentration of Risk Financial instruments that subject the Company to concentration of risk consist primarily of cash, restricted cash, funds held in escrow, including funds in transit, and trade and client receivables. The Company maintains its cash balances with large, high-credit quality financial institutions and other payment companies. At times, such deposits may be in excess of federally insured limits. The Company has not experienced any losses on its deposits. Credit risk on trade receivables is limited as a result of the large size of the Company’s client base as well as a large portion of payments made using pre-authorized credit cards. The Company performs ongoing credit evaluations of its clients and maintains allowances for potential credit losses. For any receivables that are deemed not collectible, losses are recorded when probable and estimable. These losses, when incurred, have been within the range of the Company’s expectations. One client accounted for more than 10% of trade and client receivables as of December 31, 2022. One client accounted for more than 10% of trade and client receivables as of December 31, 2021. For the years ended December 31, 2022, 2021 and 2020, the Company did not have any clients that accounted for more than 10% of total revenue. The Company is dependent upon third parties, such as Amazon Web Services, in order to meet the uptime and performance needs of its users. Fair Value of Financial Instruments The Company’s financial instruments consist of cash and cash equivalents, restricted cash, funds held in escrow, including funds in transit, marketable securities, trade and client receivables, prepaid and other current assets, escrow funds payable, and debt. The Company believes that the carrying values of the remaining financial instruments approximate their fair values. Trade and Client Receivables and Related Allowance for Expected Credit Losses Trade and client receivables are primarily comprised of amounts receivable from clients for completed work, including amounts in transit. It also includes unbilled amounts due from clients primarily through the Company’s managed services offering. Trade and client receivables are recorded and stated at realizable value, net of an allowance for expected credit losses. Credit is extended generally without collateral to the Company’s managed services and marketplace clients with Upwork Enterprise offerings based on an initial and ongoing evaluation of their financial condition and other factors. In aggregate, gross trade receivables were $ 22.6 million and $ 19.7 million and gross client receivables were $ 54.7 million and $ 50.5 million as of December 31, 2022 and 2021, respectively. The allowance for expected credit losses is the Company’s estimate of the probable credit losses on accounts receivable. The Company periodically assesses the collectability of the accounts and determines the allowance recognized by taking into consideration the aging of its receivable balances, historical write-off experience, probability of collection, and other relevant data. Trade and client receivables are written off against the allowance when management determines a balance is uncollectible and no longer actively pursues collection of the receivable. The following table presents the changes in the allowance for expected credit losses as of December 31, 2022, 2021, and 2020: (In thousands) 2022 2021 2020 Allowance for expected credit losses, beginning balance $ 3,410 $ 1,661 $ 2,215 Provision for expected credit losses 22,167 4,803 3,143 Amounts written off ( 13,113 ) ( 3,054 ) ( 3,697 ) Allowance for expected credit losses, ending balance $ 12,464 $ 3,410 $ 1,661 Derivative Instruments The Company uses derivative financial instruments not designated as hedges, such as foreign currency forward contracts, to minimize the short-term impact of foreign currency exchange rate fluctuations on certain foreign currency denominated assets and liabilities, as well as certain foreign currency denominated expenses, hedging the gains or losses generated by the re-measurement of significant foreign currency denominated monetary assets and liabilities. The Company does not enter into derivative instruments for speculative or trading purposes and these instruments generally have maturities within 12 months. 75 UPWORK INC. Notes to Consolidated Financial Statements—Continued The foreign currency forward contracts are recorded at fair value and, when in gain positions, are reported within prepaid expenses and other current assets. When in loss positions, the foreign currency forward contracts are recorded within accrued expenses and other current liabilities in the consolidated balance sheets. Gains or losses from changes in the fair value of these foreign currency forward contracts not designated as hedging instruments are recorded in other income, net to offset the changes in the fair value of the underlying assets or liabilities being hedged. The notional amounts associated with the Company’s foreign currency forward contracts as of December 31, 2022 and 2021 were $ 7.2 million and $ 7.2 million, respectively, none of which were designated as cash flow hedges. The carrying values of the foreign currency forward contracts approximated their fair values due to their relatively short settlement durations. The fair values of the Company’s outstanding foreign currency forward contracts not designated as hedging instruments as of December 31, 2022 and 2021 were not material. Losses on foreign currency forward contracts not designated as hedging instruments were $ 0.2 million for the year ended December 31, 2022. Losses on foreign currency forward contracts not designated as hedging instruments were $ 0.5 million for the year ended December 31, 2021. Losses on foreign currency forward contracts not designated as hedging instruments were $ 0.6 million for the year ended December 31, 2020. Leases The Company accounts for leases in accordance with Financial Accounting Standards Board, which is referred to as the FASB, Accounting Standards Update, which is referred to as ASU, No. 2016-02, Leases (Topic 842), which the Company adopted on December 31, 2019 effective as of January 1, 2019 using the effective date method. Property and Equipment, Net Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets, which are generally two to five years . Leasehold improvements are amortized on a straight-line basis over the shorter of the remaining lease term or their estimated useful lives. Repair and maintenance costs are charged to expense as incurred. Internal-Use Software and Platform Development Costs The Company’s policy is to capitalize certain costs to develop its internal-use software and platform when (i) preliminary project planning is completed, (ii) the Company has committed project resourcing, and (iii) it is probable that the project will be completed and the software will be used as intended. Costs incurred for enhancements that are expected to result in additional significant functionality are also capitalized. Such costs are generally amortized on a straight-line basis over their estimated useful lives determined on a project-by-project basis, which historically has ranged between two to three years , beginning when the asset is ready for its intended use. Costs incurred prior to meeting these criteria, together with costs incurred for training and maintenance, are expensed as incurred. Amortization of capitalized internal-use software and platform development costs is allocated to functional expense categories based on headcount and the nature and intended use of the project. Segment Information The Company has one reportable segment. The Company’s chief operating decision maker is its President and Chief Executive Officer, who reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. Goodwill and Other Long-Lived Assets Goodwill represents the excess of the aggregate fair value of the consideration transferred over the fair value of the net tangible and identifiable intangible assets acquired in the Elance-oDesk Combination. As of December 31, 2022 and 2021, all of the Company’s intangible assets were fully amortized. Goodwill is not amortized, but rather is assessed for impairment at least annually, or more frequently if events and changes in circumstances indicate that its carrying amount may not be recoverable. The Company performs its annual impairment assessment during the fourth quarter of each calendar year based on a single reporting unit structure by comparing the carrying value of the reporting unit to its fair value. An impairment would occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. There has been no impairment of goodwill for any of the periods presented. The Company’s long-lived assets consist of property and equipment and internal-use software and platform development costs. The Company evaluates the recoverability of its long-lived assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by comparing the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If it is determined that the asset group is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset group exceeds the aggregate future 76 UPWORK INC. Notes to Consolidated Financial Statements—Continued undiscounted cash flows. When an impairment loss is recognized, the carrying amount of such assets is reduced to fair value. For 2022, the Company conducted its goodwill impairment testing by performing step one of the quantitative assessment, of the two-step impairment model. The fair value was determined by the Company using quoted market prices of the Company’s common stock. The Company determined that the fair value of its reporting unit exceeded the carrying value, and, as such, the Company concluded that there was no impairment of goodwill at the impairment testing date. There was no impairment of goodwill in any of the periods presented. Convertible Senior Notes The Company accounts for its convertible senior notes, which are referred to as the Notes, as a single liability measured at amortized cost. The carrying value of the liability equals the proceeds received from the issuance of the Notes less debt issuance costs. See “Note 7—Debt” for additional information. Debt Issuance Costs Debt issuance costs incurred in connection with securing the Company’s financing arrangements are capitalized and amortized over the term of the respective financing arrangement under the straight-line method as the results obtained are not materially different from those that would result from the use of the effective interest method. Debt issuance costs are generally presented in the Company’s consolidated balance sheets as a reduction to the carrying amount of the outstanding borrowings. Revenue Recognition The Company primarily generates revenue from clients from its marketplace and managed service offerings and from talent from its marketplace. The Company accounts for revenue in accordance with FASB ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which the Company adopted on December 31, 2019 effective as of January 1, 2019 using the modified retrospective method. Revenue is recognized upon transfer of control of promised services to users in an amount that reflects the consideration the Company expects to receive in exchange for those services. In the ordinary course of business, the Company makes payments to users when those users provide services in their capacity as vendors. These payments are for distinct services and are at fair value. These transactions are primarily with certain financial institutions that the Company uses as payment processors on the work marketplace. The Company accounts for the consideration payable to these users in their capacity as vendors as a purchase of services from a vendor and records such payments in either cost of revenue or sales and marketing within the consolidated statements of operations and comprehensive loss. Marketplace Offerings The Company’s marketplace revenue, which represents the majority of its revenue, consists of revenue derived from its marketplace offerings. Marketplace offerings consist of all offerings other than the Company’s managed services offering, including the Company’s former Upwork Basic and Upwork Plus offerings and its current Client Marketplace and Enterprise offerings. In April 2022, the Company combined the Upwork Basic and Upwork Plus client offerings into a new Client Marketplace offering, which simplifies the pricing model for clients of those offerings. This model makes available the most popular features of the legacy Upwork Plus offering, while eliminating the monthly client subscription fees and moving to a client marketplace fee of 5% on each transaction—or 3% if paid via ACH for eligible clients. The Company generates marketplace revenue from both talent and clients. Marketplace revenue is primarily generated from talent service fees, and to a lesser extent, client marketplace fees (and prior to the launch of the Client Marketplace offering, payment processing and administration fees). Additionally, marketplace revenue includes revenue from the Company’s Upwork Enterprise offering, which is referred to as Enterprise Revenue, including all client fees, subscriptions, and talent service fees. The Company also generates marketplace revenue from fees for premium offerings, including talent memberships, purchases of Connects, and other services, such as foreign currency exchange when clients choose to pay in currencies other than the U.S. dollar, and the Company’s Upwork Payroll offering. Upwork Basic, Plus, and Other Premium Offerings The Company earns fees from talent under the Upwork Basic and Upwork Plus talent offerings, and associated premium offerings, which represent a single promise to provide continuous access (i.e. stand-ready performance obligation) to the Company’s work marketplace and site services. As each day of providing access to the work marketplace and site services (including, but not limited to, communication, invoicing, reporting, dispute resolution, 77 UPWORK INC. Notes to Consolidated Financial Statements—Continued and payment services) is substantially the same and talent simultaneously receive and consume the benefits as access is provided, the Company’s single promise under its Upwork Basic and Upwork Plus talent offerings is comprised of a series of distinct service periods. The Company allocates variable consideration to each distinct service period in which it has the contractual right to bill. The Company’s Upwork Basic and Upwork Plus talent arrangements may include fixed and variable consideration, or a combination of the two, comprised of the following: Service fees. Talent are provided access to the Upwork work marketplace to market their businesses, send proposals to and communicate with prospective clients, and, if engaged by a client, to perform specified services agreed between talent and clients, which are referred to as talent services. Talent charge clients on an hourly or a milestone basis for services rendered to clients through the Upwork work marketplace, which are referred to as talent billings. The Company charges talent a service fee as a percentage of talent billings primarily using a tiered service fee model based on cumulative lifetime billings by talent to each client. The arrangements subject to tiered service fees also include contract renewal options that represent a material right. The Company takes no responsibility for talent services, and therefore, does not control talent services. Additionally, talent and clients negotiate and agree upon the scope and the price for talent services directly with each other, and the Company is not a party to those agreements. Accordingly, for these tiered service fee arrangements, the Company presents revenue on a net basis, as an agent. The Company recognizes the service fees for each distinct service period when it has the contractual right to bill for the services. Withdrawal fees . The Company charges withdrawal fees to talent when talent withdraw their escrow funds held by the Company. A withdrawal fee is charged for each withdrawal transaction, which represents variable consideration. The Company presents revenue from withdrawal fees on a gross basis as a principal and not net of the third-party payment processing costs incurred because the Company controls the payment processing services prior to providing to the Company's t alent. The Company recognizes the withdrawal fees when transactions are processed, which is when it has the contractual right to bill for the services. Membership fees. The Company charges membership fees to talent. These fees are fixed consideration and are charged monthly. The Company recognizes the revenue over the period of the membership, which is generally monthly, consistent with the common measure of progress for the entire performance obligation. Connects fees. The Company charges fees to talent for the purchase of Connects, which are virtual tokens that are required for talent to bid on projects on the Company’s work marketplace. These fees represent variable consideration and are allocated to and recognized in the distinct service period in which the Connects are used . The Company earns fees from clients under the Client Marketplace offering, which represents a single promise to provide continuous access (i.e. stand-ready performance obligation) to the Company’s work marketplace and site services. As each day of providing access to the work marketplace and site services is substantially the same and the client simultaneously receives and consumes the benefits as access is provided, the Company’s single promise under its Client Marketplace offering is comprised of a series of distinct service periods. The Company’s Client Marketplace offering may include fixed and variable consideration, or a combination of the two, comprised of the following: Client marketplace fees (previously referred to as client payment processing and administrative fees). The Company charges a client marketplace fee on a per-transaction basis and is considered variable consideration. The client marketplace fee may include fixed and variable consideration, or a combination of the two. The Company allocates fixed and variable consideration to each distinct service period based on the contractual right to bill. For fixed consideration, the Company recognizes revenue when a client funds a contract, and for variable consideration, the Company recognizes revenue at the end of the weekly billing period, which is when the Company has the contractual right to bill for the services. For client marketplace fees, the Company presents revenue on a gross basis as a principal and not net of the third-party payment processing costs incurred because the Company controls the services prior to providing to the Company’s clients. Foreign currency exchange fees. The Company charges clients a fixed mark-up above foreign currency exchange rates that are charged to the Company when the Company collects amounts denominated in foreign currency. Foreign currency exchange fees are variable consideration and recognized as they are earned for each transaction processed, which is when the Company has the contractual right to bill for the services. Upwork Payroll service fees. The Company charges clients using the Upwork Payroll offering when their talent are classified as employees for engagements on the Upwork work marketplace. The client enters into an Upwork Payroll agreement with the Company, and Upwork separately contracts with unrelated third-party staffing providers that provide employment services to such clients. In such arrangements, talent providing talent services to clients become employees of third-party staffing providers. In arrangements where clients 78 UPWORK INC. Notes to Consolidated Financial Statements—Continued enter into Upwork Payroll agreements, the Company charges Upwork Payroll service fees to clients and does not charge service fees to talent who are employees of the third-party staffing providers. Such service fees are variable consideration and charged as a fixed percentage of the total talent billings. Under an Upwork Payroll agreement, the Company provides the client access to the Upwork work marketplace to procure and manage talent services, as well as access to employment services provided by the third-party staffing providers. The Company presents Upwork Payroll service fees revenue on a net basis as an agent of the client for providing access to employment services provided by the third-party staffing providers. The Company does not control these employment services performed by the third-party on behalf of the client or for the services performed by talent that are employed by the third-party staffing providers. Therefore, the Company is not considered the principal for these services. The Company recognizes the service fees for each distinct service period when it has the contractual right to bill for the services. Prior to April 2022, the Company earned fees from clients under its former Upwork Basic and Upwork Plus offerings, which represented a single promise to provide continuous access (i.e. stand-ready performance obligation) to the Company’s work marketplace and site services. As each day of providing access to the work marketplace and site services was substantially the same and the client simultaneously received and consumed the benefits as access was provided, the Company’s single promise under its former Upwork Basic and Upwork Plus offerings was comprised of a series of distinct service periods. The Company allocated variable consideration to each distinct service period in which it had the contractual right to bill. The Company’s former Upwork Basic and Upwork Plus arrangements included fixed and variable consideration, or a combination of the two, comprised of the following: Client payment processing and administration fees. The Company charged clients for payment processing services at the time the client was charged for the amounts due from the client. This fee was charged on a per-transaction basis and was variable consideration. Per-transaction payment processing fees were recognized when the client was charged for the amount due and fees charged on a monthly basis were recognized over the month that payment processing services were provided. For client payment processing fees, the Company presented revenue on a gross basis as a principal and not net of the third-party payment processing costs incurred because the Company controlled the payment processing and administration services prior to providing to the Company’s clients. The Company recognized the revenue when a payment from a client was processed, which was when it had the contractual right to bill for the services. Foreign currency exchange fees. These fees did not change as a result of the Company’s shift to the Client Marketplace offering. Refer to the discussion above for details of these fees. Membership fees. The Company charged membership fees to clients. These fees were charged monthly, were fixed consideration, and were recognized over the period of the membership, which was generally monthly consistent with the common measure of progress for the entire performance obligation. Upwork Payroll service fees. These fees did not change as a result of the Company’s shift to the Client Marketplace offering. Refer to the discussion above for details of these fees. Upwork Enterprise and Other Premium Offerings The Company earns fees from talent under Upwork Enterprise and other associated premium offerings, each of which represent a single promise to provide continuous access (i.e. stand-ready performance obligation) to the Company’s work marketplace and site services. As each day of providing access to the work marketplace and site services is substantially the same and talent simultaneously receive and consume the benefits as access is provided, the Company’s single promise under its Upwork Enterprise and other premium offerings is comprised of a series of distinct service periods. The Company allocates variable consideration to each distinct service period in which it has the contractual right to bill. These arrangements include variable consideration as follows: Service fees. The Company provides talent access to the Upwork work marketplace to perform talent services for clients. The Company charges talent a service fee as a percentage of talent billings. For service fees charged to talent, the Company presents revenue on a net basis, as an agent, for providing access to the Upwork work marketplace as it does not control talent services provided to clients, and therefore the Company is not considered the principal for talent services. Additionally, talent and clients negotiate and agree upon the scope and the price for talent services directly with each other, and the Company is not a party to their agreement. The Company recognizes the service fees for each distinct service period in which it has the contractual right to bill for the services. The Company earns fees from clients under Upwork Enterprise and other premium offerings, each of which represent a single promise to provide continuous access (i.e. stand-ready performance obligation) to the Company’s work marketplace and site services. As each day of providing access to the work marketplace and site services is 79 UPWORK INC. Notes to Consolidated Financial Statements—Continued substantially the same and the client simultaneously receives and consumes the benefits as access is provided, the Company’s single promise under its Upwork Enterprise and other premium offerings is comprised of a series of distinct service periods. The Company allocates variable consideration to each distinct service period in which it has the contractual right to bill. These arrangements may include fixed and variable consideration, or a combination of the two, comprised of the following: Client service fees. The Company offers clients access to the Company’s work marketplace to source talent in exchange for a client service fee calculated as a percentage of talent billings; these fees represent variable consideration. The Company recognizes the service fees for each distinct service period in which it has the contractual right to bill for the services. Enterprise compliance service fees. The Company charges fees to its enterprise compliance service clients that engage the Company to provide services to determine whether talent should be classified as an employee or an independent contractor based on the scope of talent services agreed between the client and talent and other factors. The Company charges enterprise compliance service fees as a percentage of talent billings; these fees represent variable consideration. The Company recognizes the service fees for each distinct service period in which it has the contractual right to bill for the services. Subscription fees. The Company charges monthly or annual subscription fees to clients for subscription services. These subscription fees are fixed consideration and are recognized over the period of the subscription consistent with the common measure of progress for the entire performance obligation. Upwork Payroll service fees. Upwork Payroll service fees are recognized on the same basis as described under the Client Marketplace offering and are variable consideration. Revenue Sharing Arrangements Certain of the Company’s offerings include revenue sharing arrangements under which the Company generates a revenue share as a percentage of the fees charged by certain financial institutions to talent for payment withdrawals. These arrangements are considered a single performance obligation comprised of variable consideration and are recognized over time based on transactions processed. Managed Services Under a managed services arrangement, the Company is responsible for providing services and engaging talent directly or as employees of third-party staffing providers to perform the services for clients on the Company’s behalf. These arrangements are generally time- and materials-based, and are invoiced on a monthly basis. These fees represent variable consideration. The Company controls and directs the services performed on behalf of talent and presents revenue on a gross basis as principal. As each day of providing managed services is substantially the same and the client simultaneously receives and consumes the benefits as services are provided, the Company’s single promise under its managed services is comprised of a series of distinct service periods. For managed services arrangements with clients, the Company allocates the variable amounts to each distinct service period within the series in which it has the contractual right to bill and recognizes revenue as each distinct service period is performed. Arrangements with Multiple Performance Obligations Certain of the Company’s contracts with talent contain multiple performance obligations in the event the Company determines a material right exists. Specifically, the arrangements with talent subject to tiered service fees include contract renewal options that represent a material right. For such arrangements, the Company allocates revenue to each performance obligation based on its relative standalone selling price by applying the portfolio approach practical expedient under Topic 606. Standalone selling prices for offerings subject to tiered service fees are estimated based on observable transactions when these services are sold on a standalone basis. Standalone selling price for a material right is estimated by determining the discount that talent would obtain when exercising the option, adjusted for the likelihood that the option will be exercised. Significant judgment is applied in the application of the portfolio approach practical expedient, which includes estimating the standalone selling price of the material rights and the period of time over which to defer and recognize the consideration allocated to the material rights. Specifically, management applied significant judgment in assessing the appropriateness of the model for the estimates, which include assessing the appropriateness of the methodology and relevant data inputs to (i) estimate the standalone selling price of the material rights, which includes the standalone selling price of the services when sold separately and the likelihood of exercise of the material rights; and (ii) estimate the period of time over which to defer and recognize the consideration allocated to the material rights. The Company utilized historical user transaction data in developing the estimates. The Company recognizes revenue related to the 80 UPWORK INC. Notes to Consolidated Financial Statements—Continued material rights based on the Company’s estimate of when the material rights are exercised and adjusts revenue for changes in estimates in the period of change on a cumulative catch-up basis. Deferred Revenue Deferred revenue consists of amounts attributable to unexercised material rights related to arrangements with talent that are subject to tiered service fees. Deferred revenue also consists of subscription, membership, and Connects fees collected in advance of performing the service. Cost of Revenue Cost of revenue consists primarily of the cost of payment processing fees, costs of talent to deliver services under the Company’s managed services offering, personnel-related costs for the Company’s services and support personnel, third-party hosting fees, and capitalized internal-use software. The Company defines personnel-related costs as salaries, bonuses, benefits, and stock-based compensation costs for employees, and costs related to other service providers the Company engages to provide internal services to the Company. Research and Development Research and development expense primarily consists of personnel-related costs. Research and development costs are expensed as incurred, except to the extent that such costs are associated with internal-use software and platform development that qualify for capitalization. Advertising Expense The Company expenses advertising costs as incurred. The Company incurred $ 121.2 million, $ 90.8 million, and $ 51.4 million in advertising expenses during the years ended December 31, 2022, 2021, and 2020, respectively. Provision for Transaction Losses Provision for transaction losses consists primarily of losses resulting from fraud on the work marketplace and bad debt expense associated with the Company’s trade and client receivables balance and transaction losses expense related to chargebacks. Provision for these items represents actual and estimates of losses based on the Company’s actual historical incurred losses and other factors. Stock-Based Compensation The Company accounts for stock options with service- and market-based conditions, restricted stock units, which are referred to as RSUs, performance stock units, which are referred to as PSUs, and purchase rights granted under the 2018 Employee Stock Purchase Plan, which is referred to as the 2018 ESPP, to employees and directors based on their estimated fair value on the date of grant. The fair value and derived service period of stock options with market-based conditions is estimated using the Monte Carlo valuation model. The Company evaluates the assumptions used to value option awards upon each grant of stock options. The fair value of RSUs awarded to employees is based on the closing price of the Company’s common stock, as reported on The Nasdaq Global Select Market on the date of grant. The grant date fair value of PSUs is determined using the Company’s closing common stock price on the grant date multiplied by the number of PSUs that are probable of being earned as of the grant date. The fair value of purchase rights granted under the 2018 ESPP is estimated using the Black-Scholes valuation model. The model requires the Company to make a number of assumptions, including the value of the Company’s common stock, expected volatility, expected term, risk-free interest rate, and expected dividends. Stock-based compensation expense associated with service- and market-based stock options will be recognized over the longer of the expected achievement period for the service condition and market condition. The Company generally recognizes stock-based compensation expense for RSUs on a straight-line basis over the vesting term. Stock-based compensation expense associated with PSUs is recognized over the longer of the expected achievement period for the performance condition and the service condition. Stock-based compensation for purchase rights granted under the 2018 ESPP is recognized over the offering period. The Company accounts for forfeitures as they occur. Foreign Currency The functional currency of our foreign subsidiaries is generally the local currency of the country in which the foreign subsidiary is located. At the end of each reporting period, monetary assets and liabilities are remeasured using exchange rates in effect at the balance sheet date, while revenues and expenses are translated at average exchange rates during the year. Foreign currency transaction gains and losses are included in other income, net in the consolidated statements of operations and comprehensive loss. The Company recorded net foreign currency 81 UPWORK INC. Notes to Consolidated Financial Statements—Continued transaction losses of $ 0.2 million, $ 0.5 million, and $ 0.6 million for the years ended December 31, 2022, 2021, and 2020, respectively. Income Taxes The Company accounts for income taxes in accordance with the asset and liability method. Under the asset and liability method, deferred assets and liabilities are recognized based upon anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax bases. The provision for income taxes is comprised of the current tax liability and the change in deferred tax assets and liabilities. The Company establishes a valuation allowance to the extent that it is more likely than not that deferred tax assets will not be recoverable against future taxable income. Deferred tax assets and liabilities are measured using the enacted tax rates that will be in effect for the years in which those tax assets are expected to be realized or settled. The Company regularly assesses the likelihood that its deferred tax assets will be realized from recoverable income taxes or recovered from future taxable income based on the realization criteria set forth in the relevant authoritative guidance. To the extent that the Company believes any amounts are not more likely than not to be realized, the Company records a valuation allowance to reduce its deferred tax assets. The realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. If the Company subsequently realizes deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in an adjustment to earnings in the period such determination is made. In addition, the calculation of tax liabilities involved dealing with uncertainties in the application of complex tax regulations. The Company recognized potential liabilities based on its estimate of whether, and the extent to which, additional taxes will be due. The Company accounts for uncertain tax positions in accordance with the relevant guidance, which prescribes a recognition threshold and measurement approach for uncertain tax positions taken or expected to be taken in a company’s income tax return, and also provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The guidance utilized a two-step approach for evaluation of uncertain tax positions. Step one, Recognition, requires a company to determine if the weight of available evidence indicates a tax position is more likely than not to be sustained upon audit. Step two, Measurement, is based on the largest amount of benefit, which is more likely than not to be realized on ultimate settlement. A liability is reported for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. Any interest and penalties related to unrecognized tax benefits are recorded as income tax expense. Net Loss per Share Basic net loss per share is computed by dividing the net loss by the weighted-average number of common shares outstanding for the period. Diluted net loss is computed by adjusting net loss to reallocate undistributed earnings based on the potential impact of dilutive securities, including outstanding common stock options, RSUs, PSUs, warrants to purchase common stock, common stock issuable in connection with the 2018 ESPP, and common stock issuable in connection with the Notes. For periods in which the Company has reported net losses, diluted net loss per share is the same as basic net loss per share because dilutive common shares are not assumed to have been issued if their effect is anti-dilutive. Recent Accounting Pronouncements Not Yet Adopted The Company has reviewed all recently issued accounting pronouncements and concluded they were either not applicable or not expected to have a material impact on the Company’s consolidated financial statements. Note 3— Revenue Disaggregation of Revenue See Note 12 for the Company’s revenue disaggregated by type of service and geographic area. Remaining Performance Obligations As of December 31, 2022, the Company had approximately $ 32.7 million of remaining performance obligations. The Company’s remaining performance obligations primarily consist of transaction price that has been allocated to unexercised material rights related to the Company’s arrangements with talent subject to tiered service fees. The remaining transaction price allocated to other performance obligations is immaterial. As of December 31, 2022, the Company expects to recognize approximately $ 25.1 million over the next 12 months, with the remaining balance recognized thereafter. 82 UPWORK INC. Notes to Consolidated Financial Statements—Continued The Company has applied the practical expedients and exemptions and does not disclose the value of remaining performance obligations for (i) contracts with an original expected length of one year or less; and (ii) contracts for which the variable consideration is allocated entirely to a wholly unsatisfied promise to transfer a distinct service that forms part of a single performance obligation under the series guidance. Contract Balances The following table provides information about the balances of the Company’s trade and client receivables, net of allowance and contract liabilities included in deferred revenue and other liabilities, noncurrent as of December 31, 2022 and 2021: (In thousands) 2022 2021 Trade and client receivables, net of allowance $ 64,888 $ 66,826 Contract liabilities Deferred revenue 25,075 22,083 Deferred revenue (component of other liabilities, noncurrent) 7,614 6,349 During 2022, changes in the contract liabilities balances were a result of normal business activity and deferral, and subsequent recognition, of revenue related to arrangements with talent subject to tiered service fees and related allocation of transaction price to material rights. Revenue recognized during the year ended December 31, 2022 that was included in deferred revenue as of December 31, 2021 was $ 21.0 million. Revenue recognized during the year ended December 31, 2021 that was included in deferred revenue as of December 31, 2020 was $ 15.5 million. Note 4— Fair Value Measurements The Company defines fair value as the exchange price that would be received from the sale of an asset or paid to transfer a liability 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. The authoritative guidance describes three levels of inputs that may be used to measure fair value: • Level I—Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets; • Level II—Observable inputs other than Level I prices, such as unadjusted quoted prices for similar assets or liabilities in active markets, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and • Level III—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These inputs are based on the Company’s own assumptions used to measure assets and liabilities at fair value and require significant management judgment or estimation. The categorization of a financial instrument within the fair value hierarchy is based upon the lowest level of input that is significant to its fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the assets or liabilities. The Company’s financial instruments that are carried at fair value consist of Level I and Level II assets as of December 31, 2022 and 2021. The following tables summarize the Company’s cash and available-for-sale marketable securities’ amortized cost, gross unrealized gains, gross unrealized losses, and fair value by significant 83 UPWORK INC. Notes to Consolidated Financial Statements—Continued investment category reported as cash and cash equivalents or marketable securities as of December 31, 2022 and 2021: (In thousands) December 31, 2022 Amortized Cost Unrealized Gain Unrealized Loss Fair Value Cash and Cash Equivalents Marketable Securities Cash $ 27,528 $ — $ — $ 27,528 $ 27,528 $ — Level I Money market funds 85,302 — — 85,302 85,302 — Treasury bills 172,500 13 ( 131 ) 172,382 5,096 167,286 U.S. government securities 106,167 — ( 2,025 ) 104,142 — 104,142 Total Level I 363,969 13 ( 2,156 ) 361,826 90,398 271,428 Level II Commercial paper 120,360 — — 120,360 8,038 112,322 Corporate bonds 85,639 3 ( 639 ) 85,003 3,420 81,583 Commercial deposits 28,945 — — 28,945 — 28,945 Asset-backed securities 33,261 31 ( 306 ) 32,986 — 32,986 Yankee bonds 5,176 — ( 8 ) 5,168 — 5,168 Agency bonds 12,989 7 ( 23 ) 12,973 — 12,973 Agency discount bonds 8,796 31 — 8,827 — 8,827 Supranational bonds 3,000 — ( 2 ) 2,998 — 2,998 Total Level II 298,166 72 ( 978 ) 297,260 11,458 285,802 Total $ 689,663 $ 85 $ ( 3,134 ) $ 686,614 $ 129,384 $ 557,230 (In thousands) December 31, 2021 Amortized Cost Unrealized Gain Unrealized Loss Fair Value Cash and Cash Equivalents Marketable Securities Cash $ 16,596 $ — $ — $ 16,596 $ 16,596 $ — Level I Money market funds 108,204 — — 108,204 108,204 — Treasury bills 89,992 1 — 89,993 15,000 74,993 U.S. government securities 94,839 — ( 285 ) 94,554 — 94,554 Total Level I 293,035 1 ( 285 ) 292,751 123,204 169,547 Level II Commercial paper 171,918 — — 171,918 29,544 142,374 Corporate bonds 183,303 1 ( 217 ) 183,087 17,861 165,226 Asset-backed securities 13,749 — ( 11 ) 13,738 — 13,738 Yankee bonds 6,693 — ( 12 ) 6,681 — 6,681 Total Level II 375,663 1 ( 240 ) 375,424 47,405 328,019 Total $ 685,294 $ 2 $ ( 525 ) $ 684,771 $ 187,205 $ 497,566 Unrealized Investment Losses The following table summarizes, for all debt securities classified as available for sale in an unrealized loss position as of December 31, 2022, the aggregate fair value and gross unrealized loss by the length of time those securities have been continuously in an unrealized loss position. Unrealized losses as of December 31, 2021 were immaterial. 84 UPWORK INC. Notes to Consolidated Financial Statements—Continued (In thousands) Less Than 12 Months 12 Months or Longer Total Duration of unrealized losses Fair Value Unrealized loss Fair Value Unrealized loss Fair Value Unrealized loss Treasury bills 132,995 ( 131 ) — — 132,995 ( 131 ) U.S. government securities 21,214 ( 63 ) 82,927 ( 1,963 ) 104,141 ( 2,026 ) Corporate bonds 18,274 ( 120 ) 58,235 ( 519 ) 76,509 ( 639 ) Asset-backed securities 23,515 ( 285 ) 1,707 ( 20 ) 25,222 ( 305 ) Yankee bonds 2,578 ( 6 ) 2,591 ( 2 ) 5,169 ( 8 ) Agency bonds 9,478 ( 23 ) — — 9,478 ( 23 ) Supranational bonds 2,998 ( 2 ) — — 2,998 ( 2 ) Total $ 211,052 $ ( 630 ) $ 145,460 $ ( 2,504 ) $ 356,512 $ ( 3,134 ) For available-for-sale marketable debt securities with unrealized loss positions, the Company does not intend to sell these securities, and it is not more likely than not that the Company will be required to sell the securities. As of December 31, 2022 and 2021, the decline in fair value of these securities was due to increases in interest rates and not due to credit related factors. As of December 31, 2022 and 2021, the Company considered any decreases in market value to be temporary in nature and did not consider any of the Company’s marketable securities to be other-than-temporarily impaired. The Company did not record any impairment charges with respect to its marketable securities during the years ended December 31, 2022, 2021, and 2020. Note 5— Balance Sheet Components Property and Equipment, Net Property and equipment, net consisted of the following as of December 31, 2022 and 2021: (In thousands) 2022 2021 Computer equipment and software $ 6,514 $ 5,493 Internal-use software and platform development costs 33,273 25,738 Leasehold improvements 11,644 11,644 Office furniture and fixtures 3,475 3,365 Total property and equipment 54,906 46,240 Less: accumulated depreciation ( 32,843 ) ( 24,911 ) Property and equipment, net $ 22,063 $ 21,329 Depreciation expense related to property and equipment was $ 3.2 million, $ 3.7 million, and $ 3.6 million for the years ended December 31, 2022, 2021, and 2020, respectively. The Company capitalized $ 7.5 million, $ 5.0 million, and $ 8.0 million of internal-use software and platform development costs during the years ended December 31, 2022, 2021, and 2020, respectively. Amortization expense related to the capitalized internal-use software and platform development costs was $ 4.9 million for the year ended December 31, 2022, of which $ 2.7 million was included in cost of revenue related to developed technology used on the work marketplace. Amortization expense related to the capitalized internal-use software and platform development costs was $ 5.9 million for the year ended December 31, 2021, of which $ 3.8 million was included in cost of revenue related to developed technology used on the work marketplace. Amortization expense related to the capitalized internal-use software and platform development costs was $ 3.9 million for the year ended December 31, 2020, of which $ 2.9 million was included in cost of revenue related to developed technology used on the work marketplace. Intangible Assets, Net All of the Company’s identifiable intangible assets were fully amortized as of December 31, 2022 and 2021. Total amortization expense of intangible assets was $ 0.7 million and $ 2.7 million for the years ended December 31, 2021 and 2020, respectively. Amortization expense is included in general and administrative expenses. 85 UPWORK INC. Notes to Consolidated Financial Statements—Continued Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following as of December 31, 2022 and 2021: (In thousands) 2022 2021 Accrued compensation and related benefits $ 17,239 $ 23,047 Accrued indirect taxes 14,102 4,137 Accrued vendor expenses 8,858 7,728 Operating lease liability, current 6,502 6,315 Accrued payment processing fees 2,425 2,085 Accrued talent costs 2,352 1,417 Other 2,133 1,013 Total accrued expenses and other current liabilities $ 53,611 $ 45,742 Operating Leases The Company leases office space and certain equipment under various operating leases, with the vast majority of its lease portfolio consisting of operating leases for office space. The Company has also entered into arrangements where it acts as a sublessor in its leases of office space. The Company has not entered into any significant finance, sales-type, or direct financing leases. The Company’s significant judgments include determining whether an arrangement is or contains a lease, the determination of the discount rate used to calculate the lease liability, and whether or not lease incentives are reasonably certain to occur in the initial measurement of the lease liability. Operating lease assets and lease liabilities are recognized at commencement date and initially measured based on the present value of lease payments over the defined lease term. Lease expense is recognized on a straight-line basis over the lease term. A contract is or contains an embedded lease if the contract meets all of the below criteria: • There is an identified asset; • The Company has the right to obtain substantially all of the economic benefit of the asset; and • The Company has the right to direct the use of the asset. For initial measurement of the present value of lease payments and for subsequent measurement of lease modifications, the Company is required to use the rate implicit in the lease. Since the majority of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate, which is a collateralized rate. The application of the incremental borrowing rate is performed on a lease-by-lease basis and approximates the rate at which the Company could borrow, on a secured basis for a similar term, an amount equal to its lease payments in a similar economic environment. The Company’s leases have remaining lease terms of approximately one year to six years , which may include the option to extend the lease. The Company includes lease payments associated with renewal options in its operating lease asset and liability only when it becomes reasonably certain the company will exercise the renewal option. The Company has not included renewal options for any of its operating leases in its determination of lease liabilities. The Company does not have lease agreements with residual value guarantees, sale leaseback terms, or material restrictive covenants. Leases with an initial term of 12 months or less are not recognized on the consolidated balance sheet. The Company recognizes lease expense for these leases on a straight-line basis over the lease term. 86 UPWORK INC. Notes to Consolidated Financial Statements—Continued The following table summarizes the Company’s operating lease assets and lease liabilities as of December 31, 2022 and 2021: (In thousands) Balance Sheet and Cash Flow Classification 2022 2021 Assets Operating—noncurrent Operating lease asset $ 7,603 $ 10,682 Liabilities Operating—current Accrued expenses and other current liabilities 6,502 6,315 Operating—noncurrent Operating lease liability, noncurrent 11,177 16,753 Total lease liabilities $ 17,679 $ 23,068 For the years ended December 31, 2022, 2021, and 2020, operating lease cost, inclusive of variable lease charges, was $ 6.6 million, $ 6.0 million, and $ 6.0 million, respectively, and sublease income recognized was approximately $ 1.6 million, $ 0.5 million, and $ 0.3 million, respectively. For the years ended December 31, 2022, 2021, and 2020, charges related to operating leases that are variable, and therefore not included in the measurement of the lease liabilities, were $ 2.2 million, $ 1.2 million, and $ 0.7 million, respectively. For the years ended December 31, 2022, 2021, and 2020, the Company made lease payments of $ 6.6 million, $ 6.4 million , and $ 3.3 million , respectively. San Francisco Sublease and Santa Clara Sub-Sublease In December 2021, the Company executed a sublease agreement to sublease one of the two suites the Company is currently leasing as its headquarters in San Francisco, California. The suite that was not subleased will continue to be utilized by the Company as it was prior to entering into the sublease agreement. The sublease agreement became effective in December 2021 upon receipt of the consent of the Company’s landlord. The term of the sublease commences on February 1, 2022 and expires on August 31, 2024, unless terminated earlier in accordance therewith. Rent payments began on March 1, 2022 and approximate $ 0.1 million per month. Rent payments will be recorded within general and administrative expenses within the Company’s consolidated statements of operations and comprehensive loss. Neither party has the option to renew or extend the sublease agreement. In April 2021, the Company executed a sub-sublease agreement to sublease the entirety of its former headquarters in Santa Clara, California, which became effective in May 2021. The term of the sub-sublease commenced on June 1, 2021 and expires on May 31, 2024, unless terminated earlier in accordance therewith. Rent payments began on January 1, 2022 and approximate $ 0.1 million per month. Rent payments will be recorded within general and administrative expenses within the Company’s consolidated statements of operations and comprehensive loss. Neither party has the option to renew or extend the sub-sublease agreement. Under both of these sublease agreements, the Company is not relieved of its original obligation with the master lessor, which expires on August 31, 2024 for the San Francisco lease and October 15, 2028 for the Santa Clara lease. The Company determined the sublease agreements are an operating lease, which is consistent with the classification of the original subleases with the landlords. As a result of the execution of the sublease agreements, the Company determined that indicators of impairment existed with respect to the asset group that consisted of the operating lease asset and related leasehold improvements associated with the suites being subleased. Accordingly, the Company conducted an impairment test to assess whether the fair value of the asset group was lower than its carrying value. The results of the impairment test indicated that the fair value of the asset group was lower than its carrying value. The Company determined the fair value of the asset group using the discounted cash flow method. The assumptions used in the discounted cash flow analysis included projected sublease income over the remaining term of the original lease with the landlord and a discount rate the Company believes reflects the level of risk associated with these future cash flows. The Company considers these assumptions to be Level III inputs in accordance with the fair value hierarchy described in “Note 4—Fair Value Measurements.” As a result of the partial sublease of its San Francisco office, during the year ended December 31, 2021, the Company recorded an impairment charge of $ 1.4 million. As a result of the sublease of its Santa Clara office, which expires on May 31, 2024 , during the year ended December 31, 2021, the Company recorded an impairment charge of $ 7.4 million. The Company recorded these impairment charges within general and administrative expenses within its consolidated statement of operations and comprehensive loss for the year ended December 31, 2021. 87 UPWORK INC. Notes to Consolidated Financial Statements—Continued The following table shows the Company’s future lease commitments due in each of the next five years and thereafter for operating leases, which excludes amounts received in the form of sublease income discussed above: (In thousands) Year Ended December 31, Leases 2023 $ 6,776 2024 5,843 2025 2,356 2026 1,729 2027 1,781 Thereafter 1,427 Total lease payments 19,912 Adjustment for discount to present value ( 2,233 ) Total $ 17,679 As of and for the year ended December 31, 2022, the weighted-average remaining lease term is 3.8 years , and the weighted-average discount rate is 5.80 % . Note 6— Commitments and Contingencies Letters of Credit In conjunction with the Company’s operating lease agreements, as of December 31, 2022 and 2021, the Company had three irrevocable letters of credit outstanding in the aggregate amount of $ 0.8 million. The letters of credit are collateralized by restricted cash in the same amount. No amounts had been drawn against these letters of credit as of December 31, 2022 and 2021. Contingencies The Company accrues contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. Potential contingencies may include various claims and litigation or non-income tax matters that arise from time to time in the normal course of business. Due to uncertainties inherent in such contingencies, the Company can give no assurance that it will prevail in any such matters, which could subject the Company to significant liability or damages. Any claims, litigation, or other contingencies could have an adverse effect on the Company’s business, financial position, results of operations or cash flows in or following the period that claims, litigation or other contingencies are resolved. As of December 31, 2022 and 2021, the Company was not a party to any material legal proceedings or claims, nor is the Company aware of any pending or threatened litigation or claims, including non-income tax matters, that could reasonably be expected to have a material adverse effect on its business, operating results, cash flows, or financial condition. Accordingly, the amounts accrued for contingencies for which the Company believes a loss is probable were not material as of and for the years ended December 31, 2022 and 2021. Indemnification The Company has indemnification agreements with its officers, directors, and certain key employees to indemnify them while they are serving in good faith in their respective positions. In the ordinary course of business, the Company enters into contractual arrangements under which it agrees to provide indemnification of varying scope and terms to clients, business partners, vendors, and other parties, including, but not limited to, losses arising out of the Company’s breach of such agreements, claims related to potential data or information security breaches, intellectual property infringement claims made by third parties, and other liabilities relating to or arising from the Company’s products and services or its acts or omissions. In addition, subject to the terms of the applicable agreement, as part of the Company’s Upwork Enterprise and certain other premium offerings, the Company indemnifies clients that subscribe to worker classification services for losses arising from worker misclassification. It is not possible to determine the maximum potential loss under these indemnification provisions due to the Company’s limited history of prior indemnification claims and the facts and circumstances involved in each particular provision. 88 UPWORK INC. Notes to Consolidated Financial Statements—Continued Note 7— Debt The following table presents the carrying value of the Company’s debt obligations as of December 31, 2022 and 2021: (In thousands) 2022 2021 Convertible senior notes—interest accrues from August 2021 and will be payable semiannually in arrears on February 15 and August 15 of each year, beginning February 2022, maturing August 2026; interest at 0.25 % per annum $ 575,000 $ 575,000 Total debt 575,000 575,000 Less: Unamortized debt issuance costs ( 10,739 ) ( 13,701 ) Debt, noncurrent $ 564,261 $ 561,299 Weighted-average interest rate 0.76 % 0.76 % Term and Revolving Loans The Company’s Loan and Security Agreement, which is referred to as the Loan Agreement, was terminated in August 2021. Under the Loan Agreement, the aggregate amount of the facility was up to $ 49.0 million, consisting of a term loan in the original principal amount of $ 15.0 million, which is referred to as the First Term Loan, a term loan in the original principal amount of $ 9.0 million, which is referred to as the Second Term Loan and, together with the First Term Loan, as the Term Loans, and a revolving line of credit, which permitted borrowings of up to $ 25.0 million subject to customary conditions. In August 2021, the Company entered into an agreement, which is referred to as the Payoff Agreement, with its lender to fully repay the remaining outstanding principal amounts plus accrued and unpaid interest outstanding under its Term Loans and terminate the Loan Agreement. There were no amounts outstanding under the Company’s revolving line of credit as of the date of termination. Pursuant to the Payoff Agreement, the full repayment of the Term Loans amounted to $ 5.8 million, and as of August 5, 2021, the Loan Agreement, including the Term Loans and revolving line of credit, was terminated. As of December 31, 2021, no amounts remained outstanding under the Loan Agreement. The Company was in compliance with its covenants under the Loan Agreement as of August 5, 2021. During the year ended December 31, 2021, the Company repaid $ 6.3 million and $ 4.5 million related to the First Term Loan and the Second Term Loan, respectively. During the year ended December 31, 2020, the Company repaid $ 5.0 million and $ 2.6 million related to the First Term Loan and the Second Term Loan, respectively. Amortization expense related to the debt discount was immaterial for the years ended December 31, 2021 and 2020. Convertible Senior Notes Due 2026 On August 10, 2021, the Company issued, at par value, $ 575.0 million aggregate principal amount of 0.25 % convertible senior notes due 2026. The issuance included the full exercise of an option granted by the Company to the initial purchasers of the Notes to purchase an additional $ 75.0 million aggregate principal amount of Notes. The Notes were issued pursuant to and are subject to the terms and conditions of an indenture, which is referred to as the Indenture, between the Company and Wells Fargo Bank, National Association, as trustee. The Notes were offered and sold in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. The Notes are senior, unsecured obligations of the Company and bear interest at a rate of 0.25 % per year. Interest will accrue from August 10, 2021 and is payable semiannually in arrears on February 15 and August 15 of each year, beginning on February 15, 2022, and the principal amount of the Notes will not accrete. The Notes will mature on August 15, 2026, unless earlier redeemed, repurchased, or converted in accordance with the terms of the Notes. Holders may convert all or any portion of their Notes, in multiples of $1,000 principal amount at the option of the holder (i) on or after May 15, 2026, at any time until the close of business on the second scheduled trading day immediately preceding the maturity date, and (ii) prior to the close of business on the business day immediately preceding May 15, 2026, only upon satisfaction of certain conditions and during certain periods specified as follows: • during any calendar quarter commencing after the calendar quarter ending on December 31, 2021, if the last reported sale price of the Company’s common stock is greater than or equal to 130 % of the conversion price for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading 89 UPWORK INC. Notes to Consolidated Financial Statements—Continued days ending on, and including, the last trading day of the immediately preceding calendar quarter of the conversion price on each applicable trading day; • during the five consecutive business day period after any five consecutive trading day period, which is referred to as the Measurement Period, in which the trading price (as defined in the Indenture) per $1,000 principal amount of Notes for each trading day of the Measurement Period was less than 98 % of the product of the last reported sale price per share of the Company’s common stock on such trading day and the conversion rate on such trading day; • if the Company calls such Notes for redemption, at any time prior to the close of business on the second scheduled trading day immediately preceding the redemption date; and • upon the occurrence of specified corporate events described in the Indenture. Upon conversion, the Notes may be settled in shares of the Company’s common stock, cash or a combination of cash and shares of the common stock, at the election of the Company. The Notes have an initial conversion rate of 15.1338 shares of common stock per $1,000 principal amount of Notes, which is subject to adjustment in certain circumstances. This is equivalent to an initial conversion price of approximately $ 66.08 per share of the Company’s common stock. The conversion rate is subject to customary adjustments under certain circumstances in accordance with the terms of the Indenture. In addition, if certain corporate events that constitute a make-whole fundamental change (as defined in the Indenture) occur or if the Company issues a notice of redemption with respect to the Notes prior to the maturity date, then the conversion rate will, in certain circumstances, be increased for a specified period of time. The Company may redeem for cash all or any portion of the Notes (subject to a partial redemption limitation), at the Company’s option, on or after August 20, 2024, if the last reported sale price per share of the Company’s common stock has been at least 130 % of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which the Company provides notice of redemption at a redemption price equal to 100 % of the principal amount of the Notes to be redeemed, plus any accrued and unpaid interest, if any, to, but excluding, the redemption date. No sinking fund is provided for the Notes, which means that the Company is not required to redeem or retire the Notes periodically. Upon the occurrence of a fundamental change (as defined in the Indenture), subject to certain conditions, holders have the right to require the Company to repurchase for cash all or a portion of their Notes at a price equal to 100 % of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest thereon, if any, until, but excluding, the fundamental change repurchase date. The Notes are the Company’s senior unsecured obligations and rank senior in right of payment to any of the Company’s existing and future indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to any of the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s existing and future secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness and other liabilities (including trade payables) of the Company’s subsidiaries. The net proceeds from the issuance of the Notes were approximately $ 560.1 million, after deducting debt issuance costs. The total debt issuance costs incurred and recorded by the Company amounted to $ 14.9 million, which were recorded as a reduction to the face amount of the Notes and will be amortized to interest expense on a straight-line basis, which produces a materially consistent amount as the effective interest method over the contractual term of the Notes. For the year ended December 31, 2022, interest expense was $ 1.4 million and amortization of the issuance costs was $ 3.0 million related to the Notes. For the year ended December 31, 2021, interest expense was $ 0.6 million and amortization of the issuance costs was $ 1.1 million related to the Notes. As of December 31, 2022 and December 31, 2021, the if-converted value of the Notes did not exceed the outstanding principal amount. As of December 31, 2022 and December 31, 2021, the total estimated fair value of the Notes was $ 437.0 million and $ 538.3 million, respectively, and was determined based on a market approach using actual bids and offers of the Notes in an over-the-counter market on the last trading day of the period. The Company considers these assumptions to be Level II inputs in accordance with the fair value hierarchy described in “Note 4—Fair Value Measurements.” 90 UPWORK INC. Notes to Consolidated Financial Statements—Continued Capped Calls In connection with the pricing of the Notes on August 5, 2021 and in connection with the full exercise by the initial purchasers on August 9, 2021 of their option to purchase additional Notes, the Company used approximately $ 49.4 million of the net proceeds from the issuance of the Notes to enter into privately negotiated capped call transactions, which are referred to as the Capped Calls, with various financial institutions. Subject to customary anti-dilution adjustments substantially similar to those applicable to the Notes, the Capped Calls cover the number of shares of the Company’s common stock initially underlying the Notes. By entering into the Capped Calls, the Company expects to reduce the potential dilution to its common stock (or, in the event a conversion of the Notes is settled in cash, to reduce its cash payment obligation) in the event that at the time of conversion of the Notes its common stock price per share exceeds the conversion price of the Notes, with such reduction subject to a cap based on the cap price. If, however, the market price per share of common stock, as measured under the terms of the Capped Calls, exceeds the cap price of the Capped Calls, there would be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that the then-market price per share of common stock exceeds the cap price of the Capped Calls. The initial cap price of the Capped Calls is $ 92.74 per share of common stock, which represents a premium of 100 % over the last reported sale price of the common stock of $ 46.37 per share on August 5, 2021, and is subject to certain customary adjustments under the terms of the Capped Calls; provided that the cap price will not be reduced to an amount less than the strike price of $ 66.08 per share. The Capped Calls are separate transactions and are not part of the terms of the Notes. The Capped Calls meet the criteria for classification as equity and, as such, are not remeasured each reporting period and are included as a reduction to additional paid-in-capital within stockholders’ equity. Note 8— Preferred and Common Stock Preferred Stock As of December 31, 2022 and 2021, the Company was authorized to issue up to 10,000,000 shares of undesignated preferred stock, $ 0.0001 par value per share. The Company did not have any outstanding shares of preferred stock as of December 31, 2022 and 2021. Common Stock Holders of common stock are entitled to one vote per share and are entitled to receive dividends, if any, on a pro rata basis whenever funds are legally available and when, as, and if declared by the Company’s board of directors. 91 UPWORK INC. Notes to Consolidated Financial Statements—Continued As of December 31, 2022 and 2021, the Company was authorized to issue 490,000,000 shares of common stock. As of December 31, 2022 and 2021, the Company had reserved shares of common stock for future issuance as follows: 2022 2021 Options issued and outstanding 3,851,647 4,264,068 RSUs and PSUs issued and outstanding 7,913,985 4,583,823 Warrant to purchase common stock 350,000 350,000 Remaining shares reserved for future issuances under 2018 Equity Incentive Plan 22,823,608 22,250,297 Remaining shares reserved for future issuances under 2018 Employee Stock Purchase Plan 3,794,128 3,033,401 Common stock issuable in connection with convertible senior notes 8,701,935 8,701,935 Total 47,435,303 43,183,524 Common Stock Warrant In 2018, the Company established The Upwork Foundation initiative. The program includes a donor-advised fund created through the Tides Foundation. In 2018, the Company issued a warrant to purchase 500,000 shares of its common stock at an exercise price of $ 0.01 per share to the Tides Foundation. The vesting and exercisability provisions of the warrant became effective upon the Company’s initial public offering, which is referred to as the IPO, in October 2018. This warrant is exercisable as to 1/10th of the shares on each anniversary of the IPO, with proceeds from the sale of such shares to be donated in accordance with the Company’s directive. The holder of the warrant did not exercise in 2022. In 2021 and 2020, this warrant was exercised as to all 50,000 of the then-vested and exercisable shares. In lieu of a cash payment, the holder of the warrant surrendered shares of common stock to cover the exercise price. In each of the years ended December 31, 2022, 2021, and 2020, the Company recorded $ 0.8 million of expense related to this warrant, which is included in general and administrative expense in the Company’s consolidated statement of operations and comprehensive loss. Note 9— Stock-Based Compensation Equity Incentive Plans 2014 Equity Incentive Plan In 2014, the Company’s board of directors and stockholders each adopted the 2014 Equity Incentive Plan, which is referred to as the 2014 EIP. The total number of shares of common stock reserved and available for grant and issuance pursuant to such plan was originally 12,462,985 plus (i) shares that were then subject to outstanding option grants under the oDesk Corporation 2004 Stock Plan, the Elance 1999 Stock Option Plan, and the Elance 2009 Stock Option Plan, which are referred to collectively as the Prior Plans, but subsequently ceased to be subject to an award for any reason other than exercise of a stock option, (ii) shares that had been reserved but not subject to any outstanding awards under the Prior Plans and (iii) shares issued under the Prior Plans that were repurchased, forfeited, or used to pay employee withholding or exercise price obligations. Under the terms of the 2014 EIP, incentive stock options may be granted at prices not less than 100 % of the fair value of the Company’s common stock on the date of grant unless determined in writing by the Company’s board of directors. The options granted under the 2014 EIP generally vest over a four-year period from the original date of grant and expire ten years from the original grant date. 2018 Equity Incentive Plan In 2018, the Company’s board of directors and stockholders each adopted the 2018 Equity Incentive Plan, which is referred to as the 2018 EIP, which became effective on the date immediately prior to the date of the IPO. A total of 10,701,505 shares of common stock were initially reserved for issuance pursuant to future awards under the 2018 EIP. On January 1 of each year, shares available for issuance are increased based on the provisions of the 2018 EIP. Any shares subject to outstanding awards under the 2014 EIP that are canceled or repurchased subsequent to the 2018 EIP’s effective date are returned to the pool of shares reserved for issuance under the 2018 EIP. Awards granted under the 2018 EIP may be (i) incentive stock options, (ii) nonqualified stock options, (iii) RSUs, (iv) restricted stock awards, or (v) stock appreciation rights, as determined by the Company’s board of directors or compensation committee at the time of grant. 92 UPWORK INC. Notes to Consolidated Financial Statements—Continued Pursuant to the terms of the 2018 EIP, the number of shares available for grant was increased by 6,456,523 shares in January 2022. Option Awards The fair value of options with service- and performance-based conditions is determined using the Black-Scholes valuation model as of the grant date using the following assumptions: Dividend Yield —The dividend yield is assumed to be zero as the Company has never paid dividends and has no current plans to do so. Expected Term —The expected term represents the period that the Company’s stock-based awards are expected to be outstanding. For awards containing only service conditions, the Company determines the expected term using the simplified method as the Company did not have sufficient historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior at the time of grant. The simplified method deems the term to be the average of the time-to-vesting and the contractual life of the options. For performance-based awards, the Company uses relevant data, including past exercise patterns, if available, to determine the expected term. Risk-Free Interest Rate —The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of grant for zero-coupon U.S. Treasury notes with maturities approximately equal to the option’s expected term. Expected Volatility —Since the Company did not have a sufficient trading history of its common stock at the time of grant, the expected volatility is derived from the average historical stock volatilities of several unrelated public companies within the Company’s industry that the Company considers to be comparable to its business over a period equivalent to the expected term of the stock option grants. Fair Value of Common Stock —Given the absence of a public trading market prior to the IPO, the Company’s board of directors considered numerous objective and subjective factors to determine the fair value of its common stock at each grant date. These factors included, but were not limited to: (i) independent contemporaneous third-party valuations of common stock; (ii) the prices for the Company’s redeemable convertible preferred stock sold to outside investors; (iii) the rights and preferences of redeemable convertible preferred stock relative to common stock; (iv) the lack of marketability of its common stock; (v) developments in the business; and (vi) the likelihood of achieving a liquidity event, such as an initial public offering or sale of the Company, given prevailing market conditions. Subsequent to the IPO, the fair value of common stock is based on the closing price of the Company’s common stock, as reported on The Nasdaq Global Select Market on the date of grant. The following table summarizes activity under the Company’s stock option plans: Number of Shares Underlying Outstanding Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (in thousands) Balances at December 31, 2021 4,264,068 $ 16.29 6.37 $ 76,025 Exercised ( 412,171 ) 3.99 Forfeited and canceled ( 250 ) 8.18 Balances at December 31, 2022 3,851,647 17.58 5.51 15,037 Vested and exercisable as of December 31, 2022 2,347,914 4.04 3.86 15,016 Vested and expected to vest as of December 31, 2022 3,851,647 17.58 5.51 15,037 93 UPWORK INC. Notes to Consolidated Financial Statements—Continued In 2021, the compensation committee of the Company’s board of directors approved a stock option grant, which is referred to as the CEO Award, exercisable for up to 1,500,000 shares of the Company’s common stock to Hayden Brown, the Company’s President and Chief Executive Officer, under the 2018 EIP. The CEO Award is subject to a service-based vesting requirement, which is referred to as the Service Condition, and a performance-based vesting requirement, which is referred to as the Market Condition. In order for any shares subject to the CEO Award to be exercisable, both the Service Condition and the Market Condition must be satisfied with respect to such shares. The CEO Award vests with respect to the Service Condition in sixteen equal quarterly installments following the grant date, subject to Ms. Brown’s continuous service to the Company as Chief Executive Officer, Executive Chairperson, or any C-level officer position. The CEO Award vests with respect to the Market Condition upon the achievement of certain volume weighted-average common stock price targets measured over any consecutive 90-day period between the grant date and April 18, 2026. The 90-day volume weighted-average common stock price targets, and the number of shares of the CEO Award that become vested with respect to the Market Condition upon the achievement of each such target, are reflected in the following table: Stock Price Number of Shares Vested $ 60 100,000 $ 70 200,000 $ 80 300,000 $ 90 400,000 $ 100 500,000 Stock-based compensation expense associated with the CEO Award will be recognized over the longer of the expected achievement period for the Market Condition and the Service Condition. The Market Condition period and the valuation of each tranche of the CEO Award were determined using a Monte Carlo simulation. In the event the Market Condition is met prior to the expected achievement period, any then-unrecognized compensation expense associated with the shares that have vested with respect to both the Market Condition and the Service Condition will be recognized immediately in the Company’s consolidated statements of operations and comprehensive loss. For the years ended December 31, 2022 and 2021, the Company recorded stock-based compensation expense related to the CEO Award of $ 11.0 million and $ 11.3 million, respectively. Stock-based compensation expense for the CEO Award is recorded as a component of general and administrative expense in the Company’s consolidated statement of operations and comprehensive loss. The Company estimated the fair value of the CEO Award using a Monte Carlo simulation. The Company estimates the expected term based on a future exercise assumption. The weighted-average derived service period for the CEO Award is 2.1 years. The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of grant for zero-coupon U.S. Treasury notes. The expected volatility is derived from the average historical stock volatility of the Company over a period equivalent to the expected term of the CEO Award. The following assumptions were used to estimate the fair value of the CEO Award: Dividend yield — % Risk-free interest rates 1.7 % Expected volatility 65 % For the years ended December 31, 2022, 2021, and 2020, the intrinsic value of options exercised was $ 6.6 million , $ 88.9 million, and $ 124.1 million, respectively. The aggregate intrinsic value represents the difference between the exercise price of the options and the closing price of the Company’s common stock on The Nasdaq Global Select Market on the day prior to the date of exercise. For the year ended December 31, 2021, the weighted-average grant-date fair value of options granted was $ 19.19 . The Company did not grant any stock option awards during the years ended December 31, 2022 and 2020. As of December 31, 2022, total unrecognized stock-based compensation cost was $ 6.4 million, which is expected to be generally recognized on a straight-line basis over a weighted-average period of 1.2 years. RSU and PSU Awards The fair value of RSUs awarded to employees is based on the closing price of the Company’s common stock, as reported on The Nasdaq Global Select Market on the date of grant. 94 UPWORK INC. Notes to Consolidated Financial Statements—Continued The following table summarizes the RSU and PSU activity and related information under the 2018 EIP: Number Outstanding Weighted-Average Grant Date Fair Value Unvested balance - January 1, 2022 4,583,823 $ 26.86 Granted 8,130,375 20.18 Vested ( 2,553,300 ) 23.68 Forfeited/canceled ( 2,246,913 ) 25.14 Unvested balance - December 31, 2022 7,913,985 $ 21.73 In 2022, the compensation committee of the Company’s board of directors approved PSU grants to certain members of the Company’s leadership team under the 2018 EIP. The number of PSUs that were earned by the recipients, which are referred to as Earned PSUs, was determined based on the Company’s revenue achievement during the year ended December 31, 2022, which is referred to as the PSU Performance Condition. The Earned PSUs are subject to a time-based vesting requirement conditioned on the recipient of the PSU Award continuing to provide service to the Company for four years from the PSU Grant Date, which is referred to as the PSU Service Condition. The Earned PSUs will vest with respect to 25 % of the Earned PSUs on the one-year anniversary of the PSU Grant Date and 1/16th of the Earned PSUs on a quarterly basis thereafter. Stock-based compensation expense associated with the PSU Awards is a component of operating expenses in the Company’s consolidated statements of operations and comprehensive loss and will be recognized over the longer of the expected achievement period for the PSU Performance Condition and the PSU Service Condition. The grant date fair value of the PSU Awards was determined using the Company’s closing common stock price on the PSU Grant Date multiplied by the number of PSUs that were probable of being earned on the PSU Grant Date. At each interim reporting date prior to the date on which the compensation committee of the Company’s board of directors certifies the PSU Performance Condition, the number of PSUs that are probable of being earned is reassessed and any changes are reflected in the total stock-based compensation expense associated with the PSU Awards. For the years ended December 31, 2022 and 2021, the weighted-average grant-date fair value of PSUs granted was $ 24.49 and $ 56.42 , respectively. During the years ended December 31, 2022 and 2021, the Company recorded stock-based compensation expense related to the PSUs of $ 4.4 million and $ 3.4 million, respectively. As of December 31, 2022, unrecognized stock-based compensation cost was $ 3.9 million, which is expected to be recognized over a weighted-average period of 1.7 years. For the years ended December 31, 2022, 2021, and 2020, the weighted-average grant-date fair value of RSUs granted was $ 19.66 , $ 51.37 , and $ 10.96 , respectively. For the years ended December 31, 2022, 2021, and 2020, the fair value of RSUs vested was $ 57.4 million, $ 30.5 million, and $ 20.3 million, respectively. As of December 31, 2022, there was $ 147.5 million of unrecognized stock-based compensation expense related to outstanding RSUs to employees that is expected to be recognized over a weighted-average period of 3.0 years. 2018 Employee Stock Purchase Plan In 2018, the Company’s board of directors and stockholders each adopted the 2018 ESPP. A total of 1,700,000 shares of common stock was initially reserved for issuance under the 2018 ESPP. On January 1 of each year, shares available for issuance are increased based on the provisions of the 2018 ESPP. The 2018 ESPP allows eligible employees to purchase shares of the Company’s common stock at a discount of up to 15 % through payroll deductions of their eligible compensation, subject to any plan limitations. Except for the initial offering period, the 2018 ESPP provides for 24-month offering periods beginning November 15 and May 15 of each year, and each offering period consists of four 6-month purchase periods. Pursuant to the terms of the 2018 ESPP, in January 2022, the number of shares of common stock available for issuance was increased by 1,033,043 shares. 95 UPWORK INC. Notes to Consolidated Financial Statements—Continued For the years ended December 31, 2022, 2021, and 2020, the assumptions used to determine the fair value of the shares to be awarded was estimated on the grant date using the Black-Scholes valuation model with the following assumptions: 2022 2021 2020 Dividend yield — % — % — % Expected term (in years) 0.5 - 2.0 0.5 - 2.0 0.5 - 2.0 Risk-free interest rates 1.5 % - 4.6 % — % - 0.5 % 0.1 % - 0.2 % Expected volatility 68 % - 76 % 60 % - 76 % 50 % - 82 % On each purchase date, eligible employees may purchase the Company’s common stock at a price per share equal to 85 % of the lesser of (1) the fair market value of the Company’s common stock on the offering date or (2) the fair market value of the Company’s common stock on the purchase date. In the event the price is lower on the last day of any purchase period, that price is used as the purchase price for that purchase period. Additionally, in the event the fair market value of the Company’s common stock on the first day of a subsequent offering period is less than the fair market value of the Company’s common stock on the offering date of the current offering period, the offering period resets, and the new lower price becomes the new offering price for a new 24 month offering period. During the year ended December 31, 2022, the Company issued 272,316 shares of common stock under the 2018 ESPP. As of December 31, 2022, there was $ 6.7 million of unrecognized stock-based compensation expense that is expected to be recognized over the remaining term of the respective offering periods. Stock-Based Compensation The following table summarizes the components of stock-based compensation expense recognized in the consolidated statements of operations and comprehensive loss for the years ended December 31, 2022, 2021, and 2020: (In thousands) 2022 2021 2020 Cost of revenue $ 1,356 $ 794 $ 779 Research and development 26,881 16,232 9,783 Sales and marketing 11,511 5,923 4,440 General and administrative 35,753 30,643 10,506 Total $ 75,501 $ 53,592 $ 25,508 Stock-Based Compensation to Employees Stock-based compensation expense related to employees for the year ended December 31, 2022 was $ 11.4 million, $ 59.7 million, and $ 4.5 million related to stock option grants, RSU and PSU grants, and the 2018 ESPP, respectively. Stock-based compensation expense related to employees for the year ended December 31, 2021 was $ 12.7 million, $ 38.8 million, and $ 2.2 million related to stock option grants, RSU grants, and the 2018 ESPP, respectively. Stock-based compensation expense related to employees for the year ended December 31, 2020 was $ 2.5 million, $ 20.0 million, and $ 3.2 million related to stock option grants, RSUs, and the 2018 ESPP, respectively. 96 UPWORK INC. Notes to Consolidated Financial Statements—Continued Note 10— Net Loss per Share The following table sets forth the computation of the Company’s basic and diluted net loss per share for the years ended December 31, 2022, 2021, and 2020: (In thousands, except share and per share data) 2022 2021 2020 Numerator: Net loss $ ( 89,885 ) $ ( 56,240 ) $ ( 22,867 ) Denominator: Weighted-average shares used to compute net loss per share, basic and diluted 130,517,920 127,163,591 118,698,567 Net loss per share, basic and diluted $ ( 0.69 ) $ ( 0.44 ) $ ( 0.19 ) For the years ended December 31, 2022, 2021, and 2020, the following potentially dilutive shares were excluded from the computation of diluted net loss per share because including them would have been anti-dilutive: 2022 2021 2020 Options to purchase common stock 3,851,647 4,264,068 4,858,590 Common stock issuable upon exercise of common stock warrants 350,000 350,000 400,000 Common stock issuable upon vesting of RSUs and PSUs 7,913,985 4,583,823 5,568,225 Common stock issuable in connection with employee stock purchase plan 1,781,469 329,650 540,580 Common stock issuable in connection with convertible senior notes 8,701,935 8,701,935 — Total 22,599,036 18,229,476 11,367,395 Note 11— Income Taxes For the years ended December 31, 2022, 2021, and 2020, the loss before income taxes consisted of the following: (In thousands) 2022 2021 2020 Domestic $ ( 89,440 ) $ ( 56,165 ) $ ( 22,748 ) Foreign 91 47 31 Total loss before income taxes $ ( 89,349 ) $ ( 56,118 ) $ ( 22,717 ) For the years ended December 31, 2022, 2021, and 2020, the components of the income tax provision were as follows: (In thousands) 2022 2021 2020 Current: Federal $ — $ — $ ( 19 ) State ( 494 ) ( 120 ) ( 127 ) Foreign ( 42 ) ( 2 ) ( 4 ) Total current $ ( 536 ) $ ( 122 ) $ ( 150 ) Deferred: Federal $ — $ — $ — State — — — Foreign — — — Total deferred $ — $ — $ — Income tax provision $ ( 536 ) $ ( 122 ) $ ( 150 ) The Company had an effective tax rate of ( 0.60 )%, ( 0.21 )%, and ( 0.66 )% for the years ended December 31, 2022, 2021, and 2020, respectively. The reconciliation of the statutory federal income tax rate to the Company’s effective tax rate for the years ended December 31, 2022, 2021, and 2020 were as follows: 97 UPWORK INC. Notes to Consolidated Financial Statements—Continued 2022 2021 2020 Tax at federal statutory rate 21.00 % 21.00 % 21.00 % State tax, net of federal benefit ( 0.38 ) ( 0.19 ) ( 0.49 ) Stock-based compensation ( 4.02 ) 44.13 94.02 Officer’s compensation limitation ( 1.51 ) — — Other items ( 0.60 ) ( 0.16 ) ( 0.59 ) Research and development credits 4.36 7.04 9.74 Net operating loss expiration — ( 8.08 ) ( 14.00 ) Change in valuation allowance ( 19.45 ) ( 63.95 ) ( 110.34 ) Effective tax rate ( 0.60 ) % ( 0.21 ) % ( 0.66 ) % Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. As of December 31, 2022 and 2021, the significant components of the Company’s deferred tax assets and liabilities were as follows: (In thousands) 2022 2021 Deferred tax assets: Net operating loss carryforwards $ 80,296 $ 100,836 Stock-based compensation 7,628 5,617 Operating lease liability 4,066 5,296 Accrued liabilities, reserves and other 10,216 7,259 Capitalized research and development 33,179 — Tax Credits 24,470 17,044 Gross deferred tax assets 159,855 136,052 Valuation allowance ( 157,353 ) ( 132,162 ) Total deferred tax assets 2,502 3,890 Deferred tax liabilities: Prepaid expenses ( 753 ) — Operating lease asset ( 1,749 ) ( 2,452 ) Debt issuance cost — ( 75 ) Depreciation and amortization — ( 1,363 ) Total deferred tax liabilities ( 2,502 ) ( 3,890 ) Net deferred tax assets $ — $ — The change in valuation allowance for deferred tax assets was as follows for the periods presented: (In thousands) Year Ended December 31, Balance at Beginning of Year Additions Charged to Costs & Expenses Additions Charged to Other Accounts Deductions Balance at End of Year 2022 $ 132,162 $ 24,489 $ 702 $ — $ 157,353 2021 92,390 39,772 — — 132,162 2020 63,542 28,848 — — 92,390 The Company records a full valuation allowance of $ 157.4 million and $ 132.2 million as of December 31, 2022 and 2021, respectively. The Company regularly assesses the realizability of its deferred tax assets and establishes a valuation allowance if it is more-likely-than-not that some or all of its deferred tax assets will not be realized. Realization of deferred tax assets is dependent upon the generation of future taxable income, if any, the timing and amount of which are uncertain. Due to the history of losses the Company has generated in the past, the Company believes that it is not more likely than not that all of the deferred tax assets can be realized as of December 31, 2022. Accordingly, the Company has recorded a full valuation allowance on its deferred tax assets. 98 UPWORK INC. Notes to Consolidated Financial Statements—Continued The Company has federal net operating loss, which is referred to as NOL, carryforwards of approximately $ 341.4 million and $ 444.6 million as of December 31, 2022 and 2021, respectively. The federal NOLs generated in the years ended December 31, 2001 through 2017 will begin to expire in 2024. The federal NOL carryforwards of $ 324.7 million generated after December 31, 2017 can be carried forward indefinitely with utilization in any year limited to 80% of the Company’s taxable income. The Company has California NOL carryforwards of approximately $ 95.0 million and $ 90.4 million as of December 31, 2022 and 2021, respectively. California NOLs generated in the years ended December 31, 2008 through 2018 will begin to expire in 2028. The Company has federal research and development credits of approximately $ 27.1 million and $ 19.1 million as of December 31, 2022 and 2021, respectively. In 2022, $ 0.2 million of federal research and development credits expired and the remaining carryforward is subject to expiration through 2042. The Company has California research and development credits of approximately $ 15.7 million and $ 13.6 million as of December 31, 2022 and 2021, respectively. California research and development credits have an infinite carryforward period. The Tax Reform Act of 1986 and similar California legislation impose substantial restrictions on the utilization of net operating losses and tax credit carryforwards in the event that there is a change in ownership as provided by Section 382 of the Internal Revenue code and similar state provisions. Such a limitation could result in the expiration of the NOL carryforwards and tax credits before utilization, which could result in increased future tax liabilities. Uncertain Tax Positions As of December 31, 2022, the Company’s total amount of unrecognized tax benefits was $ 16.6 million, none of which would impact the Company’s effective tax rate, if recognized. For the years ended December 31, 2022, 2021, and 2020, the activity related to the unrecognized tax benefits were as follows: (In thousands) 2022 2021 2020 Gross unrecognized tax benefits—beginning balance $ 15,391 $ 13,338 $ 12,782 Increase related to tax positions taken during prior year 1,234 697 131 Decrease related to tax positions taken during prior year ( 1,253 ) ( 148 ) — Increase related to tax positions taken during current year 1,354 1,635 608 Decrease related to expiration of unrecognized tax benefit ( 153 ) ( 131 ) ( 183 ) Gross unrecognized tax benefits—ending balance $ 16,573 $ 15,391 $ 13,338 The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the provision for income taxes in the period that such determination is made. As of December 31, 2022, the Company did not currently recognize any penalties or interest charges relating to uncertain tax positions. The Company does not anticipate the recorded reserves to change significantly in the next 12 months. The Company is subject to taxation in the United States and various other state and foreign jurisdictions. Due to certain tax attribute carryforwards, the tax years 2001 to 2021 remain open to examination by the major taxing jurisdictions in which the Company is subject to tax. As of December 31, 2022, the Company was not under examination by the Internal Revenue Service or any state or foreign tax jurisdiction. Note 12— Segment and Geographical Information The Company operates as one operating and reportable segment for purposes of allocating resources and evaluating financial performance. 99 UPWORK INC. Notes to Consolidated Financial Statements—Continued The following table sets forth total revenue by type of service for the years ended December 31, 2022, 2021, and 2020: (In thousands) 2022 2021 2020 Marketplace Basic, Plus, Client Marketplace (1) and other $ 518,282 $ 427,476 $ 317,942 Enterprise 48,341 34,864 20,210 Managed services 51,695 40,457 35,476 Total $ 618,318 $ 502,797 $ 373,628 (1) In April 2022, the Company combined its Upwork Basic and Upwork Plus client offerings into a new Client Marketplace offering. The Company generates its revenue from talent and clients. The following table sets forth total revenue by geographic area based on the billing address of its talent and clients for the years ended December 31, 2022, 2021, and 2020: (In thousands) 2022 2021 2020 Talent: United States $ 86,892 $ 74,890 $ 60,861 India 45,817 42,277 33,109 Philippines 39,946 32,918 22,924 Rest of world (1) 162,016 146,894 109,805 Total talent 334,671 296,979 226,699 Clients: United States 210,582 153,003 107,359 Rest of world (1) 73,065 52,815 39,570 Total clients 283,647 205,818 146,929 Total $ 618,318 $ 502,797 $ 373,628 (1) During the years ended December 31, 2022, 2021, and 2020, no country included in the Rest-of-World category had revenue that exceeded 10% of total talent revenue, total client revenue, or total revenue. Substantially all of the Company’s long-lived assets were located in the United States as of December 31, 2022 and 2021. Note 13— 401(k) Plan The Company offers the Upwork Retirement Savings Plan, which is referred to as the Retirement Plan, a defined contribution plan that allows employees to contribute a portion of their salary, subject to the annual limits. Under the Retirement Plan, eligible employees may defer a portion of their pretax salaries, but not more than the statutory limits. The Retirement Plan provides for a discretionary employer cash matching contribution. The Company makes matching cash contributions equal to 50 % of each dollar contributed, subject to a maximum contribution of $ 5,000 annually per participant. The Company’s total expense for the matching contributions was $ 3.5 million, $ 2.5 million, and $ 2.5 million for the years ended December 31, 2022, 2021, and 2020, respectively. 100 Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure. None.