UPWORK, INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis of our financial condition and results of operations together with the section titled “Risk Factors” and the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, as well as assumptions that may never materialize or that may be proven incorrect. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed in the sections titled “Special Note Regarding Forward-Looking Statements” and “Risk Factors,” and in other parts of this Quarterly Report. Overview Independent talent is an increasingly sought-after, critical, and expanding segment of the global workforce. We operate the world’s largest work marketplace that connects businesses with independent talent from across the globe, as measured by gross services volume, which we refer to as GSV. GSV represents the total amount that clients spend on both our marketplace offerings and our managed services offering as well as additional fees we charge for other services. We define talent as users that advertise and provide services to clients through our work marketplace, and we define clients as users that seek and work with talent through our work marketplace. Talent includes independent professionals and agencies of varying sizes. Clients on our work marketplace range in size, including small businesses to Fortune 100 companies. Financial Highlights For the three and six months ended June 30, 2023, marketplace revenue increased by 9% and 11%, respectively, as compared to the same periods in 2022. These increases were driven by client fee changes related to the shift to our Client Marketplace offering in April 2022, an increase in the second quarter of 2023 in the number of virtual tokens, which we refer to as Connects, needed by talent to bid on projects and paid promotional products on our work marketplace, and the contract initiation fee for clients on our Client Marketplace offering introduced in April 2023. These drivers were partially offset by a reduction in talent service fees, as a result of the changes we made in May 2023 to our tiered service fee structure. Additionally, we continued our efforts to better address large enterprise and other clients through our Upwork Enterprise and other premium offerings. As a result, for the three and six months ended June 30, 2023, Enterprise Revenue (as defined below) increased 16% and 12%, respectively, as compared to the same periods in 2022, which also contributed to the increase in marketplace revenue during those periods. During the three and six months ended June 30, 2023, GSV remained relatively flat at $1.0 billion and $2.0 billion, respectively, as compared to the same periods in 2022, primarily due to the lapping of strong growth in the prior periods, as well as changes to client fees as a result of the shift to our Client Marketplace offering in April 2022. The number of active clients increased 2% as of June 30, 2023, as compared to the same period in 2022, and our GSV per active client increased 2% as of June 30, 2023, as compared to the same period in 2022, primarily due to increased spend from existing clients. During the three months ended June 30, 2023, we generated a net loss of $4.0 million and adjusted EBITDA 1 of $14.4 million, as compared to a net loss of $23.8 million and adjusted EBITDA loss of $1.9 million during the same period in 2022. During the six months ended June 30, 2023, we generated net income of $13.2 million and adjusted EBITDA of $11.4 million, as compared to a net loss of $48.6 million and adjusted EBITDA loss of $2.3 million during the same period in 2022. During the three and six months ended June 30, 2023, we implemented a number of cost-saving measures, including reducing our investmen 1 Adjusted EBITDA is not prepared in accordance with, and is not an alternative to, financial measures prepared in accordance with U.S. GAAP. See “Key Financial and Operational Metrics—Non-GAAP Financial Measures” below for a definition of adjusted EBITDA and for information regarding our use of adjusted EBITDA and a reconciliation of adjusted EBITDA to net loss, the most directly comparable financial measure prepared under U.S. GAAP. 18 ts in brand marketing, vendor spend, and other non-personnel costs. Additionally, in light of the challenging macroeconomic conditions as well as our efforts to reduce spend and streamline operations, we implemented a reduction of our workforce in May 2023 representing approximately 15% of full-time employees, largely in our sales team, and we also reduced a smaller percentage of independent team members. We expect these measures will positively impact adjusted EBITDA for the full year 2023. Key Financial and Operational Metrics As of and for the three and six months ended June 30, 2023 and 2022, our key financial and operating metrics are as follows: Three Months Ended June 30, % Change Six Months Ended June 30, % Change (In thousands, except percentages) 2023 2022 2023 2022 GSV $ 1,036,507 $ 1,046,014 (1) % $ 2,039,852 $ 2,047,389 — % Marketplace revenue $ 156,631 $ 144,325 9 % $ 304,719 $ 273,750 11 % Marketplace take rate 15.3 % 14.0 % 1.3 % 15.1 % 13.5 % 1.6 % Net income (loss) $ (3,991) $ (23,820) 83 % $ 13,176 $ (48,558) * Adjusted EBITDA $ 14,362 $ (1,865) * $ 11,436 $ (2,298) * * Not meaningful As of June 30, % Change (Active clients are in thousands) 2023 2022 Active clients 822 807 2 % GSV per active client $ 4,987 $ 4,874 2 % We monitor the following key financial and operational metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions. For a discussion of limitations in the measurement of our key financial and operational metrics, see “Risk Factors—We track certain performance metrics with internal tools and do not independently verify such metrics. Certain of our performance metrics may not accurately reflect certain details of our business, are subject to inherent challenges in measurement, and real or perceived inaccuracies in such metrics may harm our reputation and negatively affect our business” in Part II, Item 1A of this Quarterly Report. Gross Services Volume (GSV) GSV includes both client spend and additional fees charged for other services. Client spend, which we define as the total amount that clients spend on both our marketplace offerings and our managed services offering, is the primary component of GSV. GSV also includes fees charged to users, such as for transacting payments through our work marketplace, user memberships, purchases of Connects, and foreign currency exchange. GSV is an important metric because it represents the amount of business transacted through our work marketplace. Marketplace Revenue Marketplace revenue, which represents the majority of our revenue, consists of revenue derived from our marketplace offerings. Marketplace offerings consist of all offerings other than our managed services offering, including our Client Marketplace and Enterprise offerings and, for periods prior to the introduction of our Client Marketplace offering in April 2022, our former Upwork Basic and Upwork Plus offerings. We generate marketplace revenue from both talent and clients. Marketplace revenue is primarily generated from fees charged to talent as a percentage of their billings to clients, which we refer to as talent service fees, and to a lesser extent, fees charged to clients through our Client Marketplace offering, 19 which we refer to as client marketplace fees. Additionally, marketplace revenue includes revenue from our Enterprise offering, which we refer to as Enterprise Revenue, including all client fees, subscriptions, and talent service fees. We also generate 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 our Upwork Payroll offering. In April 2023, we introduced a contract initiation fee for clients on our Client Marketplace offering—up to $4.95 per contract. Additionally, in May 2023, we retired the tiered service fee structure for talent working with clients on our Client Marketplace offering—ranging from 5% to 20%—in favor of a flat fee of 10%. This change took effect on new contracts and existing contracts that would have otherwise been subject to a 20% fee under the tiered service fee model. Talent that have existing contracts with a 5% fee under the tiered service fee model will retain that rate for those contracts through the end of 2023. Marketplace Take Rate Marketplace take rate measures the correlation between marketplace revenue and marketplace GSV and is calculated by dividing marketplace revenue by marketplace GSV. We define marketplace GSV as GSV derived from our marketplace offerings. Marketplace take rate is an important metric because it is the key indicator of how well we monetize spend on our work marketplace from our Client Marketplace (and previously Upwork Basic and Upwork Plus), Enterprise, Payroll, and other premium offerings, which we refer to as our marketplace offerings. Active Clients and GSV per Active Client We define an active client as a client that has had spend activity on our work marketplace during the 12 months preceding the date of measurement. GSV per active client is calculated by dividing total GSV during the four quarters ended on the date of measurement by the number of active clients on the date of measurement. We believe that the number of active clients and GSV per active client are indicators of the growth and overall health of our business. The number of active clients is a primary driver of GSV and, in turn, marketplace revenue. Non-GAAP Financial Measures In addition to our results determined in accordance with generally accepted accounting principles in the United States, which we refer to as U.S. GAAP, adjusted EBITDA is a non-GAAP measure that we believe is useful in evaluating our operating performance. We define adjusted EBITDA as net income (loss) adjusted for stock-based compensation expense; depreciation and amortization; interest expense; other (income) expense, net; income tax (benefit) provision; and, if applicable, certain other gains, losses, benefits, or charges that are non-cash or are significant and the result of isolated events or transactions that have not occurred frequently in the past and are not expected to occur regularly in the future. Adjusted EBITDA is not prepared in accordance with, and is not an alternative to, financial measures prepared in accordance with U.S. GAAP. 20 The following table presents a reconciliation of net loss, the most directly comparable financial measure prepared in accordance with U.S. GAAP, to adjusted EBITDA for each of the periods indicated: Three Months Ended June 30, Six Months Ended June 30, (In thousands) 2023 2022 2023 2022 Net Income (loss) $ (3,991) $ (23,820) $ 13,176 $ (48,558) Add back (deduct): Stock-based compensation expense 18,437 18,980 38,337 35,715 Depreciation 1,854 2,016 3,878 4,025 Interest expense 713 1,120 1,814 2,245 Other income, net (1) (4,695) (375) (48,796) (443) Income tax provision 1,857 27 2,652 56 Other (2)(3) 187 187 375 4,662 Adjusted EBITDA $ 14,362 $ (1,865) $ 11,436 $ (2,298) (1) During the six months ended June 30, 2023, we recognized a gain on the early extinguishment of debt of $38.9 million, which is included in other income, net. (2) During each of the three and six months ended June 30, 2023 and 2022, we incurred $0.2 million and $0.4 million, respectively, of expense related to our Tides Foundation warrant. (3) During the six months ended June 30, 2022, in response to Russia’s invasion of Ukraine, we incurred certain incremental expenses associated with our humanitarian response efforts. These expenses are not representative of our ongoing operations, and, as a result, we excluded these costs from adjusted EBITDA for the six months ended June 30, 2022. These expenses consisted of (i) $1.4 million of special one-time bonuses to our team members in the region impacted by Russia’s invasion of Ukraine, (ii) $1.5 million of expenses incurred in connection with the relocation of our team members in the impacted region, (iii) $1.1 million of donations made to humanitarian aid organizations to support initiatives related to humanitarian response efforts in the impacted region, primarily to Direct Relief International, a humanitarian aid organization, and (iv) $0.4 million of payments of one-time service award bonuses (and associated taxes) to certain of our team members paid in recognition of contributions made by such team members to our humanitarian response efforts in the impacted region. We use adjusted EBITDA as a measure of operational efficiency. We believe that this non-GAAP financial measure is useful to investors for period-to-period comparisons of our business and in understanding and evaluating our operating results for the following reasons: • adjusted EBITDA is widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as stock-based compensation expense; depreciation and amortization; interest expense; other (income) expense, net; income tax (benefit) provision; and, if applicable, certain other gains, losses, benefits, or charges that are non-cash or are significant and the result of isolated events or transactions that have not occurred frequently in the past and are not expected to occur regularly in the future, all of which can vary substantially from company to company depending upon their financing, capital structures, and the method by which assets were acquired; • our management uses adjusted EBITDA in conjunction with financial measures prepared in accordance with U.S. GAAP for planning purposes, including the preparation of our annual operating budget, as a measure of our core operating results and the effectiveness of our business strategy, and in evaluating our financial performance; and • adjusted EBITDA provides consistency and comparability with our past financial performance, facilitates period-to-period comparisons of our core operating results, and also facilitates 21 comparisons with other peer companies, many of which use similar non-GAAP financial measures to supplement their U.S. GAAP results. Our use of adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our financial results as reported under U.S. GAAP. Some of these limitations are as follows: • adjusted EBITDA excludes stock-based compensation expense, which has recently been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy; • although depreciation and amortization expense are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; • adjusted EBITDA does not reflect: (a) changes in, or cash requirements for, our working capital needs; (b) interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us; or (c) tax payments that may represent a reduction in cash available to us; and • other companies, including companies in our industry, may calculate adjusted EBITDA or similarly titled measures differently, which reduces the usefulness of this measure for comparative purposes. Because of these and other limitations, you should consider adjusted EBITDA along with other financial performance measures, including net loss and our other financial results prepared in accordance with U.S. GAAP. Components of Our Results of Operations Marketplace Revenue Marketplace revenue represents the majority of our revenue and is generated from our marketplace offerings. Under these marketplace offerings, we generate revenue from both talent and clients. Managed Services Revenue Through our managed services offering, we are responsible for providing services and engaging talent directly or as employees of third-party staffing providers to perform services for clients on our behalf. Under U.S. GAAP, we are deemed to be the principal in these managed services arrangements and therefore recognize the entire GSV of managed services projects as managed services revenue, as compared to recognizing only the percentage of the client spend that we receive, as we do with our marketplace offerings. Cost of Revenue Cost of revenue consists primarily of the cost of payment processing fees, amounts paid to talent to deliver services for clients under our managed services offering, personnel-related costs for our services and support personnel, third-party hosting fees, and the amortization expense associated with capitalized internal-use software and platform development costs. We define personnel-related costs as salaries, bonuses, benefits, travel and entertainment, and stock-based compensation costs for employees and the costs related to other service providers we engage. 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 qualifies for capitalization. 22 Sales and Marketing Sales and marketing expense consists primarily of expenses related to advertising and marketing activities, as well as personnel-related costs, including sales commissions, which we expense as they are incurred. General and Administrative General and administrative expense consists primarily of personnel-related costs for our executive, finance, legal, human resources, and operations functions; outside consulting, legal, and accounting services; impairment expense; and insurance. Provision for Transaction Losses Provision for transaction losses consists primarily of losses resulting from fraud and bad debt expense associated with our trade and client receivables balance and transaction losses associated with chargebacks. Provisions for these items represent estimates of losses based on our actual historical incurred losses and other factors. Interest Expense Interest expense consists of interest on our outstanding borrowings. Other (Income) Expense, Net Other (income) expense, net consists primarily of interest income that we earn from our deposits in money market funds and investments in marketable securities and gains and losses from foreign currency exchange transactions. Additionally, during the six months ended June 30, 2023, we recognized a gain on the early extinguishment of debt of $38.9 million, which is included in other income, net. For additional information about the gain on early extinguishment of debt, see the section below titled “—Convertible Senior Notes Due 2026.” 23 Results of Operations The following table sets forth our condensed consolidated results of operations for the periods presented: Three Months Ended June 30, Six Months Ended June 30, (In thousands) 2023 2022 2023 2022 Revenue Marketplace $ 156,631 $ 144,325 $ 304,719 $ 273,750 Managed services 11,980 12,573 24,750 24,485 Total revenue 168,611 156,898 329,469 298,235 Cost of revenue (1) 40,882 40,857 81,309 78,773 Gross profit 127,729 116,041 248,160 219,462 Operating expenses Research and development (1) 43,246 35,830 87,727 73,991 Sales and marketing (1) 59,069 63,283 124,069 120,925 General and administrative (1) 28,983 33,324 58,270 62,465 Provision for transaction losses 2,547 6,652 9,248 8,781 Total operating expenses 133,845 139,089 279,314 266,162 Loss from operations (6,116) (23,048) (31,154) (46,700) Interest expense 713 1,120 1,814 2,245 Other income, net (4,695) (375) (48,796) (443) Income (loss) before income taxes (2,134) (23,793) 15,828 (48,502) Income tax provision (1,857) (27) (2,652) (56) Net income (loss) $ (3,991) $ (23,820) $ 13,176 $ (48,558) (1) Includes stock-based compensation expense as follows: Three Months Ended June 30, Six Months Ended June 30, (In thousands) 2023 2022 2023 2022 Cost of revenue $ 490 $ 347 $ 910 $ 586 Research and development 6,903 6,565 14,532 12,180 Sales and marketing 2,998 2,663 6,566 4,928 General and administrative 8,046 9,405 16,329 18,021 Total stock-based compensation $ 18,437 $ 18,980 $ 38,337 $ 35,715 24 Comparison of the Three and Six Months Ended June 30, 2023 and 2022 Revenue Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change Marketplace $ 156,631 $ 144,325 $ 12,306 9 % $ 304,719 $ 273,750 $ 30,969 11 % Percentage of total revenue 93 % 92 % 92 % 92 % Managed services 11,980 12,573 (593) (5) % 24,750 24,485 265 1 % Percentage of total revenue 7 % 8 % 8 % 8 % Total revenue $ 168,611 $ 156,898 $ 11,713 7 % $ 329,469 $ 298,235 $ 31,234 10 % During the three and six months ended June 30, 2023, GSV remained relatively flat at $1.0 billion and $2.0 billion, respectively, as compared to the same periods in 2022, primarily due to the lapping of strong growth in the prior periods, as well as changes to client fees as a result of the shift to our Client Marketplace offering in April 2022. The number of active clients increased 2% as of June 30, 2023, as compared to the same period in 2022, and our GSV per active client increased 2% as of June 30, 2023, as compared to the same period in 2022, primarily due to increased spend from existing clients. For the three months ended June 30, 2023, marketplace revenue represented 93% of total revenue and increased by $12.3 million, or 9%, as compared to the same period in 2022. For the six months ended June 30, 2023, marketplace revenue represented 92% of total revenue and increased by $31.0 million, or 11%, as compared to the same period in 2022. Marketplace revenue growth was driven primarily by the changes to client fees related to the shift to our Client Marketplace offering in April 2022, an increase in the second quarter of 2023 in the number of Connects needed to bid on projects on our work marketplace, and the contract initiation fee for clients on our Client Marketplace offering introduced in April 2023. Marketplace revenue growth was partially offset by a reduction in talent service fees for the three and six months ended June 30, 2023, as a result of the changes we made in May 2023 to our tiered service fee structure. Overall, these factors caused marketplace revenue to grow at a faster rate than GSV from our marketplace offerings, which caused marketplace take rate to increase to 15.3% and 15.1% for the three and six months ended June 30, 2023, respectively, as compared to 14.0% and 13.5% for the same periods in 2022. Additionally, during the three and six months ended June 30, 2023, we continued our efforts to better address large enterprise and other clients through our Upwork Enterprise and other premium offerings. As a result, for the three and six months ended June 30, 2023, Enterprise Revenue increased 16% to $14.3 million and 12% to $25.7 million, respectively, as compared to the same periods in 2022, due to spend from new clients of our Enterprise offering, as well as existing clients of our Enterprise offering shifting spend to Enterprise offerings that have a higher take rate, which also contributed to the increase in marketplace revenue during those periods. We expect marketplace revenue and marketplace take rate to increase throughout the remainder of 2023. For the three months ended June 30, 2023, managed services revenue decreased by 5%, or $0.6 million, to $12.0 million, as compared to the same period in 2022, as a result of decreased spend from existing clients of our managed services offering, partially offset by an increase in revenue from a new contract from an existing client. The reduction in spend during the three months ended June 30, 2023 impacted growth of managed services revenue for the six months ended June 30, 2023, which grew 1%, or $0.3 million, to $24.8 million, as compared to the same period in 2022. 25 Cost of Revenue and Gross Margin Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change Cost of revenue $ 40,882 $ 40,857 $ 25 — % $ 81,309 $ 78,773 $ 2,536 3 % Components of cost of revenue: Cost of talent services to deliver managed services 9,140 9,271 (131) (1) % 18,673 18,231 442 2 % Other components of cost of revenue 31,742 31,586 156 — % 62,636 60,542 2,094 3 % Total gross margin 76 % 74 % 75 % 74 % For the three months ended June 30, 2023, cost of revenue increased by 0.1% due to immaterial changes to underlying drivers. For the six months ended June 30, 2023, cost of revenue increased primarily as a result of increases in personnel-related costs of $1.9 million and the increase in cost of talent services to deliver managed services of $0.4 million driven by new spend from existing clients of our managed services offering, as compared to the same period in 2022. For the three and six months ended June 30, 2023, gross margin was 76% and 75%, respectively, as compared to 74% for each of the three and six months ended June 30, 2022. The increase in gross margin was primarily due to an increase in the second quarter of 2023 in the number of Connects needed to bid on projects on our work marketplace and the introduction of a contract initiation fee up to $4.95 per contract for clients on our Client Marketplace in April 2023, as well as changes to client fees as a result of the shift to our Client Marketplace offering in April 2022. We expect cost of revenue to increase in absolute dollars in future periods as we continue to support growth on our work marketplace. Amounts paid to talent in connection with our managed services offering are tied to the volume of managed services used by our clients. The level and timing of these items could fluctuate and affect our cost of revenue in the future. We expect the pricing changes that we have made over the past twelve months will continue to positively impact gross margin throughout the remainder of 2023. While we expect gross profit to increase in absolute dollars in future periods, because our managed services revenue and marketplace revenue grow at different rates, gross margin, expressed as a percentage of total revenue, may vary from period to period. Research and Development Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change Research and development $ 43,246 $ 35,830 $ 7,416 21 % $ 87,727 $ 73,991 $ 13,736 19 % Percentage of total revenue 26 % 23 % 27 % 25 % For the three and six months ended June 30, 2023, research and development expense increased primarily due to investments we made to increase the size of our research and development workforce that resulted in increases in personnel-related costs of $9.0 million and $19.0 million, respectively, as compared to the same periods in 2022. This increase was partially offset by $2.4 million and $4.2 million incremental internal-use software and platform development costs that we capitalized during the three and six months ended June 30, 2023, respectively, as compared to the same periods in 2022. Additionally, during the six months ended June 30, 2022, we incurred $2.7 million of research and development expense related to our humanitarian response efforts related to the war in Ukraine. 26 We intend to focus our investment in research and development on the quality and adoption of our current offerings and products, and expect our research and development expense to increase in absolute dollars in future periods, although this expense, expressed as a percentage of total revenue, may vary from period to period. Sales and Marketing Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change Sales and marketing $ 59,069 $ 63,283 $ (4,214) (7) % $ 124,069 $ 120,925 $ 3,144 3 % Percentage of total revenue 35 % 40 % 38 % 41 % In the second quarter of 2023, we implemented a number of cost-saving measures, including reducing our investments in brand marketing, vendor spend, and other non-personnel costs, which drove reductions in marketing and advertising expense of $9.7 million and $10.5 million during the three and six months ended June 30, 2023, respectively, as compared to the same periods in 2022. We also implemented a reduction of our workforce in May 2023, resulting in employee severance and benefit costs of $2.5 million, largely in our sales team, in the second quarter of 2023. During the three and six months ended June 30, 2023, we continued to invest in marketing and other opportunities for growth, which drove increases in personnel-related costs of $3.2 million and $10.7 million in those periods, respectively, as compared to the same periods in 2022. As a result of the reduction of our workforce, reduced investment in brand marketing, and other cost-saving measures implemented in May 2023, we expect sales and marketing expense to decrease throughout the remainder of 2023, although this expense expressed as a percentage of total revenue may vary from period to period. General and Administrative Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change General and administrative $ 28,983 $ 33,324 $ (4,341) (13) % $ 58,270 $ 62,465 $ (4,195) (7) % Percentage of total revenue 17 % 21 % 18 % 21 % For the three and six months ended June 30, 2023, general and administrative expense decreased primarily due to additional expense incurred during the three and six months ended June 30, 2022 related to indirect taxes of $4.7 million and $5.0 million, respectively, and $1.3 million of expenses incurred during the same periods in 2022 resulting from our humanitarian response efforts and charitable donations related to the war in Ukraine. For the six months ended June 30, 2023, these decreases were partially offset by an increase in personnel-related costs of $1.3 million, as compared to the same period in 2022. We expect to continue to invest in general and administrative expenses to achieve our strategic objectives. We are considering certain actions relating to certain of our office spaces, including closing or subleasing, which could result in impairment charges being recognized in general and administrative expense. 27 Provision for Transaction Losses Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change Provision for transaction losses $ 2,547 $ 6,652 $ (4,105) (62) % $ 9,248 $ 8,781 $ 467 5 % Percentage of total revenue 1.5 % 4.2 % 2.8 % 2.9 % For the three months ended June 30, 2023, provision for transaction losses decreased by $4.1 million, or 62%, as compared to the same period in 2022, as a result of improved internal review processes, which reduced bad debt losses, instances of fraud, and chargeback losses in the second quarter of 2023. For the six months ended June 30, 2023, provision for transaction losses increased slightly by $0.5 million, or 5%, as compared to the same period in 2022, as a result of fraud protection fees paid to a third-party vendor, partially offset by reduced bad debt losses, instances of fraud, and chargeback losses. We continue to closely monitor this activity and maintain a number of measures designed to decrease transaction losses going forward. Interest Expense and Other Income, Net Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change Interest expense $ 713 $ 1,120 $ (407) (36) % $ 1,814 $ 2,245 $ (431) (19) % Other income, net (4,695) (375) (4,320) * (48,796) (443) (48,353) * * Not meaningful For the three and six months ended June 30, 2023, interest expense decreased as a result of the Repurchases (as defined below), which lowered our outstanding debt balance in March 2023. For the three and six months ended June 30, 2023, other income, net was driven by increases in interest income from our marketable securities of $3.8 million and $8.8 million, as compared to the same periods in 2022, primarily due to increased interest rates. Additionally, during the six months ended June 30, 2023, we recognized a gain on early extinguishment of debt of $38.9 million related to the Repurchases. Income Tax Provision Three Months Ended June 30, Six Months Ended June 30, (In thousands, except percentages) 2023 2022 Change 2023 2022 Change Income tax provision $ (1,857) $ (27) $ (1,830) * $ (2,652) $ (56) $ (2,596) * * Not meaningful For the three and six months ended June 30, 2023, income tax provision increased by $1.8 million and $2.6 million, respectively, as compared to the same periods in 2022, primarily due to a year-over-year increase in our U.S. federal taxable income. Liquidity and Capital Resources Our principal sources of liquidity are our cash and cash equivalents and marketable securities, including the net proceeds from the sale of our 0.25% convertible senior notes due 2026, which we refer to as the Notes. Our cash equivalents and marketable securities primarily consist of money market funds, commercial paper, treasury bills, corporate bonds, U.S. and foreign government securities, asset-backed securities, and other types of fixed income securities. The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Since our inception, 28 our business has consisted of the operation of an online work marketplace that connects business with independent talent from across the globe, and we do not make investments for trading or speculative purposes. As of June 30, 2023 and December 31, 2022, we had $154.1 million and $129.4 million in cash and cash equivalents, respectively. As of June 30, 2023 and December 31, 2022, we had $362.6 million and $557.2 million in marketable securities, respectively. We believe our existing cash and cash equivalents, marketable securities, and cash flow from operations (in periods in which we generate cash flow from operations) will be sufficient for at least the next 12 months to meet our requirements and plans for cash, including meeting our working capital requirements and capital expenditure requirements. In the long term, our ability to support our working capital and capital expenditure requirements will depend on many factors, including our revenue growth rate, the timing and the amount of cash received from users, the expansion of sales and marketing activities, the timing and extent of spending to support research and development efforts, the cost to host our work marketplace, the introduction of new offerings and services, the continuing market adoption of our work marketplace, any acquisitions or investments that we make in complementary businesses, products, and technologies, macroeconomic conditions, and our ability to obtain equity or debt financing. Our principal commitments consist of obligations under our non-cancellable operating leases for office space and the Notes. There were no material changes to our lease agreements from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022. In March 2023, we sold $138.2 million of available-for-sale marketable securities to enable the Repurchases. Assuming the remaining Notes are not converted into our common stock, repurchased, or redeemed prior to maturity, (i) annual interest expense relating to the Notes will be $2.7 million in each fiscal year through 2026 and (ii) principal in the amount of $361.0 million will be payable upon the maturity of the Notes on August 15, 2026. For additional information about our Notes, see the section below titled “—Convertible Senior Notes Due 2026.” As market conditions warrant, we may, from time to time, repurchase additional outstanding Notes in the open market, in privately negotiated transactions, by tender offer, by exchange transaction, or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity, and other factors, and may be commenced or suspended at any time. The amounts involved and total consideration paid may be material. We anticipate satisfying our short-term cash requirements with our existing cash and cash equivalents and may satisfy our long-term cash requirements with cash and cash equivalents on hand or with proceeds from future equity or debt financing. To the extent existing cash and cash equivalents, cash from marketable securities, and cash from operations (in periods in which we generate cash flow from operations) are insufficient to fund our working capital and capital expenditure requirements, or should we require additional cash for other purposes, we will need to raise additional funds. In the future, we may attempt to raise additional capital through the sale of equity securities or through equity-linked or debt financing arrangements as we did with the offering of the Notes in 2021. If we raise additional funds by issuing equity or equity-linked securities, the ownership and economic interests of our existing stockholders will be diluted. If we raise additional financing by incurring additional indebtedness, we will be subject to additional debt service requirements and could also be subject to additional restrictive covenants, such as limitations on our ability to incur additional debt, and other operating restrictions that could adversely impact our ability to conduct our business. Any future indebtedness we incur may result in terms that could also be unfavorable to our equity investors. There can be no assurances that we will be able to raise additional capital on terms we deem acceptable, or at all. The inability to raise additional capital as and when required would have an adverse effect, which could be material, on our results of operations, financial condition, and ability to achieve our business objectives. During the periods presented, we did not have, and we do not currently have, any commitments or obligations, including contingent obligations, arising from arrangements with unconsolidated entities or persons that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, cash requirements or capital resources. 29 Escrow Funding Requirements As a licensed internet escrow agent, we offer escrow services to users of our work marketplace and, as such, we are required to hold our users’ escrowed cash and in-transit cash in trust as an asset and record a corresponding liability for escrow funds held on behalf of talent and clients on our balance sheet. We expect the balances of our funds held in escrow, including funds held in transit, and the related liability to grow as GSV grows and may vary from period to period. Escrow regulations require us to fund the trust with our operating cash to cover shortages due to the timing of cash receipts from clients for completed hourly billings. Talent submit their billings for hourly contracts to their clients on a weekly basis every Sunday, and the aggregate amount of such billings is added to escrow funds payable to talent on the same day. As of each Sunday of each week, we have not yet collected funds for hourly billings from clients as these funds are in transit. Therefore, in order to satisfy escrow funding requirements, every Sunday we fund the shortage of cash in trust with our own operating cash and typically collect this cash shortage from clients within the next several days. As a result, we expect our total cash and cash flows from operating activities to be impacted when a quarter ends on a Sunday. As of June 30, 2023 and December 31, 2022, funds held in escrow, including funds in transit, were $177.7 million and $161.5 million, respectively. Convertible Senior Notes Due 2026 In August 2021, we issued the Notes pursuant to an Indenture between us and Computershare Trust Company, National Association (as successor in interest to Wells Fargo Bank, National Association), as trustee. The Notes are senior, unsecured obligations and bear interest at a rate of 0.25% per year, payable semiannually in arrears, and are due August 15, 2026. Upon conversion, we have an option to pay or deliver, as the case may be, cash, shares of our common stock, or a combination of cash and shares of our common stock. In March 2023, we entered into separate, privately negotiated repurchase agreements with a limited number of institutional holders of the Notes to repurchase for cash an aggregate of $214.0 million principal amount of the Notes, which we refer to as the Repurchases. We paid $170.8 million in cash to consummate the Repurchases. As a result, during the six months ended June 30, 2023, we recognized a gain on the early extinguishment of debt of $38.9 million, which is net of $3.7 million related to the pro-rata write-off of unamortized issuance costs associated with the sale of the Notes in August 2021, and $0.6 million of other fees incurred to effect the Repurchases. The resulting gain on early extinguishment of debt is included in other income, net in the condensed consolidated statement of operations and comprehensive income (loss). As of June 30, 2023, $361.0 million aggregate principal amount of the Notes remain outstanding. Capped Calls In connection with the issuance of the Notes, we entered into capped call transactions, which we refer to as Capped Calls. The Capped Calls are expected generally to reduce the potential dilution to our common stock upon any conversion of the Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap based on the cap price. The initial cap price of the Capped Calls is $92.74 per share of common stock, subject to certain customary adjustments under the terms of the Capped Calls. See “Note 7—Debt” of the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report for additional information regarding the Notes and the Capped Calls. The Capped Calls remain in effect notwithstanding the Repurchases. 30 Cash Flows The following table summarizes our cash flows for the periods presented: Six Months Ended June 30, (In thousands) 2023 2022 Net cash used in operating activities $ (4,392) $ (11,922) Net cash provided by (used in) investing activities 196,943 (43,169) Net cash provided by (used in) financing activities (151,631) 31,138 Net change in cash, cash equivalents, and restricted cash (1) $ 40,920 $ (23,953) (1) Includes increases in funds held in escrow, including funds in transit of $16.2 million and $27.6 million during the six months ended June 30, 2023 and 2022, respectively. Operating Activities Our largest source of cash from operating activities is revenue generated from our work marketplace. Our primary uses of cash from operating activities are for personnel-related expenditures, marketing activities, including advertising, payment processing fees, amounts paid to talent to deliver services for clients under our managed services offering, and third-party hosting costs. In addition, because we are licensed as an internet escrow agent, our total cash and cash used in operating activities may be impacted by the timing of the end of our fiscal quarter as discussed in the section titled “—Liquidity and Capital Resources—Escrow Funding Requirements.” For the six months ended June 30, 2023, net cash used in operating activities was $4.4 million, which resulted from net income of $13.2 million and adjustments of $5.7 million, driven by the gain on early extinguishment of debt of $38.9 million, offset by net cash outflows of $23.3 million from changes in operating assets and liabilities. For the six months ended June 30, 2022, net cash used in operating activities was $11.9 million, which resulted from a net loss of $48.6 million and net cash outflows of $15.6 million from changes in operating assets and liabilities, partially offset by non-cash charges of $52.2 million. The change in operating assets and liabilities primarily resulted from the increase in trade and client receivables of $10.9 million. Investing Activities For the six months ended June 30, 2023, net cash provided by investing activities was $196.9 million, which was primarily a result of proceeds from maturities of marketable securities of $307.4 million and proceeds from the sale of marketable securities of $149.9 million, including $143.7 million to enable the repurchase of a portion of the Notes, partially offset by investing $254.1 million in various marketable securities, as well as $6.1 million of internal-use software and platform development costs that we paid during the period. For the six months ended June 30, 2022, net cash used in investing activities was $43.2 million, which was primarily a result of investing $231.4 million in various marketable securities, as well as $2.8 million of internal-use software and platform development costs that we paid during the period, partially offset by proceeds from maturities of marketable securities of $191.6 million. Financing Activities For the six months ended June 30, 2023, net cash used in financing activities was $151.6 million, which was driven by $171.3 million that we paid to consummate the Repurchases, including related fees to effect the Repurchases, partially offset by an increase in escrow funds payable of $16.2 million, proceeds received from our employee stock purchase plan of $2.6 million, and cash received from stock option exercises of $0.9 million. 31 For the six months ended June 30, 2022, net cash provided by financing activities was $31.1 million, which resulted primarily from an increase in escrow funds payable of $27.6 million, proceeds received from our employee stock purchase plan of $2.5 million, and cash received from stock option exercises of $1.0 million. Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of the condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis using historical experience and other factors and adjust those estimates and assumptions when facts and circumstances dictate. Actual results could materially differ from these estimates and assumptions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. Except as otherwise disclosed in “Note 2—Basis of Presentation and Summary of Significant Accounting Policies” of the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” there have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the year ended December 31, 2022. Recent Accounting Pronouncements See “Note 2—Basis of Presentation and Summary of Significant Accounting Policies” of the notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report for recently issued accounting pronouncements not yet adopted as of the date of this Quarterly Report.