Restaurant software platform Toast (NYSE:TOST) announced better-than-expected results in the Q3 FY2021 quarter, with revenue up 105% year on year to $486.3 million. Guidance for next quarter's revenue was surprisingly good, being $480 million at the midpoint, 7.27% above what analysts were expecting. Toast made a GAAP loss of $252.4 million, down on its loss of $62.6 million, in the same quarter last year.
Toast (TOST) Q3 FY2021 Highlights:
- Revenue: $486.3 million vs analyst estimates of $433.6 million (12.1% beat)
- EPS (GAAP): -$1.05
- Revenue guidance for Q4 2021 is $480 million at the midpoint, above analyst estimates of $447.4 million
- Free cash flow was negative $21.1 million, down from positive free cash flow of $52.5 million in previous quarter
- Gross Margin (GAAP): 17.1%, down from 20.4% same quarter last year
Founded by three MIT engineers at a local Cambridge bar, Toast (NYSE:TOST) provides integrated point of sale (POS) hardware, software, and payments solutions for restaurants.
Many restaurants still rely on manual processes or antiquated one off technology solutions to manage operations, which results in a myriad of operational inefficiencies. Today’s restaurants must juggle online ordering, delivery, takeout, and curbside pickup orders, and are expected to communicate timing for order completion to both customers and employees. Layer on demand managing menu changes, incorporating marketing and loyalty programs, and keeping track of employee payroll and tracking supplies, and the need for a modern vertical specific software operating system targeted at restaurants becomes clear.
Toast is a cloud-based, end-to-end software and payments platform that is built specifically for restaurants. The company offers a range of functionality that includes the ability to accept and process payments, manage kitchen display systems, along with payroll and labor. It also has a marketing component that allows restaurants to build loyalty programs and email marketing, and even has Toast Capital, which provides working capital through small business loans. In 2021 prior to its IPO, Toast acquired xtraCHEF, which added functionality for supply chain management, such as accounts payable automation and inventory management. The Toast platform also has a range of integrations with third parties like DoorDash for delivery or Staples for supplies.
The value proposition for restaurants is to generate a virtuous cycle between restaurants, their employees, customers, and suppliers. Happy customers increase sales and tips, improving employee morale, and so forth. Additionally, the end-to-end nature of the operating system allows restaurants analytics and insights that leads to better decisions and improved restaurant performance.
Enterprise resource planning (ERP) and customer relationship management (CRM) are two of the largest software categories dominated by the likes of Microsoft, Oracle, and Salesforce.com. Today, the secular trend of mass customization is driving vertical software that customizes ERP and CRM functions for specific industry requirements. Restaurants are a prime example where a set of customized software providers have sprung up in recent years to create unique operating systems that blend tax and accounting software, order management and delivery, along with supply chain management.
Toast’s main competitors are a mix of legacy restaurant systems like Oracle’s Micros (NYSE:ORCL), Par Technology Corp (NYSE:PAR), and NCR (NYSE:NCR) along with newer general purpose POS technologies readily configurable to restaurants such as Square (NASDAQ: SQ), Shopify (NYSE:SHOP), along with Olo (NYSE:OLO) and a host of mostly private pure play rivals.
As you can see below, Toast's revenue growth has been incredible over the last year, growing from quarterly revenue of $236.7 million, to $486.3 million.
This was another standout quarter with the revenue up a splendid 105% year on year. But the growth did slow down a little compared to last quarter, as Toast increased revenue by $61.6 million in Q3, compared to $72.8 million revenue add in Q2 2021. So while the growth is overall still impressive, we will be keeping an eye on the slowdown.
Analysts covering the company are expecting the revenues to grow 42.2% over the next twelve months, although estimates are likely to change post earnings.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Toast's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 17.1% in Q3.
That means that for every $1 in revenue the company had $0.17 left to spend on developing new products, marketing & sales and the general administrative overhead. This would be considered a low gross margin for a SaaS company and it has dropped significantly from the previous quarter, which is probably the opposite of what shareholders would like it to do.
Key Takeaways from Toast's Q3 Results
With a market capitalization of $29.3 billion, more than $1.3 billion in cash and the fact it is operating close to free cash flow break-even, we're confident that Toast has the resources it needs to pursue a high growth business strategy.
We were impressed by how strongly Toast outperformed analysts’ revenue expectations this quarter. And we were also excited to see the really strong revenue growth. On the other hand, it was less good to see the pretty significant deterioration in gross margin. Zooming out, we think this impressive quarter should have shareholders feeling very positive. But investors might have been expecting more and the company is down 6.37% on the results and currently trades at $57 per share.
Is Now The Time?
When considering Toast, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in case of Toast we will be cheering from the sidelines. Its revenue growth has been exceptional, though we don't expect it to maintain historical growth rates. Unfortunately, its gross margins show its business model is much less lucrative than the best software businesses, and its customer acquisition costs are higher than we like to see.
Toast's price to sales ratio based on the next twelve months is 7.1x, suggesting that the market does have lower expectations of the business, relative to the high growth tech stocks. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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