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Toast (NYSE:TOST) Beats Expectations in Strong Q1, Stock Soars


Full Report / May 12, 2022
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Restaurant software platform Toast (NYSE:TOST) reported results ahead of analyst expectations in the Q1 FY2022 quarter, with revenue up 52% year on year to $535 million. On top of that, guidance for next quarter's revenue was surprisingly good, being $650 million at the midpoint, 13.4% above what analysts were expecting. Toast made a GAAP loss of $23 million, improving on its loss of $117.3 million, in the same quarter last year.

Toast (TOST) Q1 FY2022 Highlights:

  • Revenue: $535 million vs analyst estimates of $490.4 million (9.07% beat)
  • EPS (GAAP): -$0.20
  • Revenue guidance for Q2 2022 is $650 million at the midpoint, above analyst estimates of $572.7 million
  • The company lifted revenue guidance for the full year, from $2.37 billion to $2.52 billion at the midpoint, a 6.13% increase
  • Free cash flow was negative $50 million, compared to negative free cash flow of $34 million in previous quarter
  • Gross Margin (GAAP): 16.6%, down from 22.2% 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.

Sales Growth

As you can see below, Toast's revenue growth has been incredible over the last year, growing from quarterly revenue of $351.8 million, to $535 million.

Toast Total Revenue

And while we saw even higher rates of growth previously, the revenue growth was still very strong; up a rather splendid 52% year on year. But the growth did slow down a little compared to last quarter, as Toast increased revenue by $23 million in Q1, compared to $25.6 million revenue add in Q4 2021. So while the growth is overall still impressive, we will be keeping an eye on the slowdown.

Guidance for the next quarter indicates Toast is expecting revenue to grow 53% year on year to $650 million, slowing down from the 192% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 31.4% over the next twelve months.

Profitability

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 16.6% in Q1.

Toast Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.16 left to spend on developing new products, marketing & sales and the general administrative overhead. While it improved significantly from the previous quarter this would still be considered a low gross margin for a SaaS company and we would like to see the improvements continue.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Toast burned through $50 million in Q1, increasing the cash burn by 264% year on year.

Toast Free Cash Flow

Toast has burned through $52.6 million in cash over the last twelve months, resulting in a negative 2.68% free cash flow margin. This below average FCF margin is a result of Toast's need to invest in the business to continue penetrating its market.

Key Takeaways from Toast's Q1 Results

With a market capitalization of $6.48 billion Toast is among smaller companies, but its more than $757 million in cash and the fact it is operating close to free cash flow break-even put it in a robust financial position to invest in growth.

We were very impressed by the strong improvements in Toast’s gross margin this quarter. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. Zooming out, we think this impressive quarter should have shareholders feeling very positive. The company is up 5.18% on the results and currently trades at $15 per share.

Is Now The Time?

Toast may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. 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 2.8x, 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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