Restaurant software platform Toast (NYSE:TOST) reported Q3 FY2022 results beating Wall St's expectations, with revenue up 54.6% year on year to $752 million. Guidance for next quarter's revenue was $745 million at the midpoint, 2.04% above the average of analyst estimates. Toast made a GAAP loss of $98 million, improving on its loss of $252.4 million, in the same quarter last year.
Toast (TOST) Q3 FY2022 Highlights:
- Revenue: $752 million vs analyst estimates of $720.9 million (4.31% beat)
- EPS: -$0.19 vs analyst estimates of -$0.20 (4.5% beat)
- Revenue guidance for Q4 2022 is $745 million at the midpoint, above analyst estimates of $730 million
- Free cash flow was negative $80 million, compared to negative free cash flow of $30 million in previous quarter
- Gross Margin (GAAP): 20%, up from 17.3% 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 two years, growing from quarterly revenue of $236.7 million in Q3 FY2020, to $752 million.
And while we saw even higher rates of growth previously, the revenue growth was still very strong; up a rather splendid 54.6% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $77 million in Q3, compared to $140 million in Q2 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.
Guidance for the next quarter indicates Toast is expecting revenue to grow 44.6% year on year to $745 million, slowing down from the 112% 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 32.7% over the next twelve months.
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 20% in Q3.
That means that for every $1 in revenue the company had $0.20 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 have followed 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 $80 million in Q3, increasing the cash burn by 278% year on year.
Toast has burned through $194 million in cash over the last twelve months, resulting in a negative 7.83% 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 Q3 Results
Since it has still been burning cash over the last twelve months it is worth keeping an eye on Toast’s balance sheet, but we note that with a market capitalization of $9.11 billion and more than $1.05 billion in cash, the company has the capacity to continue to prioritise growth over profitability for some time.
We were very impressed by the strong improvements in Toast’s gross margin this quarter. And we were also excited to see the really strong revenue growth. Zooming out, we think this impressive quarter should have shareholders feeling very positive. The company is up 7% on the results and currently trades at $21.4 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 cash burn raises the question if it can sustainably maintain its growth.
Toast's price to sales ratio based on the next twelve months is 3.1x, 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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