Restaurant software platform Toast (NYSE:TOST) reported Q2 FY2023 results beating Wall Street analysts' expectations, with revenue up 44.9% year on year to $978 million. Guidance for next quarter's revenue was also optimistic $1.03 billion at the midpoint, 2.3% above analysts' estimates. Toast made a GAAP loss of $98 million, down from its loss of $54 million in the same quarter last year.
Toast (TOST) Q2 FY2023 Highlights:
- Revenue: $978 million vs analyst estimates of $944.8 million (3.51% beat)
- EPS: -$0.19 vs analyst expectations of -$0.14 (31.8% miss)
- Revenue Guidance for Q3 2023 is $1.03 billion at the midpoint, above analyst estimates of $1 billion
- The company lifted revenue guidance for the full year from $3.76 billion to $3.84 billion at the midpoint, a 2.26% increase
- Free Cash Flow of $39 million is up from -$65 million in the previous quarter
- Gross Margin (GAAP): 21.3%, up from 16.9% in the 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. Hotels and other hospitality providers are another example.
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 two years, growing from $426 million in Q2 FY2021 to $978 million this quarter.
Unsurprisingly, this was another great quarter for Toast with revenue up 44.9% year on year. On top of that, its revenue increased $159 million quarter on quarter, a very strong improvement from the $51 million increase in Q1 2023. This is a sign of re-acceleration of growth and great to see.
Next quarter's guidance suggests that Toast is expecting revenue to grow 36.3% year on year to $1.03 billion, slowing down from the 54.7% year-on-year increase it recorded in the same quarter last year. Ahead of the earnings results announcement, the analysts covering the company were expecting sales to grow 28.1% over the next 12 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's left after paying for servers, licenses, technical support, and other necessary running expenses, was 21.3% in Q2.
That means that for every $1 in revenue the company had $0.21 left to spend on developing new products, sales and marketing, and general administrative overhead. Despite trending up over the last year, Toast's gross margin is poor for a SaaS business. We have no doubt that shareholders would like to see its improvements continue.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Toast's free cash flow came in at $39 million in Q2, turning positive over the last year.
Toast has burned through $135 million of cash over the last 12 months, resulting in a negative 4.59% free cash flow margin. This below-average FCF margin stems from Toast's poor unit economics or a continuous need to reinvest in its business to penetrate the market.
Key Takeaways from Toast's Q2 Results
Sporting a market capitalization of $10.8 billion, more than $990 million in cash on hand, and near-breakeven free cash flow status, we believe that Toast is well-positioned for growth.
This was a milestone beat-and-raise quarter for Toast as it won a deal with Marriott, exceeded $1 billion in ARR, and reached adjusted EBITDA profitability and positive free cash flow for the first time since the IPO. On top of that, the company raised its revenue and adjusted EBITDA guidance for the full year, topping analysts' expectations. Overall, we think this was a really good quarter that should please shareholders. The stock is up 13.5% after reporting and currently trades at $22.93 per share.
Is Now The Time?
When considering an investment in Toast, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter. We cheer for everyone who's making the lives of others easier through technology but in case of Toast, we'll 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 12 months is 2.5x, 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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