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Toast (NYSE:TOST) Surprises With Strong Q2, Stock Jumps 10.6%


Full Report / September 28, 2022
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Restaurant software platform Toast (NYSE:TOST) reported Q2 FY2022 results beating Wall St's expectations, with revenue up 58.9% year on year to $675 million. On top of that, guidance for next quarter's revenue was surprisingly good, being $715 million at the midpoint, 7.8% above what analysts were expecting. Toast made a GAAP loss of $54 million, improving on its loss of $135.5 million, in the same quarter last year.

Toast (TOST) Q2 FY2022 Highlights:

  • Revenue: $675 million vs analyst estimates of $647.6 million (4.22% beat)
  • EPS (GAAP): -$0.11
  • Revenue guidance for Q3 2022 is $715 million at the midpoint, above analyst estimates of $663.2 million
  • The company lifted revenue guidance for the full year, from $2.52 billion to $2.64 billion at the midpoint, a 4.55% increase
  • Free cash flow was negative $30 million, compared to negative free cash flow of $50 million in previous quarter
  • Gross Margin (GAAP): 16.7%, down from 21% 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 $424.7 million, to $675 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 58.9% year on year. On top of that, revenue increased $140 million quarter on quarter, a very strong improvement on the $23 million increase in Q1 2022, and a sign of acceleration of growth, which is very nice to see indeed.

Guidance for the next quarter indicates Toast is expecting revenue to grow 47% year on year to $715 million, slowing down from the 105% 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 31.5% 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 16.7% in Q2.

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. This would be considered a low gross margin for a SaaS company and we would like to see it start improving.

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 $30 million in Q2, with cash flow turning negative year on year.

Toast Free Cash Flow

Toast has burned through $135.1 million in cash over the last twelve months, resulting in a negative 6.11% 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 Q2 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 $9.44 billion and more than $1.17 billion in cash, the company has the capacity to continue to prioritise growth over profitability.

We were impressed by the very optimistic revenue guidance Toast provided for the next quarter. And we were also excited to see the really strong revenue growth this quarter. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The company currently trades at $17.9 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 3.2x, 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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