Toast (NYSE:TOST) Reports Upbeat Q1, Stock Soars

Restaurant software platform Toast (NYSE:TOST) announced better-than-expected results in the Q1 FY2023 quarter, with revenue up 53.1% year on year to $819 million. On top of that, guidance for next quarter's revenue was surprisingly good, being $935 million at the midpoint, 3.44% above what analysts were expecting. Toast made a GAAP loss of $81 million, down on its loss of $23 million, 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 quarterly revenue of $282 million in Q1 FY2021, to $819 million.

And while we saw even higher rates of growth previously, the revenue growth was still very strong; up a rather splendid 53.1% year on year. On top of that, revenue increased $51 million quarter on quarter, a very strong improvement on the $16 million increase in Q4 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 38.5% year on year to $935 million, slowing down from the 58.5% 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 28.2% 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 21.2% in Q1.

That means that for every $1 in revenue the company had $0.21 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 $65 million in Q1, increasing the cash burn by 30% year on year.

Toast has burned through $204 million in cash over the last twelve months, resulting in a negative 6.77% 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

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 $10.2 billion and more than $950 million in cash, the company has the capacity to continue to prioritise growth over profitability.

We liked to see that Toast beat analysts’ revenue expectations pretty strongly this quarter. And we were glad that the revenue guidance for the next quarter also exceeded analysts' expectations. Beat and raise is more rare these days and it was good to see Toast deliver good results. Zooming out, we think this was a great quarter and shareholders will likely feel excited about the results. The company is up 7.34% on the results and currently trades at $20.9 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 2.6x, 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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