Toast (TOST)

Restaurant software platform Toast (NYSE:TOST) missed Wall Street’s revenue expectations in Q1 CY2025, but sales rose 24.4% year on year to $1.34 billion. Its non-GAAP profit of $0.09 per share was 51.6% below analysts’ consensus estimates.

Company Overview

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.

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.

A company’s long-term sales performance can indicate its overall quality. Any business can have short-term success, but a top-tier one grows for years. Thankfully, Toast’s 38.6% annualized revenue growth over the last three years was exceptional. Its growth beat the average software company and shows its offerings resonate with customers, a helpful starting point for our analysis.

This quarter, Toast generated an excellent 24.4% year-on-year revenue growth rate, but its $1.34 billion of revenue fell short of Wall Street’s high expectations.

Looking ahead, sell-side analysts expect revenue to grow 21.9% over the next 12 months, a deceleration versus the last three years. Still, this projection is admirable and implies the market is forecasting success for its products and services.

While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.

Toast’s ARR punched in at $1.71 billion in Q1, and over the last four quarters, its growth was fantastic as it averaged 30.4% year-on-year increases. This alternate topline metric grew faster than total sales, which likely means that the recurring portions of the business are growing faster than less predictable, choppier ones such as implementation fees. That could be a good sign for future revenue growth.

The customer acquisition cost (CAC) payback period measures the months a company needs to recoup the money spent on acquiring a new customer. This metric helps assess how quickly a business can break even on its sales and marketing investments.

Toast’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its incremental sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a competitive market and must continue investing to grow.

For software companies like Toast, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.

Toast’s gross margin is substantially worse than most software businesses, signaling it has relatively high infrastructure costs compared to asset-lite businesses like ServiceNow. As you can see below, it averaged a 24.7% gross margin over the last year. That means Toast paid its providers a lot of money ($75.30 for every $100 in revenue) to run its business.

In Q1, Toast produced a 25.9% gross profit margin, marking a 2.6 percentage point increase from 23.3% in the same quarter last year. Toast’s full-year margin has also been trending up over the past 12 months, increasing by 2.5 percentage points. If this move continues, it could suggest better unit economics due to more leverage from its growing sales on the fixed portion of its cost of goods sold (such as servers).

While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain talent. This metric shows how much revenue remains after accounting for all core expenses – everything from the cost of goods sold to sales and R&D.

Toast has done a decent job managing its cost base over the last year. The company has produced an average operating margin of 2.2%, higher than the broader software sector.

Looking at the trend in its profitability, Toast’s operating margin rose by 8.3 percentage points over the last year, as its sales growth gave it operating leverage.

This quarter, Toast generated an operating profit margin of 3.2%, up 8.4 percentage points year on year. The increase was solid, and because its operating margin rose more than its gross margin, we can infer it was more efficient with expenses such as marketing, R&D, and administrative overhead.

If you’ve followed StockStory for a while, you know 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 has shown mediocre cash profitability over the last year, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 7.8%, subpar for a software business.

Toast’s free cash flow clocked in at $69 million in Q1, equivalent to a 5.2% margin. Its cash flow turned positive after being negative in the same quarter last year, but we note it was lower than its one-year cash profitability. Nevertheless, we wouldn’t put too much weight on a single quarter because investment needs can be seasonal, causing short-term swings. Long-term trends are more important.

Over the next year, analysts predict Toast’s cash conversion will slightly improve. Their consensus estimates imply its free cash flow margin of 7.8% for the last 12 months will increase to 8.9%, giving it more flexibility for investments, share buybacks, and dividends.

Companies with more cash than debt have lower bankruptcy risk.

Toast is a profitable, well-capitalized company with $1.49 billion of cash and $22 million of debt on its balance sheet. This $1.47 billion net cash position is 7.1% of its market cap and gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

We were impressed by Toast’s optimistic EBITDA guidance for next quarter, which blew past analysts’ expectations. We were also excited its EBITDA outperformed Wall Street’s estimates by a wide margin. On the other hand, its revenue slightly missed. Zooming out, we think this quarter featured some important positives. The stock traded up 3.9% to $37.99 immediately after reporting.

Updated: May 11, 2025 at 10:19 PM EDT

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in Toast.

We think Toast is a solid business. To kick things off, its revenue growth was exceptional over the last three years. And while its customer acquisition is less efficient than many comparable companies, its ARR has surged, showing its fundamentals are improving because it’s becoming a more predictable business. On top of that, its expanding operating margin shows it’s becoming more efficient at building and selling its software.

Toast’s price-to-sales ratio based on the next 12 months is 3.9x. Looking at the software space right now, Toast trades at a compelling valuation. If you’re a fan of the business and management team, now is a good time to scoop up some shares.

Wall Street analysts have a consensus one-year price target of $42.44 on the company (compared to the current share price of $40.89), implying they see 3.8% upside in buying Toast in the short term.

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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