Toast

Q4 22’ SUMMARY

Toast delivered revenue in Q4 that outperformed management’s guidance and consensus estimates. The business delivered earnings that outperformed management’s guidance and met consensus expectations. These results reflect continued strength in the business as the expectations were based on Toast continuing to drive immense revenue growth along with even stronger margin improvements. While the market continues to signal doubt that Toast will scale into a massive payments and enterprise player, the business continues demonstrating a smooth trajectory that will end with Toast being many times its current size.

In Q4, revenues were driven by monetizing spending at new and existing restaurants as well as upselling SaaS products. This is an additional data point supporting the view that Toast’s integrated software and payments solution is a disruptor in the restaurant industry. It is also evidence that Toast’s land and expand strategy is highly effective. Additionally, it is evidence that Toast’s R&D investments are yielding strong customer adoption and the sales and marketing investments are yielding strong win rates.

Toast’s performance was largely impacted by the continued strength in the restaurant industry, which was the result of persistent consumer demand for out of home dining. This is another strong testament to Toast’s ability to position itself between restaurants and consumers. This is a highly valuable market position as it places Toast directly in the pathway of the massive consumer spending.

Toast continues to take share from legacy POS providers driven by the business’ product suite designed for the unique needs of restaurants. The business continued to drive strong momentum from restaurants seeking Toast out as word of mouth continued to be positive within the restaurant community. Overall, Toast has a long growth trajectory ahead as the TAM continues expanding and Toast continues developing solutions that address the unique needs of restaurants.

Key Takeaways from Q3 22’

Key Takeaway 1- FinTech Solutions Business Remains Strong

• Restaurants using the Toast platform materially increased as the business continues gaining share in the massive restaurant industry, which is a key misunderstanding by the market view that Toast is near maturation.

• Views on Toast in isolation miss the fact that the business is well positioned in a materially expanding market. In Q4, gross payment value (GPV) continued to grow driven by spending at new and existing locations.

Key Takeaway 2- Software Solutions (SaaS) Momentum Accelerated

• The market does not appreciate how valuable Toast’s SaaS solutions are for restaurants. Toast leveraged its unique position inside restaurants to upsell SaaS products to help restaurants navigate a highly dynamic environment characterized by record demand and tight labor conditions.

• Toast’s SaaS products were increasingly adopted by new and existing customers, which has led to the business getting many customers to subscribe for 6+ add-on products. This is another point the market is clearly not appreciating- Toast’s platform and API integrations meets a massive need for an all-in-one solution.

Key Takeaway 3- Restaurant Spending in the U.S. Remains Robust

• The market is discounting the immense demand Toast is capturing from being rightly positioned in a market with an expanding TAM.

• Restaurant spending remained strong in Q4 22’ as consumers return to outdoor activities now that the pandemic is behind us.

• Market research firms forecast sustained momentum through 22’ and the next several years.

GROWTH TRENDS

growth Factor 1- Financial technology solutions

Toast’s core FTS business is the main growth engine of the company’s business model. This service is the intro to Toast’s platform- the company offers well-designed POS systems that are made for restaurants, which can only be used if the restaurant uses Toast as their payment processing provider. This positions Toast between the restaurant and its customers, which enables the business to capitalize on consumers eating out at restaurants as Toast earns a percentage of every dollar the restaurant receives through the Toast system. In Q4, Toast continued to take share from legacy vendors as restaurants are increasingly gravitating towards solutions designed for restaurants. Toast saw gains from increased transactions as well as average order value.

The strong FTS growth was largely driven by continued momentum in GPV as the massive return to restaurant eating continued in Q4 22’. This substantiated the company’s claim that there was no observable pullback in consumer spending at Toast restaurants.

• GPV increase was partially driven by a 39% increase in restaurants using Toast.

• GPV increase was also driven by 8% growth in spending at existing Toast Restaurants.

Momentum in the FTS business was also driven by a strong increase in restaurants using the Toast platform. This expansion is a critical aspect of Toast’s business model, which is based on penetrating the massive restaurant industry that consists of over 860k locations in the US.

• Restaurant growth was driven by new customers, existing customers, and newly launched restaurants.

• Toast has a win rate greater than 50% when being considered head-to-head with competitors.

• Toast’s strength was driven by SMB restaurants as well as large national chains.

growth Factor 2- Software services (SAAS PRODUCTS)

Toast’s software business continues to see strong adoption as the business offers restaurants solutions to improve outcomes for operators, customers, and employees. Toast’s SaaS product suite is designed to address problems across the entire restaurant ecosystem. This includes solutions in the front of the house that are consumer facing as well as solutions in the back of the house that are operationally focused. The company continues to capture share from legacy vendors due in large part to Toast’s full product suite, which offers customers a fully integrated system of solutions.

Toast’s strong software services solutions revenue was driven by several factors in Q4 22’.

• Toast’s upsell trends continue improving with 22’ adoption rates even stronger than 21’.

• Toast launched an integration with Google to reduce friction between restaurants and their customers.

• Almost half of Toast’s customers use at least 6 SaaS products.

• Over half of Toast’s customers use Toast’s API to integrate with other applications, which has yielded 30% higher ARPU and lower churn for customer who use the API.

• ARPU of customers with 6+ SaaS products is significantly higher than those with less than 6 add-ons.

growth Factor 3- hardware and professional services

Toast’s actual hardware continues to serve a critical role for the business despite a declining importance from a revenue perspective. In Q4 22’, combined hardware and professional services revenues represented just 5% of total revenues. Toast does not seek to make money from the hardware sales as the POS terminals are more tools to get in the door rather than money making machines. This is the bedrock of Toast’s business model as the hardware is purpose-built for restaurants and designed to seamlessly interface with Toast’s software suite of products. Additionally, the professional services business is an ancillary line of business designed to serve as an additional support to restaurants. Interestingly, the business did call out Toast Capital as a contributor to gross profit expansion in the quarter. While this business is still nascent, it could become a material contributor to earnings growth over time as Toast is uniquely positioned to offer working capital loans to customers.

OPERATIONAL EFFICIENCIES

The market is significantly discounting the immense operating leverage that Toast is positioned to generate. Based on the stock price movement, the market is not placing much confidence that 22’ was an investment year, which means that the expectation is for Toast to struggle to reach profitability. This is in stark contrast with Toast’s disciplined expenditures in 22’ that were characterized by balancing growth investments with margin improvements.

Toast’s operational efficiency continued to outperform guidance and expectations. While the efficiency in Q4 was slightly below Pragmatic forecast, this will largely driven by an aggressive expectation of efficiency rather than weakness in the business. Toast continued to balance margin improvement with continued investments to drive the platform in 23’ and beyond. In the quarter, Toast drove continued margin expansion in the key FTS and SaaS lines of businesses while the hardware business’ margins were less of a drag on profitability. Toast’ Capital had higher OpEx related expenses; however, this line of business is still highly accretive to margins as there is very little COGS impact from this business.

Importantly, Toast has made good on the guidance put out at the top of 22’, which consisted of the business increasing expenses to invest in innovation. The step up in expenses was not expected to be recurring, which means operating leverage would occur as revenues would be driven by the investments while incremental expenses would not grow at the same rate. Based on the material improvement in margins as the year progresses, management has demonstrated the ability to target an investment level and outperform that target. As a result, margins in 23’ are poised to turn positive in 2H 23’ driven by revenue growth far outpacing expense growth.

INDUSTRY TRENDS

Toast’s business model positions the company to capitalize on the strong spending in the restaurant industry, which is expected to persist for the foreseeable future. Additionally, spending on delivery services is expected to remain strong, which drives higher margins for Toast as the economics for Card Not Present transactions are more favorable for Toast.

Specifically, spending at restaurants increased 12% in Q4 22’, which is strong given that growth in the year has been materially strong despite negative sentiment and inflation. Consumer spending continues to increase driven by high employment levels as well as demand for outdoor activities.

In 22’, market research firm Mintel expects restaurant spending growth to have reached 5%, which is on par with pre-pandemic levels. Going forward, Mintel expects spending to generate a 5yr CAGR of 4% through 26’. Additionally, market research firm eMarketer expects restaurant delivery intermediary sales to increase 11% in 22’. Going forward, the research firm is forecasting a 5yr CAGR of 11% through 26’.

FORECAST AND VALUATION

Toast is well positioned to continue driving strong growth in 23’, which the market is clearly not expecting based on the negative stock reaction to the results. While Toast’s stock was having an immense rise in 23’, the massive selloff is a clear indication that many investors are pessimistic on the business’ trajectory. There really is not much support for such a pessimistic perspective especially given that the guidance was largely in-line with consensus expectations, which were highly constructive on the business’ revenue growth and margin improvements in 23’. Additionally, Toast has a consistent track record of providing highly conservative guidance as management appears to subscribe to an under promise and over deliver approach to guidance.

Based on the underlying strength in the business and massive market opportunity, the Pragmatic forecast is even more positive than management’s guidance and consensus estimates. Specifically, the Pragmatic forecast is for revenue growth of 42% in 23’ compared to management’s guidance of 32% (and consensus estimate of 33%). This revenue momentum is expected to result in margins that are even stronger than guidance and consensus expectations, which are pegged to management’s guidance. Specifically, the Pragmatic forecast is for EBITDA of $18mm in 23’ compared to management’s guidance of a loss of -$10mm. The key difference is that the Pragmatic forecast implies Toast reaching profitability in Q3 23’ as opposed to Q4 23’ (management’s target) as the business has been significantly over delivering on the efficiency front. Importantly, the Wall St. consensus implies Toast reaching profitability in early 24’, which is at least two quarters after the Pragmatic forecast.

Toast is well positioned to deliver this kind of performance as the flywheel is turning without any signs of moderation. Growth is supported by strong spending in the restaurant industry, which directly drives Toast’s growth as the business is paid based on restaurant’s gross payment value. Toast stands to gain more spend per store in addition to significant spending growth from incremental restaurants as the business continues to drive material restaurant additions. Toast is still barely penetrating many markets, which positions the business to land and expand from a large base. This is a critical set up as Toast has demonstrated an ability to upsell SaaS products to customers, which the market is simply not appreciating. Both the FTS and SaaS lines of businesses are far from maturity, which makes the market’s reaction appear highly irrational.

Despite the stock’s massive drop on the day of earnings, the story is far from over as Toast has plenty of opportunities to disprove the prevailing sentiment. The stock is steeply discounted when taking into consideration the compounding that will occur over the next several years from a revenue and earnings perspective. Actually, the earnings of the business are poised to multiply as the business emerges from negative margins. The stock is likely to be in high demand as the business proves that the potential of Toast’s integrated software and payments solutions is far from maturity. The business’ entrance into the massive international market will also likely trigger a material revaluation of the stock.