Toast, Inc. (TOST) Earnings Call Transcript & Summary

Good morning. Thank you for joining for the session with Toast. I'm Stephen Sheldon, for those who don't know me, and I'm an analyst in the tech group here at William Blair. For compliance purposes, I'm required to inform you that a complete list of research disclosures and potential conflicts of interest is available at our website at williamblair.com. So we're thrilled to have the Toast team with us at the conference again this year, which was our top stock pick across my coverage coming into 2023. From the company today, we have CFO, Elena Gomez, here to your left. We also have Michael Senno and Emily Woodward in the audience here upfront. There's a lot to dig into, especially as Toast continues to -- seems to be really executing on all fronts recently. For context, Toast has put up 55% ARR growth year-over-year in the first quarter, soon likely to surpass $1 billion in ARR and just be -- and will become adjusted EBITDA positive here at some point soon. So a lot to dig into. We're going to be doing more of a fireside chat today, followed by a breakout afterwards is going to be held in [ Mayor ] upstairs. So yes, thank you so much for being here.

To start here, Elena and maybe for those that are less familiar and given this is more of a generalist conference, maybe just start with a high-level overview of the solutions you provide to the restaurant industry?

Yes. Sounds good. Thank you for having me. So at the highest level, Toast is a payment processing and software company, purpose-built for restaurants, which is a key differentiator for us. We have 85,000 customers on our platform and really the breadth of customers is all sizes and formats and we often talk about our biggest opportunity lies ahead because we have about 10% of the TAM today in the U.S. So excited about that. When we talk about our mission statement, we really talk about empowering restaurant operators to really run their business efficiently, delight their guests, which is one of the key stakeholders and really thrive as a restaurant operator, really centered around -- I think the key point of that mission statement is centered around the customer and around helping the restaurant operator run a more efficient business, whether it's front of house or back of house, and I'll expand on some of that later. I think the key differentiator for us that we often talk about and we hear from our sales reps, one is it's purpose-built for restaurants. Two is we have a go-to-market team that's hyper local end markets, which has proven to be really, really helpful to continue to penetrate the TAM. And then this focus on just being purpose-built for restaurants is critical. And that verticalization, what it does is it allows you to speak the language of the customer, et cetera. And you can bring payments and SaaS all into one platform, which has proven to be that all-in-one integrated platform has proven to be really powerful. So that's sort of in a nutshell, the opportunity we have. But we're early, like we often talk about the fact that the 10% TAM leaves us a lot of room just in the U.S., not to mention our opportunity beyond as we extend and innovate more into other parts of our TAM.

Got it. It's a good place to start. Maybe starting with the health of the consumer. I feel like you guys probably have pretty good visibility into trends there. What are you seeing in terms of propensity to spend at restaurants, any shifts in customer behavior that you've seen in terms of maybe raining in spend, smaller baskets, less expensive restaurants, things like that. What are you seeing from customers perspective?

Yes, I won't use my own house as an indicator because we got out to the restaurants a lot. But at the highest level, our consumers -- restaurants are resilient, consumers are continuing to spend our restaurants. And in Q1, we had -- just as an example, we had healthy growth. Some of that was Omicron. You got to remember that from last year. But even outside of that, we're still seeing seasonal patterns that are very common for us. So typically, our summer warmer months have higher payment volume. We're still continuing to see that entering into Q2. And when we look back at prior recessions, restaurants are quite resilient. It turns out. And what we're seeing is customers are orienting -- consumers are orienting to service-oriented experiences and so that bodes really well for us. And so we're encouraged by that so far.

Got it. Maybe as we think about the platform, you were here at the conference last year, how much different does the platform look today than it would have looked a year ago? Where are you kind of allocating R&D spend? Where are you kind of focusing on the product side?

Yes, sure. The meta point is we're really proud of our innovation velocity that's always been in our DNA as a company. And the way I would frame it is and how we think about our R&D strategy is 3 ways. One is, can we look and extend our TAM? Like what innovation can we do to extend our TAM. Two, can we serve our key stakeholders better. And our stakeholders, just as everyone knows, is the restaurant operator, the employee or the diner of the guest. And then three, of course, we want to make sure we have a resilient platform as we scale. So there is some investment pointed at our infrastructure always. It's just a matter of good hygiene. When you think about the TAM, just to make it a bit more tangible, for you all. Hotels is a great example of -- we launched a hotel product and integration with PMS last year around this time. already March -- no, May, and that has proven really well. It's allowed us to deeply penetrate and resonate more with that section of our TAM, there's over 40,000 hotels in our TAM. And an example of that, we talked about on the earnings call was a hotel called McMenamins and they have a brewery attached to most of their hotels. So that opportunity opened up for us, I forget the number of locations, but it's a pretty -- it's over 100 locations to actually McMenamins is less than that. But point being, we are able to go into that TAM now differently. And then another example, I think many of you have heard about Toast Tables, which is a recent opportunity that we just launched. And that's really getting a stakeholder around the restaurant, both the restaurant operator, but also the guest and the guest has a better experience. I used to have actually on Friday night at a local restaurant in my town. And I was able to check out, they were using scan to pay at the table, but I was able to -- I was excited that I was using resi before and then I went to that same restaurant I was able to use Toast Table. So that was awesome. So yes, so we've done -- we continue to think about our innovation as extensions of TAM or ways to help the restaurant operator be more effective and/or create a better guest experience.

Got it. Maybe on the pain points, I feel like since you guys have an end-to-end software platform, you probably have pretty good visibility into the pain points, how they shift over time. What are you seeing? How do the pain point -- how much different do the pain point is looking now versus what they would look like three years ago, early in the pandemic. What does that mean for demand across different solutions?

Yes. No, we're -- so we have a very healthy voice to the customer program. So we're talking to customers all the time. And the themes we are continuing to hear are really around inflation and labor shortages. And I think we've all read a lot of articles about that. And so high food cost is a pain point that every restaurant operator is thinking about. And margins has historically been something that a restaurant operator is focused on. With inflation, how it's been, there's been a lot of focus on how do I manage my food cost. And so we have elements of our platform that can really help them with, whether it's xtraCHEF and sort of line item detail on their cost, menu optimization, things like that, that really point at those features. And then labor shortage is another one where there's several parts of our platform, whether it's a Toast Go device. It allows a waiter to serve more tables and actually get more tips as well in the process. So that's another pain point is how do I serve more diners with less resources. And so the Toast platform is really positioned to capture some of that opportunity.

Yes. Maybe on the competitive environment, how do you think about the competitive environment when you think about the legacy players that are out there, other cloud-based vendors? Is there room for multiple scale players in this industry? And just generally, how do you think about the opportunity to drive location growth given.

Yes. No, it's -- so the competitive landscape has always been intense in restaurant software. The good news is we've been able to compete really well, whether it's a cloud player or a legacy player. And actually, as we get deeper and deeper into our TAM, we're 10% today, but as you get deeper and deeper into the TAM in certain markets where we have even deeper penetration, we have great success, what we call the flywheel markets. But generally, when we're in a competitive bid, we win the majority of the time as long as we know that we're in that competitive situation. So that's encouraging. And then I talked about differentiation, like why do we win? I think it really comes back to the breadth of the platform and really being purpose-built for a restaurant really helps that rep have that value-added conversation at that time. And I mentioned on our earnings call, we're really seeing momentum in that business, and our competitive win rates are healthy, over 6,500 locations in Q2, which would be a record for us, which is great. And then in back half of the year, even continuing that momentum. So we're excited about that.

Yes. You think about market share and you talk about the flywheel markets, do you think it's -- and I think I asked this on the earnings call, but you think about getting market share, is it easier to get the first 10% or the next 10% to 20%.

I think it's harder to get that first 10% because you have to establish that footprint, right? I talked about the go-to-market motion and having reps on the ground. That's been really powerful. But for us, what we see is as we capture the market, what happens is there's referrals, right, all restaurant operators all talk to each other. So there's a couple of things that play to our benefit. One is the referrals and the rep getting more productive. The other is the tenure of that rep makes them more productive as well. And so we're starting to see this pattern with our flywheel market. So we actually want to replicate because what we're seeing is you can still grow the territory. You can still grow the ARR in that territory and keep the rep count relatively constant.

Got it. As you think about -- it seems like growth has been pretty balanced between locations, adding locations and driving revenue per location higher over time. How much room do you see to drive SaaS, if you would focus specifically on the SaaS ARR, software ARR, how much higher do you think it could get over time? And if you've got a full -- you've got a large platform, I think guess over 20 elective modules now with all the capabilities you've added, what could the SaaS ARR with a full suite of adoption look like?

Yes, that's a great question. Let me offer a little bit of context how we think about it. And our meta goal has always been, let's grow ARR, right? And that's really that combination of locations and how much is that location paying you that SaaS ARPU. And so the locations we have momentum right now. So if you think about as we get deeper into that TAM, that's just a massive distribution for us to go back and upsell to those customers. So that's an important element of this conversation. But in SaaS in general, we believe there's still continued opportunity to grow it. We grew 16% in Q1. We mentioned as we exit this year will be plus or minus 10% in terms of near-term SaaS growth. But if you look back over the last couple of years, what you saw was, are we launched an upsell team, we added a bunch of new product, Payroll, xtraCHEF is a good example. And then we also were positioning our reps to sell the breadth of the platform as we became more than just a POS solution. And so the combination of those 3 things really led to this over 50% growth of SaaS ARPU. And now that we've learned a ton from upsell, what we're seeing is customers want to adapt the platform on their terms when it's right for them. And so we're getting a little bit smarter about when to position certain elements of the platform. And now with the confidence that we have of the upsell team, we're less worried about -- we've got to get that sell upfront. We actually think in certain cases, it may be better to build trust with the customer and then later on, come back and sell them Payroll or sell them xtraCHEF as an example. So we're learning a lot, but that's sort of how we think about the ARPU opportunity. And today, we have over 10,000 customers paying us $10,000. So that's a testament to -- if our average is below that, we do have examples of customers paying us more. I shared an example I think, either on an earnings call or right after. We have a brewery that has 9 modules. They have a big hardware footprint and they're paying us over $15,000. Conversely, we have a QSR format restaurant, recent restaurant that we won, and they are paying a $15,000. And that's a combination of handhelds, loyalty, gift cards, et cetera. So the point being there's really different ways that a consumer can end up paying to us more than $10,000 and we're seeing that already as proof points. And over time, as we get a bigger percentage of our customers paying us that we'll look at the patterns and figure out when is the right time to go upsell. But that's really the focus of the upsell team.

That's going to compare to $5,000 to $6,000 right now on average.

Correct. Yes.

For context. So payments. I want to dig in payments a little bit. It's a big part of the monetization. We get the question all the time, how do you think about payment economics, near term, long term, kind of the way I've always kind of thought about it is, I feel like restaurant owners and operators sign up for you guys because of the software because of -- it's not necessarily about the payment economics, they sign up because of the software. And the more ingrained you get in the workflow is probably the tougher it be to rip it out. But just how do you think about payment economics both near term and long term?

Yes, it's a great question. So we always think about both, right? We think about the totality of the customer and our opportunity that the all-in-one platform allows us to monetize on the payment side and of course, on SaaS, which we talked about already. But on the payment side, we're -- we have a whole team that's really focused on optimization of our take rate effectively. And it's really through how do we look at our workflows to drive cost per transaction down over time. And then there's the natural scale as we continue to grow, we should see some leverage in our scale, which is important. And sometimes over the last couple of years, we added another processor, which sort of helped a little bit with getting that leverage as well. And then there's pricing, right? There's always pricing that is an opportunity for us. We've not done a wholesale pricing change but the way we think about pricing is really how do we drive value to the customer and are we connecting that value to the price that they're willing to pay. And we do a lot of testing to make sure that we're thoughtful about that. Recently, we were testing pricing for some of our digital programs, and we're getting feedback on that. So that's a near-term opportunity for us. But longer term, I think we're always going to consider how do we align the value with the pricing that we have and approach it that way.

Got it. I think there's been a lot more investor focus on Toast Capital recently. I feel like that's picked up in the last few quarters. So maybe talk a little bit about what that is, why it's strategically important for Toast and I guess, how you manage the risk that you undertake there?

Yes, sure. So for those of you who don't know, our Toast Capital, just give some context about the program is our way to offer lending to our customers in a pretty friction-free manner and really in an expedient way. And what we understood was our customers, they need access to capital and they need it quickly. And we're in a really unique position because we have access to their payment data, which we just talked about. And so that data allows us to have just a view of the customer, the creditworthiness of the customer, our desire -- enough data to say we can underwrite this customer. So that's sort of the premise. And what we've seen is as we've launched, we have 3 loan programs, a 90-day, 270-day, and 360-day. They're all different terms and different pricing, et cetera. But what we've seen is customers will come back for a loan after they repay their first loan. So that's been -- and that's really demand coming from our customers that they need, which is always how we build our products, really solving the customer pain point. And then in terms of managing risk, which is incredibly important to this program, the data is a key part of that. The fact that we see the data and the fact that we see their daily payment volume and most -- the loans we have, most customers are with us at least 6 months, so we have enough history with them to know that -- kind of have enough context around them to loan. And then the second thing is they pay that back based on their payment volume, based on a fixed percentage of their daily payment volume. So that gives us some predictability in our collection rate. And default rates have been pretty much in line with expectations as well. And then we -- the really important point is we work with a partner who actually issues the capital and so we limit our loss to 15% of the total loan portfolio. And so that is also sort of a stop gap. Now we've not gotten anywhere close to that in terms of our default rates, but it's just good to know that there is a stop gap. And then we have a whole team that's all they do. They are focused on risk and looking at this portfolio and patterns, et cetera. And probably really important, and we did this during COVID is it's at our control. So we can change the hurdle rate of who we loan to immediately if we needed to or we can pause the program. We did that during COVID, as it wasn't the right time. So our approach will always be somewhat measured. And as we think about growth over the long term, it's going to grow as our customer base grows, of course, but we'll be mindful of that risk profile that we're managing to.

Got it. That's helpful. Maybe I want to shift back to the location side. You guys are predominantly focused on SMBs at this point, SMB restaurants, you've got some larger customers. It seems like you're winning more mid-market and larger customers every quarter. As you think about moving more upmarket, what do you guys need to get right, I guess, to get real traction on the enterprise side with enterprise restaurants.

Yes. I mean I think the -- so you're absolutely right. We're getting pulled up market. And as we're getting deeper into the TAM, we're seeing inbound from enterprise customers. We have served enterprise customers already but our core -- when you think about the platform, the capabilities of the platform really resonate across all formats and sizes of restaurants, whether it's QSR, FSR, SMB, mid-market enterprise. And that's because when you think about the core operation in a restaurant, that's our sweet spot, right? That's where we started. That's -- and so it's not that different when you think about the in-store needs of a restaurant. As you think about how we innovate, we're always thinking how do we expand our TAM. Hotels was that example I gave earlier. Enterprise is similar in a sense that how can we leverage the core of our platform, but extend it enough to offer capabilities for a different part of the TAM. And Enterprise is a great example of that. And some of their needs are really more above store. So you can imagine. It's a CIO who's trying to make a decision around a multiunit location format, for example. So they're going to need things like P2PE, which is encryption and security, they're going to need different data needs, they might need different menu configuration needs and reporting needs. So those are all things that are additive and above-store capabilities that we're adding, but leveraging the existing platform that we're using for the breadth of our customer base, if that makes sense.

Got it. Yes. And I think you mentioned something maybe recently, it's been within the last few months that if you think about SMBs, you kind of require payments adoption, you become the payback up market, I think you're at least considering, maybe not requiring it. I guess, how would...

Yes, that is a fair question. So our core strategy, to your point, hasn't changed. Like for our core SMB, it's an all-in-one solution. And that's, in fact, a differentiator. It makes us -- and we have enterprise customers actually today that do use our platform all-in-one. But in certain cases, there may be a situation where that makes sense. And so we'll have an open stance to it, I would say, not never, but we'll be thoughtful about if we were to entertain that, where would we do that and in what parts of our TAM.

Got it. Maybe shifting to international. You're launching capabilities. I guess you already have launch capabilities in Canada, U.K., Ireland, how should investors be thinking about the international opportunity? When could that be more material as you think about top line growth?

Yes. I think of international as a longer -- it's a longer-term opportunity. We started the foundation last year. I think we shared that last year and we intentionally focused on English-speaking countries. And the thesis was we know -- we studied the market before we obviously went in. And what we learned was when you look at the competitive landscape, it's largely fragmented and many of the same players that you see here in the U.S. So when you think about our competitive win rates here in the U.S., we felt that we could have success internationally. So what we're doing now is we built out the team last year. We're continuing to build that foundation. Where our focus is, is what elements of our product and our platform makes sense internationally. We're building that out over time. We're kind of honing the go-to-market motion. And so that -- as I'm talking, you can see that's going to take some time. We do have customers live in all 3 of those countries, and so far, the response has been really positive. The product market that seems really encouraging. So we'll continue to invest. We'll invest a little more than last year, but it's not -- it's still not material to our total investment profile and definitely not to revenue yet.

And would the focus be driving adoption, I guess, within those 3 countries, how do you think about them expanding into other countries that can be?

Yes. I mean that's longer. So I would say with any bet and our investment philosophy is really -- let's be measured and make sure we have the signals in ROI that are proof points that sort of earn that [ game ] the right to go to Horizon 2, she knows that. So we'll explore, but I think we want to really have great success in Horizon 1 and prove that out before we go too much further. So I'd say that's years away, not quarters.

Got it. You finally provided some long-term profit targets earlier this year, you've been asked.

Surprised that was not the first question today.

Yes. So maybe talk about those and just the broader levers that you have as you think about what levers do you have that should support the path to profitability?

Sure. So the -- what Stephen is referring to is a couple of quarters ago, we gave a long-term margin profile. And that long-term margin profile was really fintech and SaaS gross margins. And what we said was, as we become a multibillion-dollar company, we would see margins in the 30% to 35% range. And when you think about that, so how do you get there from here? So a couple of things. One, we talked about take rate, right? Today, for the near term, we're saying we're going to be in the low 50s. But over time, we want to scale that, right, and through our optimization drive that steadily up. And then within gross margin, as we think about support, there's ways that we can optimize support through offshore through better self-service, et cetera. So we'll do that. And then as it relates to our operating expenses, driving more flywheel markets really drive that productivity and making sure we're continuing to replicate that as much as we can. And we always manage through a payback philosophy. Like we're very maniacal about. This is our payback period. And if it doesn't fit that, then what is the path to get back to that payback period. And then in R&D, we made significant investment over the last few years. So we're going to continue to innovate. You'll see some growth there, but it won't be at the same clip that you saw in the last couple of years. And then with G&A, just like any other company, we're going to expect to scale through automation. And then we've lapped public company expenses now. I think we've a couple of quarters of that. So I do see a path to driving really leverage across the business, and that discipline is really important to us. I think the other thing to consider as you think about -- and how we think about it is, as the market evolves, we will sort of control when -- how that profitability plays out. And so it may not be exactly linear, but our ambition is to get to that 30% to 35%.

Got it. And you're talking about becoming adjusted EBITDA positive in the next couple of quarters. I think your guidance for the second quarter -- you are at the high end or breakeven. So as we think about adjusted EBITDA translating to free cash flow, do you think you'll become free cash flow positive pretty quickly thereafter...

Yes, I would say it should largely match our EBITDA trajectory. We're not really capital-intensive business at the highest level. I mean there may be some occasional quarters where like payroll taxes in Q1 are always a thing for everyone, but for the most part, you should see those align pretty closely.

Got it. Maybe on the balance, I mean, you got close to $1 billion in cash and equivalents on the balance sheet. So maybe just an update on your M&A outlook. You've done a few tuck-in acquisitions here and there. So maybe talk about the M&A outlook? And then how do you think about the buy versus build decision? I mean most of your platform has been built organically. You have done tuck-in acquisitions for certain modules, but...

Yes. So we do have a buy-build partner framework that we really think about internally, but our philosophy around acquisitions is relatively consistent, which is what control points do we want to own on our platform. And as we think about buying, is it a speed to market, is it we got to get to the market now that would compel us to make an acquisition, is it a complementary set of capabilities to our platform, something that would have been on our road map, but now we're accelerating that. And then the economics have to make sense. So there's that. And then the cultural, all the things that you think about when you're doing an acquisition, a cultural fit and things like that. But we're open-minded. I would characterize it as opportunistic versus that's primarily our strategy because as you mentioned, we've primarily been building the platform over time.

And how does -- you run an open platform, you've got a ton of integration partners. I guess how does that fit into the M&A.

Yes, it's a really good question. Yes, we have over 150 partners. It's -- so one, we want to have -- we want to be, if you will, a good citizen in the ecosystem of partners and so on. But Sling was a great example of we had a partnership with them and ultimately, we got to know them and acquired them. And so our ecosystem and innovation that's going to continue to happen around the ecosystem is really an opportunity for us to look at and say, does this asset make sense for us to own and why? And really, customers tell us like what they need. Like we're very in touch with our customers. So that gives us a little bit of what does innovation look like 2 or 3 years from now.

Got it. Well, I think we are out of time. So we'll leave it there. We'll break out again after this. It's going to be [ Mayor ] upstairs. So if you want to dig in more, come join us there. All right. Thank you so much.

Thank you.