Toast S-1 Thoughts

The best thing since sliced bread for restaurants?

Hi friends!

Earlier this week Toast filed to go public, and its filing provides an interesting look at many things including SaaS + fintech business models, responding to COVID-19, and using hardware as a loss-leader. I’ll go into a few things that stood out to me from the filing.

1. Building an end-to-end offering for Restaurants

Toast recognized in the early days that restaurants were dissatisfied with the existing on-premise point of sale systems and the vast ecosystem of disconnected point solutions.

They sought to address this by building a highly scalable, end-to-end, cloud-based restaurant management platform.

Over the last decade, they have executed against this vision, building an offering that has the breadth and depth needed to uniquely serve the needs of restaurants.

Their product suite can handle all aspects of restaurant management from point of sale to restaurant operations to loyalty to payment processing and financing.

2. Using Hardware as a Loss Leader

Toast developed its own hardware to build the aforementioned end-to-end offering.

One of the interesting parts of Toast’s strategy has been to give away the hardware below cost.

Two of the four primary sources of revenue for Toast are the hardware sales and the professional services revenue derived from installation and training to use the product.

However, as highlighted in their financials, both of these are provided at a loss.

  • Hardware revenue accounts for 8-10% of revenue and its gross margins are -5% to -30% depending on the period

  • Professional services revenue accounts for 1-2% of revenue and its gross margins are -184% to -239% (you read that right).

In essence, Toast is heavily subsidizing its hardware and installation to get restaurants up and running on Toast.

3/ “SaaS 3.0” Business Model

With the hardware being given away below cost, how does Toast actually make a gross profit? It’s from the other 2 of the 4 revenue sources: subscriptions and financial technology solutions.

Subscriptions

Toast charges a subscription fee, typically per restaurant location, which is typically sold in a 12-36 month-long contract.

Subscription prices range from $69 per month to upwards of 270 a month depending on the features.

Toast made just over $100M in revenue from subscriptions in 2020 which is growing >50% y/y.

Today, subscriptions account for 10% of their revenue and have ~65% gross margins (the highest of the four revenue sources), meaning it contributes roughly ~30% of overall gross profit.

Financial Technology Solutions

Like many other PoS and ordering systems, Toast also makes revenue from payments on the transactions through its platform.

The typical pricing is 2.49%-2.99% + 15 cents per transaction, though since Toast is just facilitating those payments, a big chunk of that is paid out by them to the card networks.

However, in addition to the online and point-of-sale payments, Toast also offers restaurants working capital loans from third-party banks through Toast Capital. Today, it isn’t a material component of revenue but shows that Toast is going beyond just payments in terms of monetization from the fintech perspective.

In terms of specifics:

  • Toast facilitated $25B in gross payment volume (GPV) in 2020. In the first half of 2021, they’ve already done $23.4B representing a 125% year-over-year growth.

  • Of that GPV, Toast typically earns 2.4-2.5% on average as fintech solution revenue, almost all of it from payments.

  • This fintech revenue represented over 640M in 2020, and 580M already in H1 of 2021, and accounts for ~80% of Toast’s revenue.

  • Now, with payment processing revenue, Toast needs to pay fees to issuers and card networks, which actually make up over three-quarters of the revenue. This means that the gross margins on this revenue stream are relatively low at ~20-22%, though they may improve over time as Toast continues to grow.

  • However, given its large size, even from a gross profit perspective, fintech solutions represent 70-74% of gross profit, more than double that of subscriptions.

One way to think about it is that Toast’s net take rate (gross profit) on the payment volume it facilitates is 53-55 basis points.

There’s this chart from Stripe on the evolution of SaaS models over time, and Toast definitely fits into the SaaS 3.0 commerce platform trend.

They generate revenue from SaaS + online payments + POS payments + lending, with the fintech aspects comprising over 3/4 of gross profit and 80% of revenue.

4/ The COVID-19 Recovery

Toast deserves praise for its remarkable execution through COVID-19.

While the early stages were incredibly rough for the company, with 50% of the company laid off or furloughed, the team has stayed focused and executed well against the needs of their target customer of restaurants.

While they did see a drop in revenue initially as visible in the chart below in Q2, they were able to remain focused and continue building for the customer and saw growth pick back up in Q3 2020.

In Q2 of 2021, as more of the US started to re-open post the vaccine, they saw a 193% increase compared to the “COVID quarter” of 2020. More impressively, they returned to sequential growth in Q3 of 2020 and have continued to grow quarter over quarter since.

It should also be noted that they grew locations by ~13500 from June 19 to June 20 and by 14000 from June 20 to 21, which is quite impressive given the ongoing pandemic.

This past quarter, Toast was free cash flow profitable, with FCF margins of ~12.5%.

A lot of this came down to excellent product velocity during the period, which included:

  • Launch of Toast Delivery Services, a flat-fee based solution (costs <4% of orders vs 20-30% on competitors platforms) which allows restaurants to collect orders themselves and better manage delivery margins

  • Launch of Toast Now, a digital-only platform to provide restaurants with online ordering, delivery, and email marketing capabilities

  • Launch of Order and Pay, a suite of contactless payment solutions to help restaurants as they re-opened during the pandemic.

They also temporarily waived subscription fees of $20M for all their customers and lobbied on behalf of their restaurants to call on Congress to provide relief to restaurants.

This, especially when combined with their relatively low pricing when compared to some other platforms that offer online ordering and pickup helped them continue to grow after the brief blip and earn the trust and loyalty of restaurants and cement themselves as a good partner to them.

Closing Thoughts and future growth

Toast is obviously in a competitive market with the likes of Square, Lightspeed, and Clover directly, the incumbent POS solutions, and with the delivery platforms such as Doordash and Uber Eats who also now offer takeout. But through their laser focus, they’ve built a good product and got it in the hands of restaurants, and built a growing and now FCF profitable business.

Their net dollar retention has been over 110% in the last 5 years, indicating that gross retention is probably also quite strong and that they are growing with their customers.

In addition, they’ve only penetrated 6% of the ~850K restaurants in the US, and so the unaddressed market is large, even aside from international expansion. Given their favorable payback period of under 15 months, and that they are now free-cash-flow profitable (12.5% margins), they have the opportunity to continue to invest in growing the number of customers/locations they have.

COVID-19 highlighted the need for restaurants to seek out innovative and end-to-end technology solutions to manage their operations which include take-out, online ordering, loyalty, and contactless payments, and Toast is well-positioned to continue to benefit.


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