All right, my name is Josh Baer, software analyst here at Morgan Stanley. We're joined by Toast CFO, Elena Gomez. Thank you so much for joining us.
Yeah, thanks for having me.
Great. First, some research disclosures. For important disclosures, please see the Morgan Stanley Research Disclosure website, www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. There's a lot of great debates and topics that I wanna discuss today, starting with macro and what you're seeing in the environment today, as it relates to consumer spending and GPV per location. You've talked about increased uncertainty around macro, but so far we've generally seen strong demand trends. Wanted to ask what you are seeing in the consumer dining behaviors. Are you seeing trading down, headwinds to restaurant GPV, over the past several months?
Yeah, that's a great question. Thanks for having me. At the highest level, consumer demand continues to be solid. For us, GPV per location in Q4 was up 7% year-over-year. Seasonally, obviously Q4 was in line with historical patterns and tends to be a lighter seasonal quarter for us GPV-wise. Similarly, we're still seeing the same seasonal pattern in Q1, which also tends to be a lower seasonal quarter for us. The thing I'd point out about this Q1 is last year we had the Omicron impact, you'll see a bigger year-over-year compare in Q1. For the most part, demand feels pretty healthy, and the funnel's strong, and we're seeing our reps really execute well.
Great. What assumption around consumer spending and macro is embedded in the 2023 outlook?
Yeah, that's a good question. A couple things. Just the reminder that, you know, in past recessions, what we've seen is restaurants have been fairly resilient. We as a team thought about guidance, we've considered a bunch of facts. One of those is: How did restaurants fare in prior recessions? Fairly resilient, and you can see that they held up fairly well relative to things like travel and things like apparel. We have that data point. We look at our own dynamic within our business. In Q1 tends to be seasonally a slower GPV per location quarter. When you think about that, you think about, you know, the biggest quarters are ahead for us in terms of our business.
That layered on with a macro backdrop, we thought it would be best to be somewhat prudent in that guidance, given that we have a lot ahead. For the most part, you know, we feel restaurants are resilient, and we're still seeing pretty good momentum.
Looking at past downturns, is there a more optimistic standpoint when you factor in inflation and restaurants passing on higher prices and maybe some reopening, you know, continued reopening tailwinds as well?
When we look at, Definitely, you know, inflation has played a role in 2022 and probably will, and will play a lighter role in 2023. What we've seen in that dynamic is, in a recessionary time period, restaurants, even though net adds may be declined, total locations did not. That presents an opportunity. When a restaurant is looking for a player who's gonna help them drive efficiency, especially in this backdrop, we think we're really well positioned to capture that growth.
Okay, great. Wanted to shift to location additions.
Yeah
as it's really touch on TAM and competition. I think you ended last year with 79,000 locations, less than 10% of the overall U.S. restaurant population. Wanted to ask, does it make sense to look at TAM that way to include, you know, all U.S. restaurants, including chains, enterprise, quick serve? another way to put it, what is your realizable TAM that you can address today?
It's a great question. One meta point is we believe that the entire U.S. restaurant market is available to us and something we can service now. The way we think about it internally is there's different segments of the market, of course, whether it's SMB, which has been our bread and butter, whether it's mid-market, whether it's enterprise or even very small businesses. When you think about the SMB space, which is where we've proven that we can succeed there, we've proven we can build out flywheel markets, we're gonna try to continue to do much of the same around that. Then you layer on mid-market, which we've proven as well that we can win with mid-markets. Philly's Pretzels is a good example, or BBQ Holdings, great examples of mid-market restaurants with over 150 locations.
Those are proof points that we're resonating in that space, and we'll continue to do that. You think about enterprise, which has a completely different dynamic. They're, they're focused more on above-market operations, whether it's reporting, whether it's security, et cetera. We feel we already have a handful of enterprise customers in Jamba Juice and Nothing Bundt Cakes. When you think about that, we're able to serve customers in the enterprise market already. We've proven that, and we are getting pulled up-market. We're building some of that capability already. We'll be able to penetrate that market deeper as we continue to innovate in that space.
When you think about the very low end of the market, you can also see an opportunity there for us to, you know, through different pricing and packaging, also land that customer. Regardless of the segment, we'll obviously keep that, you know, payback period and unit economics in mind. We do feel that we'll be able to penetrate the entirety of the market over time.
Great. Really helpful on TAM. From the competitive perspective, who do you see most often, and can you give a sense for win rates?
Yeah, sure. The competitive landscape hasn't changed. It continues to be, you know, point solutions, legacy players, modern cloud players, and we see all of them in the market. The good news is when we're in a competitive deal, we win the majority of the time, and that has continued and been very consistent. That said, we don't win all the time, obviously. Why do we not win? Is it someone needs a specific solution if they have an executive sponsor? There's definitely reasons that we don't win, but for the most part, if we're in a deal, it's a competitive deal, we've found that our win rates are, we win majority of the time and have been relatively consistent.
What is driving that win rate is really back to the differentiation we talked about at IPO, you know, being purpose-built for restaurants, being specifically focused and able to deliver product that resonates with customers. Tips Manager is a great example of that, and other products that land and resonate really well with restaurants. Overall, very healthy win rates in the competitive landscape is generally the same as it has been.
Okay, great. Really helpful. Putting together TAM and competition, you know, the end result for everyone's models is locations, location additions. Considering sort of your commentary and what you're seeing in the market, is adding 5,000 locations-6,000 locations a quarter or maybe 20,000 locations-25,000 locations a year, like, is that a realistic outcome looking ahead?
Yeah. I'd share a couple things. One, it's both locations and ARPU that we are very focused on. We stepped up to the 5K-6K range in 2022. We think that's a pretty healthy clip over time. As we add more flywheel markets, obviously, we are able to consistently deliver that growth rate. At the same time, we're building emerging markets. Longer term, as you think about the opportunity that we have with international enterprise, those could serve as ways to sort of bend that curve over time, but they're early, so that's not a near-term dynamic, but you should see that over time.
Great. You mentioned ARPU. Why don't you start with software ARPU and touch on a dynamic from Q4 where we saw.
Yep.
strong growth in sequential SaaS ARPU and SaaS ARR, but weaker sequential increase in subscription revenue. I was hoping you could dig in a little bit to the, to that dynamic and provide some context on the difference between SaaS ARR and subscription revenue.
Yeah. No, it's a great question. First zooming out, if you think about what's driving SaaS ARPU, we have seen momentum throughout 2022, and that's driven because our customers are adding more of the platform upfront, which is, you know, obviously a good testament to what the reps are doing on the ground, and we are investing in upsell. The combination of those two drive that ARPU that you're seeing. When you look at the actual data points that we're talking about, SaaS ARR grew, you know, 60% year-over-year and double digits in terms of sequential. SaaS ARPU in Q4 grew 20%, and sequentially also grew.
When you think about that's just a testament to what I just talked about, which is landing more of the platform upfront, but also building that upsell motion, which we're very encouraged by, as well as with the. Embedded in the upsell motion is also Toast Shop, where customers can go into our into their Toast Web and purchase product. In terms of revenue, which is really your question, how do we think about revenue? Every quarter, we have ASC 606 adjustments, which, you know, there's puts and takes every quarter. Certain quarters, they could benefit us, certain quarters that could be a negative impact to our revenue. That coupled with some prior period adjustments is what you're seeing play out in Q4.
Again, zooming out, there's nothing structurally that has changed. We continue to have momentum with upsell. As we innovate more, we'll continue to see SaaS ARPU continue to grow.
Just a follow-up on the ASC 606 adjustments. Is it related to the allocation of bundling?
Yeah. Right on point. Depending on the dynamic of the quarter, the various product lines could benefit more or less. That's the dynamic that played out in Q4, and that's the dynamic we see every quarter. Was disproportionate this quarter in Q4.
Okay. going forward from a sequential standpoint, is like sequential Q3- Q4, is that on the revenue side for subscription?
Yeah.
Right way to think about going forward or, the seasonality from, you know, prior to Q4?
Yeah. I would point everyone back to the earlier part of the year. That's a good question. I wouldn't use a sequential from Q3- Q4 as the proxy for the future.
Okay. Very helpful. Taking a step back and talking about the software ARPU, it's always a moving target around, like, the fully baked what if the hypothetical customer spend on software if you adopt all products because you have innovation, new products, and do M&A. What are we up to the hypothetical $1 million, GPV restaurant, if they adopted all software? Is there opportunity to expand that fully baked?
Yeah, it's a good question. We get that a lot. The, you know, one way to frame it is when you think about the percentage of sales that a restaurant spends on technology. It's been around 3%, and we think that's going to continue to grow. If you just take that example of $1 million of GPV per location, we're slightly higher than that. For easy math, let's just take the $1 million. If you take that math, that would imply $30K of SaaS ARPU, which is what's possible. Well, you know, if we innovate and continue to innovate and drive more to our platform. Today, we already have customers paying us SaaS alone, $10,000 of ARPU, and that's not unusual. We even have some customers paying us in the mid-teens.
We have a pizzeria in, I think it's Arizona, that has, you know, it has APIs, it has online ordering, it has payroll, it has Sling. It's adopted, you know, definitely the breadth of the platform, and they're kind of in the mid-teens. We have examples of that already, and some of that is our upsell motion, some of that is landing bigger upfront, but we believe that we can replicate that over and over.
Great. Moving on to the payments side of the equation. You mentioned, and maybe starting with Toast Capital. The non-payment fintech products contributed $24 million to gross profit last quarter. Most of that was Toast Capital. Maybe to start, if you could outline, you know, what has driven Toast Capital's success. Like, how do you think about that opportunity for Toast Capital?
Yeah, it's a great question. At the, at the highest level, I think if you just zoom out, you think about the fact that we have the payment rails gives us that opportunity to offer more products to our customers that are not just payments alone. Toast Capital is a great example of that. When you think about Toast Capital, you know, the idea was formed on the fact that we know our customers, our restaurants are underbanked, and we know they need access to capital. We know they have liquidity needs, whether it's to do, you know, redo their patio or get new kitchen equipment. We found that the fact that we can see their data, their payment volume, puts us in a unique advantage. We can see that data day in and day out.
That data is what helps inform our models on who we can lend, you know, lend basically capital to. That creditworthiness gives us, you know, knowing that creditworthiness gives us the conviction that we can therefore lend and meet that customer need at the moment they need it. We've developed a very sort of friction-free, easy way to get access to that capital. In 2022, we launched a 360-day product towards the end of the year, Q3 into Q4. On the whole, we, you know, the impact of Toast Capital for the full year was about $58 million. And we exited Q4 with a $24 million impact to our gross margin.
That's a great proxy to think about for 2023, that exit rate, because we did launch that 360- day product towards the back half of the year.
That's really helpful. I guess, how do you weigh some of the risks associated with Toast Capital with the contribution to your bottom line?
Yeah. It's a question that we are answering a lot, and part of it is just to make sure that it's understood, we're being completely measured about the investment here. Part of the, there's a few things that we think about to measuring risk. One is we have access to the data, which I talked about, and that data gives us the indication of the creditworthiness of the customer. That's number one. It's a unique advantage. Number two is we cap the losses at 15%. The partner that we work with issues the loans. We get a servicing fee for that loan. Three, we have a risk dedicated team just focused on looking at the performance day in and day out.
Finally, the way that the customers pay us is a fixed percentage of their payment volume. It's a way to have predictability of the program and manage that risk very carefully. The other thing I would tell you is we have the opportunity, and we have done this before, to throttle back and forth if we wanted to. If we started to see performance that was what we didn't want, then we would throttle it back if we needed to. That's number one. Number two, the performance has been exactly what we expected in line with our expectations. In fact, a lot of our customers have come back for another loan. 80% of our customers, in fact, have come back for another loan. That tells us a couple things.
One is we wouldn't give them another loan, obviously, if they had performance dynamics that we didn't like. Two, it's really resonating. The more we're testing, for example, we started with 90-day loan program, we went to 270-day, and then we launched 360-day. You'll see some of that testing and learning before we go too far, and we're trying to be incredibly measured about that risk. It's something we're paying attention to, and so far it's had great success with the customers we have.
Great. More broadly on net take rates, you know, where are we today? How should we think about the trajectory going forward? You know, how does scale or reduction in transaction costs, mix changes impact that take rate?
Yeah. There's so many dynamics that impact take rate. No question, it's something, you know, always top of mind for us, whether it's scale and volume. We added a redundant processor at some point in the last, 6 quarters. That's been helpful. Then really just thinking about, you know, when you think about the net take rate, we both have ability to test pricing, but we also have the ability to optimize as we scale, and more volume will naturally get us that as well.
It's not in the near term, not in our model, not in your, you know, margin outlook, but how would international or, you know, moving more, significantly upmarket to the enterprise impact the take rates?
You know, we, it's too early to tell on those, two segments. They're super early in our impact to the financials, as you'd point out. I would say a good proxy to use for overall take rate, including Toast Capital for 2023 is in that, you know, kinda low 50 basis points range, and we talked about that on the earnings call. I think that's a healthy, obviously we'll always try to optimize over time, but that's probably a healthy range for us right now.
Great. I'll ask a few on margins, and then I'll see if anyone in the audience has questions. Wanted to ask about the first long-term target model introduced last earnings for 30%-35% EBITDA as a percent of fintech and subscription gross profit. The levers appeared balanced across OPEX and reducing the hardware and services mix. Wanted to ask you about the timeline associated with that target or scale because it's sort of open-ended. You know, in my mind, if you cross $2 billion in gross profit, you know, that would mean at scale. Like, what do you think about that assumption and, you know, what could push that target timeline out further or bring it in closer?
Yeah. That's a, it's a really fair question. At the highest level, you know, if you just kinda zoom out for a second and let me put it in context. In 2022, you saw us deliver consistent margin expansion, and that was, you know, getting more disciplined and really focusing the organization on driving more operating leverage. You'll continue to see that from us in 2023, and our guidance reflects that. We're gonna have over $100 million of improvement in our EBITDA in 2023, as implied in our guidance. If you think about longer term, which is, you know, what you're talking about, there's a couple things I would point you to. One is it's in our control the timing. The timing is in our control in terms of when we get to that adjusted EBITDA.
There is a framework we're thinking about, which is we wanna consistently beat the Rule of 40 over time. When you think about that, you know, you think about the scale in the multi-billions, as you suggest, is not unreasonable. At the same time, we wanna have that flexibility because as the market evolves, we wanna be able to capture the growth opportunity ahead of us. I would tell you that you may not see linear, a linear path to that 30%-35%, but you'll definitely see a, you know, continued focus on discipline and how we manage the business, and that's really important to us.
Great. Wanted to ask about at least one of the components of the levers of that margin expansion being software subscription gross margins. Believe in the past you've talked about mid-70s as a, as a potential sort of medium-term path for that for software gross margins. With ARPU continuing to increase, is there anything structurally stopping Toast from achieving 80% gross margins on the software side?
Yeah. No, you're right on point. I think as we continue, you're right on point on this ARPU point. As we continue to scale and drive more ARPU, that's gonna drive obviously the SaaS revenue. We also wanna balance that with really, you know, good customer support. As we build out enterprise and international, like we've gotta make sure we're supporting those customers. We have really low churn rates, and we wanna continue to sustain those, so some of that comes with investment and customer support. Of course, over time, we're gonna look for ways to optimize the gross margin over time for SaaS specifically.
Great. On the hardware margin side, they got worse because of supply chain and several other impacts. I guess, like, what is the trajectory of the hardware gross margins? Do we go back to where we were in 2019, 2020? Or, you know?
Yeah. It's a good question. The way we think about it and what has happened, you're right. During COVID, shipping costs went up and product costs actually also went up at the same time. That was burdening our hardware margin for the last several quarters. What you started to see in 2022 towards the end is some improvement in the shipping costs. We started realizing lower shipping costs. You'll see a little bit more of that in 2023. We'll benefit from lower shipping costs. At the highest level, we have a supply chain we're managing, and we've got to manage that very effectively. That could mean anything from, you know, relationships with the vendors who supply our products to just optimizing the negotiations we have with those vendors, et cetera.
Anything we can do to ensure we still get hardware in our customers' hands at the right time, but balancing that with a very tight supply chain optimization focus program on that. That's what you'll see, but that's over a longer term trajectory, not necessarily all in 2023.
Great. Helpful. Let me pause there and take some questions from investors. There's one up front.
Hey. Thanks. Just to clarify on the margin piece with the Rule of 40, we should think that you're not gonna hit those margin targets until you're growing more like 10% or high single digits?
What was the last part?
We should think about you hitting those longer term margin targets more when you're at 10% growth?
I wouldn't say 10% is where we wanna exceed the Rule of 40, so I wouldn't anchor us on 10%. I would anchor us on multi-billion dollars is probably the right way to think about that. That's over time. The other point I would say is the point I made earlier about it not being linear. We'll manage to try to exceed the Rule of 40 over time, of course, with trying to sustain growth rates over time. Actually, the other thing I'd point out on the long-term margin is it doesn't include international, doesn't include enterprise. Those are opportunities for us to actually grow ahead of that.
Perfect. Thank you.
Sure.
The Rule of 40 is revenue growth+ the EBITDA margin on.
It's on the gross margin and the EBITDA, like the SaaS, fintech gross margin, and the EBITDA.
Great. Any other questions? There's another in the front.
Can you talk a little bit about the process of winning an enterprise customer? If you're winning a 50-location store, they probably have a legacy or on-prem solution. A lot of the enterprises either have homegrown or built solutions, or they have many franchisees or franchisors, whatever, who may decide for themselves if it's a corporate initiative. It seems like a lot more of a complicated sales process. How do you go about actually getting in there, winning, getting a pilot, that kind of thing?
Yeah, no, you're raising a really good point, which is, you know, selling to the enterprise, obviously very different than selling to an SMB. The way, you know. We have a sales team focused on that, which is different than the core field rep. It's not a very big team, but it's still a team that's dedicated. To your point, the needs of an enterprise customer are very different. They have much more above store needs, like rich reporting and data security, and all these things that may not be as important to an SMB. What I would tell you how we'll manage it is we're still gonna make sure that as a whole, the unit economics make sense. That's what's really important to us, managing to that payback period.
It's a great opportunity, to continue to penetrate the TAM by going after that segment, but we're gonna be balanced in making sure that the unit economics also make sense.
Microphone is coming.
I had a quick follow-up on payment volumes. How do you think about the cadence this year, given the Omicron comp from last year? I know you talked about a slowdown in GPV per location seasonally, but how do you think about that in the context of the comparison? Then how might this year play out in the context of potentially tough reopening comps from last year? How do you think about that and as it informs your cadence for this year?
Yeah. The first, the first one is we continue to have the same seasonal pattern on our payment volume, and we don't have any reason to believe that'll be that different. Far, both Q4 and Q1 are playing out in the way that our historical seasonal patterns have been. Omicron obviously makes it a easier compare. As you get into the summer months, those are our higher payment volume quarters, so you won't see that same, you know, easier compare, if you will. Your second question was on locations. Is that.
Just, your reopening drag pretty high.
Oh, actually it may have played a factor, but not material. Not material.
Great. I'll ask another one. Most of the macro conversations have been around consumer spend and GPV per location. Wanted to ask on restaurant behavior, are there any software modules that if a restaurant did feel pressure, you know, would be lower on the list, like how to think about the retention of on the software side?
Yeah. You know, I think, what's interesting is we've had pretty consistent, you know, when we think about upsell and downsell, we've not seen so much of, you know, let me downsell this product, which is, you know, a pattern we pay attention to in addition to just overall churn. We haven't seen enough pattern to say this particular module would be something that would be discretionary, if you will, in a recessionary environment. In fact, I would argue the counter, which is the platform, actually resonates quite well in this environment because it's helping customers with things like, you know, detailed or, you know, detailed line item costs on their menu with supplier and accounting. It's helping them turn tables faster. If someone's really looking for an efficiency play, we actually resonate quite well in this market.
That's what our reps are really, you know, out there talking to customers about day in and day out.
Great. There's a return on the software, whether it's cost or revenue.
Yeah. I mean, I think it This market could actually be a benefit to us because we have proven that we can help restaurants be more effective and efficient.
Great. I'll ask one last question here. Just wanted to ask about stock-based comp and dilution in your philosophy on managing both.
Yeah. We're paying very close attention to it. At the highest level, we wanna take stock-based comp down as a % of recurring revenue over time. I haven't given a target specifically, but that's definitely something that's top of mind, a high priority for us.
Okay, great. Thank you so much, Elena.
Thanks, Josh.
We'll wrap there. Appreciate it.
Appreciate it.