Credit Suisse 26th Annual Technology Conference

Nov 30, 2022

Hey. All right, great. I am really excited for this presentation today in particular. We are really, really pleased to have with us today the management team from Toast. We have Chris Comparato, who is the Chairman and CEO, and we have Elena Gomez, the CFO. I also want to recognize Michael Senno, who is head of investor relations and treasury. He is also here and made the trip. I want to thank Chris, Elena, and Michael for all making the trip here to Arizona. Thanks for having us. Thanks for having us. Yeah. All right. It is a pleasure. We have so much to cover, so let us get at it. Let us just start out with where we kind of have to start. Let us start with an update on what you are seeing in today's uncertain macro environment. Yeah, no, it's a great question. We get that a lot right now. At the highest level, what we're paying attention to is consumer demand, and we really haven't seen a change in consumer demand, and we talked about that on the earnings call. Also, what we're seeing is a typical seasonal pattern, like the pattern we're seeing on payment volume is very consistent with what we've seen in prior years, and that was reflected in my guidance. The one thing, just to remind you all, is that our payment volume tends to be higher in the summer months in Q2 and Q3, and Q4 will follow a slight tick down, but that's typical. It's seasonal, and we expect that. All that to say, we're not really seeing a change in consumer demand. Obviously, we're carefully watching. We have signals that we're paying attention to. But we're not seeing that, and we'll talk later about the fact that the Toast platform actually resonates really well in this environment. We'll get an opportunity to talk about that later. Excellent. Elena, that's a great point. Actually, if you're okay with it, I think we could just go to that now because I think it's very topical. We get this question a lot from investors in terms of your ARPU and the value that it's creating for the restaurant. Part of it is efficiencies that you're creating for them, but another one that comes up related to that is it seems as though the churn of the restaurants that work with you is lower, meaning you literally could be helping them with survivorship and improving the prospects of their business. Maybe that's a good entrée into talking about the value that Toast adds. Yeah. Maybe I'll jump in on. I'll hit this in two angles. First, I'll talk about the industry and then how the platform is positioned to mitigate those risks. If you zoom out, the industry is really transforming over the course of the next 10 years to cloud, and we've seen it for the past 10 years, and we fundamentally believe that you look at the 860,000 restaurants in the U.S., they are all going to migrate to a cloud platform over time at different paces. We see different paces within the subsegments. But within the industry, if you're at a store level, you're grappling with typically three top pain points and priorities. Number 1, how do you drive top-line growth, and how do you make sure you're driving top-line efficient growth? You're looking at what service models can I open up? Should I open up online ordering? Should I open up takeout? Should I open up invoicing, which we announced last quarter? You're looking at how you drive top-line growth. Secondly, you're trying to figure out how you drive your team? With all of the labor challenges, certainly over the course of the past two years, but really, if you zoom out, labor has been a challenge for the industry for decades with high turnover. How do you mitigate hiring and retaining your staff and making sure that they're going to stick with you? The third challenge is really all around mitigating costs and how are you optimizing costs in the back office of the restaurant to make sure that you're grinding your profit margins. We're talking about razor-thin profit margins as an industry. Those tend to be the three biggest efficiency gains that restaurants can do to move the needle. What we try to do is we try to look at, well, what are the examples of how our platform can help? Certainly on Commerce, our platform allows restaurants to open up more channels to drive more top-line growth, but then also be productive when it comes to throughput. You can be an enterprise and you're worried about throughput and capacity. You could be a QSR and you could be worried about how are we going to move people through the line. You could be a fine dining or full-serve restaurant and you're thinking about how do we turn tables faster. Two weeks ago, I was on a call with a customer in the Baltimore, Washington D.C. area, mid-market chain that we haven't announced yet. Their flagship location went live on Toast, and I said, "How are we doing?" He said, "Well, let me tell you're saving us 150 to 250 hours of labor per week, and we've armed our staff with 23 handhelds, and we're driving more top-line growth." In this first category, it's all about productivity and how you drive that growth. In the second category, which is all about labor management, we're talking to restaurants about how are they doing more with less. Good example, I announced it on earnings, was Antoine's down in New Orleans. One of the biggest compelling differentiators on why they chose Toast is because they don't have to go back and forth to the back office every night to manage tips manually. Now through Employee Cloud and through our payroll and tips management tool, they can automate, set, and forget those business rules to manage tips. That's a differentiator that saves them tons of foot traffic and time and energy on a weekly basis. In the third category around food cost optimization, I mentioned another example on earnings, Plaza Pizza. With food cost and inflation hitting, we want to shine a light bulb in the back office of restaurants on who are they paying for what, and how can they optimize their food costs across their suppliers to create more margin opportunities and menu profitability. When you look at these three pain points and how our platform helps mitigate those pain points, we feel like we're well-positioned to really help the industry thrive, which is our mission. Super clear. Thank you for breaking it down into those buckets, Chris Comparato. We're going to move on to location additions and the U.S. opportunities. Clearly this is super topical for Toast. It comes up in our investor discussions all the time. Let's set the context. As you mentioned, Chris Comparato, there's about 860,000 restaurants in the U.S. Roughly speaking, we think about a third of them or so are more in the enterprise bucket, and you certainly have touched into that and been, as you've mentioned, been pulled up in that way. We think about maybe the bottom 15% or so is more micro, and certainly there are some examples where Toast has touched there. You might see a food truck that's using Toast along those lines. The question really is, as we think about the next 5 to 10 years, would you think that your mix is going to evolve more upmarket, more downmarket, or is the answer both? The answer is a little bit of both. We have conviction that the entire market, as I mentioned earlier, will move to cloud over time. Right now, the segments are moving at different paces. I tend to slice and dice it into four segments, which is similar to what you mentioned, but maybe not a third. I look at enterprise, call it 200 and above. These are the Nothing Bundt Cakes, Jamba Juices, any large enterprise. We're in that space, and I'd say we're making measured progress. I don't believe the enterprise space has really transitioned to cloud yet. Many of the larger players are dealing with multiple legacy POS platforms. I think that's going to be measured progress. You're not going to see it overnight, and we're going to continue to knock off opportunities at a pretty strategic pace. When you step down into mid-market, call this 50 to 200 units. We're seeing good movement, and we're seeing good velocity within our sales team. It's a different sales motion than our hyper-local go-to-market SMB motion, but we're seeing pretty good traction. We announced Walk-On's on earnings, but we have many brands that are pushing out Toast across their locations and moving to cloud, and also leveraging many of the same modules that SMB are leveraging, whether it's payroll, xtraCHEF, Commerce. We're seeing those brands adopt those modules. When you step into SMB, we call it 1 to 50 units, and this is where we've built a hyper-local go-to-market engine that's really moving fast. These are sales resources that are driving high productivity, and we try to create what we call flywheel markets. We mentioned this on the past earnings. When we get into a flywheel market, we see a tipping point where the sales team becomes more productive, the organic lead volume from referrals increases, we see partners in the community providing more deals, and we see sales productivity start to ramp. In the SMB regional mid-market space, we are seeing very good productivity, very good velocity, and in 5 years that is going to continue because we are only at 9% of the addressable market. Then in the vSMB space, and these are typically your food trucks or smaller cafes that are just starting out. It is all about how to take our pretty mature platform and simplify it. How can a restaurant go online, subscribe to our platform, self-onboard themselves, and then incrementally grow their modules over time? In fact, we are seeing about 25% to 33% of our total restaurants self-onboard today. We think that simplification applies to the other segments, but again, we will continue to have traction in those markets. I think these four markets will move at different paces, but over the course of the next 10 years, they will all start to adopt cloud and hopefully Toast. Okay. Perfect, Chris. You mentioned the flywheel markets. I want to get to that in just one second. Maybe we will do it in a more brief manner because I think you already hit the main point. In terms of the locations, before we wrap up there. When we think about it, there is really three ways that you can add a new location. One is brand-new restaurant formed. Group of people decide we are going to start a restaurant. We form an LLC, we get a location, and we are starting a new restaurant. Second way to do it is one of the existing restaurants that you work with is doing great, and they are going to open up a new location. The third way that you can bring in a customer is an existing restaurant that is maybe been around for years and is highly successful, but they are using maybe a different competitor or an outdated platform. Three ways that you can bring in a gross ad, if you will. Could you talk about the mix across those three buckets for the audience? Yeah. I can hit on that. At the highest level, it's fairly balanced, I would say. And you hit on exactly the different ways that restaurants can come in. It's really important to note that an existing customer, as they add more locations, that's included in that number, as you mentioned. When you look at where they're coming from, it's really a mix of the legacy players as well as the newer cloud solutions. All of that is very balanced. It's a fragmented market. I think we're well positioned to capture and be in the conversation of pretty much any restaurant that's considering either starting a brand new restaurant or considering switching from a legacy player. Excellent. Thank you, Elena. Back to flywheel markets, which we alluded to earlier. Just to find those, again, it's a market where Toast already has 20-plus share of the SMB restaurants specifically. The question I want to get at there is, if it's 20%+ now, how high can that go of SMB restaurants? When you think about it, could it be 70? Could it be 80? Could it be 50? When you think about it and talk about it internally, what's the cap? I don't think we'll throw out a projection of the number. As our sales reps become more productive in that 1 to 50 unit range, we give them plenty of TAM per rep to drive productivity for years. When we hire sales reps, they tend to climb the ladder of sales, receive more territory, achieve more productivity, and then benefit from the help that corporate gives them to be even more productive. So we expect that market penetration to continue to run well past 20. As I mentioned, at the macro level, we think the whole market's going to move to cloud over time, and we think that we are a centerpiece platform that unifies all pieces of the restaurant operating system. So that puts us in a good position to get into a restaurant, whether it's through the core platform or through other angles. We acquired Sling, which was a scheduling platform. Sling's one of the most used apps within the Toast platform because employees are managing their schedules, and they're on that app four times per day. So we think that elements of the cloud platform will penetrate the SMB regional mid-market space at a pretty good clip, and there's plenty of TAM to go after. Even in mature markets, I look at markets like Boston and New York, where we've been for 10 years, and our reps continue to be super productive. You may think that you see Toast everywhere, but it's probably close to 20%, and there's four out of five restaurants in and around Boston that aren't using Toast. So we believe it's going to be a pretty persistent TAM penetration model, but I won't predict what the saturation will be. We'll see. Okay, that's more than fair. Let's hit one last one on the flywheel markets then. You have healthy, as a total company, very healthy LTV:CAC. I think the answer is obviously yes, but to what extent or could you directionally tell us how much better is that LTV to CAC in those flywheel markets where you are benefiting from that word of mouth and that density in the market? Yeah, we haven't disclosed that, but you can imagine the benefit of that rep tenure continuing just gives us confidence. I think we had a chart in the investor deck. I don't know if you saw that chart. You could really see that you can kind of keep your rep count consistent and still continue to see that ARR growth. That's probably a good proxy for answering that question. The only other add I'd say is we continue to make the platform more exciting and interesting to sell. That's more on the innovation flywheel, which is as reps see a deeper, wider platform, they're excited to sell it. I think that allows them to sell more ARPU up front and sell the entirety of the platform right out of the gate. I think that's its own little flywheel that adds into their incentive comp, which is I'm selling more ARR. Yep. Absolutely. Okay, great. Thank you for that. Let's move on. These next two actually are probably a little bit more for you, Elena, but Chris, please feel free to chime in as well. The first one is around long-term profitability. We are fully aware that Toast has not put out a long-term target, but many investors look at somewhat comparable companies that have a SaaS type model along with payments monetization. They look to Shopify, they look to Square, and they think about some of the longer term potential margins, and you will often hear numbers in sort of the 30%-40% range in more of a steady state longer term. The question here, to make it a more fair question to you, Elena, is can you maybe just talk about some of the factors or the differences in Toast business that might shift Toast to have the potential to be slightly higher or lower within that range? Yeah. A, I am not going to guide here today. That said, I think we have a ton of conviction about the ability to build a long-term, durable, high-growth company with improving margins. That is our calculus and how we plan. You saw some of that even in this year as we were going through the year, and we had growth, and we were increasing our cost discipline. We talked about profitability by the end of 2023. If you just sort of zoom out and you think about the two business models that we have, we have obviously the SaaS piece and the fintech piece, both of which at scale can drive a profitable business. When you consider that and you consider our go-to-market motion with really high focus on unit economics and our ability to scale that profitably, flywheel markets an example of that, and then you consider our cost discipline, and then you consider the multiple monetization opportunities we have, longer term, that gives us that confidence that we can drive a high-growth business with improving margins. That is how we think about it. Great. Thank you, Elena. We appreciate that context. The follow-up to that, and this one's also for you, is more about GAAP profitability, so obviously an important topic for investors. Yep. Stock-based comp. It's been trending sort of high single digit percentage of revenue-ish. Yep. How should investors think about that in 2023 and beyond? Yeah, look, we have a pretty active comp committee, and we're paying attention to it as much as any other cost line item that we have. The calculus for us is how do we drive stock-based comp as a percentage of revenue down over time? How do we ensure that we get the same leverage, have it grow slower than our recurring revenue? That's really important to us. That's strategic decisions we want to make. We have to balance that with we've got to retain the talent. We want the best talent. We deserve the best talent. We're a top-tier company, and so we're balancing that all the time. But over time, you should expect us to focus. We talked about adjusted EBITDA profitability next year. We have that same calculus of over time, we'll get to GAAP profitability. All right. Perfect. Thank you for that, Elena. Let's move to another very topical point in our investor discussions, which is SaaS ARPU, and I really want to go more to the upsell portion. Just to set the stage, SaaS ARPU is already over $5K. The new cohorts are coming in well above that. They're attaching more products, they're spending more. You disclosed earlier in the year the $6K figure for some of the new cohorts. But more recently, you gave a slide that was really helpful, slide 18 in your most recent deck, and you had the upward sloping curves for essentially back book ARPU increases, which really caught investor attention. I want to talk about that generally, but I want to specifically dig into something that I think is somewhat underappreciated, which is in 2021, you literally formed a new team to focus on 100% going to that back book and upselling them. Maybe tell us about the size of that team, how they operate with the regular salespeople, if you will, and let's dig into that topic. Yeah. I'm going to actually go back a couple of years before that, and then we'll fast-forward to 2021. But, right around 2019, when we not only had Commerce, but we went ahead and acquired StratEx and got into the payroll Employee Cloud management space, we truly became multi-product for the first time, beyond the typical smaller modules, but these were bigger modules. As we became multi-product, many of our older cohorts asked us about subscribing to those same modules, and we didn't really have a mechanism beyond them contacting their local sales rep. So we started to see a little bit of confusion in the field between a local sales rep adding net adds versus also farming their existing customer base. So we did two things in 2021. The first thing we did was actually we built out an e-commerce channel, and we call that Toast Shop. Toast Shop allowed customers to not really deal with a rep. So if I want to add Toast Go devices, I can just go online and add more Toast Go devices. I could turn on online ordering. I can add some of the modules that should be a little bit more frictionless to the sales cycle. So now Toast Shop has a meaningful contribution on ARPU, and those activities just stream through Toast when it comes to operations. The second thing we did is we built a team, and we call it the growth team, to really sell into our existing TAM. So 74,000 locations on the platform, and as our brand has more awareness, how do we make sure that active customers understand the full value and full potential of the platform and what they're not using? That team receives triggers, both from our data set, but then also product-led growth. So within the back end of Toast, we wired in product-led growth. If you are not using a module, you could see that you are not using it. If you are interested, that lead goes right to a growth rep. That allows us to then also work with a customer success team, the restaurant success team, which is nurturing customers to make sure that we have high NPS. The growth team now receives leads through local reps, through product-led growth, and through our restaurant success management team, and then they drive their own TAM. Still early, it is only about a year in, but we are seeing really good productivity out of that team. It is a much smaller team than our field-based sales team. We are not going to comment on how many reps, but it is also a nice career path for people that want to take a break from the field and then move inside and help on the growth efforts. We are excited about it. As we roll out more and more products, then those products will feed selling the entire bundle up front, but then also feed the growth team to sell downstream. Excellent. Chris, well, it sounds like that small team is doing a great job. All right. Let us move on to this one. We were talking about this before we jumped on stage with Michael as well, and this one, you recently gave some more disclosure around Toast Capital, so it has become super topical in our investor discussions. To recap, you said $17 million of revenue/gross profit, more or less the same thing because it is a very high gross margin type of revenue stream in Q3. That was not just for Toast Capital, but for all other fintech, but we are going to assume it was mostly Toast Capital. What investors really want to dig in is the asset-light nature of that model, and I was hoping we could touch on the P&L mechanics. Toast is not funding the loan, and Toast is not absorbing the vast majority of any potential losses. Yeah, no, that's a great question, and love to clarify. You're right, the $17 million, most of it was Toast Capital. Let me start with the opportunity. I think it's a great example of the strategic benefit of having fintech solutions for our customers. In particular with Toast Capital, a lot of our customers are underserved by financials, underbanked, basically. It gives us an opportunity because we already have these customers to offer them capital. What we've seen is it's resonating quite well. In fact, in the 2021 cohort, 70% of those customers came back to us for another loan. That's telling us that the product market fit is there and proving this thesis that they're underbanked. Also, in terms of structure, it gives us, it just kind of speaks to the opportunity to give them more product over time. But in terms of the structure, which is your question, let me start with how we're managing the risk, because it's really important. We are paying very careful attention to that. There's a few things that we point to. One is we have the data around these customers, and we see the data, and so we know the risk profile, we know their credit worthiness, we know their ability to pay back the loan. Two, we actually collect the payment through their payment volume and based on their daily collection. So we have visibility into that as well. Finally, to your point, we're not writing the loans off of our balance sheet, which is the most important point. We cap up to 15% of loan origination. So we're not really subject to high risks there. In fact, we've not gotten anywhere close to that 15% cap that we're talking about. So, we've been really pleased with the performance. It's kind of in line with expectation, and the performance of the loans will vary based on the length of the loan and all that, but we're paying very close attention to that. We have a whole team focused on that. In terms of the P&L impact, we collect a marketing and servicing fee up front. It hits our P&L, our income statement, and then we also have to reserve a provision for the potential losses. Again, we've not gotten anywhere close to that. So that's what you're seeing when we talked about on the earnings call, the impact to bad debt, that's what I'm talking about, and that's showing up in our P&L. One of the reasons we wanted to point it out was because we're seeing encouraging results. We wanted to give you guys transparency into the impact it's having, and so far we're really encouraged by what's possible with all of our fintech capabilities. This is just one proof point that we can serve our customers, and we have another way to monetize the base. Elena, thank you. I think you did a great job recapping those key points. I think you really hit on a couple of important ones. One, you are not funding the loan, the partner is funding it. Right. There is no working capital drag whatsoever. That is point number one, which is very important. The second one is, do you have a little bit of exposure to the losses? Yes, but per your filings, it is literally capped at 15%. Correct. 15%. The last one, I just want to clarify for investors. I know that in the G&A line where that provision or that estimate of potential repurchase obligation, if you will, is where it hits, and it is the G&A expense. You talked about the bad debt being $13 million, but can you clarify for investors that only a portion of that $13 million has anything to do with Toast Capital? Yeah, no, for sure. I should make that clear. When we record it in a bad debt line, there is bad debt from just normal course of business, and then there is Toast Capital. Both of them are in that number. The other thing I failed to say, which I should make sure I reinforce, is when you look at the Toast Capital business in isolation, it is accretive to our business overall. Even when you take into consideration that provision for bad debt, when you look at the gross profit back out the bad debt, we still are in a very positive, accretive position to the business. Now we are going to be measured, obviously. We are not in the business of adding risk to our business. We are going to be measured about how we roll out the program, and we are going to test and iterate and learn, and that is what we have been doing, which is why and by the way, Toast Capital is not new. We have had it already since 2020. Along the way, what you have seen is we have innovated. First it was a 90-day loan program, then it was a 270-day program, and we tested that, and now we have launched in Q3 a 360-day loan program. We are going to test a lot before we go GA with our products there. All right, perfect. I think we can run a minute or two over here. Let us see if we can hit one more. Sure Which is really important to the strategic longer-term story for Toast, which is international expansion. You talked about roughly $10 million-$20 million of spend this year. You do have some strategic hires on the ground. There are some merchants live. Maybe just give us a status update on the international business and the milestones there, and then also thoughts on how that investment could ramp that $10 million-$20 million this year. What does that look like next year and beyond? How fast does that number grow? Yeah, sure. 2022, definitely a foundational year. We had said it was in the $10 million-$20 million range. We are kind of on the low end of that range in 2022. But we are really planting the seed in English-speaking countries and learning. It is a foundational year. We are learning everything around what is the go-to-market motion that is going to resonate. What is the competitive landscape look like? What is the product that is going to resonate? The conviction we have around making that investment in international has a lot to do with our success in the U.S. We want to replicate the success we have had in the U.S. with a loyal customer base, flywheel markets, et cetera, in international, but we want to do that in a very measured way. As far as 2023, are we going to invest more? Yes, we are going to invest more, but it is going to be measured. I would say, the real impact for international is over the medium term. Over the short term, you are not going to see it have a material top-line impact. Excellent. We made it just in time. I want to sincerely thank again, Chris, Elena, and Michael for making the trip here, joining us at our 26th Annual Technology Conference. It was a pleasure hosting you guys. Thanks. Thanks, Seth.