Restaurant-technology company Toast (TOST 2.63%) is bucking a negative trend in the financial technology (fintech) space. Other fintech players such as DLocal and even PayPal are seeing profit margins go down due to fierce competition, which slowly but surely pressures profits as they lower prices to keep customers and spend more to attract new ones.
Of course, that's an oversimplification. Fintech is a broad term, encompassing more than just payment processing. But when it comes to that segment, there's little a company can do to stand out from the competition. Therefore, it's natural to see companies lose pricing power in this area.
However, a company can stand out when it comes to offering fintech software services in addition to processing payments. It seems like this is what's driving strong results for Toast -- after all, the company just added 6,000 net new locations in a single quarter. And there's a related metric here that investors will love looking at.
The Toast metric that investors need to see
On May 7, Toast reported financial results for the first quarter of 2024. The company's location count was up 32% year over year, while revenue increased 31% to over $1 billion.
For some time now, Toast's management has claimed its business benefits from a network effect -- growth itself becomes a catalyst for more growth. The company says roughly 20% of its new customers come from referrals from existing ones. Therefore, as the adoption of Toast's technology becomes more concentrated in certain markets, awareness grows, making it easier to attract even more restaurants to the platform.
Despite revenue and customers increasing over 30% last quarter, the company's sales and marketing expense was only up 8%. Admittedly, there were some non-cash accounting items in this figure, but even adjusting for them, marketing expenses only increased 12% year over year.
Another reason this is good news for Toast
Sales and marketing is the biggest component of the company's operating expenses, so as revenue far outpaces those expenses, a business becomes more profitable. Toast did report an operating loss of $56 million in Q1, but that was a big improvement from its $92 million loss in the prior-year period.
Toast's network effect is just one reason to celebrate; its improving profitability is another. There's more to the profit improvements here, though. For example, Toast offers various subscription software products to its restaurant customers, and these customers are subscribing to more services over time.
In Q1, Toast's subscription revenue was up 41% year over year. Not only was this faster than overall top-line growth, this revenue is higher-margin too, which helps the bottom line.
Moreover, Toast's annual recurring revenue is now at $1.3 billion, up 32% from this time last year.
Toast's growth is accelerating, but it doesn't seem like the company needs to significantly ramp up spending at the same time. On the contrary, it seems management's claim of a network effect is true. Restaurants are hearing about its technology and initiating conversations with Toast on their own.
As Toast gains new customers organically, its profits improve. And as the company successfully upsells those customers on software products, its profits also go up. This helps the company overcome the low-margin nature of just processing payments. All of this points to future gains for Toast's shareholders if these trends keep playing out.
