Mary Long (3:10)

Yeah, that selling proposition seems to be turning out pretty well for Toast. They were gap profitable for the first time in the history of the business for the full year, brought in $19 million in net income. They were also able to reach that milestone while adding about 28,000 net new locations. Those are some stats that jumped out to me. But what about you, Tim? What's your headline from Toast's latest ear earnings?

Tim Byers (3:33)

Strong and steady wins the race here. I mean they, they are just continuing to go and notice I didn't say slow and steady because they're not slow. They still grow, you know, they still grew 29 year over year, but these are fairly strong numbers. So just to, to give you a sense of it, Overall revenue up 29.15%. Subscription revenue up almost 41%, which is really nice. Your subscription gross margin up to 70%, which is about in line with where they've been in recent quarters. Fintech revenue, which is they get a take off of the amount of business done in, in a restaurant. So, you know, they process payments, they get a little cut of those payments. The more payments there are, the more money they make. That was up 28% year over year, their gross profit. And this is up 35% year over year. So I mean, really quite good here. Mary. The other thing is they have what they call a core profitability margin. I track it in my spreadsheet and I show it now as 29.37%. That is up from last year where it was 10.7%. And it's been around that 30% mark in recent quarters. They have said in years past that they could get somewhere on an ongoing basis to between 30 and 35%. At that level of core profitability margin, it's the sum of the adjusted EBITDA divided by the sum of subscription gross profit and fintech gross profit. Just think about it as the, the unencumbered money flowing through restaurants that Toast is helps, you know, execute either that fintech revenue or the subscription that the restaurant pays. But otherwise I would say the two things that really drive value here are the revenue per restaurant, which has been relatively stable, about 40,000 per restaurant location, roughly been that for a few quarters. Now, but the restaurant locations are expanding. It was up 26% year over year. Another 7,000 net new ads, you know, this past quarter. Mary so as long as that continues to be true, if Toast is in more places and they either hold steady or slightly like rate of inflation, increase the amount they get per location, I mean, the stock is not anywhere near fairly valued if that continues to be true over a long period of time.

Mary Long (6:04)

So everything you're saying to me sounds not just pretty good, but pretty awesome. Like again, I understand why this is your highest conviction stock. And yet after these earnings came out yesterday and after market trading, the stock was down a little bit slightly this morning. Again, we're recording this pretty early, but stock was pretty steady. What didn't Wall street love about this?

Tim Byers (6:26)

They didn't like the earnings per share. They didn't like the, I mean, it seems as though I'm not entirely clear if the outlook was disappointing, but the certain, certainly the earnings per share number was disappointing. Mary. They came in at roughly 6 cents a share in earnings for the most recent quarter and the estimate was for 17 cents. So that's a big miss. I don't get too hot and bothered about per share numbers because share counts change wildly, you know, particularly with growth companies. And so it's really difficult, you know, when you are predicting a per share number, not only are you attempting to predict the top line growth, like what is the growth in the net income, you are trying to predict the growth and that net income divided by some guess about the number of shares that will be there at that particular point in time. And you know, if the company hires a bunch of people, issues a bunch of equity, the diluted shares outstanding can, can spike. And so, you know, that EPS number can go down. And to be fair, Toast does issue equity. They do try and hire in particular serious engineering talent. They are in a hiring, you know, period right now. So I'm not too surprised that the EPS number didn't meet the expectation. I just don't place a lot of faith when it comes to forecasts missed or exceeded in per share numbers. I'd be more concerned if like, like this kind of reaction or something worse than this kind of reaction, just down about 4% this morning. Would be way more understandable if like the locations came in really short. So like they've been getting at least, you know, 6,000 net new locations every quarter. Mary if suddenly it went down to like 3,000, you'd be like, okay, wait a minute, what's going on here? That would be a Serious cause for concern. This doesn't feel like a serious cause for concern.

Mary Long (8:33)

I took a little gander on the TOAST website ahead of us recording this, and there's a testimonial displayed about midway down one of the pages that quotes Wayne Carrington, who's the owner of Rock and Ramen in New Rochelle, New York. And he is singing toast praises and saying, with toast, average check size is up 15%. That's another $120,000 a year when we're at full capacity. This stuck out to me because, you know, as you're describing the migraine level problems that TOAST addresses for restaurateurs, a lot of those strike me as addressing and improving efficiencies on the back end. But this testimonial seems to suggest that, okay, it's not just stuff on the back end that TOAST can help restaurants improve. They can also lead to higher checks at the front of the house.

Tim Byers (9:16)

Sure.

Mary Long (9:16)

How exactly does TOAST do that?

Tim Byers (9:18)

Well, they do that with the point of sale systems. We missed you yesterday. We were downtown. Ricky was there, though, and. And we were at a co working space, and they have a bunch of restaurants downstairs where this co working space is. So I went to one, got myself a sandwich. I mean, it was pretty good. I'm not sure the French dip was worth $17, but that's a totally different thing. I mean, I. So yes, I paid $17 for a French dip sandwich. But it was decent, right? It was decent. The point of sale system was a very large. It wasn't even an iPad. It was like a screen. It was almost like, you know, an external laptop screen. And it was just swiveled out facing me. And it was just a, you know, a point of sale system. And it said right down there in the bottom, powered by toast. And where you get those new and improved check sizes from Mary is in those point of sale systems, TOAST allows you to customize and say, hey, highlight the stuff that you want to sell. And so, you know, what's the first thing that I see on that point of sale system? The stuff that they want to sell, the specials. And then if I want to get to the thing that I want to get to, well, then I'm going to scroll through the screen and it absolutely allows me to do that. And I did that to get to the French dip sandwich. But what it wants, what, you know, right there, that is super valuable real estate. And TOAST is letting that restaurant operator say, like, yeah, sell the stuff that's going to make you the most money. And that's how you get better check sizes. So, yeah, it does solve that problem via a very well constructed, clean point of sale system that's just one part of a full ecosystem that they provide restaurant operators.

Mary Long (11:03)

We're going to move on to another story. Yesterday, the Wall Street Journal reported that Microsoft researchers claim to have created a chip that leverages. Wait for it. A new state of matter that would serve as the foundation for quantum computing. New state of matter really caught my attention. What is that new state?

Tim Byers (11:21)

It sounds very Star Trek, doesn't it?

Mary Long (11:23)

It does. It sounds. I'm like, this is got to be the big story. This new state of matter is called a topological superconductor. It's a material that's not a solid, not a liquid, not a gas. Again, this. That sounds like the really big deal to me. But how material is this news for Microsoft's future business?

Tim Byers (11:41)

Well, it isn't yet. I mean, we, you know, you actually have to make something that is commercially viable before it becomes material. But as a matter of. Of material science, it is potentially very significant. Quantum computing is, is really hard because you are, you are essentially a quantum state is somewhere between a 0 and 1. In a binary computer system, you know, a silicon based, you know, binary computer system. You have ones and you have zeros. And a combination of ones and zeros is what gets you code. And that's, that's how you program a computer system. In a quantum system, your superposition is between. You know, sometimes we say it's 0 and 1 at the same time. It's not entirely accurate. It's somewhere between 0 and 1. So it's a superposition system. You have a multidimensional option where you can almost think of it as spherical, and then all particles, everything else moving inside that sphere all of the time. So the superposition is really hard to determine. And because everything is moving, you have a bunch of hyperactive kids running around a playground, and you can't pin anything down. And so why is it hard to, you know, do actual quantum computing? Because you can't pin anything down, which is why you have to do quantum computing at, you know, very close to absolute zero temperatures. You have to freeze it down to nothing. So you take these particles that are constantly on the move and just like, you know, come on, kid, cool it, you know, slow down, for God's sake. That's what you're doing. You're slowing them down. And so this topological superconducting technology, as it were, has something that. And I am sure that we have engineers who know this way better than I am. So I am apologizing up front for getting this wrong, and we would love for you to write in and correct me for where I have this wrong. But my understanding here, Mary, is that we have this idea in a topological superconductor called a, a Margariana bound state, so M, A J, O, R, A N, a majorana. And so the idea of a bound state, particularly on the edges of a, of a system, they're essentially a quasi particle. And they can be, if I'm understanding it correctly, they're located at the edges or boundaries of the material, and they add some amount of predictability into the system. So in a very unpredictable, very hyperactive system that has to be cooled to the, you know, to the point of absolute zero in order to generate some amount of predictability and slow movement, so we can, you know, essentially put boundaries around particles to create a predictable superposition. The idea of these bounded, bounded areas creating a little more predictability seems to me to make quantum computing more viable. Now, I am not a material scientist, so I may have that totally wrong, but I think that's the exciting part about this, is it does appear that this system as presented, could be more predictable. And predictability in a quantum system is really tough. It's really tough to do that. But the more predictable it is, given the amount of variables that can be processed in a quantum. So that's the, that's the advantage of a quantum system. You have a binary system can, you know, think of it this way. It can compute, like, X variables, a quantum system, because it has so much more surface area, so many more variables, I.e. x to the 10th power or whatever. So my ability to compute a whole bunch more variables goes up logarithmically in, in a quantum system. So if I make that system more stable, more predictable through something like a topological superconductor, that's winning. And this is winning in so many ways. You can understand why Microsoft and Alphabet want to do this, because who are the two companies, along with Amazon and Nvidia and others that want to win the AI race? That would be Microsoft and Alphabet. And in order to win, you know, compute power is a big deal. And so quantum computers are a potential AI, is a potential catalyst for quantum research. So it's not too surprising to see this. But I would not get excited about this being commercially viable soon. I think it's going to take a while.

Mary Long (16:54)

Potentially very exciting development, but yeah, still very, very early days in the technology. Probably a bit too soon to make A real move on it. Tim, I'm going to double down on your offer to our material scientists and engineering minded listeners. If you've got some input on Tim's description of how exactly this Majorana chip could work, you can write to us@podcastool.com Tim, thanks so much for taking a look at toast and for kind of giving a morning explainer of quantum computing and the potentials there and doing that before having any caffeine for the day.

Tim Byers (17:30)

I know. Like I said, listen at your own risk.

Kirsten Guerra (17:37)

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Mary Long (18:13)

For better or worse, Roblox is known for having a young user base, but it is making real strides in aging up that demographic. Up next, full analyst Kirsten Guerra joins me to check in on the gaming company. Kirsten, this recording that we're doing right now, it's not going to air for a couple days, but the viewers should know we are recording this on Valentine's Day. We're talking Roblox today. And I know you love Roblox, so I thought maybe you could kick us off with sharing. Getting a little vulnerable perhaps? Sharing any romantic words about this company to kick us off. Snippets from a love letter, a romantic haiku perhaps?

Dave (18:52)

Anything you got for us. I'm not in love with the Roblox, Mary. No. But my portfolio loves the flow. The gains keep growing from obby to obby. So thank you for this massively multiplayer UGC platform, Bobby. The CEO's name is Dave, but that didn't rhyme, so that's what you get.

Mary Long (19:11)

I was going to say for anyone listening who might be wondering, what in the world did I just tune into? We'll zoom out a bit. We're talking Roblox today checking in on this gaming company. Kristin, for those who are maybe less familiar with the platform, know that this is a gaming company. Help us understand how this is different from other gaming companies, whether that's Microsoft, Activision, Nintendo, et cetera.

Dave (19:32)

Yeah, well, all the other names that you mentioned, they own, develop and kind of produce their own games. Microsoft and Nintendo actually have the extra layer then of the fact that they, they create consoles that many people play on Microsoft, Xbox and Nintendo Switch. Roblox does not sell a console. Instead you can access Roblox from across any console, PC, mobile, even VR headsets. It is cross platform, it does not sell hardware, nor does it even create its own games. Roblox has millions of games or what they like to call experiences on their platform, but they are not designed by Roblox. Instead, Roblox hosts and provides the developer tools for users to create games on Roblox. And so if you think about this, maybe in the context of movies, an Activision might be more like a Universal Pictures. They both create and distribute their own content. Roblox is far closer to maybe a YouTube, the centralized platform where creators go to distribute and monetize their own content and creations. And so YouTube, like Roblox, just takes a cut of all the spend that happens on the platform in exchange for the hosting, distribution and those developer tools.

Mary Long (20:44)

Roblox posted their fiscal 2024 results earlier this month. Earlier in February, these numbers all looked pretty healthy to me. I'll give an overview of what I'm talking about. You've got fourth quarter revenue up 32% year over year, full year revenue also up about 29, 30%. Bookings, which is kind of the more telling top line indicator here that investors like to hone in on. That was up 21% for the quarter, 24% for the year. Daily active users hours engaged, both of those metrics up about 20% for the fourth quarter. Slightly more when you look at the full year free cash flow up 417% for the year. Those all sound pretty good to me, Kirsten, but you are the analyst. Any notes on Roblox's performance for the fourth quarter and really for the full past year, how they've been doing recently?

Dave (21:30)

I mean, what am I supposed to say, Mary, you took all the good numbers. You're right. A lot of what looks like strong numbers reported this quarter, but it's all about perspective. And so digging in deeper, specifically to the daily active users there, as you said, up 19% year over year. Sounds good. But sequentially meaning from Q3 to Q4, daily active users actually fell. And that's not the first time that that's happened for Roblox, to be sure. But Q4 is typically a strong quarter of user growth given all the gift card gifting that drums up new users around the holidays. But this time a 4% or so drop from nearly 89 million daily active users to 85. And Roblox points to Turkey here, which completely banned the platform for all of Q4. That certainly would have contributed to user drop, but I'm not sure it's the complete story. Overall though, what we have right now I would say is a single data point. So this could be the start of a downward trend, which would certainly be problematic for a stock like this with high expectations that are built in. But it could just as easily be kind of a nothing burger quick dip before a return to growth. Steady growth on the daily active users. More like what we've seen so far. So for now, not enough to call this a trend, but definitely some something I will be watching for next quarter.

Mary Long (22:52)

I pull out those good numbers, but I turn to you to give us the context to make those numbers make sense. We'll say I'm not just good at pulling out good numbers. Something that sticks out to me with Roblox in particular is that they are spending more on stock based compensation than they're making in operating cash flow. That doesn't seem like a good number to me. We'll flip the question here. Is that a red flag to you? A yellow flag? What do you make of that? That setup?

Dave (23:14)

Yeah, stock based comp has always been at least a yellow flag for this company. It's excessive. You called out before a hu jump in free cash flow this year and so yes, I appreciate your positivity. Let us take a moment to appreciate that because in part what happened there was that Roblox has put up a lot of capital expenditure over the past couple years building out Roblox cloud to support all of this real time immersive 3D interaction. And as they did that, they kept insisting that once some of this build out on our data centers creates redundancy, then future spend will be less and we'll see free cash flow rise as that capex kind of tapers off. So let's give them some credit here. True to their word, we are seeing exactly that play out. However, another contributor to that free cash flow rise is the increased stock based comp that you pointed to. And so that's essentially a non cash way that Roblox rewards its employees. And it's a great tool to have when you are an unprofitable, rapidly growing company as Roblox is. But issuing those shares also dilutes shareholders and it's always been a question mark for Roblox. But the dilution has gotten worse. It has grown to 4.4% dilution kind of compounded annually over the last three years. Ideally, I'd rather see that below 3%.

Mary Long (24:34)

Roblox has a reputation for catering primarily to a younger audience. What is it about the platform that is so appealing to young kids in particular?

Dave (24:45)

I mean, thinking about this, when I was a kid, I would spend hours staring into a big ugly monitor typing out plain text messages to my friends on AOL Instant Messenger. Why did that appeal to me? But kids are very social and naturally they gravitate toward free to use, easily accessible social environments, increasingly digital, and that is Roblox. It's just the most immersive one we've seen yet.

Mary Long (25:13)

Despite having this reputation for having an audience of primarily young people, I'll point out, and management really would like me to point out, that over 61% of Roblox's daily active users are over 13 and that that cohort is growing. How exactly is Roblox attempting to age up its user base?

Dave (25:32)

I'm sure Dave would send his. Thank you for pointing that out. Yeah, you're welcome. That's usually, that's how social networks grow, right? Young people tend to grasp it. First Facebook started with college students, then users nucleate from there. So the 23 year olds learn about it from the 20 year olds in their circles. Then the 25 year olds learn about it from the 23 year olds. Now my 80 year old grandma has been on Facebook for many years, so it's partly that this kind of natural user nucleation process that just takes time. But also in Roblox's case, specifically it's about encouraging games or experiences that feel appropriate for those older audiences. So for one, Roblox is encouraging development of specific genres in their games, Sports, Racing Action and Battle Royale especially. Then the other big thing is improving the discoverability algorithm. So when a 34 year old woman logs into Roblox to see what it's all about, the homepage should not present her with the same games that are popular with 12 year olds, or she'll probably churn from the platform. So as those mature games come online, Roblox is doing a lot to make sure that users are first presented with content that will keep them engaged and keep them on the platform.

Mary Long (26:46)

Last fall, In October of 2024, Hindenburg Research, notorious short seller that has now closed up shop, they published a report about child safety concerns at Roblox. There are other allegations in this report, predominantly like inflated numbers that we'll touch on in a minute, but for now I want to focus on that child safety piece. These are serious concerns and are very legitimate. But my question is that That's a legitimate concern anywhere on the Internet. Why does this seem to be a bigger concern in regards to Roblox than it does for Snapchat or Instagram or YouTube?

Dave (27:20)

It is a concern everywhere. As you said, we all want children to be safe on all platforms. Roblox, as I mentioned earlier, is the most immersive social environment we've ever seen that's easily accessible to kids, second, really only to the real world. And so a lot of social platforms like you mentioned have transformed from more of a town hall feel when they started to a living room model. That's how Mark Zuckerberg puts it. A lot of those platforms are now built to center connection with close friends and people you know. Roblox also tries to connect you with friends, but when you drop into some random experience in Roblox, you're almost certainly going to be interacting with a lot of randos as well. And so in 2024, Roblox spent 915 million on infrastructure, trust and safety. It's also the founding partner of roost, which stands for Robust Open Online Safety Tools. It has open sourced a lot of the AI based tools that it has developed for things like detection of policy violations that happen both in text, in chat, between users, and also via voice. So I think Roblox knows the risk of getting this wrong and therefore takes it very seriously.

Mary Long (28:30)

The other piece of that Hindenburg report is the suggestion that Roblox had inflated metrics, particularly user numbers and time spent on the platform. Roblox totally rejected the claims of that report. How seriously do or did you take those Hindenburg allegations when they came out and now after Hindenburg has closed up shop?

Dave (28:49)

Yeah, with short reports, it always depends on the outlet. But Hindenburg did have some credibility in general. I wouldn't associate, by the way, they're closing shop with this report. That doesn't change anything too much in my mind. Regardless, it's tough because any short report writer is third party to the company they're talking about, unless you're talking a whistleblower, which comes from inside the company, which was not the case here. Then it's just a group of people on the outside trying to understand and pick apart how the company is measuring things internally. And so I won't say on record that I know Hindenburg got this wrong, because I don't know that for sure. There's a chance. Right. And all we can really do as outsiders and as investors is to weigh how much validity we think is there and to factor that into the risk reward. Equation for how much you're willing to pay for a share of a company.

Mary Long (29:39)

Kirsten Guerra, Always a pleasure to talk to you about any company, but especially Roblox. Thanks so much for taking the time to come on to Motley Fool Money.

Dave (29:48)

Thanks for hosting my poetry. Mary Open invite.

Mary Long (29:58)

As always. People on the program may have interest in the stocks they talk about, and the Motley fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley fool editorial standards and is not approved by advertisers. The Motley fool only picks products that it would personally recommend. Recommend to friends like you. For Tim Byers and Kirsten Garra, I'm Mary Long. Thanks for listening. We'll see you tomorrow.