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Freshworks (NASDAQ:FRSH) Reports Q3 Results


Full Report / December 15, 2021
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Business software provider Freshworks (NASDAQ: FRSH) reported strong growth in the Q3 FY2021 earnings announcement, with revenue up 45.9% year on year to $96.6 million. On the other hand, guidance for the full year missed analyst expectations with revenues guided to $365.5 million at the midpoint, or 0.26% below analyst estimates. Freshworks made a GAAP loss of $107.4 million, down on its profit of $1.38 million, in the same quarter last year.

Freshworks (FRSH) Q3 FY2021 Highlights:

  • Revenue: $96.6 million vs analyst estimates of $90.9 million (6.26% beat)
  • EPS (non-GAAP): -$0.04 vs analyst estimates of -$0.12 ($0.08 beat)
  • Revenue guidance for Q4 2021 is $100 million at the midpoint, above analyst estimates of $96.7 million
  • Gross Margin (GAAP): 76.9%, down from 80.1% same quarter last year

Founded in Chennai, India in 2010 with the idea of creating a “fresh” helpdesk product Freshworks (NASDAQ: FRSH) offers a broad range of software targeted at small and medium sized businesses.

Small and medium sized businesses (SMB) are facing the same digital transformation pressures as larger enterprises. However, they don’t have the human and capital resources to build out integrated front office and back office products for customer service, IT service management (ITSM) and sales & marketing automation (CRM) tools, and are hesitant to have multiple vendors like Zendesk, ServiceNow, and Salesforce, which can be too complex for a small business to manage.

Freshworks has assembled a one-stop-shop for SMB customers looking for customer service, IT service management (ITSM) and sales & marketing automation (CRM) tools. Its approach is to provide enterprise grade products at a discount to larger competitors.

Freshworks benefits from dual trends around cost savings and ease of use. First is the SaaS-ification of businesses, large and small, who much prefer the flexibility of cloud-based, web-browser delivered software paid for on a subscription basis than the hassle and expense of purchasing and managing on-premise enterprise software. Second is the consumerization of business software, whereby multiple standalone processes like CRM tools and IT Help desk are aggregated into a single, easy to use platform.

Freshworks operates in a highly competitive space, with rivals like Microsoft (NASDAQ:MSFT), Salesforce.com (NASDAQ: CRM), ServiceNow (NYSE: NOW), Hubspot (NYSE: HUBS), PagerDuty (NYSE:PD), and Zendesk (NASDAQ: ZEN).

Sales Growth

As you can see below, Freshworks's revenue growth has been exceptional over the last year, growing from quarterly revenue of $66.1 million, to $96.6 million.

Freshworks Total Revenue

And unsurprisingly, this was another great quarter for Freshworks with revenue up 45.9% year on year. On top of that, revenue increased $8.27 million quarter on quarter, a solid improvement on the $7.75 million increase in Q2 2021, and even a sign of slight re-acceleration of growth.

Analysts covering the company are expecting the revenues to grow 29.4% over the next twelve months.

Product Success

One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.

Freshworks Net Revenue Retention Rate

Freshworks's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 117% in Q3. That means even if they didn't win any new customers, Freshworks would have grown its revenue 17% year on year. That is a good retention rate and a proof that Freshworks's customers are satisfied with their software and are getting more value from it over time. That is good to see.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Freshworks's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 76.9% in Q3.

Freshworks Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.76 left to spend on developing new products, marketing & sales and the general administrative overhead. Despite it going down over the last year, this is still a good gross margin that allows companies like Freshworks to fund large investments in product and sales during periods of rapid growth and be profitable when they reach maturity.

Key Takeaways from Freshworks's Q3 Results

Since it has still been burning cash over the last twelve months it is worth keeping an eye on Freshworks’s balance sheet, but we note that with a market capitalization of $6.35 billion and more than $1.32 billion in cash, the company has the capacity to continue to prioritise growth over profitability.

We were impressed by the exceptional revenue growth Freshworks delivered this quarter. And we were also excited to see that it outperformed Wall St’s revenue expectations. On the other hand, it was unfortunate to see that Freshworks's revenue guidance for the full year miss analyst's expectations. . Overall, we think this was a strong quarter, that should leave shareholders feeling very positive. The company currently trades at $24.65 per share.

Is Now The Time?

When considering Freshworks, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Freshworks is a good business. We would expect growth rates to moderate from here, but its revenue growth has been exceptional, over the last two years. And while its cash burn raises the question if it can sustainably maintain its growth, the good news is its impressive gross margins are indicative of excellent business economics, and its efficient customer acquisition is better than many similar companies.

Freshworks's price to sales ratio based on the next twelve months is 17.4x, suggesting that the market is expecting more moderate growth, relative to the hottest tech stocks. There is definitely a lot of things to like about Freshworks and looking at the tech landscape right now, it seems that the company trades at a pretty interesting price point.

The Wall St analysts covering the company had a one year price target of $49.3 per share right before these results, implying that they saw upside in buying Freshworks even in the short term.

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