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Freshworks (NASDAQ:FRSH) Reports Upbeat Q1, Provides Optimistic Full Year Guidance


Full Report / June 27, 2022
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Business software provider Freshworks (NASDAQ: FRSH) reported results ahead of analyst expectations in the Q1 FY2022 quarter, with revenue up 42.2% year on year to $114.6 million. The company expects that next quarter's revenue would be around $118 million, which is the midpoint of the guidance range. That was in roughly line with analyst expectations. Freshworks made a GAAP loss of $49 million, down on its loss of $2.41 million, in the same quarter last year.

Freshworks (FRSH) Q1 FY2022 Highlights:

  • Revenue: $114.6 million vs analyst estimates of $108.2 million (5.91% beat)
  • EPS (non-GAAP): -$0.01 vs analyst estimates of -$0.05
  • Revenue guidance for Q2 2022 is $118 million at the midpoint, above analyst estimates of $116.9 million
  • The company lifted revenue guidance for the full year, from $490.7 million to $498.5 million at the midpoint, a 1.57% increase
  • Free cash flow was negative $1.38 million, down from positive free cash flow of $2.83 million in previous quarter
  • Net Revenue Retention Rate: 115%, in line with previous quarter
  • Customers: 15,639 customers paying more than $5,000 annually
  • Gross Margin (GAAP): 80.4%, up from 79.2% 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.

Companies need to be able to interact with and sell to their customers as efficiently as possible. This reality, coupled with the ongoing migration of enterprises to the cloud drives demand for cloud-based customer relationship management (CRM) software that integrate data analytics with sales and marketing functions.

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 impressive over the last year, growing from quarterly revenue of $80.5 million, to $114.6 million.

Freshworks Total Revenue

And unsurprisingly, this was another great quarter for Freshworks with revenue up 42.2% year on year. Quarter on quarter the revenue increased by $9.15 million in Q1, which was in line with Q4 2021. This steady quarter-on-quarter growth shows the company is able to maintain a strong growth trajectory.

Guidance for the next quarter indicates Freshworks is expecting revenue to grow 33.5% year on year to $118 million, slowing down from the 56.4% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 29.9% 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 115% in Q1. That means even if they didn't win any new customers, Freshworks would have grown its revenue 15% 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 80.4% in Q1.

Freshworks Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.80 left to spend on developing new products, marketing & sales and the general administrative overhead. This is a great 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. It is good to see that the gross margin is staying stable which indicates that Freshworks is doing a good job controlling costs and is not under pressure from competition to lower prices.

Key Takeaways from Freshworks's Q1 Results

With a market capitalization of $5.13 billion Freshworks is among smaller companies, but its more than $603.4 million in cash and the fact it is operating close to free cash flow break-even put it in a robust financial position to invest in growth.

We enjoyed seeing Freshworks’s impressive revenue growth this quarter. And we were also excited to see that it outperformed Wall St’s revenue expectations. Overall, we think this was a decent quarter. The company currently trades at $13.5 per share.

Is Now The Time?

Freshworks may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We think Freshworks is a solid 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 customer acquisition costs are higher than we like to see, the good news is its impressive gross margins are indicative of excellent business economics.

Freshworks's price to sales ratio based on the next twelve months is 9.0x, suggesting that the market is expecting more steady growth, relative to the hottest tech stocks. There are definitely things to like about Freshworks and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.

The Wall St analysts covering the company had a one year price target of $33.5 per share right before these results, implying that they saw upside in buying Freshworks even in the short term.

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