Business software provider Freshworks (NASDAQ: FRSH) announced better-than-expected results in Q3 FY2023, with revenue up 19.3% year on year to $153.6 million. The company also expects next quarter's revenue to be around $158 million, in line with analysts' estimates. Turning to EPS, Freshworks made a GAAP loss of $0.11 per share, improving from its loss of $0.20 per share in the same quarter last year.
Freshworks (FRSH) Q3 FY2023 Highlights:
- Revenue: $153.6 million vs analyst estimates of $150.7 million (1.86% beat)
- EPS (non-GAAP): $0.08 vs analyst estimates of $0.05 ($0.03 beat)
- Revenue Guidance for Q4 2023 is $158 million at the midpoint, roughly in line with what analysts were expecting
- Free Cash Flow of $22.1 million, up 22.1% from the previous quarter
- Net Revenue Retention Rate: 108%, in line with the previous quarter
- Customers: 19,551 customers paying more than $5,000 annually
- Gross Margin (GAAP): 82.9%, up from 81.2% in the 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 integrates 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).
As you can see below, Freshworks's revenue growth has been strong over the last two years, growing from $96.6 million in Q3 FY2021 to $153.6 million this quarter.
This quarter, Freshworks's quarterly revenue was once again up 19.3% year on year. We can see that Freshworks's revenue increased by $8.47 million in Q3, up from $7.39 million in Q2 2023. While we've no doubt some investors were looking for higher growth, it's good to see that quarterly revenue is re-accelerating.
Next quarter's guidance suggests that Freshworks is expecting revenue to grow 18.6% year on year to $158 million, slowing down from the 26.3% year-on-year increase it recorded in the same quarter last year. Looking ahead, analysts covering the company were expecting sales to grow 18% over the next 12 months before the earnings results announcement.
One of the best parts about the software-as-a-service business model (and a reason why SaaS companies trade at such high valuation multiples) is that customers typically spend more on a company's products and services over time.
Freshworks's net revenue retention rate, a key performance metric measuring how much money existing customers from a year ago are spending today, was 108% in Q3. This means that even if Freshworks didn't win any new customers over the last 12 months, it would've grown its revenue by 8%.
Freshworks has a decent net retention rate, showing us that its customers not only tend to stick around but also get increasing value from its software over time.
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's left after paying for servers, licenses, technical support, and other necessary running expenses, was 82.9% in Q3.
That means that for every $1 in revenue the company had $0.83 left to spend on developing new products, sales and marketing, and general administrative overhead. Freshworks's excellent gross margin allows it to fund large investments in product and sales during periods of rapid growth and achieve profitability when reaching maturity. It's also comforting to see its gross margin remain stable, indicating that Freshworks is controlling its costs and not under pressure from its competitors to lower prices.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Freshworks's free cash flow came in at $22.1 million in Q3, turning positive over the last year.
Freshworks has generated $53.3 million in free cash flow over the last 12 months, a solid 9.12% of revenue. This strong FCF margin stems from its asset-lite business model, giving it optionality and plenty of cash to reinvest in its business.
Key Takeaways from Freshworks's Q3 Results
Sporting a market capitalization of $5.17 billion, Freshworks is among smaller companies, but its more than $1.16 billion in cash on hand and positive free cash flow over the last 12 months puts it in an attractive position to invest in growth.
It was encouraging to see Freshworks narrowly top analysts' revenue expectations this quarter. The company also beat Wall Street's free cash flow estimates and raised its full-year outlook for adjusted operating profit. That really stood out as a positive in these results. On the other hand, its new large contract wins slowed. Overall, this was a mixed quarter for Freshworks. In terms of new products, the company shared that it unveiled an AI-powered Customer Service Suite that brings together self-service bots, agent-led conversational messaging, and automated ticketing management. The stock is up 1.95% after reporting and currently trades at $18.31 per share.
Is Now The Time?
When considering an investment in Freshworks, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter.
We think Freshworks is a good business. We'd expect growth rates to moderate from here, but its revenue growth has been strong over the last two years. On top of that, its impressive gross margins indicate excellent business economics and its strong free cash flow generation gives it re-investment options.
The market is certainly expecting long-term growth from Freshworks given its price to sales ratio based on the next 12 months is 7.9x. There's 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.Wall Street analysts covering the company had a one-year price target of $24.9 per share right before these results, implying that they saw upside in buying Freshworks even in the short term.
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