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Freshworks's (NASDAQ:FRSH) Q3 Sales Top Estimates But Quarterly Guidance Below Expectations


Full Report / November 01, 2022
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Business software provider Freshworks (NASDAQ: FRSH) reported results ahead of analyst expectations in the Q3 FY2022 quarter, with revenue up 33.2% year on year to $128.7 million. Guidance for the full year also exceeded estimates, however the guidance for the next quarter was less impressive, coming in at $130.2 million, 2.02% below analyst estimates. Freshworks made a GAAP loss of $57.8 million, improving on its loss of $107.4 million, in the same quarter last year.

Freshworks (FRSH) Q3 FY2022 Highlights:

  • Revenue: $128.7 million vs analyst estimates of $125.4 million (2.64% beat)
  • EPS (non-GAAP): -$0.01 vs analyst estimates of -$0.05
  • Revenue guidance for Q4 2022 is $130.2 million at the midpoint, below analyst estimates of $132.8 million
  • Free cash flow was negative $7.23 million, compared to negative free cash flow of $10.1 million in previous quarter
  • Net Revenue Retention Rate: 107%, down from 111% previous quarter
  • Customers: 16,713 customers paying more than $5,000 annually
  • Gross Margin (GAAP): 81.2%, up from 76.9% 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 two years, growing from quarterly revenue of $66.1 million in Q3 FY2020, to $128.7 million.

Freshworks Total Revenue

And unsurprisingly, this was another great quarter for Freshworks with revenue up 33.2% year on year. On top of that, revenue increased $7.32 million quarter on quarter, a solid improvement on the $6.79 million increase in Q2 2022, and even a sign of slight acceleration of growth.

Guidance for the next quarter indicates Freshworks is expecting revenue to grow 23.4% year on year to $130.2 million, slowing down from the 44.4% 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 24.1% 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 107% in Q3. That means even if they didn't win any new customers, Freshworks would have grown its revenue 7% year on year. Despite it going down over the last year this is still a decent retention rate and it shows us that not only Freshworks's customers stick around but at least some of them get increasing value from its software over time.

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 81.2% in Q3.

Freshworks Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.81 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, 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.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Freshworks burned through $7.23 million in Q3, increasing the cash burn by 72.7% year on year.

Freshworks Free Cash Flow

Freshworks has burned through $15.9 million in cash over the last twelve months, resulting in a negative 3.39% free cash flow margin. This below average FCF margin is a result of Freshworks's need to invest in the business to continue penetrating its market.

Key Takeaways from Freshworks's Q3 Results

With a market capitalization of $3.89 billion Freshworks is among smaller companies, but its more than $432.3 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.

It was good to see Freshworks deliver strong revenue growth this quarter. And we were also excited to see solid full year guidance. On the other hand, it was unfortunate to see that the revenue guidance for the next quarter missed analysts' expectations. Overall, this quarter's results were ok. The company is up 2.27% on the results and currently trades at $13.47 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. Although we have other favorites, we understand the arguments that Freshworks is not a bad 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 is less efficient than many comparable companies, the good news is its impressive gross margins are indicative of excellent business economics.

The market is certainly expecting long term growth from Freshworks given its price to sales ratio based on the next twelve months is 6.5x. There are things to like about Freshworks and there's no doubt it is a bit of a market darling, at least for some. But we are wondering whether there might be better opportunities elsewhere right now.

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