Business software provider Freshworks (NASDAQ: FRSH) reported Q4 FY2022 results that beat analyst expectations, with revenue up 26.3% year on year to $133.2 million. However, guidance for the next quarter was less impressive, coming in at $134 million at the midpoint, being 2.35% below analyst estimates. Freshworks made a GAAP loss of $55.5 million, improving on its loss of $74.7 million, in the same quarter last year.
Freshworks (FRSH) Q4 FY2022 Highlights:
- Revenue: $133.2 million vs analyst estimates of $130.3 million (2.18% beat)
- EPS (non-GAAP): $0.01 vs analyst estimates of -$0.04 ($0.05 beat)
- Revenue guidance for Q1 2023 is $134 million at the midpoint, below analyst estimates of $137.2 million
- Management's revenue guidance for upcoming financial year 2023 is $582.5 million at the midpoint, missing analyst estimates by 2.25% and predicting 17% growth (vs 34.8% in FY2022)
- Free cash flow of $4.04 million, up from negative free cash flow of $7.24 million in previous quarter
- Net Revenue Retention Rate: 108%, in line with previous quarter
- Customers: 17,722 customers paying more than $5,000 annually
- Gross Margin (GAAP): 81.1%, in line with 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 $73 million in Q4 FY2020, to $133.2 million.
This quarter, Freshworks's quarterly revenue was once again up a very solid 26.3% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $4.41 million in Q4, compared to $7.33 million in Q3 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.
Guidance for the next quarter indicates Freshworks is expecting revenue to grow 16.9% year on year to $134 million, slowing down from the 42.3% year-over-year increase in revenue the company had recorded in the same quarter last year. For the upcoming financial year management expects revenue to be $582.5 million at the midpoint, growing 17% compared to 34.2% increase in FY2022.
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'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 108% in Q4. That means even if they didn't win any new customers, Freshworks would have grown its revenue 8% 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 81.1% in Q4.
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. 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.
Cash Is King
If you have followed 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's free cash flow came in at $4.04 million in Q4, up 42.5% year on year.
Freshworks has burned through $14.8 million in cash over the last twelve months, resulting in a negative 2.97% 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 Q4 Results
With a market capitalization of $4.68 billion Freshworks is among smaller companies, but its more than $304.1 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 were very impressed how strongly Freshworks accelerated the rate of new contract wins this quarter. And we were also excited to see that it outperformed analysts' revenue expectations. On the other hand, it was unfortunate to see that Freshworks's revenue guidance for the full year indicates quite a significant slowdown and it missed analysts' expectations. Overall, this quarter's results were not the best we've seen from Freshworks. The company is down 3.6% on the results and currently trades at $15.8 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 Freshworks is not a bad business, it probably wouldn't be one of our picks. Its revenue growth has been impressive, though we don't expect it to maintain historical growth rates. But while its impressive gross margins are indicative of excellent business economics, unfortunately its customer acquisition is less efficient than many comparable companies.
The market is certainly expecting long term growth from Freshworks given its price to sales ratio based on the next twelve months is 8.0x. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Freshworks doesn't trade at a completely unreasonable price point.
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