AI lending platform Upstart (NASDAQ:UPST) missed analyst expectations in Q3 FY2022 quarter, with revenue down 31.2% year on year to $157.2 million. Guidance for the next quarter also missed analyst expectations with revenues guided to $135 million at the midpoint, or 27.1% below analyst estimates. Upstart made a GAAP loss of $56.2 million, down on its profit of $29.1 million, in the same quarter last year.
Upstart (UPST) Q3 FY2022 Highlights:
- Revenue: $157.2 million vs analyst estimates of $169.4 million (7.2% miss)
- EPS (non-GAAP): -$0.24 vs analyst estimates of -$0.08 (-$0.16 miss)
- Revenue guidance for Q4 2022 is $135 million at the midpoint, below analyst estimates of $185.3 million
- Free cash flow was negative $106.8 million, compared to negative free cash flow of $57.5 million in previous quarter
- Gross Margin (GAAP): 57.9%, down from 84.7% same quarter last year
Founded by the former head of Google's enterprise business Dave Girouard, Upstart (NASDAQ:UPST) is an AI-powered lending platform that helps banks better evaluate the risk of lending money to a person and provide loans to more customers.
After a successful stint at Google where he started what later became Google Cloud, Dave Girouard founded Upstart together with his former colleague Anna Counselman and data scientist Paul Gu.
The ways lenders determine credit approvals in the US have not really changed in over 30 years and still rely mainly on FICO and simplistic rules-based systems. As a result, millions of creditworthy individuals who don’t fit into the precise brackets are either not approved for loans at all, or pay too much to borrow money. Upstart instead uses cloud-computing and machine learning to evaluate more than 1,000 data-points for each loan applicant, allowing them to estimate the risk of default on a loan more precisely, and for more people. For consumers, it means higher approval rates and lower interest rates and for banks it means access to new customers and lower fraud and loss rates. Because the decision is now made by software, it also means all-digital, automated experience from start to end.
Upstart provides their technology to banks and for some customers serves as an intermediary, but itself bears no credit risk and just simply charges the banks a fee for every provided loan. The company has started by evaluating applicants for personal loans, but their target market also includes auto loans, credit cards and mortgages.
Businesses have come to use data driven insights to stratify their customers into more granular buckets that enable more personalized (and profitable) offerings. Lending software is a prime example of fintech democratizing access to loans in a still-profitable manner for financial institutions.
Upstart’s main competitor would be FICO (NYSE:FICO), others somewhat related might include alternative lenders like Lending Tree (NASDAQ:TREE).
As you can see below, Upstart's revenue growth has been incredible over the last two years, growing from quarterly revenue of $66.7 million in Q3 FY2020, to $157.2 million.
But this quarter Upstart's revenue was down 31.2% year on year, which might be a disappointment to some shareholders.
Upstart is guiding for revenue to decline next quarter 55.7% year on year to $135 million, a big change on the 247% year-over-year increase in revenue the company had recorded in the same quarter last year. Before the earnings results were announced, Wall St analysts covering the company were estimating revenues to decline 14.6% over the next twelve months.
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. Upstart'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 57.9% in Q3.
That means that for every $1 in revenue the company had $0.57 left to spend on developing new products, marketing & sales and the general administrative overhead. This would be considered a low gross margin for a SaaS company and it has been going down over the last year, which is probably the opposite direction shareholders would like to see it go.
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. Upstart burned through $106.8 million in Q3, with cash flow turning negative year on year.
Upstart has burned through $451.1 million in cash over the last twelve months, a negative 44.9% free cash flow margin. This low FCF margin is a result of Upstart's need to still heavily invest in the business.
Key Takeaways from Upstart's Q3 Results
Since it has still been burning cash over the last twelve months it is worth keeping an eye on Upstart’s balance sheet, but we note that with a market capitalization of $1.51 billion and more than $683.9 million in cash, the company has the capacity to continue to prioritise growth over profitability.
We struggled to find many strong positives in these results. On the other hand, revenue growth has stalled and the revenue guidance for the next quarter missed analysts' expectations. Overall, it seems to us that this was a complicated quarter for Upstart. The company is flat on the results and currently trades at $19 per share.
Is Now The Time?
Upstart may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We cheer for everyone who is making the lives of others easier through technology, but in case of Upstart we will be cheering from the sidelines. Its revenue growth has been exceptional, though we don't expect it to maintain historical growth rates. But while its very efficient customer acquisition hints at the potential for strong profitability, unfortunately its growth is coming at a cost of significant cash burn.
Upstart's price to sales ratio based on the next twelve months is 1.8x, suggesting that the market does have lower expectations of the business, relative to the high growth tech stocks. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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