Freshworks Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023; unaudited. Freshworks sells cloud-based SaaS products for customer experience, IT service management, sales, marketing, and messaging. Revenue is primarily subscription-based.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $145.1 million | $121.4 million | $282.8 million | $236.1 million |
| Gross margin | 83% | 80% | 82% | 80% |
| Operating loss | $43.3 million | $67.4 million | $91.4 million | $114.5 million |
| Net loss | $35.7 million | $69.8 million | $78.3 million | $118.8 million |
| Net loss per share, diluted | $0.12 | $0.24 | $0.27 | $0.42 |
| Operating cash flow | $19.9 million | $(6.8) million | $31.4 million | $(5.5) million |
| Free cash flow | $18.1 million | $(10.2) million | $27.2 million | $(11.6) million |
Q2 revenue grew 19% year over year, led by subscription services, up 20%; six-month revenue grew 20%. Q2 non-GAAP operating income was $11.7 million and non-GAAP net income was $19.8 million, compared with losses of $15.8 million and $17.6 million, respectively, in Q2 2022. These non-GAAP measures exclude, among other items, substantial stock-based compensation.
At June 30, cash and cash equivalents were $356.2 million and marketable securities were $804.6 million. Total current assets were $1.303 billion and current liabilities were $291.6 million. Total liabilities were $342.7 million, including operating lease liabilities; the filing reports no borrowings or debt balance. Accumulated deficit was $3.6 billion. Management said available cash, equivalents, and securities should cover working capital and capital expenditure needs for at least 12 months.
Changes and operating trends
- Gross margin improved by 3 percentage points in Q2 and 2 points for the first half, which management attributed to revenue scale and cost-structure initiatives.
- Operating expenses were down 1% in Q2 year over year, but up 7% for the first half. Q2 sales and marketing expense declined 2%; first-half sales and marketing expense increased 8%, primarily from personnel and stock-based compensation costs.
- Net dollar retention fell to 108% from 111% a year earlier, reflecting lower expansion among existing customers amid macroeconomic pressure. Customers contributing more than $5,000 in ARR increased 18% to 19,105.
- Interest and other income rose materially, largely because of higher portfolio balances and interest rates. Q2 interest and other income was $11.2 million versus expense of $0.2 million a year earlier, supporting the improvement in net loss.
- Stock-based compensation was $54.2 million in Q2 and $104.9 million for the first half, versus $50.1 million and $96.8 million, respectively. Unrecognized compensation expense totaled $533.8 million at quarter-end.
Outlook, risks, and contingencies
The filing provides no specific revenue or earnings guidance. Management expects operating expenses to increase in dollars in the foreseeable future, while generally declining as a percentage of revenue over the longer term; it also expects continued investment in product development, sales, marketing, infrastructure, and customer support. Management cautions that subscription-model effects from economic conditions may emerge with a lag.
Risks discussed include macroeconomic uncertainty and customer spending, foreign-exchange volatility, competition, and reliance on Amazon Web Services. About 27% of Q2 revenue was exposed to the euro and British pound. Freshworks had $43.6 million notional in foreign-exchange forwards to hedge some forecast Indian-rupee expenses; derivative fair values and gains or losses were not material. The company also disclosed interest-rate and investment valuation risks.
Outstanding contractual commitments were $112.5 million: $30.0 million of operating lease obligations and $82.5 million under cloud infrastructure and service agreements. A securities class action alleging IPO offering-document misstatements is pending on a motion to dismiss; a related derivative action is stayed. The company says it intends to defend the claims and does not believe pending proceedings will materially adversely affect its financial statements.
Important facts for investors to verify
- Whether revenue growth and customer expansion can hold up as net dollar retention declines and macroeconomic pressures continue.
- How much reported improvement in losses and cash generation depends on non-GAAP exclusions, noncash compensation, deferred revenue movements, and interest income.
- The pace of stock-based compensation, future dilution, and recognition of the $533.8 million unrecognized expense balance.
- The performance and liquidity profile of the $804.6 million marketable-securities portfolio, including its interest-rate and credit exposures.
- Developments in the IPO-related litigation, the $82.5 million contractual commitments, and reliance on AWS and foreign-currency hedging.