Freshworks Inc. — Q3 2021 Form 10-Q
Business and period: Freshworks provides cloud-based SaaS products for customer experience, IT service management, and CRM. This unaudited report covers the three and nine months ended September 30, 2021; comparisons are with the corresponding 2020 periods.
Financial and operating performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $96.6 million | $66.2 million | $265.5 million | $176.7 million |
| Gross margin | 77% | 80% | 78% | 79% |
| Operating loss | $140.3 million | $0.1 million operating income | $148.4 million | $52.7 million |
| Net income (loss) | $(107.4) million | $1.4 million | $(117.3) million | $(55.8) million |
| Operating cash flow | $(2.0) million | $12.8 million | $6.6 million | $19.0 million |
| Free cash flow (non-GAAP) | $(4.2) million | $10.3 million | $(0.5) million | $11.6 million |
Revenue was driven by customer additions, increased agent seats, and additional product sales to existing customers. Subscription revenue was $94.3 million of Q3 revenue. Customers contributing more than $5,000 in ARR increased 31% to 14,079; net dollar retention was 117%, versus 109% a year earlier.
At September 30, cash and cash equivalents were $1.180 billion and marketable securities were $146.6 million. Current assets were $1.422 billion and current liabilities were $201.4 million. Total liabilities were $219.6 million; the balance sheet reports no debt. The company said existing cash, equivalents, and marketable securities should fund working capital and capital expenditures for at least 12 months.
Remaining performance obligations were $199.0 million, including $143.2 million of deferred revenue and $55.8 million of unbilled amounts; $159.3 million was expected to be recognized within 12 months.
Material changes and unusual items
- Revenue grew 46% in Q3 and 50% for the first nine months. Gross margin declined 3 percentage points in Q3 and 1 point year to date.
- Operating expenses rose sharply, primarily reflecting higher headcount and IPO-triggered stock compensation. Q3 stock-based compensation was $124.3 million; related employer payroll taxes on employee stock transactions were $13.4 million.
- The September IPO issued 31.35 million Class A shares at $36 per share. Net proceeds after underwriting discounts and offering expenses were approximately $1.06 billion. Preferred shares converted to Class B common stock.
- Q3 interest and other income included a $23.8 million gain on the sale of a private-company investment. This nonrecurring gain materially boosted reported non-operating income.
- Common-stockholder net loss and loss per share were substantially affected by preferred-stock accretion: $2.265 billion in Q3. This is distinct from the $107.4 million GAAP net loss for the quarter and is not an operating expense.
- The CEO received a performance-based award of 6 million RSUs with a $131.0 million grant-date fair value. Unrecognized stock-based compensation was $612.1 million at quarter-end.
Outlook, risks, and contingencies
No specific revenue or earnings guidance is provided in the supplied filing text. Management said it expects research and development, sales and marketing, and general and administrative expenses to continue increasing in dollar terms, and does not expect near-term profitability. It prioritizes growth and customer success over short-term profitability. The company expects net dollar retention may decline from the reported 117% and may fluctuate.
Management identified COVID-19 uncertainty, competition, customer retention and expansion, execution of product development and growth plans, and dependence on India-based operations as risks. The filing also describes the April 2021 Codecov vendor incident: an attacker accessed source code and limited customer information, including some business contact information and credentials; Freshworks reported no evidence of sensitive customer data exposure or source-code modification. A Zoho trade-secret and related lawsuit remained pending; management said it intended to defend the case and did not expect pending proceedings to have a material adverse effect, while noting outcomes are uncertain.
The company reported no material change in contractual commitments, no material off-balance-sheet arrangements, and no pending legal proceeding it believed would materially affect the financial statements. It disclosed $48.5 million of outstanding third-party cloud and service commitments through 2024. The dual-class structure gives Class B shares ten votes each; pre-IPO holders collectively held approximately 79.7% of voting power as of September 30.
Key facts for investors to verify
- Separate the underlying operating trend from IPO-related stock compensation, equity payroll taxes, the investment-sale gain, and preferred-stock accretion.
- Track whether revenue growth, customer additions, and 117% net dollar retention persist, and whether the company’s stated expectation of lower future retention materializes.
- Monitor operating cash flow and free cash flow, which weakened year over year despite substantial revenue growth.
- Assess the future expense and dilution impact of $612.1 million in unrecognized stock compensation, outstanding RSUs, and the CEO performance award.
- Follow developments in the Codecov incident and Zoho litigation, along with COVID-19, cybersecurity, regulatory, and India-related exposures.
- Consider the voting control of Class B holders and potential share supply from IPO lock-up expirations and equity awards.