Freshworks Inc. — Q3 2022 Form 10-Q
Business context and period. Freshworks provides cloud-based SaaS products for customer experience, IT service management, sales and marketing. This unaudited report covers the quarter and nine months ended September 30, 2022; comparisons are with the same 2021 periods.
Financial performance and liquidity
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $128.8m (+33%) | $96.6m | $364.8m (+37%) | $265.5m |
| Gross margin | 81.2% | 77.0% | 80.6% | 78.3% |
| Operating loss | $(58.3)m | $(140.3)m | $(172.8)m | $(148.4)m |
| Net loss | $(57.8)m | $(107.4)m | $(176.7)m | $(117.3)m |
| Operating cash flow | $(4.2)m | $(2.0)m | $(9.7)m | $6.6m |
| Free cash flow | $(7.2)m | $(4.2)m | $(18.8)m | $(0.5)m |
At September 30, 2022, cash and cash equivalents were $432.3m and marketable securities were $719.2m, totaling about $1.15bn. Current assets were $1.27bn and current liabilities $252.4m. No borrowings or financial debt are reported in the presented balance sheet. Total liabilities were $303.1m, including $30.0m of operating lease liabilities. Accumulated deficit was $3.45bn.
Deferred revenue was $191.0m. Remaining performance obligations were $277.4m, including $86.4m unbilled; $218.7m was expected to be recognized within 12 months. Nine-month stock-based compensation expense was $150.7m, and unrecognized compensation expense was $623.2m.
Material changes versus prior periods
- Q3 revenue rose 33%, driven by customer additions, more agents and additional product sales to existing customers. Subscription revenue was $125.5m; professional services were $3.3m.
- Gross margin improved to 81.2% from 77.0%, with management citing scale benefits, particularly in hosting costs.
- Q3 operating expenses fell 24% year over year, mainly because stock-based compensation was lower than in the prior-year period. By contrast, nine-month operating expenses increased 31%, reflecting higher personnel costs, sales and marketing activity, and stock compensation.
- Q3 GAAP operating loss narrowed, but non-GAAP operating loss was $3.1m versus $1.5m a year earlier; nine-month non-GAAP operating loss widened to $19.5m from $7.5m.
- Net dollar retention declined to 107% from 117%. Customers contributing more than $5,000 in ARR increased 19% to 16,713.
- Nine-month operating cash flow shifted from $6.6m provided to $9.7m used. Financing cash outflow included $151.7m of tax withholding on net share settlements of equity awards. Cash and cash equivalents declined from $747.9m at year-end 2021, while marketable securities increased.
Outlook, risks and unusual items
- No specific numeric revenue or earnings guidance is provided in this filing. Management said the stronger U.S. dollar—particularly against the euro and British pound—was expected to lower revenue growth compared with past results. About 26% of revenue was exposed to those currencies; the company had not entered into currency hedges.
- Management stated existing cash, cash equivalents and marketable securities should cover working capital and capital expenditure needs for at least 12 months. Longer-term funding may also depend on operating cash flow and, if needed, equity or debt financing.
- Management cited inflation, market volatility, geopolitical conflict and pandemic-related uncertainty as potential pressures on demand, sales cycles, subscription values, collections, customer expansion and retention. Freshworks also relies primarily on Amazon Web Services for cloud infrastructure.
- Other contractual commitments were $113.1m, principally cloud infrastructure and service subscriptions, in addition to $30.0m of lease commitments. No pending legal proceeding was identified as likely to have a material adverse effect.
- Comparability is affected by unusual prior-year items: Q3 2021 included a $23.8m gain on sale of a non-marketable investment and substantial IPO-related preferred-stock accretion in the per-share calculation. The company also recorded $8.0m of nine-month unrealized losses on marketable securities in 2022. Lease accounting was adopted January 1, 2022, adding right-of-use assets and lease liabilities; comparative periods were not restated.
Important facts for investors to verify
- Whether revenue growth and customer expansion can persist as net dollar retention falls and currency headwinds weigh on reported growth.
- How much of the improvement in quarterly GAAP operating loss reflects lower stock-based compensation rather than durable operating leverage; compare GAAP and non-GAAP results.
- Whether operating cash flow and free cash flow improve, given nine-month cash usage and the substantial cash tax withholding on equity awards.
- The composition, maturity profile and valuation sensitivity of the $719.2m marketable-securities portfolio, including unrealized losses.
- Execution and cost implications of the $113.1m contractual commitments, lease obligations, and significant unrecognized stock-based compensation.