UiPath’s core product is UI-based automation and they’ve recently acquired Cloud Elements to add API-based automation. The software robots are able to work across programs in the background, build applications, send emails and interact with chatbots. Although making AI/ML actionable is UiPath’s sweet spot, the trend towards low code/no code is also a tailwind for UiPath. We know the AI-bellwether Nvidia has led the market this year, which helps us gauge where we are in the AI cycle as semis must move first. Therefore, Nvidia helps provide evidence that we are early to UiPath (unlikely automation moves exactly in sync with GPUs) and the goal will be to remain invested through the ups/downs as the story unfolds.
I had posted on the forum my thoughts on the decelerating revenue and why the unique business model and change in billing terms is causing the top line to look weaker than the company actually is. Management emphasizes to focus on ARR and we break down why that’s important. Although a change in billing terms can be seen as a weakness, we don’t think this is the case as the change in terms could open up the company to more customers who aren’t willing or able to pay up front. We had outlined in our original analysis that UiPath is an expensive product with a customer concentration at the enterprise level. Customer growth above $1 million was up 100%, therefore, UiPath is showing strength in its core customer base. However, UiPath is now ready to invest at the citizen developer level in the Studio X product.
Earnings Overview
This section posted on the forum Thursday, September 16th:This section posted on the forum Thursday, September 16th:posted on the forum Thursday, September 16th:
UiPath beat and raised guidance, so there was no issue here. Rather the issue is the company’s growth is decelerating and this is raising some question marks as to how long the deceleration will continue. The market is forward looking, and in this case, the market is pricing in lower growth. The guidance does not fully illustrate the deceleration in licensing and deferred revenue. We break this down for you below.
First, I want to talk about UiPath’s unique business model which is to license software robots and then charge for support and maintenance. Here is the difference as outlined in the S-1 filing:
Licenses:
We sell term licenses which provide customers the right to use software for a specified period of time. From time to time, we also sell perpetual licenses that provide customers the right to use software for an indefinite period of time. For each respective type of license, revenue is recognized at the point-in-time when the customer is able to use and benefit from the software, which is generally upon delivery to the customer or upon the commencement of the renewal term.
Maintenance and Support:
We generate maintenance and support revenue through technical support and the provision of unspecified updates and upgrades on a when-and-if-available basis for both term and perpetual license arrangements. Maintenance and support for perpetual licenses is renewable, generally on an annual basis, at the option of the customer. Maintenance and support represents stand-ready obligations for which revenue is recognized ratably over the term of the arrangement.
The reason the company emphasizes ARR as the key metric to focus on is because it accounts for UiPath’s upgrade-heavy business model and it shows the strength from retention. Expansion revenue is essentially what drives UiPath rather than yearly subscriptions alone (revenue). Once a company licenses software robots from UiPath, they are more likely to license more software robots over time and to need more maintenance and support. This upgrade cycle is unique from other cloud companies that have only specific cohorts they can upgrade and are more focused on yearly subscriptions (i.e., Pro Plan to Enterprise Plan, etc.).
Management at UiPath is communicating that the ARR forecast is more important than the revenue forecast as it accounts for the upgrades they are expecting. The dollar based net retention rate for the company is very high at 144%. Evidence of the expansion revenue model is also seen in the company’s lifetime value which is 233X for the top 25 customers and 62X for the top 100 customers. UiPath’s customers are enterprise customers with large budgets, which is why we saw the $1 million+ ARR cohort up 100% this quarter and those accounting for $100,000+ ARR up 59% this quarter.
Why UiPath Sold Off Despite a Beat:
Given what analysts know about Q3 guidance, the current projections for fiscal year 2022 is at 44%, which is down from 81% in the last fiscal year. We’ve included the analyst projections for the following year, which right now are at 34% growth to $1.17 billion.
However, the ARR hints towards stronger revenue growth in the future. For fiscal year 2021, revenue of $608,000 exceeded ARR of $580,400. This year, we are seeing ARR slightly outpace revenue if we based revenue projections on analyst consensus. While revenue is forecast to grow 44% this fiscal year, ARR is forecast to grow at 51%. Historically, UiPath’s revenue exceeded ARR.
Another explanation for why we are seeing the lapse between ARR and revenue is that the CFO mentioned a change in terms of how the company bills. In the past, the company billed multi-year deals all at once, and instead, they are shifting towards billing annually. The management stated the reason is that it allows more upgrades as their customers’ needs change and it results in less up front from their customers. In the example provided, instead of buying 10,000 robots at once, they would buy 1,000 and then 5,000 and then 10,000 with the new billing structure with the revenue realized across three years rather than realized in one year.
Here is the quote about the difference between revenue guidance and ARR: “So when I talk about an annual ramping contract, one of the things that is really positive for us is digital transformation is a long-term trend. And what has happened with the strength of UiPath’s platform is automation is a staple for the long-term requirements for customers to transform the way they work in digital transformation. So what that means is instead of buying simple annual contracts, what we see a larger demand for is getting larger term commitments from some of our customers. But the way they look at that is instead of buying 10,000 robots today, they may buy 1,000 robots today, 5,000 next year, 10,000 in year three. And those – the license deliveries would happen into those years as we go down.
And so, one of the things that we look at is that we like that because that is better ROI for our customers. And I – when we think about the impact on financial metrics, two things. One is remember, we – and I repeat this, we really drive our company to ARR. From an ARR perspective, there is no impact that is there. Based on the way the contracts are structured, if license delivery happens in the out years, then that does have – that creates variability in revenue because we only can recognize the revenue upon delivery of the license. And so that is kind of the way that I think about it from a modeling perspective on revenue. But again, I stress ARR really, there is no impact, and that’s how we drive the business.”Based on the way the contracts are structured, if license delivery happens in the out years, then that does have – that creates variability in revenue because we only can recognize the revenue upon delivery of the license. And so that is kind of the way that I think about it from a modeling perspective on revenue. But again, I stress ARR really, there is no impact, and that’s how we drive the business.”
This change in how customers are billed likely led to lower licensing revenue in the current quarter of 20% growth compared to 72% growth from the fiscal year (not apples-to-apples comparing Quarterly to Fiscal Year but helps provide color). This is down from 57% last fiscal quarter ending in April. We see evidence that those licenses will be recognized in future quarters not only in ARR but also in support and maintenance growth, which is recognized ratably and grew 74% year-over-year compared to 79% in the quarter ending in April. In other words, customers aren’t falling off or downgrading rather they are paying for licenses across many years rather than pre-paying.
Expanding on Earnings:
UiPath reported revenue of $195.5 million compared to the consensus for $184.3 million. This represents 40% growth year-over-year compared to 65% growth in the prior quarter. EPS also beat at $0.01 compared to a consensus of ($0.05) EPS. UiPath has a total of 9,100 customers with 600 added in the recent quarter. The company also has 4,700 partners after adding 400 in the most recent quarter. The Partner Network is part of our thesis on UiPath and we think this number carries significance in terms of a defensible position. This quarter, the company highlighted its partnerships with Alteryx and Smartsheet.
The company’s adjusted gross margins are at 86% in the most recent quarter with adjusted free cash flow at a loss of $3.5 million. As stated, licensing revenue slowed down with the revenue mix being $95.5 million in licenses compared to $79.5 million in the year-ago quarter. Maintenance and other Support was at $90.3 million compared to $51.9 million in the year-ago quarter.
We believe the management is correct in focusing on ARR. As stated above, revenue typically exceeds ARR. Therefore, if we draw conclusions based on the historic performance of the company, the revenue growth would be above 60% in this quarter and above 51% in future quarters. In addition, net new ARR was up 33%. We will need to see how long it takes before the company absorbs the change in billing terms, but due to where we are in the AI cycle, we prefer to be patient. If this was cloud software, which is moving towards consolidation, we would be more concerned. Hopefully, the above section explains why we are not concerned at this time.
Guidance came in higher than expected at revenue of $208 million at the midpoint compared to consensus of $206 million. The guide in ARR was at 54% next quarter and at 51% growth for the fiscal year. When asked if the raised guidance was from a demand signal, the company pointed towards their Net Retention Rate, which remained robust at 144%, indicating that demand for their products has remained strong.
From my perspective, UiPath has very few comparables on the market but we can lump the company in with cloud software with the understanding that cloud software’s growth reflects a mature market while UiPath’s does not. Forward fiscal year P/S is at 32 based on $874 million consensus estimates for this year and 1-year forward is at 24 if based on consensus estimates of 1.17 billion. We think this is a reasonable valuation for a company that is at the forefront of automation, which is one of the least-hyped yet most practical commercial uses for AI and ML. However, the full lockup is next month and we had stated in our initial coverage on UiPath and reiterated across other analysis that even the most quality companies come under pressure from insiders and early investors needing an exit.
Of the companies pictured above, ZS, TEAM and NET have similar forward revenue growth and we can see they are fetching much higher valuations. It will be interesting to see how this unfolds if UiPath’s revenue does indeed catch up to ARR and enterprise customer growth.
Product Catalysts:
The focus of this update has been primarily on the financials as we’ve written a deep dive on the product, which you can find here.
UiPath has a few catalysts this fall, including releasing attended robots for the Linux operating system and also for Mac users. Mac OS users make up roughly 17% compared to Windows, there is a higher concentration of Mac users among citizen developers and also in enterprises in the tech industry. Linux makes up a very tiny portion of overall operating system market share at less than 2% yet dominates cloud infrastructure at 90% penetration. In 2021, 100% of the world’s top 500 supercomputers ran Linux. Here are the releases the company has planned including a web-based version of StudioX:
Now, we continue to invest in StudioX as a major tool to foster the community of citizen developers. We are going to extend it also to be available multi-platform. So, you will expect quite a bit of investment from us in the coming few quarters. It’s – right now, we are doing really a major advance into multi-cloud and multi-platform. And we are launching Linux-based robots. We just announced yesterday the public review available. We are launching Mac support. We are going to launch early next year, the web-based StudioX that will make it even easier to adopt. But overall, we really believe that it’s important to have a suite of tools that cater to a large array of options from professional developers to citizen developers and to all business users.
Conclusions:
The lockup for UiPath happened in tranches after the first fiscal quarter results and also following the second fiscal quarter results, per the S-1 filing, with some restrictions. The full lockup with no restrictions occurs on October 18th. This is likely weighing on shares more than anything in the current ER as some shares were up for lockup expiration at the time of fiscal Q2. Participating in IPOs rarely works out in the first few months of the listing unless you’re actively trading, which we stated clearly in the original write-up on UiPath. However, we decided to add this to LTBH to show our seriousness in building AI positions.
With that said, we will likely hold off on Confluent until post-lockup. You’ll get this analysis soon to set the stage for why we are building MDB, ESTC and eventually CFLT as a package as we think there’s an important trend bubbling beneath the surface. Keep an eye for this deep dive end of next week.
