UiPath: Engaging the Low Code Lever
Q3 2024 ER Update
1.0 The Upcoming Inflection Point
UiPath has two key drivers that promise to increase operating leverage: semantic automation and low code (generative AI). I see no progress on the former since I wrote my deep dive, but plenty on the latter.
When I first studied UiPath, I saw a company with high levels of process power. I continue studying the company with the hope of discerning whether my initial observation is true.
UiPath company has rented out a patch of Microsoft’s real estate, subjecting itself to tremendous existential risk. Much like other companies with commensurate process power, UiPath keeps on doing well against all odds.
In my original UiPath deep dive, I pointed out the two key drivers that will potentially trigger a financial inflection point:
Semantic automation: this will allow UiPath to better understand the workflows and their content, in order to automate tasks of higher value over time.
Low code: this will allow UiPath to democratize access to the platform, by enabling anyone to automate workflows. (Low code enables folks to build things without code).
In combination, the two drivers have the potential to result in a non-linear increase of automation volume/value over time at a marginal cost. This should in turn translate into a higher RoI (return on investment for customers), without UiPath increasing costs much.
In other words, the more UiPath understands things semantically and the easier the platform gets to use, the more money it will make. I believe the odds of the company succeeding in this sense are high, due to the aforementioned process power.
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This quarter I see no particular progress made on the semantic automation front, while UiPath is advancing well on the low code front.
In Q1 2024, UiPath released Clipboard AI, which I identified as the key mechanism via which UiPath was developing semantic automation. Unfortunately, there have been no mentions of the feature in any quarterly call since.
In the Q3 2024 call, CEO David Dines discusses the launch of the next-generation Intelligent Document Processing technology. This technology allegedly speeds up model training time by 80%, quite significant.
But, management makes no explicit mention of what the tech understands within documents.
In the Q&A section, it was nonetheless interesting to hear David Dines discussing his vision for UiPath as a data repository for AIs that help automate work.
Although the company seems to have not made explicit progress on the semantic automation front, it remains true that as the platform automates more work, the potential for further automation increases too:
And going forward on a longer term basis with UiPath are in one of the best positions to build the next generation foundational models that understand processes, tasks, screens and documents, the type of multi-modal that is built in, in order to drive automation. So it's -- to me, it's clear that the world is going into that direction. And again, we are really in a very good position to take advantage of it.
-UiPath CEO David Dines during the Q3 FY2024 call.
On the other hand, management is quite vocal about the “inflection point” to be brought on by generative AI, which will allow folks of decreasing technical expertise to create value from the platform.
In Q3 FY2024, UiPath released platform version 2023.10, which includes a feature called UiPath Autopilot. This feature is “intended to help developers across skill levels build automations faster by leveraging natural language descriptions to generate automation workflows.”
Exactly as I hypothesized in my original deep dive.
I believe this sort of automation will increase gross margins going forward. UiPath incurs costs when deploying its software for clients and providing maintenance. Generative AI is likely to bring those costs down, by removing complexity.
With the feature recently launched, the impact on the financials is yet to materialize. This will be a key element of my analysis going forward.
In the conference call, David Dines shared how they are currently seeing features in the autopilot family impact deployment times directly proportional to deployment costs:
This is always one of our major product focus on how can we shorten the adoption curve for our customers. And we are already seeing with our autopilot family that is in private preview some really good results with the initial set of few hundreds of customers that are testing the product.
In the next section, I review the company’s financial progress and how it’s impacted by the above two drivers. I also analyze what the Q3 FY2024 numbers suggest about UiPath’s battle with Microsoft.
2.0 Converging Financials
UiPath’s resilient metrics, in the face of a much leaner OpEx, point to the idea that it has a sufficiently strong moat to fend off its much larger competitor, Microsoft.
UiPath’s top line growth has stalled somewhat, tracking the broader B2B sales pipeline slowdown that we have seen for the past year and a half. Top line numbers must therefore be normalized for the macroeconomic conditions.
Broadly, this quarter I see key metrics starting to reverse back to the positive.
Net new ARR (annual recurring revenue) has been trending down, although it is up 4.4% with respect to Q3 FY2023, signalling a potential reversal of the trend.
The metric that continues to stand out most for me is dollar-based net retention rate, which despite the tough macro conditions, has remained over 120%. This quarter, the metric came in at 121%, flat QoQ for the first time since Q4 FY2022.
This shows that customers remain satisfied with UiPath, as they continue to expand their usage of the platform.
Although revenue growth has stalled, the company has been tightening OpEx which has yielded a converging bottom line, as evidenced by the inflection point in cash from operations.
I continue to believe that the two drivers analyzed in Section 1.0 will have an outsized impact on UiPath’s ability to produce cash. Certainly, while the possibility of semantic automation remains somewhat esoteric and therefore perhaps unreliable, low code is very much an emerging reality.
And in fact, the same technological driver of low code is bound to eventually yield semantic automation. The core enabler apart from neural nets remains the data, which UiPath is well positioned to continue generating and collecting.
Further, with a positive cash from operations, UiPath is now a much less risky company. However, as I explain in the deep dive, the main risk is that Microsoft can use its distribution advantage to out-muscle UiPath.
Sales and marketing expenses as a % of revenue have declined from 110.46% in Q1 FY2022 to 58.69% in Q3 FY2024. The scenario is starting to paint a picture of resilience.
Leaner operations together with robust retention rates and seemingly rebounding top line suggest UiPath has a stronghold on its distribution. I also don’t see UiPath’s pace of innovation negatively affected by the tighter OpEx.
Simultaneously, SBC (stock based compensation) levels remain moderate versus historical levels, which may indicate that employees are tolerating the tightening OpEx well, thus far.
It is nonetheless hard to tell just how much effort Microsoft is putting on RPA (robotic process automation) currently. What is true, however, is they have the data and they are currently reorienting the organization towards automation, across the board.
Thus, while the risks remain material, I currently believe UiPath’s focus on the two core drivers will generate a resistant moat. Microsoft has an absolute distribution advantage on Crowdstrike, for example, but the latter’s focus has yielded a structural advantage which is keeping the company well ahead.
UiPath is looking good in this sense.
With no debt and just $57.7M in capital leases, UiPath’s $1.82B in cash and equivalents supports a strong balance sheet.
The cash position has been declining steadily for the past few years, including this quarter. However, the pivot to positive cash from operations now considerably de-risks the thesis, as previously mentioned.
At the moment, I continue to lack high signal data points that enable me to truly discern UiPath’s competitive position, especially relative to its primary competitor, Microsoft.
I continue to be impressed with the company’s process power. I consider this quarter’s marginally rebounding top line numbers to be further indication of such, although I am yet to see a bare-knuckles encounter with Microsoft.
Until I see such an encounter, or an analogous scenario, I cannot be quite sure whether UiPath is indeed part and parcel of the modern Innovation Stack.
Meanwhile, the market is certainly not amiss of UiPath’s apparent organizational excellence, with the stock trading at just over 10 times sales. For me to initiate a large position, I not only need to gain clarity on the Innovation Stack, but also see the market disdaining the stock.
Until next time!
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