Freshworks - Q3 2023

Transcript

Operator (participant)

Hello, and welcome to the Freshworks Q3 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising that your hand has been raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. It is now my pleasure to introduce Vice President, Investor Relations, Joon Huh.

Joon Huh (VP of Finance & Investor Relations)

Thank you. Good afternoon, and welcome to Freshworks' Q3 2023 earnings conference call. Joining me today are Girish Mathrubootham, Freshworks' Chief Executive Officer, Dennis Woodside, Freshworks' President, and Tyler Sloat, Freshworks' Chief Financial Officer. The primary purpose of today's call is to provide you with information regarding our Q3 2023 performance and our financial outlook for our Q4 and full year 2023. Some of our discussion and responses to your questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on Freshworks' current expectations and estimates about its business and industry, including our financial outlook, macroeconomic uncertainties, management's beliefs, and certain other assumptions made by the company, all of which are subject to change.

These statements are subject to risks, uncertainties and assumptions that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks include, but are not limited to, our ability to sustain our growth, to innovate, to reach our long-term revenue goals, to meet customer demand, and to control costs and improve operating efficiency. For a discussion of additional material risks and other important factors that could affect our results, please refer to today's earnings release, our most recently filed Form 10-K and Form 10-Q, our Form 10-Q for the quarters ended March 31, 2023, and June 30, 2023, and our other periodic filings with the SEC. Freshworks assumes no obligation to update any forward-looking statements in order to reflect events or circumstances that may arise after the date of this call, except as required by law.

During the course of today's call, we will refer to certain non-GAAP financial measures. Reconciliations between GAAP and non-GAAP financial measures for historical periods are included in our earnings release, which is available on our investor relations website at ir.freshworks.com. I encourage you to visit our investor relations site to access our earnings release, supplemental earnings slides, periodic SEC reports, a replay of today's call, or to learn more about Freshworks. With that, let me turn it over to Girish.

Girish Mathrubootham (CEO)

Thank you, Joon, and welcome everyone. Thank you for joining us today on Freshworks earnings call covering our Q3 of 2023. We delivered another solid quarter of execution as we outperformed our previously disclosed estimates across our key financial metrics. Our revenue exceeded the high end of our financial outlook range, coming in at $153.6 million for the quarter. We surpassed our estimates for free cash flow with $22.1 million in Q3, and we improved our free cash flow margin to 14%. We also held our first Investor Day in September, where we showcased our products and outlined the path that we believe will drive us towards becoming a billion-dollar company and beyond. Freshworks continues to reap the benefits of three industry tailwinds. Businesses of all sizes are having to transform to compete digitally.

Expectations for customer and employee experience are evolving to center around modern messaging, and AI is breaking down silos, offering richer insights to help businesses understand much more about their customers and employees. This quarter, in particular, we added new generative AI capabilities across products and opened up our Freddy Insights beta program, following Freddy Self-Service and Freddy Copilot in Q2, which is intended to unlock more value out of our existing product suite. You'll hear me talk about AI quite a bit today, starting with customer support. I'm really excited by the traction we have been seeing since launching our Customer Service Suite in August. It's our all-in-one solution to combine bot, modern messaging, and ticketing.

In the first two months, our sales team signed on more than 200 Customer Service Suite customers from new and existing customers, and we are seeing higher levels of engagement with the product than with Freshchat alone. The suite not only saw great traction with new customers, but also with long-standing ones, including a large U.S. TV network and a high-fashion jewelry company, who decided to migrate to help them scale self-service features with our bot capabilities. An early adopter of the Customer Service Suite, Pathway Careers in South Africa, delivers over 16 million parcels annually to an area nearly twice the size of Texas. The company is growing but found its previous provider offering a disjointed customer service experience across different channels.

Now, with the customer service suite, agents are able to better address this issue and handle live chats with automation and gain deep insights into ticket trends. We continue to invest in cutting-edge AI capabilities for our customer support users. In our initial beta for Freddy Copilot, we were predominantly focused on driving agent productivity. We have heard great feedback from our customers, including Monos, a luxury luggage brand we featured during our Investor Day. Thomas Cook, a popular global travel company in the UK, using Freshdesk since 2021, and iCorp, a business process outsourcing company with 40,000 employees, are beta testing Copilot features to further enhance agent productivity. Freddy Copilot adoption and usage among customer service customers increased meaningfully from Q2. In Q3, we continued to see growing demand for our IT product with mid-market and enterprise customers.

We win with a unified service operations platform that enables customers to improve service reliability. Our customers, including Child Hope Group, Valley Children's Healthcare, and Travelopia, see great value in our unified product. ITOM, in particular, is gaining traction with momentum for Freshservice's major incident management feature. We added new capabilities to this feature, and the customer base is growing. Almost 1,500 customers now take advantage of post-incident reports, automated major incident creation via alerts, and organizational updates through a branded status page. We continue to harness the power of generative AI to enable IT and other business users to focus on high-value work by using auto-generated ticket summary and ticket response suggestions. Our newest beta release includes Gen AI-powered virtual agent that eliminate forms to create a more conversational experience for employees.

Early adopters of these new AI features for Freshservice include existing customers, Restaurant365 and Confluent Health. Freshservice customer adoption of these features has more than doubled since Q2. Through our continued innovation to meet the IT needs of large enterprises and the mid-market, we believe we are increasing mindshare with CIOs and anticipate that this will enable us to execute on the broader ITSM opportunity. On to sales and marketing. We continue to execute on our vision of delivering an easy-to-use, quick-to-set-up smart CRM that assists sales teams in generating leads, increasing conversion, and accelerating revenue. In Q3, we made improvements to the inbound experience in our sales and marketing products. We revamped the UI of Freshsales to improve user efficiency, productivity, and data accessibility. The upgraded interface for sellers helps boost context, AI-powered action, and team collaboration for faster deal closure.

For example, a local cabinet maker in Georgia named Click Studios uses both Freshsales and Freshdesk to help support and sales teams to collaborate better, which has helped Click Studios improve its sales cycle by up to 35%. We also continue to strengthen our AI capabilities for marketers to improve campaign creation, while boosting efficiency, conversion rates, and customer satisfaction. In summary, Q3 innovation was centered around unlocking more productivity for our customers through AI-powered customer service, IT, and sales and marketing products. And we will continue building and offering richer insights to help businesses understand their customers and employees. Now, over to Dennis, who will give more detail on the opportunities we are realizing with customers and the ongoing impact of changes we are making to our GTM operations.

Dennis Woodside (President)

Thanks, Gee, and thank you, everyone. We appreciate you joining us for today's call. As we talked about at our Investor Day, on top of product innovation, a few key growth drivers are helping us deliver on our targets for revenue, operating profit, and free cash flow. Let me provide some highlights from Q3. Firstly, our unique go-to-market approach efficiently serves the Fortune 5 million, combining an efficient inbound sales motion, growing field sales presence, and a partner ecosystem that's built to scale. Large customers like Tri Pointe Homes and Qualfon turn to Freshworks, along with mid-market customers like Salvation Army Australia, ASPCA, and Jackson Family Wines. We added nearly 1,000 net customers in the quarter, resulting in a total of over 66,600. While we're addressing companies of all sizes, we're also targeting larger, higher-yielding customers.

In Q3, Freshworks customers paying us over $50,000 in ARR grew 32% year-over-year, or 30% on a constant currency basis. This cohort continues to represent 46% of our ARR as larger customers fuel the growth of our business. One example, a national home builder, has $4 billion in annual sales and 6,000 employees. They needed a consolidated platform that manages ticketing, ITSM, and asset management to improve their efficiency, given each of those was previously managed in disparate systems. They chose Freshservice and added marketplace integrations to help them scale their global service management needs. Another large company using Freshservice is Qualfon, a leading business processing outsourcer with fifteen thousand employees. They used a legacy provider's ITSM tool for years, but it never delivered on automation.

Qualfon chose Freshservice because it is easy to use and supports employee needs right out of the gate. They can now automate over 2,000 requests per month and saw an average resolution time improvement of 70%. Looking at our opportunity for expansion, higher rates of multi-product adoption with larger customers are contributing to this growth driver. In Q3, 25% of our total customers used more than one product. In our larger customers, we're finding more than half of our $50,000+ ARR customers are using multiple products. One example is Giant Eagle, a retailer with more than 470 stores and approximately 36,000 team members. Giant Eagle chose Freshservice for its user-friendly, results-driven platform, and this summer introduced Freshchat to better measure employee engagement.

Building off an encouraging increase in self-service among team members, Giant Eagle is now eager to integrate other communication platforms like Text. Western Financial Group is another great example of Freshservice to Freshchat expansion. The Canadian insurer needed an enterprise tool to allow support teams to collaborate and respond effectively to frontline teams, keeping data and reporting separate. Moreover, they wanted to unlock tools for change, problem, and asset management, and CMDB. They chose Freshservice because of its vast automation opportunities, ease of use, and clean interface. Most recently, they have expanded and begun using Freshchat. Turning to our SMB opportunity, this remains large. As Gee mentioned earlier, we're taking advantage of that by enhancing our inbound motion with a view to driving higher conversions and attracting stickier customers.

We saw encouraging signs in the SMB segment in Q3 as the churn rate improved year-over-year and also quarter-over-quarter. Millions of SMBs need to adopt AI and automation now to stay competitive, and we believe AI can greatly simplify customer and employee experiences. Underscoring this, many of our AI beta customers today are SMB and mid-market companies, including Ultrafabrics, an early pioneer of socially conscious fabric manufacturing, Jacob Stern and Sons, a distributor of specialty agricultural products since 1850, and Virtual Identity, a digital creative agency. Each of these customers uses Freddy Self-Service to automate level zero and level one support with modern virtual agent conversations. We're embedding AI capabilities across our products as this is a critical growth driver for us.

New features include contact scenario for Freddy Insights, which analyzes top contact scenarios in tickets and conversations and helps deploy bots for them. This is just one of many enhancements we released with Freddy AI to deliver more value to our customers in Q3. Our plan is to monetize increased automation through bot sessions in a consumption or usage-based model. As automation frees up agents to focus on higher value work, we can also assist with our Copilot add-on that helps them be more productive. Our continued traction with larger customers over $50,000 in ARR, combined with our expansion motion and large SMB opportunity, create a go-to-market motion unique to Freshworks. We believe it is this combination of growth levers that gives us confidence in our ability to reach our goal of $1 billion in revenue in the next three years.

I'm also excited to announce the upcoming appointment of a new management team member, who will be crucial in helping us reach that big goal. Mika Yamamoto will join us as Chief Customer and Marketing Officer on November twentieth. Mika has proven executive leadership experience at large public tech companies with deep technology, sales, and marketing experience, serving multiple buyers that are relevant to Freshworks. She was most recently the Chief Customer Experience and Marketing Officer of F5, and was previously the President of Marketo, Chief Digital and Marketing Officer at SAP, and held senior roles at Amazon, Gartner, and Microsoft. Now over to Tyler to go through the Q3 financials and talk about how we're driving efficiency.

Tyler Sloat (CFO)

Thanks, Dennis, and thanks again to everyone for joining us. Before I get started, I want to thank you once again to everyone who attended our first Investor Day. It was great to spend time with many of you in person and to provide an update on the Freshworks story. Once again, we had another quarter of good execution in Q3. We beat our revenue growth estimates and continued driving additional leverage in the business to expand both non-GAAP, operating, and free cash flow margins quarter over quarter. We continue to realize the financial benefits resulting from the operational changes made earlier in the year, and we're creating a healthier position to drive profitable long-term growth for the business. For our call today, I'll cover the Q3 financial results, provide background on the key metrics, and close with our forward-looking commentary and expectations for Q4 and the full year 2023.

I'll also include constant currency comparisons for certain metrics to provide a better view of our business trends. As a reminder, most of our discussion will be focused on non-GAAP financial results, which exclude the impact of stock-based compensation expenses and other adjustments. Starting with the income statement, revenue grew 19% year-over-year to $153.6 million on a reported basis, and 18% adjusted for constant currency, as we're beginning to see the positive impacts on currency rates for the euro and pound against the dollar over the past year. ITSM deal activity continued to drive much of the growth in Q3, while expansion rates ticked down slightly in the quarter. Turning to margins, we had another strong quarter of non-GAAP gross margin of 84% as we efficiently scale the business.

In Q3, we achieved a non-GAAP operating margin of 11%, which represents a 3 percentage point improvement quarter-over-quarter. This is driven by lower than expected headcount-related costs, some delays in spend, and ongoing improvements on operating expenses. Turning to our operating metrics, we have two key business metrics, net dollar retention and customers contributing more than $5,000 in ARR. Net dollar retention was 108% in the quarter, which includes a 2 percentage point benefit from FX. In Q3, our overall churn came better than our initial estimates, slightly improving from the prior quarter. Looking ahead, we are planning for the lower net expansion trends to persist for the remainder of the year, as we expect net dollar retention to be approximately 105% for both constant currency and as reported in Q4.

Moving to our other key business metric of number of customers contributing more than $5,000 in ARR. This metric grew 17% year-over-year to 19,551 customers in the quarter and continues to represent 88% of our ARR. On a constant currency basis, this customer metric grew 16% year-over-year. For our larger customer cohort, contributing more than $50,000 in ARR, this cohort grew 32% year-over-year to 2,268 customers and represents 46% of our ARR. Adjusting for constant currency, this cohort grew at 30%. We added nearly 1,000 net customers in the quarter, which was an increase from Q2.

We ended the quarter with a customer count of approximately 66,600 as we continued our focus on attracting higher-yielding customers and building a healthier base and driving a higher ARPA. Moving to calculated billings, balance sheet and cash items. Calculated billings grew 21% year over year to $165.3 million and 19% on a constant currency basis. Factors including timing, duration of contracts, and revenue reserves in the quarter, created a slight benefit of 1% to these growth numbers. Looking ahead to Q4 2023, our preliminary estimate for calculated billings growth is 18% as reported and 17% on a constant currency basis. For the full year 2023, we expect calculated billings growth to be similar to our expected annual revenue growth of approximately 20% for both as reported and constant currency.

During the quarter, we generated $22.1 million in free cash flow, ahead of our estimates and reflective of the efficiency improvements we're making in the business. We ended the quarter with a similar balance for cash, cash equivalents, and marketable securities of $1.16 billion. We continued to net settle vested equity amounts using $24 million during the quarter, which is reflected in financing activities, and this activity is excluded from free cash flow. As we look forward to Q4, we plan to continue net settling vested equity amounts, resulting in Q4 cash usage of approximately $18 million using current stock price levels. For the year, we expect to use approximately $70 million to net settle vested equity amounts.

Given the meaningful operational efficiencies we've realized so far this year, we are raising our free cash flow estimates for the full year 2023 by $15 million to $75 million. Turning to our share count for Q3, we had approximately 327 million shares outstanding on a fully diluted basis as of September 30, 2023. The fully diluted calculation consists of approximately 295 million shares outstanding, 29 million related to unvested RSU and PRSU, and 3 million shares related to outstanding options. Let me now provide our forward-looking estimates. For the Q4 of 2023, we expect revenue to be in the range of $156.7 million-$159.3 million, growing 18%-20% year-over-year.

Adjusting for constant currency, this reflects growth of 17%-19% year-over-year. Non-GAAP income from operations to be in the range of $5.5 million-$8.5 million, and non-GAAP net income per share to be in the range of $0.04-$0.06, assuming weighted average shares outstanding of approximately 303.3 million shares. For the full year 2023, we expect revenue to be in the range of $593 million-$595.5 million, growing 19%-20% year-over-year. Adjusting for constant currency, this reflects growth of 19%-20% year-over-year.

Non-GAAP income from operations to be in a range of $38.5 million-$41.5 million, and non-GAAP net income per share to be in the range of $0.23-$0.25, assuming weighted average shares outstanding of approximately 300.1 million. Given the US dollar trends over the past year, we saw a slight positive impact to our growth rates in Q3. Our forward-looking estimates are based on FX rates as of October 27, 2023, so any future currency moves are not factored in. Let me close by saying we continue to execute on our goals in Q3. We maintained our rapid pace of product innovation, realized the benefits of operational changes made earlier this year, and remain focused on the growth initiatives to help drive momentum into 2024. We're excited and look forward to our many opportunities ahead.

With that, let us take your questions. Operator?

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one, one on your telephone. To withdraw your question, press star one, one again. Our first question comes from the line of Scott Berg with Needham and Company. It's Scott, please check your mute button. Okay, one moment please for our next question. Our next question comes from the line of Ryan McWilliams with Barclays.

Ryan McWilliams (Software Equity Research Analyst)

Hey, guys. Thanks for taking the question. Pleased to see the continued work to improve profitability here. Just asking about, you know, kind of how things moved through the Q3. Like, how would you say your new business did, you know, in the month of September? And, you know, how has October been so far? Thanks.

Tyler Sloat (CFO)

Hey, hey, sorry about that, Ryan. Thanks, man. I think the question is around linearity, and so as we went through September, kind of played out as, as we expected, meaning that, you know, we've been dealing with larger companies and larger deals, and have over the last, you know, let's call it year, become a little bit more back-end loaded. So that was expected. October, you know, the guidance that we just gave out is, you know, takes into account everything we see. We're trying to call it as we see it, so October is going as we expected as well.

Ryan McWilliams (Software Equity Research Analyst)

Appreciate that. I know it's early, but you know, we've heard a lot of customer interest around Freddy AI. So, any more detail on the timing of the rollout there, any of the early expectations or any, just any more additional commentary around how that can be initially adopted within your customer base? Like, maybe a penetration rate or what kind of customer we can see that first? Thank you.

Girish Mathrubootham (CEO)

Sure, Ryan, I'll take that. This is Girish. So, actually, if you remember last quarter during Investor Day, we actually said that several of our customers were beta testing our Freddy AI, specifically our Freddy Self-Service, which is the self-service automation capability for customer service and employee service. That is being used by our customers. We are monetizing it through our bots in the customer service platform. And, Freddy Copilot and Freddy Insights, this quarter, we have actually put it in, when I say this quarter, I mean Q3, we have actually put it in beta into our customers. Thousands of customers are using it.

Our plans for monetizing Freddy Copilot would be, we're thinking of Q1 2024, is when we would start charging for Copilot, and that's an add-on to agent seat licenses. We are still working with customers on insights. We have not finalized the pricing for insights yet.

Ryan McWilliams (Software Equity Research Analyst)

Appreciate the color. Thanks, guys.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Scott Berg with Needham and Company.

Scott Berg (Senior Analyst)

Hi, hopefully everyone can hear me this time. Congrats on the strong quarter, and thanks for taking my questions. I guess a couple, Dennis, wanted to start with you. Sales in quarter, you seem, you know, quite pleased with them. One of the trends I've noticed over the last couple of years is your Q3 customer adds are, you always have a seasonal dip versus the Q2 kind of results, and this year looks like it's, you know, very much the same. Can you help remind us what you see internationally that might be causing a little bit of that change from Q to Q2 to Q3? My guess is that has something to do with just the European sales cycles, but didn't know if there's anything more nuanced to call out there in particular.

Dennis Woodside (President)

Yeah. Thanks, Scott. Yeah, nothing really nuanced there. I don't think we had anything this quarter related to European sales cycles. We continue to see strength in the larger accounts, continue to see strength in IT. And, you know, we did see an uptick in net adds to around 1,000 net adds for the quarter from last quarter. So we didn't see the kind of dip that perhaps we've seen in the past. Remember, last quarter, in Q2, we had a free offering for our Freshsales product that we then pulled back, and that has resulted in the increase in the overall net adds for Q3.

Scott Berg (Senior Analyst)

Got it. Helpful. And then I wanted to follow up on the question on improving win rates, or excuse me, improving churn downmarket. I think that's always super interesting because you know, points improvement there makes a big difference, both on the top line and bottom line profitability. How should we think about your opportunity to improve that, you know, churn in that segment? SMB churn across software is always notoriously low. I know you all have had some success improving that number, but how do we think about what that kind of runway for improvement looks like, maybe over the next several quarters?

Tyler Sloat (CFO)

Yeah. Hey, Scott, this is Tyler. You're, you're right. We've actually done a really good job on churn just as a company over the last, I would call it, you know, year plus, where we've had quarters where it's kind of remained stable, and then, you know, other quarters where we actually make some good improvement on it. This past quarter was a company best for us in terms of churn in general, and that's across the board, across the products.

On the SMB side, I think it's, you know, more characteristic that the products are getting better, and we're getting also better at kind of focusing on the right ICPs for ideal customer profiles for our customers, even on SMB, which has led to, you know, maybe slightly lower total number of customers, which we've seen in the last couple quarters, but better customers in some cases. So I do think that going forward, you know, the improvements are gonna be more subtle, but I do think that we do have a little bit of room to go in terms of improving churn over the next year and a half.

Scott Berg (Senior Analyst)

... Excellent, very helpful. Thanks for taking my questions and congrats on the strong quarter again.

Dennis Woodside (President)

Thanks, Scott.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Pinjalim Bora with JP Morgan.

Pinjalim Bora (Executive Director of Equity Research)

Hey, guys, thanks for taking the questions and congrats on the quarter. I wanted to ask you on the bot side, can you help us maybe understand what portion of the overall ARR today is driven by bot-based pricing? And how should we think about kind of the changes in the pricing and packaging that went into effect in August? How is that going to be layered into the model?

Tyler Sloat (CFO)

Yeah, I'll start with that, talking about the financial parts, Penjaliam. This is Tyler. You know, we changed the pricing at the end of Q2 in terms of you know, our chat pricing, which then you know, the bots are kind of embedded in that, which would also embed the Freddy Self-Service capabilities. It's really new, and so we don't have that much embedded in terms of the new feature functionality. We do have a decent amount of chat revenue, and we would expect that to continue to kind of increase as we progress here. The other AI capabilities, right, we haven't started charging for it.

They're still in beta, and they will be coming out kind of, you know, Q1, and that's really Copilot will be the next one that's coming out. And so, you know, every quarter, we expect to have a little bit more increase on Freddy self-service. Again, that's gonna be reflected more in chat usage.

Pinjalim Bora (Executive Director of Equity Research)

Yeah, understood. And Tyler, on that topic, it seems like you have a few tailwinds, like, going into next year, the bot-based pricing, the AI SKUs that I think Girish said will be monetizing in Q1, maybe potential stabilization on the NDR metric. Obviously, macro and geopolitical climate is a wild card, but help us understand how are you thinking about 2024? What are the puts and takes as we look forward?

Tyler Sloat (CFO)

Yeah. So, so we haven't guided to anything for 2024 yet. In our Investor Day, you know, we kind of talked about 2025 in terms of getting to rule of 40, and then we, we talked about some revenue numbers for 2026. We'll give out the 2024 numbers at the end of this quarter. I do think you're, you're right, you know, in terms of churn, I just said I think we can make some, you know, slight improvements there, but it's, it's definitely heading in the right direction. In terms of the, the AI SKUs, the... It's so new, we'll have to wait and see, on, on those things. And, the, the one other comment you made on macro, we, we don't expect, you know, macro to immediately be turn around, turn around.

For us, that would be reflected in, you know, our expansion motion, increasing with agent addition, meaning companies are going back to hiring. You know, we expect that to see continued pressure for a while, so we've kind of built that into our expectations.

Pinjalim Bora (Executive Director of Equity Research)

Got it. Thank you.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Rob Oliver with Baird.

Rob Oliver (Senior Research Analyst)

Great. Hi, good afternoon. Thanks for taking my questions. Dennis, one for you, just on the comment around more than half of the 50,000 plus customers now using two products. Clearly great, great product progress on that front for you guys. I think you said overall it's at 25%, which is kind of what you had said at the Analyst Day, which is great. Just curious, you know, as you make that move sort of upmarket, are you seeing more multi-product lands, or are these, are these still largely expands? And then can you talk a little bit about what you see in the pipe and if there's a mix of those? And then I had a quick follow-up.

Dennis Woodside (President)

Yes, sure. Yeah. So, thanks, Rob. We do see multi-product lands. They tend to be, multi-products within the same family. So an example would be a customer taking IT plus ESM, or Freshchat and Freshdesk. Now, most of our expansion in those larger accounts tends to go across true persona, so from IT to CS. In fact, if we look at our largest expansions, those are true cross-product expansions. Some of them, I think we talked about in the, in the prepared remarks, like Giant Eagle and, Western Financial. So as we, as we continue to move upmarket, that expansion motion is becoming more and more important for us, and that's gonna be a big emphasis for us going into next year.

Rob Oliver (Senior Research Analyst)

Great. That's really helpful. Thanks for the color there. Yeah, and then just on the macro, you know, Tyler, I appreciate your comment in response to the last question, just about how you're thinking about macro and around agent count. You know, where you kind of reiterated what you said at the Analyst Day, which is, you know, "Hey, we're not really counting on those agent additions." You know, and that sounds like that's the pressure that's likely gonna remain here.

But on the other hand, you know, it does seem like you guys, I mean, you deliver tremendous value for the price, so I'm just be curious, you know, to get a sense, you know, as the execution's been strong here, what, you know, is there, is there a flip side to the sort of macro headwinds, where some of those mid-market customers are feeling like it maybe upper end can get a lot more value with you guys? Are you seeing some of that as well? Thanks.

Dennis Woodside (President)

Hey, Rob. I'll take that. This is Girish. So first of all, I would like to say that, from a macro standpoint, we are not seeing any significant change, in Q3 compared to Q2. And one of this, clearly, when companies are still carefully considering their spends, we are a vendor of choice, because of our affordable, pricing and lower total cost of ownership. So that may be in play, but not, that's not specific to Q3. That's pretty much our promise to our customers. And as we see continued demand for AI and even-

Girish Mathrubootham (CEO)

... to offset, moving forward, we hope that, hey, our AI strategy will help us make money when businesses are not hiring agents, that we'll make money when businesses are hiring agents by making them more productive, and also our Insights product helping open up a new SKU for leaders.

Rob Oliver (Senior Research Analyst)

Great. Thanks, Chief. Thanks, everyone.

Tyler Sloat (CFO)

Thanks, Rob.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Brett Knoblauch with Cantor Fitzgerald.

Brett Knoblauch (Director of Software & Internet Equity Research)

Hi, guys. Thanks for, for taking my question. Congrats on the quarter. I guess the first for me, you guys talked about your AI product, and made it seem like that maybe SMEs might be the biggest early adopters of this. Is that how you're thinking about it, and you think that could help maybe drive a step function improvement in churn at the lower end of the market?

Girish Mathrubootham (CEO)

So, yeah, I'll take that. So first of all, if you look at the three pillars of our AI strategy, Freddy Self-Service, I think will be really, really useful and adopted by larger customers because they are the ones who have a large volume of support, like millions of customers coming in for support. So that's where the scope for automation is much higher. On the other hand, Freddy Copilot would probably be like more universally applicable to SMBs and mid-market customers because every user can now become more productive, and SMBs really want to do more with less. So and Freddy Insights is for leaders. Again, larger companies may benefit more because their needs for data from different teams could be larger.

Specifically on AI helping us deal with the macro, I think we said this in the last earnings call. We are focused. We are not waiting for the macro to improve. We are focused on controlling the variables that we can, like our focus on four growth pillars, like how can we use product innovation in AI? How can we cross-sell more into our existing base? How can we focus on larger deals and drive more operational efficiency? So that is our plan to keep executing as while we wait for the macro to turn.

Tyler Sloat (CFO)

Yeah, and just, hey, it's Dennis. Just to add some color there. Today, we're seeing, even though our products are still in beta, we're seeing pretty broad adoption across all customer sizes for our AI products. So we have over 2,500 customers in beta using Freddy Copilot to improve agent productivity. We have over 4,000 customers using some aspect of Freddy Insights, and those range the gamut from our largest to our smallest customers. So I think AI is on the agenda for every CEO. They're all looking for improved outcomes. They're looking for improved efficiency in their operations. And all of our customers, whether you're a customer support leader or an IT leader, you have to have an AI strategy.

So that's provoking a lot of discussions, and we're very optimistic about how this is gonna play out over the next year.

Brett Knoblauch (Director of Software & Internet Equity Research)

Perfect. Appreciate it. Thanks, guys.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Nick Altman with Scotiabank.

Nick Altmann (Director of Software Equity Research)

Awesome. Thanks, guys. I think earlier you had noted that, churn has improved in SMB, both year-over-year and quarter-over-quarter. I was wondering if you could maybe talk about the expansion side and how that's trended. And then just as a follow-up, were any of the, you know, any of the changes that you'd made to pricing earlier this year, has that been sort of a tailwind to NRR? And if you could quantify that, if you're willing to disclose that, that'd be helpful. Thanks.

Tyler Sloat (CFO)

Hey, Nick, this is Tyler. I'll take that one. So, yeah, you know, in churn, we're just doing better, kind of have been for a while, and just these are subtle improvements. And I just mentioned we made, you know, kind of a company best ever in churn this past quarter. And, you know, it goes from SMB all the way up. I mean, part of that is because we have been moving to larger customers, they're signing annual deals. So the mix shift of our customer base is changing. Part of it, Freshservice in general, which plays in the larger markets, that is growing faster, and that has great characteristics. When on the flip side of the question, you asked about expansion.

Expansion is, you know, it really hasn't changed, and it, it's still a pretty tough environment for expansion, and specifically around agent addition. And so what we have been doing is looking at other ways to expand with our customer base. One of those, which you've alluded to, is that, you know, we did do some, some price changes on our Freshservice product. We did get some, you know, some benefit from that so far this year. And so that, that has helped our net dollar retention slightly. And so, even though, you know, on one side, the expansion motion overall is coming down, we did, we did get some expansion benefit from, from price a little bit, but also benefit from churn. So hopefully that breaks it down for you.

Nick Altmann (Director of Software Equity Research)

Awesome. Thanks, guys.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Brent Thill with Jefferies.

Brent Thill (Managing Director)

Tyler, on NRR, you mentioned it is gonna moderate more in Q4. Is Q4 gonna be a bottom for that moderation in NRR? And maybe for Dennis, U.S. and EMEA held up really well, but the APAC showed a pretty big slowdown. Anything going on in APAC that would describe what happened there? Thanks.

Tyler Sloat (CFO)

Hey, hey, Brent, I'll take the first part of it. So, you know, we had been calling, kind of coming out of Q1 even, that we thought Q2 was gonna go to the $105-$106 range. You know, we've been doing a little bit better, and part of the reason is 'cause churn has been doing better, 'cause we've kind of, you know, the expansion's kind of come through as we expect. You know, we're calling the kind of $105 for Q4, and based on what we see right now, we do hope that that's gonna kind of be kind of the floor. You know, going, and we'll obviously update that, you know, going into next year if anything changes.

That kind of assumes that, you know, we'll be able to maintain the levels of churn, and expansion is not gonna get dramatically worse. And so that's, you know, obviously the assumptions going into that number.

Brent Thill (Managing Director)

Yeah, just on the geography question, we really didn't see a slowdown in Asia Pac. We have pretty consistent performance across our three big geos. So, you know, no... I would say no appreciable trend to call out there.

Tyler Sloat (CFO)

Great. Thanks.

Thanks, Brent.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Alex Zukin with Wolfe Research.

Ethan Bruck (Senior Equity Research Associate of Enterprise Software)

Hey, guys. This is Ethan Bruck on for Alex Zukin, and congrats on the solid results. I have two quick questions. Just first, so one of your peers earlier in the month noted that there's some growth slowdown in September. So I'm just curious, like, what you're seeing in the environment, just given the solid results, and, like, based on early customer conversations around budgets, like, were the discussions in, like, for 2024? We've heard a lot around, like, tool consolidation. So just curious how you guys saw them across the front office stack, helping driving some larger strategic deals.

Tyler Sloat (CFO)

Hey, Ethan, I'll take that. So in terms of the first part of the question was around September. You know, I already mentioned, hey, we've become a little bit more back-end loaded, you know, as we've been dealing with larger customers. But it kind of came through as we expected, and, you know, it wasn't, you know, there was no real surprise there. And we expect that kind of, you know, that back-end loaded nature of the quarters to continue, as we are, you know, kind of doing that, more of that field motion. As we look into next year, and you asked about, hey, in terms of budgets, are we seeing, you know, anything different? We're not seeing anything different.

You know, part of our play, as G just mentioned, is to be a great, you know, kind of, a great cost alternative, and we're gonna continue to try to flex that muscle as we go engage with customers, especially if they're seeing budget pressures. We feel that we can be a great alternative to some of their big, heavy software that they might have.

Ethan Bruck (Senior Equity Research Associate of Enterprise Software)

Yeah. And then just a quick follow-up around the AI suite. So, hearing about Copilot coming in Q1 is constructive. I'm just curious, and based on the early traction you're seeing in beta, and just how would you stack rank what you guys would expect to be the most impactful to 2024 numbers? If we think about impact from new spend on just the GenAI SKUs, all to uplift, just improving gross retention. Just curious, like, directionally, how you guys are thinking about this, and thanks again.

Tyler Sloat (CFO)

There's a question on monetization. So, yeah, I mean, it's so early, Ethan, right? We have our, the monetization that is just starting essentially in, Freddy Self-Service, which is again, gonna be reflected in chat. We've talked about Q1 being kind of rolling out GA of, Copilot, which we'd start selling it. I think, you know, Dennis just mentioned we've got, you know, a lot of customers across the three different AI platforms that we have that are in beta right now. And, you know, we're planning to learn as we go and then start to roll this stuff out. So I think the first time we're really gonna have anything that we would talk about is probably the first half of next year.

Ethan Bruck (Senior Equity Research Associate of Enterprise Software)

Got it. Thank you, guys, and congrats again on the results.

Tyler Sloat (CFO)

Thanks.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Brent Bracelin with Piper Sandler.

Brent Bracelin (Head of Technology Equity Capital Markets)

Thank you. Good afternoon. G, I'll start with you here. Sounds like you're excited by the CS Suite product, 200 customers deploying that this quarter. What is the ACV uplift as you think about a customer that moves to CS Suite? Is there an ASP uplift when customers move, or should we think about this more as a modernized stack with no uplift? Thanks.

Girish Mathrubootham (CEO)

Hey, thanks, Brent. And, so first of all, yes, there is an uplift. I probably have to get back to you the exact numbers, but because the pricing is slightly higher for the CSS suite than standard Freshdesk or Freshchat alone, I would think it's probably I would say 10%-20% higher, but actual realizations could be different. So but yes, in principle, there is an ASP uplift because the customer is getting bots and conversational agent experience, as well as ticketing all in one package. So, it's higher than Freshdesk standalone and Freshchat standalone, and bots will add on a usage-based pricing as well.

Brent Bracelin (Head of Technology Equity Capital Markets)

Got it. Helpful color there. And then, Dennis, just as you think about the business here, there's some moving parts. You guys are doing a good job of navigating a challenging environment. One of the things that stood out to me is, clearly you're talking about strength on the enterprise, strength in ITSM. We're looking across the industry, seeing some weakness on the SMB side. But if I look at net logo adds, it did look like enterprise was down slightly, and the SMB space was up. Maybe if you could just give us an update on what you saw overall in the quarter relative to larger customer demand, SMB, and update that PLG 2.0 initiative. Is that starting to have a little bit of an impact here on net adds? Thanks.

Dennis Woodside (President)

... Yeah. So, just to back up a bit, remember, the markets that we're competing in are massive, between sales and marketing, customer support, and IT. And, any business of any size needs what we provide, needs an IT solution, needs a customer support solution, needs a sales and marketing solution. So the market is massive, and still, when you get into SMB, still relatively under-penetrated. About 40% of our revenue is, is from SMB today. We, you know, in any given quarter, we're gonna see fluctuations across SMB versus our large account acquisition. Also, if you think about, like, in enterprise in particular, you tend to have a lot of buying cycles that take place at the end of the year as opposed to in the Q3. So that potentially played into it for Q3.

But in SMB, in particular, we've started to do some of the things that I talked about at the Analyst Day to improve the efficiency and the scale of our SMB business. We've spent this past quarter, Q3, diversifying some of the sources of leads in before the funnel. So early, think about, like, going into affiliate marketing and investing more in SEO to drive organic leads into our trial funnel. What we're doing this quarter is focusing on improving the efficiency of that funnel itself, and that's through things like creating more personalized journeys for a prospect that's in the trial itself, using chat and other means to communicate to that trialist, to help them get educated on the product and get to value faster.

And we know if you get to value faster, ideally in the first day or two of trying the product, you're much higher—much more likely to convert. So we think there's a lot of levers that we haven't really pulled there in optimizing that funnel, which will play out over the course of the next year. So I think we've got, you know, it—very broadly speaking, continued to be pushing into mid-market customers, lower end of enterprise, in particular, with our IT products. More and more emphasis on cross-sell and expansion of our existing base, and then getting that SMB funnel humming through what we're calling PLG 2.0. Those are the three big levers we're really gonna be playing with over the course of the next year, that we'll be talking about on our calls.

Brent Bracelin (Head of Technology Equity Capital Markets)

Super helpful, Tyler. Thank you.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Brian Schwartz with Oppenheimer and Company.

Brian Schwartz (Managing Director and Senior Analyst)

Thank you for taking my question. Tyler, just to button up the NRR guidance and the compression, I think you called out ITSM kind of being the expansion's weaker than expected in your introductory commentary. But then in the Q&A, it sounds like maybe it was a little more broad-based. So just wanted to get maybe some clarity on that, if it's constrained to the ITSM business or you're seeing it across the product set. And then, Dennis, one question for you, just on the customer -- the new customer adds. Can you shed any light on what you're seeing across industries? You know, we heard about some weakness in automotive and suppliers.

Just wondering if you're seeing, you know, any strength or, or weaknesses across industries, given how horizontal the solution is. Thank you.

Tyler Sloat (CFO)

Yeah. Hey, hey, Brian, I'll take the first part. No, I don't think we, or we didn't mean to call out ITSM expansion in particular, seeing pressure. I mainly just saying, you know, the expansion motion in general continues to see pressure, which it has for over a year now, really the, you know, the agent addition part of that. I think what we called out is that, you know, on ITSM, we actually, you know, had a little bit of price leverage this year, and so that kinda offset a little bit of the agent additions that might have slowed. And so that was, you know, kind of more of a positive to ITSM. In general, ITSM also has better churn characteristics, as it's dealing with, you know, larger customers. So hopefully that clarifies.

We weren't trying to call out expansion, pressure on ITSM specifically.

Dennis Woodside (President)

I think, so, just on the industry question, you know, for the reasons that I was just talking about, the fact that we address such a broad market, the fact that the market is very horizontal, if you have an IT department or a customer support department, you need to automate it. We don't have any single industry that really drives a lot of concentration for us today. We tend to get. I would say on the larger accounts, we tend to get a nice reference cycle, where we get two or three travel companies. Next thing you know, we've got 10 travel companies. We've seen that with industrial recently, where we had a handful of industrial companies, some in steel, some in manufacturing. All of a sudden, we've got a lot going on there.

And then the other area that we have seen, I would say, fairly continued strength over the course of the last several quarters is in higher ed and education, where lots of universities are trying to automate all aspects of their business. They're trying to become more efficient as well, typically have very fragmented IT stacks across different departments. University of Pennsylvania is an example of one that we referred to, where that was an expansion of an existing account, where they're trying to put everybody in on the school in the same platform. So those are the kinds of things that we're seeing in across the board, but I wouldn't say that there's any specific industry that showed particular strength or weakness, given the broad base of customers that we have.

Brian Schwartz (Managing Director and Senior Analyst)

Thank you for taking my questions.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Pat Walravens with JMP Securities.

Pat Walravens (Managing Director)

Oh, great. Thank you, and congratulations on the results.

... So billings growth was 19% in constant currency in Q3 versus 21% in Q1 and Q2. So Dennis, is it fair for us to assess that sales attainment was good in Q3, but maybe not quite as good as in the first half?

Dennis Woodside (President)

So overall, look, we, we are pleased with the quarter in terms of where we landed. Of course, we kind of, we set high goals for ourselves, and I think we said this at the, at the, at the investor day. You know, we're not, we're not satisfied with, with the growth rates that we're seeing now. We think we can do much better. We've got a lot going on, to get there. I think the addition of, Mika Yamamoto as our, our new, Chief Customer and Marketing Officer, that's a big, add for us because a lot of what we need to do also is in that marketing space.

Yeah, I mean, our aspiration, our goals are to continue to grow the business at rates that are higher than what we're seeing now, and that's what we're gonna continue to do.

Pat Walravens (Managing Director)

All right, great. That's helpful. And then, you know, at the Analyst Day, you guys, and I know you're very specifically not breaking out by segment, but at the Analyst Day, IT was growing in the low 40s and, customer service in the low- to mid-10s and sales less than 10. Is that still like a overall, a roughly accurate assessment of the business, or was there some change?

Dennis Woodside (President)

Yeah, so, you know, we shared that data at the Analyst Day specifically to give investors some sense as to the size and scale of the different parts of our business. We don't intend to update those numbers on a quarterly basis, potentially at a future Investor Day. But broadly speaking, you know, the trends that we and the data that we shared back in September, the trends that we shared are consistent with what we've seen in Q3 as well.

Pat Walravens (Managing Director)

All right, great. Thank you very much.

Operator (participant)

Thank you. One moment, please, for our next question. Our next question comes from the line of Adam Bergere with Bank of America.

Adam Bergere (VP of Equity Research)

Hey, thanks for taking my question. So with the focus on cross-sell, what are some of the biggest initiatives or investments there? Just, you know, naturally, you know, what products have you found to be more, you know, common pairings that you're kind of pushing for? Thanks.

Dennis Woodside (President)

Yeah, I'll take that. So I think... You know, one of the motions that we highlighted last quarter that started to really hum is that, IT and ESM. So we're finding more and more customers are looking to provision a single workflow engine for all of their departments. And often we can turn an IT-only discussion into an IT plus finance, you know, finance plus legal department discussion. Or we can go back to our customers that are just on ITSM and broaden the discussion to include other departments, because we've proven that we can serve their IT department. So that's a real clear motion for us, that we're just making part of how we go to market.

You're seeing on the customer support side, moving customers into bots who previously may not have tried to automate their interactions with their customers. So we have a natural upsell for customers that, or that maybe they have fairly rudimentary bots that are just handling a small fraction of their inbound inquiry. There's an opportunity there to educate them on how to automate more and more interactions with their customers, how to apply AI to those interactions to build bots, and that's actually an upsell opportunity for us because it creates this consumption revenue stream. That's really where we're gonna be spending a lot of time this quarter and then next year, because we have a lot of customers that have sizable consumer bases in particular.

This is in particular B2C, it does apply to B2B as well, but particularly B2C, who have not automated as many workflows as they can, or they've automated only the rudimentary workflows. AI allows you to automate a lot more, and, and that, in turn, creates a revenue stream for us.

Adam Bergere (VP of Equity Research)

Okay.

Dennis Woodside (President)

Those, that's a little bit of flavor of, of the big motions that we're focused on.

Adam Bergere (VP of Equity Research)

Yeah, that's awesome color. Thank you.

Operator (participant)

Thank you. One moment, please. Our final question comes from the line of Taylor McGinnis with UBS.

Taylor McGinnis (Equity Research Analyst)

Yeah, hi. Thank you so much for squeezing me in. Just a question, so you kept the median of the constant currency revenue guide for Q4 unchanged, but you lowered the high end of the range. So is that a reflection of any areas being a tad softer than expected? You know, perhaps maybe there was something at the end of the quarter. And if you look at the upside to billings, it was a bit lighter than what we saw last quarter, so maybe that had a role. I know earlier you mentioned things being more back-end loaded, but maybe you can help us bridge those two metrics. Thanks.

Dennis Woodside (President)

Hey, Taylor, this is Tyler. I wouldn't read too much into it. I think in general, yeah, I mean, there are still macro pressures on expansion, right? So we are cautious still, and, you know, we every quarter, we've kind of been like that as we go in, as we wanna see things play out. In terms of the guidance, you know, we are just trying to call it as we see it. On the billing side, you know, we have had this, you know, this shift to kind of, you know, slightly larger deals, but those tend to play annual in advance, which does help your billing cycle.

But then again, you know, we saw, we still do have a really decent expansion motion, and a lot of that's unpredictable as it comes through based on the proration of those contracts. So I wouldn't read in too much on the midpoints and whatnot. But going into Q4, I mean, we're still gonna be cautious on the expansion side of it, but new businesses, you know, it came in decent in Q3. The numbers, the net adds were good, and we just need to execute this quarter.

Operator (participant)

Thank you.

Taylor McGinnis (Equity Research Analyst)

Thank you.

Operator (participant)

Ladies and gentlemen, thank you for participating. This concludes today's program. You may now disconnect.