Freshworks - Q4 2022

Transcript

Operator (participant)

Thank you for standing by. Welcome to the Freshworks' fourth quarter and full year 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. If you wish to remove yourself from the queue, simply press star one one again. As a reminder, today's program is being recorded. Now I'd like to introduce your host for today's program, Mr. Joon Huh, Vice President of Investor Relations. Please go ahead, sir.

Joon Huh (VP of Investor Relations)

Thank you. Good afternoon, welcome to Freshworks' fourth quarter and full year 2022 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 the information regarding our fourth quarter and full year 2022 performance and our financial outlook for our first quarter 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. For a discussion of the material risks and other important factors that could affect our results, please refer to today's earnings release, our most recently filed Form 10-Q, 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 presentation, 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 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, 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 fourth quarter and full year 2022. Overall, we executed well in the quarter. We exceeded expectations across our operating results for total revenue, non-GAAP operating income, and free cash flow. We capped off a strong finish to the year with $133.2 million in quarterly revenue, as we surpassed $500 million in annual recurring revenue. In this environment, as companies are seeking greater value for their IT spend, we are seeing the Freshworks value proposition resonate more than ever. In Q4, we added approximately 1,800 new customers to our growing base and ended up with more than 63,400 total customers, including the San Francisco 49ers, FinChoice, Mahindra, Supara, St. Marche, and Yulu Bikes.

I'm incredibly proud of how we grew the business. We also improved our non-GAAP operating margin by 8 percentage points in Q4 on a year-over-year basis. We generated positive free cash flow of $4 million in the quarter. Our approach during this recent period of macroeconomic uncertainty was to focus on driving our growth through four key strategies. We believe these four business drivers will continue to move us forward in 2023. First is our continued focus on product innovation. In 2022, we expanded our unified CRM platform to include Freshchat. We launched Freshservice for business teams to extend Freshservice beyond IT. We made our bots smarter across our CX, IT, and broader CRM products to help businesses engage their customers faster. Second, we saw results from our focus on larger customers, which is driving most of our growth.

Today, nearly 60% of our business comes from mid-market and larger companies, with many of our Q4 deals starting with Freshservice. The third business driver is expansion. Despite the challenging macroeconomy, customers expanded through agent additions, cross-sells, and upgrades into larger deployments. In Q4, our net dollar retention was 110% on a constant currency basis. Finally, our focus on operating efficiency. We generated positive cash flow in Q4 and improved our non-GAAP operating margin. We plan to build on this momentum and improve our efficiency in the years ahead. During today's call, Dennis, Tyler, and I will go deeper on these four business drivers and how they played a role in our Q4 results, and how we see them contributing going forward. Starting with our product innovation, we continued to make improvements last year across our IT, CX, and broader CRM solutions.

New business increased as companies chose Freshworks products as credible alternatives to expensive and bloated software. This is really important in the current environment that businesses want to control IT spend without sacrificing powerful functionality in mission-critical applications. In fact, positive reviews from our customers this quarter earned us TrustRadius Awards for Best Value for the Price and Best Feature Set. It is those two reasons why we believe Freshservice continues to grow and gain traction in the mid-market. Take Swire Coca-Cola, for example. Swire is one of the world's largest Coca-Cola bottling partners in the U.S. and Asia, and it chose Freshworks for the breadth of our features, fast deployment, and lower cost of ownership. Swire brought on Freshworks because they were looking for a platform that was comprehensive enough to support their complex needs while reducing their ITSM spend.

Last quarter, we launched Freshservice for business teams, and in the past three months, we have seen strong early success. As businesses eliminate siloed support and service management platforms, other departments like HR and finance are able to use Freshservice to build a more modern and consolidated employee experience. New customers like Coherent Corporation, a semiconductor company with over 23,000 employees, chose Freshservice over a large incumbent thanks to our integrations and the ability to scale across IT and HR teams. In our CX business, we continued to enhance Freshchat and Freshdesk products with a focus on customer self-service and agent experience. In Freshdesk, we added new integrations with multiple telephony partners. Enterprises can now bring their own telephony solution into Freshdesk to create a comprehensive omnichannel customer service solution. In Freshchat, we introduced simpler ways to build self-service bots.

In Q4, we added more bot languages and industry-specific bot templates, extending the reach of our products to global markets. In Q4 alone, Freshchat powered hundreds of millions of bot conversations. With the rise of modern messaging apps, companies have rapidly shifted to engaging with customers over conversational messaging channels. Via [Active], an active lifestyle brand in the U.S., Canada and Australia, started with Freshdesk and later bought Freshchat to handle repetitive support requests like returns and order status more efficiently. By automating responses across email, chat, and calls, they reduced resolution time by several hours. Turning to our broader CRM solutions in sales and marketing, we improved analytics and reporting. We launched a new revenue attribution capability to help marketers better understand the sales impact of their cross-channel marketing campaigns. We also added integrations to analyze sales calls to scale the effectiveness of their customer conversation.

I am super proud of our product innovation in 2022, and our dedication to building new capabilities that can deliver value to our customers through a challenging macro environment. As I look ahead at our product priorities for this year, we will continue to differentiate Freshservice as a comprehensive IT service, IT operations and enterprise service management solution. In CX, we will continue to deliver on the promise of an omnichannel customer support experience with self-service automation, conversational experience, and ticketing. Finally, we'll continue to build a unified CRM with an out-of-the-box customer data platform and AI ML insight. I'll now turn it over to Dennis to talk about what we are seeing in the market, how larger customers are driving our business growth, and how customers are expanding on our products.

Dennis Woodside (President)

Thank you, G. Hello, everyone. Thanks for joining us today. I'm five months in at Freshworks, and I'm excited by the progress we're making in the business. We closed the year on a high note, beating our financial estimates and improving our operating efficiency. In a tougher market environment, we improved our execution to drive the highest new business quarter ever. We saw increased competition for many of our deals, and yet we still improved our win rates for our CX and ITSM products. This was especially true for our larger deals in the field, with Freshservice leading the way as a scalable and cost-effective solution that is delivering incredible value to our customers. G talked about our first of four business drivers, product innovation. I'll cover the next two, our success with mid-market and enter-enterprise customers and our expansion motion.

I'll start with our enhanced focus on mid-market and enterprise customers. Over the last 18 months, we've made substantial investments in people and tools to expand our go-to-market motions. We believe those investments, which are now reflected in our cost base, are paying off in higher win rates, participation in more deals, and the expansion of our mid-market and enterprise business. In 2022, our new business wins increased with companies spending more than $50,000 in ARR, and in Q4, this customer cohort grew 35% year-over-year and now represents 44% of our business. While our business was historically more in SMB, our revenue base has shifted over the years towards more mid-market and enterprise customers.

Today, nearly 60% of our business is coming from mid-market companies, those with 251-5,000 employees, and enterprise customers with more than 5,000 employees. That's because our cost-effective, yet powerful products are delivering real value fast. They can scale to serve thousands of agents and millions of customer and employee interactions. These benefits resonate with companies of all sizes, especially in the current economy. The days of selecting a vendor only based on market share or brand name awareness are over. Customers want rapid impact and lasting value at a reasonable cost, and Freshworks delivers. That's why Freshservice was chosen by Carrefour Belgium, a subsidiary of the eighth-largest retailer in the world. Their team of 300 IT professionals now have a more simplified and nimble approach to IT service management to support more than 11,000 employees.

While legacy incumbents are focused on the 2,000 largest companies in the world, Freshworks has the opportunity to serve hundreds of thousands of others who are dissatisfied or underserved by bloated and expensive software. We provide mid-sized organizations like Databricks, TaylorMade, and Georgetown University with a better choice, powerful yet cost-effective solutions. Turning to expansion, I'm pleased to say that despite the macro conditions, our customers are still expanding through seat additions, cross-sells, and upgrades. In Q4, net dollar retention was 110% in constant currency as the overall churn rate for our business remained in the high teens. We see better retention rates in our mid-market and enterprise customers, which helps our overall net dollar retention. While seat additions continue to drive the vast majority of our expansion today, we expect cross-sell to be a bigger contributor to our growth over time.

The percent of customers using more than one product remained relatively the same as the prior quarter at 24%, with just a slight increase in Q4. We are implementing specific initiatives to create more bundling and cross-sell opportunities for our go-to-market team this year. Take Addison Lee, for example. The British private hire cab and courier company started as a Freshservice customer in 2015, and in 2022 added on Freshsales and Freshdesk. They believe their previous CRM system from a large incumbent caused low agent productivity and did not deliver sufficient value. Our Freshsales Suite was selected to replace the older CRM for our modern intuitive UI built for the end user. Looking at our customer cohort of over $50,000 in ARR, we added a net 191 customers in Q4.

While this customer number benefited from FX movements and new deals in the quarter, the biggest driver continued to be expansion as customers increased their spend on our products, and especially for the ITSM market. An example is iQor, a managed services provider with more than 35,000 employees in 10 countries. As part of iQor's digital transformation strategy, the company expanded the use of Freshservice and Freshdesk bots to its IT, HR, and finance teams to immediately answer questions before transferring to a technology team member. The platform enables iQor team members to focus on more complex tasks and creates a better experience for both employees and customers. To me, it's customers like the ones you heard about today that validate my decision to join Freshworks. I believe we have the opportunity to build a large, impactful company that can serve hundreds of thousands of businesses over time.

By focusing on the four business drivers of product innovation, mid-market and enterprise customers, expansion, and efficiency, we believe we can grow well beyond our current levels. I'm excited about the progress we've made to better align our go-to-market teams and the many opportunities ahead of us. Now over to Tyler to talk about how we are improving efficiency as Freshworks continues to grow.

Tyler Sloat (CFO)

Thanks, Dennis. Looking back on our Q4 and full year 2022 performance, I'm pleased with our ability to drive operational efficiencies in the business. Starting last year, we knew that 2022 would be a big investment year, building out our go-to-market teams, investing in product development, and taking on a full year of G&A public company costs. What we didn't know was how the macroeconomy would play out and how that would impact the overall market for our products. During a year of a slowing demand environment, negative FX movements, and pressure on small businesses, we still beat the high end of our 2022 estimates for revenue that we laid out one year ago by $3 million. More significantly, we effectively managed our costs throughout the year to beat the high end of our 2022 estimates for non-GAAP operating income by over $26 million.

We believe we have a durable business model, and we're improving our operational efficiency as we drive business growth. In Q4, we had another quarter of increased efficiency. With revenue being expectations, non-GAAP operating loss outperformed expectations by $6.5 million in the quarter. We improved our non-GAAP operating margin year-over-year, and our business inflected to generate positive free cash flow of $4 million and non-GAAP EPS of $0.01 in the quarter. As I normally do, I'll review our Q4 financial results, provide background on key metrics, and close with our expectations for the first quarter and full year of 2023. I will also include constant currency comparisons to provide a better view of our business fundamentals.

Most of our discussion will be focused on non-GAAP financial results, which exclude the impact of stock-based compensation expenses, payroll taxes on employee stock transactions, amortization of acquired intangibles, and other adjustments. Starting with the income statement, revenue grew 30%, adjusting for constant currency or 26% as reported to $133.2 million. Although the FX trend for the dollar against the euro and pound reversed in Q4, we continued to see the trailing negative impact to revenue resulting from FX movements earlier in the year. As Dennis mentioned, we had a strong quarter of new business driven by Freshservice, while expansion continued to see pressure from the effects of the broader economic slowdown. Smaller customers continued to feel the pressure as churn rates increased slightly for the SMB segment, leading to slower growth.

Overall, churn for the company remained relatively stable, ticking up less than 100 basis points in the quarter. As a whole, we have made good improvements to our gross churn rates over the past several years. In Q3 and Q4, we were able to keep gross churn relatively stable, but do see potential risk of churn increasing slightly going into 2023. Moving to margins. Our non-GAAP gross margins were roughly similar to Q3, rounding up to 83% for the quarter. We continue to achieve strong non-GAAP gross margins with over 82% for the full year as we scale the business. In Q4, non-GAAP operating margins improved 8 percentage points year-over-year to -2%, driven mostly by lower R&D and G&A costs as a percentage of revenue.

Specifically for G&A, expenses in the prior year included non-recurring litigation settlement costs that were not included in the most recent quarter. On a quarter-over-quarter basis, we had a very small improvement to non-GAAP operating margins as we largely maintained our run rate cost base in matching the business growth. Similar to Q3, we had a one-time type benefit of approximately $4 million related to the reversal of accrued expenses from earlier in the year. Our revenue outperformance, combined with an improving cost base, led to non-GAAP operating loss of $2.8 million in Q4. I'm pleased with our ability to control costs in the current market environment and expect to drive more operating leverage as we go forward. Turning to our operating metrics.

Net dollar retention was 110% on a constant currency basis, or 108% as reported, and is largely in line with our commentary from the prior quarter. As expected, we saw expansion slow down in the quarter reflective of the overall economic trend. Looking ahead, as we expect the broader trend to continue, we estimate Q1 2023 constant currency net dollar retention to be 107% and holding FX rates constant, reported net dollar retention to be 105%. In terms of our customer metrics, customers contributing more than $5,000 in ARR grew 20% to 17,722 customers in the quarter and now represents 87% of our ARR. On a constant currency basis, this customer cohort grew 21% year-over-year.

For larger customers contributing more than $50,000 in ARR, this customer count grew 35% to 1,908 and ticked up to represent 44% of our ARR. Adjusting for constant currency, this customer cohort grew at 38%. Lastly, we ended the quarter with a total customer count of more than 63,400, and our average revenue per account continued to increase. Moving to our billings, balance sheet, and cash items. In Q4, calculated billings grew 21% to $147.8 million. Holding constant currency over the past year, calculated billings grew 25%. The other factor impacting the growth rate was billings duration mix of -4%. Adjusting for this, the normalized calculated billings growth was approximately 29% in Q4.

Looking ahead to Q1 of 2023, our preliminary estimate for calculated billings growth is 20% on a constant currency basis or 17% as reported basis on current FX rates. For the full year 2023, we expect calculated billings growth to be similar to our expected revenue growth for the year of approximately 17%. Turning to our balance sheet and cash items. We maintained a steady cash balance as we ended the quarter with cash and marketable securities of approximately $1.1 billion. In Q4, we generated $4 million of free cash flow, coming in ahead of our estimates. Looking back on the full year, we outperformed our initial free cash flow estimate of -$25 million by more than $10 million in 2022, despite a tougher economic environment, further demonstrating our ability to drive efficiencies in the business.

We continued to net settle vested equity amounts and used nearly $16 million under financing activities for Q4. For the full year, we used approximately $167 million for the net settlement of nearly 9.8 million shares. As a reminder, this financing activity is excluded from free cash flow. We plan to continue net settling vested equity amounts, resulting in quarterly cash usage of approximately $17 million at current stock price levels. As we look forward to 2023, we expect to generate approximately $10 million of free cash flow for the year, with approximately $3 million in Q1. We have some seasonality in spend throughout the year, so we anticipate Q2 and Q3 will be near break even and the remainder of the free cash flow expected in Q4.

With positive free cash flow now coming from the business, no debt, and a strong balance sheet, we believe we are well-positioned to drive sustained growth into the future. Turning to our share count for Q4. We had approximately 324 million shares outstanding on a fully diluted basis as of December 31st, 2022. The fully diluted calculation consists of 289 million shares outstanding, approximately 32 million related to unvested RSUs and PRSUs, and 3 million shares related to outstanding options. Let me now talk about our forward-looking estimates. I'll go through the numbers first and then provide background commentary afterwards. For the first quarter of 2023, we expect revenue to be in the range of $133 million-$135 million, growing 16%-18% year-over-year.

Adjusting for constant currency, this reflects growth of 19%-21% year-over-year. Non-GAAP loss from operations to be in the range of -$9 million to -$7 million. Non-GAAP net loss per share to be in the range of -$0.03 to -$0.01, assuming weighted average shares outstanding of approximately 290.2 million shares. For the full year 2023, we expect revenue to be in range of $575 million-$590 million, growing 15%-18% year-over-year. Adjusting for constant currency, this reflects growth of 16%-19% year-over-year. Non-GAAP loss from operations to be in a range of -$14 million to -$6 million.

Non-GAAP net income or loss per share to be in a range of -$0.01 to +$0.03, assuming weighted average shares outstanding of approximately 293.8 million. We want to provide our best views of the business as we see it today, and in a changing market environment, it can be tough. A couple areas and assumptions to call out. First, on FX. The weaker dollar trend in Q4 created a slight benefit to revenue and billings metrics compared to the prior quarter. On a year-over-year comparison, we still saw a negative impact. These estimates are based on FX rates as of February 3rd, 2023, so any future FX moves are not factored in.

We started to hedge a small portion of our INR-based expenses in January 2023. We expect the impact of the hedging program to increase throughout the year, which will improve the predictability for operating expenses moving forward. Second, on profitability. I'm pleased that we delivered on our commitment to reach positive free cash flow by Q4 last year. Now, as we head into 2023, we're driving additional efficiencies to show quarter-over-quarter improvement throughout the year. As such, we expect non-GAAP operating loss to improve to -$6 million in Q2, near breakeven in Q3, and then turn positive by Q4. We plan to maintain sustained profitability in the years ahead. Let me close by saying I'm pleased with our execution in the quarter. Our ability to operate efficiently over the past year highlighted the durability and resiliency of our business model.

Our view is that we're well positioned to execute through a changing market environment in the near term, and we remain bullish on our long-term opportunities. With that, let us take your questions. Operator?

Operator (participant)

Certainly. Ladies and gentlemen, if you have a question at this time, please press star one one on your telephone. If your question has been answered and you'd like to remove yourself from the queue, simply press star one one again. One moment for our first question. Our first question comes from the line of Pat Walravens from JMP Securities. Your question please.

Pat Walravens (Managing Director and Director of Technology Research)

Oh, great. Thank you very much. Congratulations. I have two, if that's okay. The first one's on the macro, which is just, you know, last quarter, you guys were talking a lot about companies reducing their growth forecast and headcount needs, but your tone seems so much better now. Did the macro... I mean, I hate to even say this, but did the selling environment for you guys improve in some way in Q4?

Tyler Sloat (CFO)

Hey, Pat. This is Tyler. I'll start the answer. Is this the first part or you wanna ask the second question as well?

Pat Walravens (Managing Director and Director of Technology Research)

Yeah. The second part is just I think it'd be great to have Dennis. I mean, obviously he's on the board of ServiceNow, and he was at Dropbox and Google, you know, why he take this job? I'll just throw that out there.

Tyler Sloat (CFO)

Got it. Well, let me start on the macro. Look, we had a really good quarter, especially on new business, right? We called that out, and that felt strong, which I just think is a testament to our products and the value that they can bring to customers even in tough markets. The place that we continue to see pressure was on expansion, and that macro is still playing there, right? That the expansion motion, you know, did slow down throughout the year. We talked about that, you know, throughout the year. We expect to continue to see that for a while. On the new business side, yes, we are upbeat 'cause we're optimistic 'cause we had a good quarter on new business. I'll hand it over to Dennis.

Dennis Woodside (President)

Yeah. Just some commentary on the new business front. I think over the last 18 months, we've made substantial investment in the products themselves. If you think about our ITSM product, we announced enhancements that allow us to fulfill ITOM requirements. In the second half of last year, we rolled out an ESM product. We're able to address broader and broader needs of larger customers. Really, this is just a continuation of a trend and a set of investments that have taken place over the last 12 months or so that really are starting to pay off in terms of those new business wins. We are seeing better win rates, competitive win rates in Q4 than we did in Q3, both for Freshdesk and for Freshservice.

We're getting involved in more deals. Companies are looking to us when they're evaluating better solutions with lower total cost of ownership. Everybody's looking for value. We're getting more swings, and we're hitting the ball more often, and I think that really started to show in Q4. In terms of why I joined, you know, I see an opportunity to build a company that does serve every business in the world. Every business in the world has a need for the products that we currently build. We can serve companies, employees, and customers equally well, and I think the vision that G has laid out and the products that he's built around creating a seamless easy to use, easy to implement set of business software is super compelling.

That's why I joined.

Pat Walravens (Managing Director and Director of Technology Research)

Awesome. All right. Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Ryan MacWilliams from Barclays. Your question please.

Ryan MacWilliams (Software Equity Research Analyst)

Thanks for taking the question. Tyler, I would love to hear about maybe how we should think about net retention as we move through this year. Just on your full year guide, you know, how does this contemplate the macro? Have you guys thought about a scenario where, you know, should things get worse, you know, from the economy perspective, you know, plan to get to break even faster from here? Thanks.

Tyler Sloat (CFO)

Yeah, you bet, Ryan. Net dollar retention, to start off, we did say, you know, something on the call there that we do expect that to decrease a little bit. The net dollar retention churn, you know, there's two sides to that coin. We've been pretty open that we had made really good progress on gross churn, over the last couple of years. In Q3 and Q4 of this past year, you know, the churn kind of remained stable. Just essentially stayed flat, which, you know, churn includes down sell for us, so that, you know, is a good thing. Our goal right now is to try to keep it there, 'cause I do think that's gonna see some additional pressure.

The expansion motion, you guys know our biggest form of upsell is agent addition. You know, we started to see that, you know, kind of after Q1, we talked about it last year, and we saw it throughout the year. You know, we expect to continue to see pressure on that, and that is what's driving the net dollar retention down. Yeah, we said it could come down in Q2, in Q1. It could come down a little bit after that in Q2. Obviously we're gonna work as hard as we can to normalize that. In terms of our guidance, we've built in everything that we see. We're trying to call it as we see it. We have. You know, we do expect that expansion motion to see some pressure.

We are looking at other ways that we can expand with our customers, specifically like Freshservice for business teams, our new ESM application. We're really excited about that. Obviously we're gonna, you know, continue to lean in on new business, which was really good in Q4.

Ryan MacWilliams (Software Equity Research Analyst)

Great. Just to follow up on Patrick's question, the customer adds above 5K ARR appeared strong in the quarter. Just given what you mentioned on headwinds to seed expansion, was the strength in these adds primarily from net new customers or perhaps maybe customers renewing larger with upsells or upgrading the plans? Just like to piece apart the strength there. Thanks.

Tyler Sloat (CFO)

Yeah. We talked about the $50,000 that actually the biggest add to the $50,000 were in expansion, and that actually helps the $5,000 as well, but the $50,000 I think was helped a little bit more. There's a little bit of FX on both sides. Yes, also driven by new customer lands. You know, we really had a really strong new business quarter in Q4. Obviously, we're gonna continue to lean in on that. Customers are still expanding. net dollar retention, you know, was still. It came down slightly, but it was still, it's still good.

You know, even though there's pressure there, we do have customers who are growing on us, and that definitely that was the number one reason for the greater than $50,000 and also helped the greater than $5,000.

Ryan MacWilliams (Software Equity Research Analyst)

Appreciate the color. Thanks, guys.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Pinjalim Bora from JPMorgan. Your question, please.

Pinjalim Bora (Executive Director of Equity Research)

Hey, thank you for taking the questions and congrats on the quarter. I wanted to dig in on the guidance a bit. basically trying to understand if you added billings growth of about 29%, if I heard that correctly adjusted. The guidance is I think about 17.5% revenue growth next year. I'm trying to think, would you go, you know, Are you expecting kind of a step down in macro from here? When I look at the additions to revenue, I think, in 2023 versus what you added in 2022, it's something like a 33% decline. It seems pretty conservative. I mean, would you go as far to say it is de-risk at this point?

Like, how should we think about the guidance?

Tyler Sloat (CFO)

Yeah. Again, hey, Pinjalim, this is Tyler. Again, on guidance in general, we are trying to call it as we see it. You know, what we've, what we've done is we've taken into account that we expect to see continued pressure on the expansion motion. That, you know, as our biggest form of upsell, is agent addition. When we look at that, you know, the Q1 calculated billings, it says 17% and, you know, 20% on a constant currency. Obviously, if we've seen the adjustments, like the 4% you mentioned that we talked about in Q4, we'll add that at the end of the quarter to provide more color. In general, we're calling it as we see it.

I can't say it's completely de-risk 'cause I don't know how long the macro conditions are gonna hold. I think there's upside. If companies go back to growing, we would clearly expect to take advantage of that growth with them. If things get worse, we could actually see pressure there as well.

Pinjalim Bora (Executive Director of Equity Research)

Understood. Thank you for that. One for Girish. We recently hosted one of your partners, and he seemed pretty bulled up on ITSM, and you're seeing good traction on the ITSM side. Seems like you're taking share. How do you see that, the position of Freshservice at this point in the market? Maybe talk about it with respect to Atlassian seems like entering the market as well. How should kind of investors think of that business, sustainable growth of that business, you know, minus any macro?

Girish Mathrubootham (CEO)

Sure. Hey, Pinjalim. From a Freshservice, business standpoint, let me talk to you about the competitive landscape and our positioning and strengths.

Clearly, we know that ITSM is a huge market, and from a TAM standpoint, now we expanded into ITSM, ITOM, as well as enterprise service management. There's no doubt on how big the market is. Freshservice is today the most credible alternative to ServiceNow in the industry, and we are seeing that come into play, especially in mid-market and enterprise companies, specifically in this environment where businesses are scrutinizing their spend very clearly, like every dollar of IT spend. We are actually competing against and winning against ServiceNow, and we have also replaced ServiceNow anecdotally, even in the last quarter, multiple times. That is on the enterprise side, where there is ServiceNow.

Now, before I comment on Atlassian, you should also understand that there is a ton of legacy out there like BMC Remedy and Ivanti, Cherwell. We actually, Mahindra, one of the largest conglomerates in India, moved off of a large legacy incumbent in 2022. Specifically with Atlassian, we are seeing them in some of the lower end of the mid-market deals. We win. Freshservice wins purely based on the fact that we are built from the ground up as a full-blown ITSM and ITOM solution. Whereas Atlassian, I think, has made around four acquisitions and they're trying to stitch together a unified product experience. I think our customers choose us because of the unified product experience.

Pinjalim Bora (Executive Director of Equity Research)

Got it. Thank you very much.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Rich Hilliker from Credit Suisse. Your question, please.

Rich Hilliker (VP of Equity Research)

Hi, everyone. Thanks for taking my question. So you mentioned it was the highest new business ever in this quarter. I think you talked about for some customers, they were expanding. I think you called out the ITSM side. Tyler, I think you mentioned some stable retention. The question is, I'm wondering what portion of overall bookings would you say came from newer expansion versus renewal in this quarter? Maybe for the new business, can you give us a sense of the duration of those deals?

Tyler Sloat (CFO)

Rich, I'll take that. We don't break out the new versus expansion in terms of quarter, but we did have, you know, one of our best new business quarters ever. We did say that, you know, where it's coming from Freshservice is still smaller than Freshdesk from an ARR perspective, but it continued its trend of being the biggest ARR contributor in the quarter, which it has been for the last couple quarters, and it's growing faster than Freshdesk. On a duration perspective, you know, we've got about, let's call it 60% of our business, roughly, those aren't exact, that are on annual contracts. That there was no big change on that.

What does happen is that the bookings mix can change based on the expansion motion, right? 'Cause it depends on where you are within the contract on expansion and how much that billings would look like. In terms of the new business, there wasn't any significant change. There has been this steady change of moving more to annual over the last couple years.

Rich Hilliker (VP of Equity Research)

Okay, great. Yep, that makes sense. Maybe one last one here for you, Dennis. I was wondering if you can talk a little bit about your vision for unlocking multi-line of business selling. I know you guys disclose multi-product, but multi-line of business is kind of where I'm zeroing in here. Maybe what do you still need to stand up or mobilize to ignite this even further? Thanks.

Dennis Woodside (President)

Yeah. Yeah, thanks for the question. Well, you know, first of all, I would just say that it's happening, right? You know, one of the examples that we talked about was Addison Lee. Addison Lee originally was a Freshservice customer for a couple of years, satisfied with the product. You know, we're serving their IT department, they decide they're not satisfied with their existing CRM, you know, large incumbent, they're not getting value out of it, very expensive to continue to maintain, they look to us. That kind of, that kind of situation we're seeing across the pitch. iQor was another account that was an expansion from Freshservice into Freshdesk. It's happening right now. I think the focus has been very much on new business.

As we kinda continue to scale up and we continue to have success with these larger accounts, you know, iQor is a company with 35,000 employees. There's lots of opportunities for ESM and for other product expansion there. We're gonna be leaning into that motion much more. Like I said, so far, you know, a lot of the emphasis has been on new business, and we're getting natural kinda product co-cross-sell, we call it persona cross-sell. That's gonna become an increasingly important part of our business going forward and a big opportunity for us.

Rich Hilliker (VP of Equity Research)

Understood. Thank you all so much.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Brian Peterson from Raymond James. Your question, please.

Brian Peterson (Financial Advisor)

Hi, gentlemen. Thanks for taking the question, and congrats on a strong quarter. You know, I just wanted to hit on the net adds. Obviously, I think it was better than what we were expecting. Is there any commonality in terms of the geo where you guys are having more success or, you know? I actually would love to understand, too, maybe what you guys are displacing in terms of what you're picking up from net new. I know it's different by product segment, but any color there would be helpful.

Dennis Woodside (President)

Thanks, Brian. This is Dennis. On, net adds overall by geo, you know, for Q4, we saw pretty good performance across the board. Our North America business was actually a little bit stronger than the rest of the world, than Europe and Asia-Pac. Our European business performed well. We were pretty satisfied with kind of each of the geographic units. I wouldn't say there's any specific trend geographically that is driving the business. In terms of who we're displacing, you know, customers come to us with a wide variety of current IT footprints and, you know, situations. In some cases, we're displacing very much kind of old on-prem systems, think of BMC, that where the product just is not scaling to what the customer needs, and they are looking to make a change.

In other cases, we are displacing the likes of a Zendesk or a ServiceNow or a Service Cloud, where the customer is no longer satisfied with the overall value proposition, especially in the current economy. They're looking for much better value. They're looking for a simpler product that they can deploy quickly and get fast time to value. They're looking for a product that doesn't require them to have, you know, a number of consultants or specialists on staff just to maintain the product and make sure it does what it's supposed to be doing. There's not... I wouldn't say there's one competitor. I wouldn't say there's one situation. It's really a fairly wide range of situations that's driving our growth.

Brian Peterson (Financial Advisor)

Great. Thanks, Dennis. Maybe a follow-up. I'm curious if you've seen any changes in the pricing environment over the last 90 days and maybe anything that you guys have seen so far in 2023. Thanks, guys.

Dennis Woodside (President)

Yeah. This is Dennis. We haven't seen any major change in pricing. I would say the second half of last year, on the Freshdesk side, you know, the Service Clouds of the world and Zendesk have been very aggressive on pricing. That was true in Q3 and really continued into Q4. I wouldn't say there's any discernible trends on the ITSM side to note.

Operator (participant)

Thank you. One moment for our next question. Our next question comes on the line of Elizabeth Porter from Morgan Stanley. Your question, please.

Elizabeth Porter (Executive Director of Equity Research)

Great. Thanks so much. You mentioned earlier just the better win rates, and I wanted to get a little bit more color if you're seeing any particular improvement at the low end versus the high end or if it's broad-based. You know, I know you guys have been doubling down on functionality. Second, just kind of within those competitive conversations, you know, in your conversations, is there any bit more of a lean towards just the product functionality versus price being the incremental driver that tilts your deals, the deals your way? Thanks.

Dennis Woodside (President)

Great. It's Dennis. I'll take that one. The trends that we're seeing on win rates are broad-based, so it's not confined to any one segment or any one product. Both our Freshdesk and Freshservice product in Q4 saw higher win rates than Q3. That said, for mid-market and enterprise, the mid-market and enterprise segment, our win rates improved at a higher rate. We saw meaningful improvement there. In terms of why is that happening? Most of the customers that we're talking to now, one of the number one things on their mind is value, either total cost of ownership. They're looking at, you know, they need a business case on ROI. Part of that equation is what is the cost to implement the products? What is the timeline for implementation?

How fast can we get the value? What's the ongoing maintenance cost to get the functionality out of the products that they need? In many cases, we are superior on all three dimensions. Now, from a product functionality standpoint, if you were to wind back the clock, you know, 12 or 18 months, you know, we've done a lot in the last 12 months, 18 months to be able to compete on a feature by feature basis with the likes of a Zendesk or Service Cloud or a ServiceNow. You know, the product functionality has gotten better. The robustness has gotten better. Product is scaling incredibly well. We support thousands of agents, millions of customer interactions across our customer base.

All of those investments that we've made over the last 12 or 18 months are paying off, and that really is helping drive those win rates up. We think it's quite promising for, you know, for the future and for where our buyers are going. We think the product we have is the right product, the right strategy for where the market is today, and that's a big opportunity for us.

Elizabeth Porter (Executive Director of Equity Research)

Great.

Girish Mathrubootham (CEO)

Dennis. Sorry, Elizabeth, I just wanted to add on. This is Girish. On the product functionality itself, it's important to note that if you take CX, for example, Freshdesk and Freshchat together offers the most comprehensive omnichannel customer service solution today, covering the whole spectrum of automation, self-service automation with bots, as well as conversational agent experience on modern messaging channels combined with ticketing, right? If you take Freshservice, like we have a unified single product across ITSM and ITOM and ESM, which is Freshservice Business Team. I think that is the value that we're talking about, really, customers not having to buy four or five different tools and struggle with integrating all of that. That is the superior product value where everything is built organically in one platform.

Elizabeth Porter (Executive Director of Equity Research)

Great. Thank you so much. Just following up, you know, you mentioned just now, the conversational kind of bots and the seamless kind of one platform. Earlier this week, there was the announcement just around the Meta Messenger integrations and bots. There was a good amount of buzz in the market, post that announcement. Just wanted to get a little bit more color from you on, you know, the opportunity around that function and feature set to just either add new customers or accelerate revenue per customer. Kind of how are we thinking about, you know, those capabilities more specifically that were recently announced?

Girish Mathrubootham (CEO)

Sure. I'll take that. First of all, let me clarify by saying that our partnership with Facebook and Meta goes a long way, since 2011, where we were the first, Freshdesk was the first helpdesk to integrate Facebook Messenger when they introduced that. The recent announcement that we did was more calling out some of the customers' usage of this. We know that conversational has really been picking up in the last few years, like the Messenger apps under the Meta portfolio, which is WhatsApp or Instagram or Facebook Messenger. There are more than a billion messages every month that businesses are sending over these channels.

This announcement was specifically to call out some of the customer wins that we have with our conversational product and showcasing how we are powering those conversational customer support experiences, specifically for B2C companies. I just want to call out that it is our partnership with Meta is like, it's not a new one, and it's been ongoing. This is more to showcase some of our customer work.

Elizabeth Porter (Executive Director of Equity Research)

Great. Thank you so much.

Operator (participant)

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

Scott Berg (Managing Director and Senior Research Analyst)

Hi, everyone. Thanks for taking my questions. I have a couple. First is on kinda sales process as you look at calendar 2023 here. We all know what's happening with the macro last year and into this year. As you look at your sales processes and overall go-to-market strategies, outside of maybe just leaning into something like ITSM that's selling a little bit better, is there anything that you're changing in those processes that would be noteworthy, you know, to try to, you know, effectively maybe get some of these new customers over the line faster?

Dennis Woodside (President)

Hey, Scott, it's Dennis here. Yeah, there are a number of things that we're doing. I think before I get to the sales specific ones, I would just go back to the product side. You know, a number of the features that and big enhancements that we launched in the second half of last year, we're really getting traction with now and into Q4, things like ITOM, things like ESM, and the enhancements on the conversational side to Freshdesk that G referred to. You know, a lot of it is, hey, we've got products that really are well suited to the market. In terms of the field side, you know, one of the a couple of the adjustments that we've made have been to focus on bigger deals and focus more squarely in the mid-market.

I would say this is just an enhancement to the strategy that we've been pursuing for the last year or so. One of the things we did was we shifted our field team to focus on accounts with employees from 500-5,000 employees as the ideal customer profile. In the past, the field team would focus from 250-500. We can serve those 250-500 employee companies very well and more efficiently through our India operations, through inbound. Many of them, most of them are coming to us anyway through a response to a marketing message or coming to our website and signing up for a trial. That was one pretty meaningful change.

Another change, we've created a set of product specialists to focus on Freshchat and Freshsales in particular. Both of those products are fairly complex. The competitive set is complex, so we feel the specialization on the sales side is really important. We think that that will result in continued improvement in win rate for those products. In general, the field team is pretty jazzed up about kinda what the product set looks like, the competitive positioning and kinda where we are in the market. We're excited about this year, and I think we're gonna see quite a few opportunities.

Scott Berg (Managing Director and Senior Research Analyst)

Got it. Very helpful there. From a follow-up perspective, Tyler, as you look at your guidance to start fiscal 2023 here, have you changed it at all with regards to what you're seeing in the macro compared to maybe a year ago? I know you talked about you're trying to call it as you see it right now, but as you think about that general philosophy, just curious to know if there's anything different about it.

Tyler Sloat (CFO)

There's no, there's no change in philosophy, Scott. I mean, like, trying to take everything into account that we know. A year ago, we did not know the impact of kinda the macro, right? We did not expect the expansion motion to slow down the way it did throughout the year. You know, now it's kinda the opposite. We actually expect it to continue to be tough for a while, and we've built that in. You know, we'll see how it goes throughout the year, and obviously, we're gonna do our best to find other ways to grow with customers. In terms of the philosophy itself, there is no, there is no big change.

Scott Berg (Managing Director and Senior Research Analyst)

Excellent. Thanks for taking my questions.

Tyler Sloat (CFO)

Okay.

Operator (participant)

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

Luv Sodha (SVP)

Hi, this is Luv Sodha on for Brent Thill. Thank you for taking my question. Just wanted to ask one for Girish on ESM.

Could you maybe, you know, to categorize that opportunity, could you maybe give us an attach rate to, you know, core Freshservice? How should we think about the opportunity within the install base that you already have?

Girish Mathrubootham (CEO)

Sure, Luv. If you really think about Freshservice or Freshservice for Business Teams, one of the things I would like to tell you is even before the launch, we knew that almost 4,000+ customers of Freshservice were actually using it outside of IT, like in departments like HR, facilities, legal, and finance. I think that gave us the real product validation that we needed to create the new module to kind of price it separately, give the workspaces that are required. We actually think there is tremendous opportunity to go into all of the existing customer base and actually encourage them to use Freshservice inside those other teams.

Also, the Freshservice for business teams actually priced lower than an IT agent. We think it'll be attractive for that. There is an expansion motion play which we will be taking on to take this to existing customers. Having said that, we also have multiple new lands where we are landing in multiple departments, not just IT. I think both of this will allow us to extend Freshservice for business teams into multiple departments within the company.

Luv Sodha (SVP)

Got it. One quick follow-up for Dennis. In terms of the go-to-market organization is, you know, I know last quarter, obviously, Patty was appointed as the interim CRO. Any, any other changes, I guess, in terms of the organization itself, and do you feel like you have all the resources you need to execute this year? Thank you.

Dennis Woodside (President)

Thanks. First of all, Patty's done an amazing job taking on the CRO role. A number of the changes that I described earlier around the focus on, you know, 500-5,000 employee companies, crispening the team's focus on larger deals, winning larger deals, some upskilling that's going across the organization, that all is being driven by Patty. All very positive. I think it's incremental changes from where we were, but it's really meeting the customers where they are coming to us. As I said earlier, as our product market fit is becoming much more apparent to the market, that's creating a lot of opportunity for us to move up.

We're very pleased with where things are on the go-to-market side right now.

Luv Sodha (SVP)

Good. Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes on the line of DJ Hynes from Canaccord. Your question, please.

DJ Hynes (Managing Director and Software Lead Analyst)

Hey, guys. Thanks for taking the question. Girish, maybe I could just follow up on Luv's question there around the broader ESM strategy. I mean, how much attention do you think investors should be putting on that today? Like, if we fast-forward, could ESM be ultimately a bigger opportunity than core IT? Like, how are you thinking about sizing, you know, the two relative opportunities within the Freshservice portfolio?

Girish Mathrubootham (CEO)

I think, right now it is still early days for us. And also we are landing, ESM through IT departments, right? We are not actually starting a go-to-market motion where we're trying to sell this to HR teams or finance teams.

DJ Hynes (Managing Director and Software Lead Analyst)

Okay.

Girish Mathrubootham (CEO)

I think in that sense, Our go-to-market is go to IT and then focus on organizations where IT is helping HR, legal, and finance teams to do that. I don't expect ESM to be much bigger than IT in the short or in the coming short term. I would still say that we will land with IT and then expand into other or maybe co-land into multiple departments.

DJ Hynes (Managing Director and Software Lead Analyst)

Yeah. Yeah. Okay. Okay, that makes sense. Then, Tyler, on the sales and marketing side, how much of your spend is variable versus fixed? I'm really getting at kinda the inbound side, which I think is largely driven by, you know, digital marketing spend. Like, how much flexing up and down can you do there to control margins, and where are you on that spectrum today?

Tyler Sloat (CFO)

We don't think of it as flexing up and down. We do look at the digital marketing spend, and we plan it out, and then we do kinda change it if we're seeing big changes in auction rates or conversions. But it's not one that we're, you know, using as a margin lever necessarily, because it does feed one whole side of the business, right? Which is that kind of SMB, that lower than 250, a lot of that is fed by digital marketing spend. Outside of that, you know, that's a variable component, and for the SMB, it's the biggest kind of cost.

On the flip side for the field and the, you know, where most of our business is coming from now, which is that, you know, that field business, which is kind of the greater than 500, you know, the variable component there is commissions, but it's all headcount, right?

DJ Hynes (Managing Director and Software Lead Analyst)

Yeah.

Tyler Sloat (CFO)

That's mainly headcount driven. It is important to note that we spent a lot of, you know, kind of end of 2021 and a lot of last year building out that field presence. You know, We think we have a lot of those piece parts in place right now. We still, you know, are hiring quota-bearing reps where we think we need them. You know, we have built out a lot of that already.

DJ Hynes (Managing Director and Software Lead Analyst)

Yep. Perfect. Okay. Thank you for the color, guys.

Operator (participant)

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Joon Huh for any further remarks.

Joon Huh (VP of Investor Relations)

Great. Thanks, everybody, for joining us today. If you have any other questions, please feel free to call or email. We look forward to catching up with you throughout the quarter. Thank you.

Operator (participant)

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.