Freshworks Inc. (NASDAQ:FRSH) Q4 2023 Earnings Call Transcript

Freshworks Inc. (NASDAQ:FRSH) Q4 2023 Earnings Call Transcript February 6, 2024

Freshworks Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and thank you for standing by. Welcome to the Freshworks Fourth Quarter and Full Year 2023 Conference Call. At this time, all participants are in a listen only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to turn the conference over to your speaker for today, Joon Huh, VP of Investor Relations. Please go ahead.

Joon Huh: Thank you. Good afternoon and welcome to Freshworks fourth quarter and full year 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 fourth quarter and full year 2023 performance and our financial outlook for our first quarter and full year 2024. 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 Form 10-Q from the quarter ended March 31st, 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. And with that, let me turn it over to Girish.

Girish Mathrubootham: Thank you, Joon and welcome everyone to Freshworks’ earnings call covering our fourth quarter and full year of 2023. A year ago, we laid out our growth strategies to focus on product innovation, winning in enterprise, landing and expanding to drive revenue growth, and improving our operating efficiency. Over the course of 2023, we launched the Freshworks customer service suite and a range of AI capabilities like Freddy Self-service, Copilot, and Insights, all in pursuit of our mission to power businesses with AI-enabled software that helps customers optimize their work and boost productivity. We landed or expanded with big brands like Big Lots, S&P Global, Fila, Cineworld, Forbes, L.A. Dodgers, Nucor, Giant Eagle, and Johnsonville Sausage.

We significantly improved our operating efficiency and inflected our financial model. We went from using cash for operations in 2022 to generating $78 million of free cash flow in 2023. Turning to the quarter, I would like to thank the entire Freshworks’ team for delivering a strong Q4 as we outperformed across our key business metrics. Our revenue exceeded the high end of our financial estimates, coming in at $160.1 million for the quarter. We outperformed our non-GAAP operating margin and delivered a record amount of free cash flow, generating $28.6 million in Q4. For the full year 2023, we finished with revenue of $596.4 million and free cash flow margin of 13%. During today’s call, I want to highlight three of our key differentiators and how they help finish out the year with a strong Q4.

The first is the power of our Neo Platform, which underpins our product portfolio, giving us the ability to serve enterprise buyers and cross-sell into more departments with multiple products. Second is our AI innovations which are already helping customers achieve concrete productivity improvements. And third is our talented product development team in India that drives our innovation velocity and brings products to customers faster. Our Neo Platform is a critical component of our success and provides all the services that power our product analytics and Freddy AI, offers extensibility and interoperability for our customers through marketplace apps, and offers a unified customer data model across our products. The development and launch of Customer Service Suite illustrates the power of our platform.

Customer Service Suite combines three distinct Freshworks product capabilities, generative AI bot, conversational messaging, and ticketing, in one integrated solution to meet the many needs of our customers. For example, ClickFunnels, a provider of sales, marketing, e-commerce, and analytics tools replaced their previous support solution with our Customer Service Suite. The long developer times required to make even the smallest change, force the funnel marketing company to search for a more robust and agile solution. ClickFunnels chose CSS because of our integrated offering that is powered by AI capabilities, resulting in improved resolution rates. According to our Forrester Total Economic Impact Report published in Q4, Freshworks CSS customers surveyed could achieve over a 200% return on investment over three years.

Our platform also helps us with rapid adoption of new technologies into all of our products. For example, we built generative AI capabilities across our products in just a few months. We started with Freddy Self-service through bots and later introduced Freddy Copilot, built for fresh chat first and then extended to Freshdesk and Freshservice. We are excited about the AI opportunity and potential monetization, as Copilot became generally available recently and we plan to launch Freddy Insights later this year. With Freddy Copilot capabilities in the hands of our customers, we are encouraged by the early results. Several power user customers realized approximately 50% reduction in the resolution times for their customer service agents with the help of Freddy Copilot.

As customers grow, many of them will use acquisitions as a part of the growth strategy. And when they do, they have a choice to either cobble together inherited disparate software solutions, our pick one unified solution that works for all like Freshworks. For example, [Indiscernible] Group in the UK, a retail customer that has grown over four decades and completed several acquisitions. It now represents 70 store brands, including sportswear, games, homeware, fashion, and beauty. After they chose Freshdesk in 2022 to consolidate 16 customer support systems into one, the company saved over $1 million in software licensing costs. Then in recent months, [indiscernible] Group added our AI-powered bot and can now reflect more than a quarter of their customer interactions from human agents, saving more time and money for the company.

For our partners, we are seeing them utilize Freddy Copilot for developers to significantly accelerate the app development cycle. In Q4, one partner, Connectify, went from publishing four apps per month to building an average of seven per month, a productivity improvement of 78% with the help of Copilot for developers. With the introduction of ChatGPT 4 last year, every company had the chance to reimagine its use of the latest AI technology. One of our strategic advantages in this moment was our access to high-quality talent in India. Our product and engineering teams were able to quickly innovate on our product roadmap. In 2023, this included integrating generative AI into our platform to leverage the latest large language model. This year, we plan to continue to advance our AI features across our products and platform.

In CS, we expect to migrate more customers to our integrated Customer Service Suite, which is designed to improve agent productivity. In Freshservice, we plan to enhance ESM, ITOM and verticalized offerings to fuel upmarket growth and expansion across departments. And we plan to make significant upgrades to our sales and marketing products to drive more inbound demand and cross-sell opportunities. Let me now turn it over to Dennis to share what we are seeing in the marketplace, how larger customers are driving our business growth, and how companies are expanding the use of our products.

Dennis Woodside: Thank you, G and congratulations to the team for our strong finish to 2023. G talked about our enterprise-grade platform, AI capabilities, and the strategic advantage of our India teams. Now, let me spend some time talking about how these played out for us in our go-to-market success. Macroeconomic pressures and a greater emphasis on fast time-to-value our leading enterprise companies to choose a smaller number of platform solutions to build their businesses. We believe Freshworks is well-positioned to continue taking advantage of this trend. In 2023, we continued our progress in winning upmarket. In Q4, we closed the year by adding 229 more customers contributing more than $50,000 in ARR. This represents the highest number of quarterly adds for this customer cohort ever.

We also closed a record number of new deals over $100,000 in both IT and CS segments contributing to our strong quarter. These include a US-based footwear and apparel company operating in over 120 countries and a leading wholesaler to millions of restaurants, hotels and catering firms. As G said, we win with large businesses because of the power of our Neo Platform underpinning our multiproduct offerings. This enables us to rapidly roll out new technologies like AI, all at a third the cost of larger competitors. Customers across a variety of industries are quickly realizing the benefits. In the CPG sector, Tata Consumer Products is a prime example of our enterprise customers, leveraging improved automation workflows. As one of India’s leading food and beverage companies, they are the world’s second largest tea manufacturer, and operate Starbucks in India.

Their legacy ITSM solution provided no control over admin configuration, making it difficult to create automation workflows. At the same time, the company faced an overwhelming volume of e-mail and phone calls. Since adopting Freshservice, e-mail queries have fallen by 21% in five months. In addition, Tata Consumer Products is one of the highest users of Freddy Copilot. For industrials, Klöckner & Co. supplies more than 90,000 customers worldwide with steel and metal products. The company is also digitizing and largely automating its supply and service chain. They needed to find a new Self-service tool that’s easy to use, fast, and a trustworthy daily assistant. Freshservice beat the competition, helping them optimize budget and repurpose funds for other IT initiatives.

Shifting to expansion. We have several paths to grow our business with existing customers. These include agent seat additions, product cross-sells, addition upsells, and enhanced pricing. Our recent introductions of AI capabilities, including bot sessions and Copilot add-ons, offer additional opportunities across our 67,100 customers. Digging into our Q4 numbers, we’re pleased that our net dollar retention increased 1 percentage point quarter-over-quarter to 107% on a constant currency basis. We closed several large expansion deals in Q4 as growth expansion improved from the prior quarter and reversed declining trends from earlier in the year. We also continue to improve our dollar-based churn incrementally from the prior quarter. Lastly, our multiproduct adoption increased to 26% of our customer base.

For example, we saw higher adoption for Freshservice for business teams as accounts grew more than 50% quarter-over-quarter, ending the year with more than 1,000 customers. One of these customers is Brunel University London, a college highly recognized for its research. They serve up to 18,000 students and more than 2,500 staff across the academic year. Already a Freshservice customer, they saw an opportunity to improve and provide a more consistent service experience to departments beyond IT. These include health and safety, campus service, the student center, and student welfare. By adding business agent licenses and workspaces, they reduced the average ticket resolution time from a previous backlog of several weeks to around four hours and achieved over 85% positive customer feedback.

We’re also seeing expansion from early Freshdesk adopters to the newer Freshworks Customer Service Suite. For example, Canadian-based Carlson One made the switch and has since achieved a two-hour first response SLA. They are resolving over 1,000 tickets daily and landing a 60% first contact resolution rate through AI and bots. And finally, Freshworks interoperable products give us a natural expansion path across solutions. For example, Agito, a mid-market travel management company in the UK first bought Freshdesk. This was to replace an on-premise customer support solution that couldn’t deliver unified analytics and limited collaboration across teams. Later, they added Freshcaller and Freshchat to unify support channels and more recently, in Q4, they rolled out Freshsales to generate more qualified leads.

In addition to our powerful platform and multiple expansion paths, what we believe makes Freshworks unique is our go-to-market motions, which include both inbound, product-led growth and field sales. Our inbound business is primarily marketing-led, while our field business is sales-led. As our company matures, we have hired two proven leaders across these distinct go-to-market motions that can help us scale. In Q4, Mika Yamamoto joined us in the new role of Chief Customer and Marketing Officer to drive greater inbound activity, including responsibility for our customer support, SMB and commercial sales. Under her leadership, this team will drive our inbound product-led growth motion. Our field sales team will be led by Abe Smith, who I’m excited to announce has joined as our Chief of Global Field Operations this week.

He’s a sales executive with nearly 25 years of global experience at Zoom, Oracle, and Cisco and will lead our talented field team to scale the business. With these changes in the organization, Pradeep Rathinam, our CRO, will be departing Freshworks at the end of this month. Pradeep stepped up to lead and stabilize our go-to-market teams during a transition period and delivered a strong Q4 to finish out the year. After joining us in 2020 through an acquisition, Pradeep made countless contributions, first as our Chief Customer Officer and later as CRO. We thank him and wish him all the best in his future endeavors. Now, over to Tyler to go through the Q4 and full year financials and talk about how we’re driving efficiency.

Tyler Sloat: Thanks Dennis and thanks again to everyone for joining us. As I reflect on Q4 and 2023, I was really pleased with our ability to adapt to a changing macroeconomic environment to deliver durable revenue growth while also improving our operating efficiency throughout the year. Specifically, we continued our product innovation cycles, injecting generative AI capabilities into our offerings. We retooled our go-to-market approach to more efficiently serve our diverse customer base. We brought on new leaders and team members to help drive additional growth. At the same time, we significantly improved our full year non-GAAP operating and free cash flow margins by 12 percentage points and 16 percentage points, respectively, compared to the prior year.

For our call today, I’ll cover the Q4 and full year 2023 financial results, provide background on the key metrics, and close with our forward-looking commentary and expectations for Q1 and the full year 2024. I’ll 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. Q4 revenue grew 20% year-over-year to $160.1 million. Adjusting for constant currency, revenue growth was 19% as we saw the positive impacts from currency rates for the euro and pound against the US dollar over the past year.

Similar to prior quarters, ITSM continued to drive the majority of our growth in Q4. In addition, we were encouraged to see an improvement in our CS expansion activity quarter-over-quarter. Looking at our margins. Non-GAAP gross margin remained flat compared to Q3 at 84% as we are efficiently scaling the business. Similarly, for the full year 2023, we achieved strong non-GAAP gross margins of 84%, which represents a 150 basis point improvement from the prior year. 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 1 percentage point benefit from FX and came in ahead of our previous estimates of 105%.

In Q4, we saw improvements in both gross expansion and churn rates quarter-over-quarter. The higher expansion rate was mainly driven by strong execution from our field teams closing a number of large deals with existing customers. This was despite the overall macro demand continuing to feel pressure in Q4. Looking forward, we are planning for Q1 net dollar retention of 106%. Moving to our other key business metric of number of customers contributing more than $5,000 in ARR. This metric grew 14% year-over-year on an as-reported and constant currency basis, to 20,261 customers in the quarter and now represents 89% of our ARR. For our larger customer cohort contributing more than $50,000 in ARR, we saw strong growth in this cohort of 31% year-over-year to 2,497 customers and it now represents 48% of our ARR.

Adjusting for constant currency, this cohort grew at 30%. As G and Dennis mentioned earlier, we’re excited about our ongoing success in winning upmarket deals. For total customers, we added over 500 net customers and ended the quarter with over 67,100 customers. The lower net adds in the quarter was primarily impacted by higher logo churn from smaller customers in the customer service segment, but we continue to see improvement in ARPA as we focus on attracting higher-yielding, more profitable customers. Moving to calculated billings, balance sheet, and cash items. Calculated billings grew 22% year-over-year to $180.4 million and 20% on a constant currency basis. Factors, including timing duration of contracts created a slight benefit of 2% to these growth numbers.

Looking ahead to Q1 2024, our preliminary estimate for calculated billings growth is 16%. For the full year 2024, we expect calculated billings growth to be similar to our expected annual revenue growth rate of 18% to 19%. During the quarter, we generated $28.6 million in free cash flow and for the full year, we generated $78 million in free cash flow. This annual figure was nearly $70 million above our initial estimates we provided at the start of the year as we realize efficiencies throughout the year. This improvement was driven by lower-than-expected head count costs, improvements on our infrastructure spend, and consolidation of vendor spend, resulting in both ongoing efficiencies as well as some one-time benefits. For the full year 2024, we expect to generate approximately $110 million of free cash flow with approximately $26 million of that in Q1.

We ended Q4 maintaining a similar balance to Q3 for cash, cash equivalents, and marketable securities with $1.19 billion. We continue to net settle invested equity amounts using $16 million during the quarter and $68 million for the full year 2023. This activity is reflected in our financing activities and is excluded from free cash flow. Since our IPO in 2021, we have used approximately $239 million in net settlement of vested equity. As we look forward to Q1, we plan to continue net settling invested equity amounts resulting in Q1 cash usage of approximately $21 million using current stock price levels. For the full year, we expect to use approximately $80 million to net settle vested equity amounts. Turning to our share count for Q4. We had approximately 326 million shares outstanding on a fully diluted basis as of December 31st, 2023, representing share growth of less than 1% from the prior year.

The fully diluted calculation consists of approximately 297 million shares outstanding, 27 million related to unvested RSUs and PRCs and 2 million shares related to outstanding options. Let me now provide our forward-looking estimates. For the first quarter of 2024, we expect revenue to be in the range of $162.5 million to $164.5 million, growing 18% to 19% year-over-year, non-GAAP income from operations to be in the range of $12.5 million to $14.5 million, and non-GAAP net income per share to be in the range of $0.07 to $0.08, assuming weighted average shares outstanding of approximately 305 million shares. For the full year 2024, we expect revenue to be in the range of $703.5 million to $711.5 million, growing 18% to 19% year-over-year, non-GAAP income from operations to be in the range of $52 million to $60 million, and non-GAAP net income per share to be in the range of $0.29 to $0.31, assuming weighted average shares outstanding of approximately 306.1 million shares.

We want to provide our best view of the business as we see it today and as part of that, I want to call out a couple of assumptions in our financial model. First, our forward-looking estimates are based on FX rates as of February 2nd, 2024. So, any future currency moves are not factored in. Second, we have seasonality in our business with expenses, typically stepping up in Q2 as our annual merit increases come into effect. As a result, we anticipate non-GAAP operating income to be approximately $6 million in Q2 and $15 million in Q3 and the remainder coming in Q4 to add up to the full year amount. Let me close by saying, I’m pleased with all that we accomplished in 2023. We continued our rapid pace of innovation and enhance our go-to-market efforts, all while making meaningful improvements to our operational efficiency.

As we look to 2024, we are focused on our growth initiatives, and we’re excited for the many opportunities ahead. And with that, let us take your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question that we have today is coming from Scott Berg of Needham. Your line is open.

Scott Berg: Hi everyone. Really nice quarter on the sales side and thanks for taking my questions here. I get a couple. G, I wanted to start with — start with what you’re seeing on some of the AI front with some of the functionality that you have in beta. I think one of the concerns amongst investors and enterprise software is the more prevalent these technologies become the more they have a chance to eat at seats and a seat-based model like what Freshworks is? And you had commented that in one of your beta customers made a 50% improvement in resolution timeframe. How do you think about the use or the impact of AI in terms of what your business looks like going forward? Is it just going to be a module that adds maybe some ARPU uplift for customers or is there some seat opportunity maybe on the positive or less positive side that might be impacted as well?

Girish Mathrubootham: Yes. Thanks for the question, Scott. So, let me start off by saying right from the very early days, even before AI, one of the goals for — like for Freshworks and in particular, for most technology vendors in customer service or employee service is how can we help businesses drive more automation? Think about IVR driving automation in the call centers and things like that, right? So, from 2018, we have been helping customers in the Freshdesk, Freshchat business to drive more automation and that’s always a business driver. So, what we have with Gen AI and Freddy Self-service and bots is the opportunity to bring a natural language, conversational automation of customer service, and some of the largest B2C companies are using our Freddy AI today for customer service automation.

So, we actually believe in this and it will actually help us — help Freshworks be a beneficiary in driving better automation and with — along with a seamless transfer to a live agent when the actual customer query goes beyond a simple automatable question. So, I think overall, you have to look at it as how do we use — how do businesses use automation as the first line of defense and then seamlessly hand over to a human, and then handle all the complex workflows. We think we have the best omnichannel customer service product in the industry today and we will be a big beneficiary of that.

Scott Berg: Got it, helpful. And then from a follow-up, Dennis, you mentioned you have a new field sales that are starting. You’ve obviously helped enact in a number of changes to the organization since you came. But with this individual, are there a lot of moving parts that are going to be occurring here in terms of what your go-to-market strategy looks like in 2024? Is this might be more of an opportunity to make some subtle adjustments? Thank you.

Dennis Woodside: Well, I would say this is more of an opportunity to make subtle adjustments. We announced in Q4 that we made a change to separate our inbound business from our field business, that’s to create more focus on both that SMB primarily inbound business from field. Field, we’ve done quite well over the last year. We have some opportunity in that SMB inbound business. And that’s why we brought Mika in. I think today’s announcement with Abe is really the next step and creating focus on those two businesses as distinct. It’s very different going out, negotiating big deals with large industrial customers, and on the other hand, managing a funnel that’s generating thousands of leads every single week. So we want to bring focus to both of those businesses, and that’s why we made the change.

Scott Berg: Very helpful. Thank you. And congrats again on the nice quarter.

Dennis Woodside: Thank you.

Operator: Thank you. And our next question is coming from in Pinjalim Bora of JPMorgan. Your line is open.

Pinjalim Bora: Great. Thank you for the question. Good to hear about the improvement in the CX expansion side. I wanted to ask you if you can go a little bit deeper, are you seeing seats starts to grow and kind of accelerate there? Or is it — is that expansion characteristic largely driven by the Customer Service Suite or maybe the pricing changes around bots?

Tyler Sloat: Hey Pinjalim, this is Tyler. We actually — in the quarter, we had strong expansion. We called out CX. It’s a mix of all of the above, but we did have seat expansion specifically on that mid-market enterprise, which is driving a lot of it. Some of it was pull forward early renewals from Q1 with expansion, which I always see is a good sign, that they’re coming — a customer coming up in renewal and they’re going to actually increase their ARR and renew early with us. And so that was encouraging. It’s — CX has seen pressure on Asia for a couple of years. We’ve been calling that out and so we thought it was a really good quarter of execution on that side.

Pinjalim Bora: Understood. Tyler, another one for you. The guidance, can you maybe unpack some of the some of the assumptions on guidance? What are you thinking from a net retention perspective for the whole year from a logo perspective? Are you thinking about macro to be kind of the same? What should we think about from a pricing leverage point of view in that guidance? Anything you can add will help.

Tyler Sloat: Yes. So, I’ll take that in a couple of different pieces. On guidance, you mentioned net dollar retention. We have been calling 105%, and we really didn’t think it was going to hit 105% in Q4, and we had called that earlier in the year. And kind of coming into Q2, Q3, one of the reasons that we didn’t get down to 105% because we’re doing really, really well on churn. In hitting our number for Q4, it was really a combination of churn still getting better as well as expansion kicking in a little bit. And now we’re saying, hey, we’re going to be at 106% in Q1. And we do think that’s going to be the number. But previously, we thought we’d stabilize at 105%, and now we think we’re going to stabilize at 106% and it really is just a reflection of the health of the customer base.

On the other areas of guidance on revenue, we are — it’s our best estimate based on what we see today and that kind of 18%, 19% growth. And then billings for the year, we expect to actually track that. We did call out that Q1 just the way that renewals are kind of falling, and also, I just mentioned that we had some early renewals into Q4 that pulled some billings from Q1 into Q4 that, that number is going to be a little bit — calculated billings we expect to be a little bit lower in Q1, but it really is just around timing. And for the year, we actually expect it to track revenue for the full year 2018 to 2019.

Pinjalim Bora: Understood. Thank you so much.

Operator: Thank you. And our next question will be coming from Elizabeth Porter of Morgan Stanley. Your line is open.

Elizabeth Elliott: Great. Thank you so much. First, I just wanted to ask on the AI monetization impacts. You have some of the usage-based revenue from bots coming in and the Copilot seat add-ons. I believe Freddy Insights, you mentioned is coming later this year. So, what kind of attach or penetration rate are you assuming? Or is this more of an upside driver to guidance? Thanks.

Dennis Woodside: So — and thanks for the question. So, first of all, I think in terms of adoption so far, we have thousands of customers that have opted into the beta programs for Freddy Self-serve for Insights and for Copilot. And not only have they opted in, but the usage rates amongst those customers is quite high. So, we track things like active usage and so forth. We recently put those programs into GA. So, you can purchase Insights — or sorry, you can purchase Copilot and Self-serve today on our website. If you’re a new customer and then we’re moving all the beta customers into pay programs over the next month or so. So, we’ll start to see the monetization flow through. But for now, we’re very much focused on adoption.

We’re very much focused on the value that those products are providing to our customers. That’s a good leading indicator for us. In terms of how we’re thinking about it for the full year, we haven’t baked in a meaningful upside to the year from AI because we wanted to see how things play out before putting anything into our number.