Freshworks Inc. Q3 FY2022 Earnings Call

Welcome to the Freshworks' Third Quarter 2022 Earnings Conference Call. All participants are currently in a listen-only mode. Following the presentations, there will be a question-and-answer session. I would now like to turn the call over to your host, Joon Huh. You may begin.

Thank you. Good afternoon and welcome to Freshworks' third quarter 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 information regarding our third quarter 2022 performance and our financial outlook for our fourth quarter and full year 2022. 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 and the macroeconomic environment in which it operates. Management's beliefs and the ability to continue to operate efficiently and drive growth and certain other assumptions made by the company as of the date hereof, 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 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 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 for our second quarter 2022 results, which we issued earlier today and 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. And with that, let me turn it over to Girish.

Thank you, Joon. Good afternoon everyone, and welcome to the Freshworks Q3 earnings call. We delivered a strong quarter with $128.8 million in revenue, which represents growth of 37% on a constant currency basis. Our non-GAAP operating loss came in well ahead of expectations as we adjusted our spend in a changing macro environment. Overall, we continue to operate efficiently while growing at a healthy rate. In Q3, we added approximately 1,700 new customers and saw good momentum in new business led by Freshservice. This quarter, we crossed over 61,000 customers as our powerfully simple products served consumer brands like HelloFresh and Plume, and B2B companies like Dynata and Altasciences. This quarter we added some exciting new features across all three business lines. Specifically in CX, we continue to make enhancements to the Freshchat product to help support teams engage conversationally with their customers. Earlier this year, we added new channels like Instagram, Google Business messages, and WhatsApp. In Q3, we invested in making the agent experience of managing those channels even easier. An exciting new addition in Freshchat is the ability to bring support for customer emails into the unified agent inbox. We have also added new auto-complete responses that turns Freshchat into a high-speed engagement solution for modern customer experience teams. An exciting new feature in our Freshdesk product is the Freddy Auto Triage feature, where the system automatically categorizes, prioritizes, and routes the ticket to the right support agent or group saving agents hours of manual effort, giving them time to focus on solving critical issues. Together Freshchat and Freshdesk improve the agent and customer experience. An example of this is Blue Nile, a leading online retailer of fine jewelry who uses Freshdesk and Freshchat to resolve approximately 90% of its customer queries at the first touch point. 200 agents are able to engage their customers across telephone, email, and chat channels. Blue Nile also recently added Freshsales to offer personalized experiences across the entire customer lifecycle. We also enhanced our unified CRM solution by adding AI-powered features to help sales and marketing teams increase productivity to win more business. Our Freddy AI for Freshsales, new intelligent lead scoring helps businesses understand how customers use their products and who's ready to buy more. The AI learns from customer data and behavior to deliver insights and predictions that help companies make data-driven decisions and have more personalized conversations with their customers. A large American HVAC manufacturer of more than 200,000 products chose Freshsales with Freshdesk to unify its new business and upsell processes. The new predictive lead scoring identifies buyers that are most likely to reorder and alert sellers, ensuring that they can stay on top of customer requests and orders. The unified Freshworks dashboards create alignment across sales, marketing, and support teams, ultimately helping the company deliver more value to their customers. We also help our customers create incredible employee experiences. That's why we have made it easier and more secure to extend Freshservice beyond the IT department to now support all business teams. There are already thousands of companies that use Freshservice within HR, finance, and legal teams to support their internal stakeholders. Take Databricks for example. After using Freshservice to support the IT needs of 4,500 employees, Databricks expanded its deployment to HR, legal, security, and learning and development departments to provide its employees with the same great experience when interacting with any team internally. Recently, we announced an exciting new module Freshservice for business teams with capabilities that enable departments beyond IT to offer a modern employee experience. What makes Freshservice for business teams unique is the support for private workspaces for every team. These new workspaces within Freshservice empower the HR, finance, legal, or any internal operations team with the ability to manage employee requests and automate their departmental workflows. Multiple teams can coexist independently within a single Freshservice instance with the ability to configure, manage, and control access to those individual workspaces. Viessmann, a German provider of climate solutions with €3.4 billion in revenue is another customer that saw our position to launch this product. Leman has 13,000 employees spread across 74 countries, and their people organization and IT team use Freshservice to unify their internal teams with a single service management solution for a fast, easy, and seamless employee experience. Companies of all sizes are realizing the benefit of expanding IT service management principles to non-IT departments, empowering the employee experience with ensured service delivery. What makes all of these product innovations possible is our platform Freshworks Neo. It has evolved from being a set of internally focused shared platform services and analytics deployed across Freshworks products to a customer-impacting developer-friendly platform that makes building apps for Freshworks products faster and easier. Today, more than 50% of our customers extend the core utility of our products through the Freshservice marketplace and custom-built apps powered by the Neo platform. In Q3, our team built a brand new SaaS application entirely on top of the Neo platform and NPS survey tool to help businesses run surveys to measure customer satisfaction and delight. We are using it internally for now, but this serves as a great example that demonstrates the power of our platform. In Q3, we held our first developer summit in Bangalore and have another in San Francisco scheduled later this month. Next week, we'll be hosting a virtual event to demo all of these Q3 product updates from our fall product release to our customers. To recap, we had a strong quarter given the changing market conditions. Our continued growth coupled with our operational efficiency is a differentiator among new public software companies. But like others in the tech sector, we are not immune to the slower economy. While our new business activity picked up, expansion slowed down as companies reduce their growth forecasts and headcount needs. On a positive note, we saw good new business growth in North America in the mid-market and enterprise. Our overall gross churn rate remained roughly the same, and we even saw SMB churn stabilize in the quarter. Anecdotally, we are hearing that mid-market and enterprise businesses are focused on value and managing their software costs toward the end of the year. Our modern affordable solutions are well poised for this segment of customers. As we look ahead, I'm optimistic about our future. I'm happy to introduce our new President, Dennis Woodside, who comes with a proven track record of helping businesses scale. We brought in Dennis to accelerate our growth and he will start with a focus on go-to-market strategy and operations. This will enable me to focus on our long-term vision and product strategy. The entire management team will report to both Dennis and I as we partner together on our journey ahead. Now, I would like to welcome Dennis to talk about why he chose to join Freshworks, what he's observed so far, and the opportunities he sees for us.

Thanks, Girish, and good afternoon everyone. I'm excited and honored to be here today as a member of the Freshworks management team. I spent 20 years working in technology for growth companies that have challenged the status quo and delivered amazing experiences for their customers, Google, Dropbox, and Possible Foods, and now Freshworks. I've always been inspired by founders Larry Page, Drew Houston, and Pat Brown. They push the limits of what the rest of us think is possible, and I know how to help them scale. That's why I joined Freshworks. I believe in the company's vision. We put the power of software back in the people's hands with applications easy enough for everyone to use. Girish has always believed that enterprise software doesn't have to be complicated, and that businesses can have powerful technology without sacrificing agility. I believe in that mission. During my first two months, I've had several observations that make me excited about the opportunity ahead for Freshworks. First, our customers love our products. I traveled around the world and met with customers like Viessmann and Internetstores in Germany, Sodexo in France, and Frazier's Group in the U.K. It's clear that Freshworks customers see immediate value from our software, and we continue to innovate fast to keep our customers happy. Second, we are set up to continue innovating at scale. You heard Girish talk about the differentiating features and new products we introduced in just one quarter. That's because we have a team of product and engineering veterans from the world's leading tech companies. Finally, there is a huge opportunity to serve larger customers and win more big deals. As Girish mentioned, I've been focused initially on our go-to-market operations. Over the last few years, Freshworks products have evolved to meet the needs of larger companies, and I see this as a big opportunity for our growth. We have a great team and we're already making changes to our sales organization to meet that demand. I believe that with a few adjustments we can make our field sales even more efficient and effective. Earlier today, we announced the upcoming departure of our Chief Revenue Officer, Jose Morales. We thank Jose for his contributions over the last two years towards the growth of the business. In the interim, our Chief Customer Officer, Paddy Rathinam, has taken over CRO responsibilities. He is acutely familiar with our customer needs and products and has decades of sales experience at Microsoft and Harmon. I am looking forward to working closely with Paddy and the other go-to-market leaders to build a sales motion that can deliver the consistent performance that we expect. I am bought into Girish's vision and believe that our value to customers, our business model, and our people can achieve it. Over the coming months, I'm sure I'll be meeting with many of you and sharing more insights on our journey ahead. Now, I'll hand things over to Tyler.

Thanks Dennis. Welcome aboard. We're excited to have you on the Freshworks team and we are looking forward to working with you. Now looking at our Q3 performance. We delivered a strong quarter of financial results, beating expectations for revenue by approximately 3% and coming in more than $10 million ahead of expectations on non-GAAP operating loss, further highlighting our ability to drive efficient growth in our financial model. Given the FX rate changes throughout the quarter and the year, including since our last earnings call, I'll spend more time today talking through constant currency comparisons to provide a better view of our business fundamentals. I'll review our Q3 financial results, provide background on key metrics, and close with our expectations for the upcoming quarter, Q4 and full year 2022. Most of our discussion for the financial results will be around non-GAAP numbers, which exclude the impact of stock-based compensation and related expenses, payroll taxes on employee stock transactions, amortization of acquired intangibles, and other adjustments. Starting with the income statement. Revenue grew 37% adjusting for constant currency or 33% as reported to $128.8 million. While overall macro pressures led to slower expansion activity in Q3, we saw increased year-over-year growth for our new business bookings in the quarter. Our diversified business mix across multiple product segments with customers ranging from SMB to mid-market and enterprise continues to be durable through a tougher macro environment. In Q3, the overall churn rate for the company remained in line with the prior quarter and has been relatively consistent over the first three quarters of the year. Customers using more than one product continued its steady increase, up 1% again to 24% in Q3, and represents approximately half of our overall business. We saw good wins in CX with customers seeking modern solutions for conversational messaging, and we're addressing the ongoing need for a unified sales and marketing solution. In ITSM, customers are discovering the powerful capabilities of Freshservice and extending use cases into other functions. In Q3, Freshservice continued to be the largest contributor to ARR growth. Turning to margins. Our non-GAAP gross margins increased slightly, rounding up to 83% for the quarter. This is the fifth consecutive quarter with strong non-GAAP gross margins in the 82% to 83% range, so we're pleased with these levels as our business grows. In Q3, non-GAAP operating margins improved approximately 11 percentage points quarter-over-quarter to negative 2%. Most of the improvement was driven by lower than expected costs related to headcount, digital marketing spend, and shifting of spend into Q4. While we are continuing to add to our Freshworks family, we're slowing the pace of hiring as we align our resources with the current market. We also had a one-time benefit of nearly $3 million related to the reversal of accrued expenses from earlier in the year. The revenue beat, combined with a more efficient cost base led to a non-GAAP operating loss of $3.1 million, which was significantly ahead of our previously given estimates. I'm really pleased with our ability to invest prudently to drive efficiency. Moving to our operating metrics. Net dollar retention was 113% on a constant currency basis or 107% as reported, as we saw increasing impacts from FX rates and lower expansion activity in the quarter. As we mentioned in the prior call, the slowing economic environment is resulting in lower growth projections for businesses and impacting the expansion motion. Looking ahead to Q4, we expect constant currency net dollar retention to be 110% and assuming the current FX rates hold, reported net dollar retention to be 105%. Looking at our customer metrics. Customers contributing more than $5,000 in ARR, grew 19% to 16,713 customers in the quarter and continues to represent 86% of our ARR. Once again, a large number of customers fell below the threshold of $5,000 in ARR because of FX moves. So, we're also providing the constant currency figure of 23% growth year-over-year for this metric. For larger customers contributing more than $50,000 in the ARR, this customer count grew 36% to 1,717 and represents 43% of our ARR. Adjusting for constant currency, this customer cohort grew at 44%. Lastly, our total customers grew to over 61,600 customers with a net add of approximately 1,700 customers in Q3 as our average revenue per account increased in the quarter. Now moving to billings, balance sheet, and cash items. Despite increasing FX pressures during the quarter, calculated billings grew 25% to $136.9 million. Holding currency constant over the past year, calculated billings grew 31%. Other factors impacting the growth rate include billing duration mix of positive 2% and reserve activity of negative 1%. Adjusting for these factors, the normalized calculated billings growth was approximately 32% in Q3. Looking ahead to Q4, our preliminary estimate for calculated billings growth is 22% on a constant currency basis or 16% as reported based on current FX rates. As a reminder, we will have tougher year-over-year comparisons in Q4 as we had significant early renewal activity and duration benefit in Q4 of last year. Turning to our balance sheet and cash items. We maintained a similar cash balance as we ended the quarter with cash and marketable securities of approximately $1.2 billion. Free cash flow was negative $7.2 million in Q3, beating expectations by approximately $3 million. We continue to net settle vested equity amounts and used just over $13 million under financing activities for Q3. Once again, this financing activity is excluded from free cash flow. We expect to continue net settling vested equity amounts for the foreseeable future, resulting in quarterly cash usage of approximately $18 million at current stock price levels. Looking out to the remainder of the year, we expect to generate positive free cash flow in the range of $1 million to $2 million in Q4. This translates to an estimate of negative $17 million to $18 million of free cash flow for the full year, which is better than our prior estimates. We're pleased with our ability to manage spend and show improvements throughout the year. We expect to maintain positive free cash flow on an annual basis in the upcoming years. As we've said before, we've built a durable and efficient financial model for the business. We are well capitalized with no debt and have a strong balance sheet, creating financial flexibility to drive sustained growth for our business. Turning to our Q3 share count. We had approximately 326 million shares outstanding on a fully diluted basis as of September 30, 2022. The fully diluted calculation consists of 287 million shares outstanding and approximately 36 million related to unvested RSUs and PRSUs and nearly 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 afterward. For the fourth quarter of 2022, we expect revenue to be in the range of $129.2 million to $131.2 million, growing 22% to 24% year-over-year. Adjusting for constant currency, this reflects growth of 27% to 28% year-over-year. Non-GAAP loss from operations to be in the range of $10.5 million to $8.5 million, and non-GAAP net loss per share to be in the range of $0.05 to $0.03, assuming weighted average shares outstanding of approximately 288.5 million shares. For the full year 2022, we expect revenue to be in the range of $494 million to $496 million, growing 33% to 34% year-over-year. Adjusting for constant currency, this reflects growth of 36% to 37% year-over-year. Non-GAAP loss from operations to be in a range of $30 million to $28 million, and non-GAAP net loss per share to be in the range of $0.13 to $0.11, assuming weighted average shares outstanding of approximately 284.6 million. These estimates are based on FX rates as of October 28, 2022. As always, we're trying to provide our best view of the business today and in a dynamic market environment, so a few areas to call out. First, on FX. With the dollar strengthening again over the quarter, this has resulted in a negative impact of approximately $1.5 million to our full year 2022 revenue compared to our previously provided estimates. Second, on expansion. As we called out earlier, the macro environment is having an impact on our expansion activity, and especially for our smaller customers. Our biggest driver of expansion revenue is agent addition with higher costs and downsizing of workforces were seen in hearing of customers planning for slower headcount growth going forward. Third, on operating loss. In addition to incorporating our significant Q3 beat on operating loss into the full year estimates, we're improving our outlook by another $1 million, given our ability to effectively manage our cost base. We plan to continue to drive efficiencies wherever possible. We feel really good about our financial position. We have a strong balance sheet with nearly $1.2 billion in cash and equivalents. We're growing at healthy rates and have a good handle on our cost structure. We expect to generate positive free cash flow in Q4 and the years ahead. Let me close by saying, I'm pleased with our results for this quarter. Our diverse business model has proven to be resilient and durable in a changing market environment. We're continuing to execute on our operating plans and remain excited about our opportunities ahead. With that, let us take your questions.

Our first question comes from Scott Berg with Needham. Your line is open.

Hi, everyone. Congrats on a good quarter and thanks for taking my questions. I guess, I'll start with the macro question, will follow up to maybe, Tyler, the exact last thing that you talked about there, which was less seat expansions. How should we think about the magnitude of this? Obviously, it's been an important component of your kind of expansion strategy, but is this, I don't know, 10% lighter from an expansion cadence on what you're seeing? Or is this maybe more significant than that?

Hey, Scott. It's Tyler. Yeah. We're not quantifying the expansion rates right now, but it is a significant part of our business. And as you know, agent addition drives the majority of our expansion. And as such, that's what's driving that dollar retention down and is causing some of the growth coming down as well. So, expansion is significant for our business. And as companies are not expanding, they're just not adding as many agents.

Got it. Helpful there. And I guess, as you look at your business today and think about the success that you've had in the sales and marketing side, yet balancing the profitability of the business as you mentioned $1 million improvement in Q4 here and being mindful of that is, how do you think about the company's own growth investments, you or Girish, maybe over the next I don't know, two to four quarters? Do you continue to invest at the pace that we've seen over the last year, a year and a half? Or have you maybe changed your philosophy a little bit based on what you're seeing in the market today?

Yeah. I think if you look at what we did in Q3, right, we were able to drive efficiencies in Q3 and essentially every line item, G&A, R&D, and sales and marketing came down as a percentage of revenue. And there's a lot of factors just thinking about cost and efficiency, but also we've been hiring at a really high pace and it gives us the opportunity to just kind of digest. Now, we're still going to invest in sales and marketing. Specifically, we're actively hiring quota-bearing reps right now. We think there's a big opportunity there still, and we're going to continue to do that. But of course, we're going to look at efficiencies. We said, Scott, as you know, we're going to produce cash in Q4, and we said on an annual basis, we plan to produce cash going forward. And that just is leverage that we see in our model that we can gain.

Great. Thanks for taking the question and congrats on the strong quarter.

Thanks Scott.

One moment for our next question. Our next question comes from Elizabeth Porter with Morgan Stanley. Your line is open.

Hi. Thanks for taking my question. It's Ryan Bressner on for Elizabeth. You mentioned a little bit earlier, strength in new business for mid-market and enterprise the last few quarters. What's driving this? How much of this is due to kind of product advancements market versus just an increased focus on lower cost solutions by these types of companies in a slowing environment.

I'll take that. This is Girish. So, I think it's a combination of both. Our products, especially Freshdesk and Freshservice are both mature products, which are helping us win more and more into larger accounts. Specifically, Freshservice does not play as much into SMB; it's more mid-market focused. That is the primary reason, but also given the changing macro, companies need to kind of spend more cautiously looking to save costs. I think the Freshworks promise has always been a lower total cost of ownership and a rapid time to value. I think that is resonating well with customers.

Got it. That's very helpful. Thank you. Maybe just one more for me quickly then. When we're taking a step further on the conversation around expansion, is it purely just a slowdown in net expansion for these customers? Or are we seeing maybe some contraction from specific customers that are most impacted by slowing macro?

Yeah. Hey, Ryan. I'll take that. So, what we did say is that churn has been relatively stable, and we've been making improvements on churn kind of quarter-over-quarter for the last year and a half, which we've talked about and we've been able to keep it stable. When we talk about contractions or what would be a downsell theoretically, that is recorded in churn. So, we've been able to see the stability there. So, it really is more on the expansion motion that is reflected in the numbers.

One moment for our next question. Our next question comes from Alex Zukin with Wolfe Research. Your line is open.

Hey, guys. It's Ryan on for Alex. Thanks for taking the question. So, I just had one around kind of the changes to the sales motion. With the change to CRO this quarter, you talked about broader changes in the sales motion that you want to implement. I just want to know what can you guys do to kind of ensure that you aren't taking a step backward in your sales execution, particularly in Europe, where it was an issue earlier this year with all the new changes. And then how long do you expect those changes to take to implement until productivity and execution is back to where you want it to be?

Hi, Ryan. It's Dennis. Thanks for the question. First of all, I think we're very excited about Paddy coming in as our interim CRO. Paddy had 20 years of sales experience and previously was our Chief Customer Officer. So, we don't envision in the very near term, substantial changes in our model. We are very happy with the traction we're getting with larger customers. I think Girish talked about this in his remarks earlier; customers over $50,000 in ARR really are driving a big part of our business, a big part of the growth. So, we're excited about that. We're excited to lean more into that. And we'll continue to, I think, be successful in those kinds of deals.

Great. Thanks.

One moment for our next question. Our next question comes from Adam Bergere with Bank of America. Your line is open.

Hi. Thanks for taking my question. I guess, for you, Tyler, has the macro deteriorated in Q2 versus Q3? Or is it mostly consistent between two? And put another way, would you say that there's been like an added level of conservatism or cushion in the guide between Q3 and Q4?

No. I think at the end of our call in Q2, we mentioned that we anticipated pressure. The pressure on our expansion efforts is what we observed. The remainder of the quarter unfolded as we had anticipated. Currently, we recognize that, first, foreign exchange rates have continued to work against us, and we have factored that in. Secondly, we have also experienced pressure on our expansion efforts, which we expect to persist for some time. Therefore, I don't believe the situation has worsened significantly beyond our expectations; it's simply that these factors are now reflected in the numbers.

Got it. Super helpful. Thanks. And then for you, Dennis, you used the word interim when describing the new CRO. So, do you plan on hiring another at some point?

We have no plans at the moment. We want to see how Paddy performs, and I will be working closely with him over the next couple of months as we consider next year. That's why we are sticking with the interim title for now.

Got it. Thanks guys.

One moment for our next question. Our next question comes from Brent Thill with Jefferies. Your line is open.

Thank you. Hey, Tyler. I find it interesting that strong new customer acquisition and slowing expansion seem to contradict each other. Do you anticipate that new customer growth will slow while expansions continue? Could you elaborate on that dynamic? Additionally, Dennis, considering your extensive experience in go-to-market roles, typically when there is a leadership change, it takes time for the effects to materialize. Can you provide some insight on why you believe this situation might not be as severe and share what is happening from that perspective?

Yeah. Hey, Brent. I'll take the new business. One that we did see increased year-over-year growth in new business compared to Q3 of the prior year and that was a positive. And especially, we got some good CX wins in the U.S. in North America with our Freshdesk products. Freshservice continues to do well. And we've been talking about that product for a long time. And again, I think it's the largest contributor to ARR growth again in the quarter. So, it's not like it was like shockingly spiked up in terms of new business. But in these environments, we've also proven that we are a great alternative for companies if they are trying to move away from expensive solutions or making new decisions and they can see the value in our products and the right size for them. So, we were pleased in how we did there.

I believe there are several key points regarding our go-to-market strategy. One major reason for my joining the team is the significant opportunity I see in our strong product-market fit across several large total addressable markets. Over the past two months, I've traveled extensively and engaged with about 20 customers. It has become evident that we have the potential to participate in larger deals. Notably, the fastest-growing segment we are targeting consists of deals exceeding $50,000, which is crucial for our growth. These deals typically come from larger companies and often present opportunities for multi-product sales from the outset or through expansion over time. As we pursue this direction, we will need to make adjustments to our team and strategy. However, I do not foresee any significant changes in the near future. Our focus remains on securing deals in our sweet spot of $50,000 to $200,000, rather than pursuing $10 million deals. Therefore, I do not anticipate a period of major instability; instead, this is about refining and concentrating our efforts on the deals that will drive significant impact.

Thank you.

One moment for our next question. Our next question comes from Ryan MacWilliams with Barclays. Your line is open.

Hey, it's Jack on for Ryan. Thanks for taking the question. Just one quick one for Dennis. Congrats on the new role Dennis. Just wanted to see if we can get any more specifics on improvements you can help with in the next year and just how you're thinking about the opportunity broadly. Thanks.

I believe the opportunity is enormous, especially when we consider our ITSM product in a vast market. Our desk product also reflects how customer support is shifting toward more conversational applications. We have the solutions that cater to modern B2C and B2B companies in their service operations. Then there's CRM, another significant area ripe for innovation, where we see potential for our involvement. All these product areas are appealing to us. We can become more effective in engaging in deals and ensuring our presence in as many opportunities as possible. There is room for growth in our recognition among IT decision-makers, which directly influences our engagement outcomes. I believe there are many operational enhancements we can implement to elevate a team that is already performing well, and that’s the primary reason I joined.

Great. That’s it for me. Thanks.

One moment for our next question. Our next question comes from Pinjalim Bora with JPMorgan Chase. Your line is open.

Thank you and congratulations on the quarter. I have two questions. First, Tyler, regarding operating expenses, it appears there's a nice sequential decrease. Could you clarify how much of this is due to intentional cost reductions versus foreign exchange savings? Additionally, how should we view the margin trajectory heading into 2023? Secondly, I noticed the billings guidance, which I believe is around 22% in constant currency. A year ago, your renewals provided about a three-point benefit. If we adjust for that, could we expect the adjusted early renewals to be around 25% in terms of the guidance? Any insights you could provide would be appreciated.

Hey, Pinjalim. To address your two questions, regarding operating expenses, we performed exceptionally well. However, it wasn't simply a matter of focusing on cost reduction. We did slow down hiring and assessed our spending in sales and marketing to drive efficiencies. Although we are still hiring, we managed to achieve this. Additionally, we benefited from favorable exchange rates with the Indian Rupee, which relates to your question. Overall, it mainly reflects our ability to manage growth rates related to operating loss. There were also some quarter-to-quarter fluctuations, including a significant marketing event and our focal process in Q2 that resulted in higher expenses. As for billings, on a constant currency basis, we expect a 22% increase for Q4. It’s worth noting that this comes against a challenging comparison since last year's Q4 included some favorable duration effects and early renewals. I wouldn't suggest adjusting the 22% for those factors; it should be regarded as the constant currency number.

Got it. Thank you.

One moment for our next question. Our next question comes from Brian Peterson with Raymond James. Your line is open.

Hi. Thanks for taking the question. This is John on for Brian. I'm just curious on the channel partner here. Any updates you can give us on those efforts over the last 90 days? And any key data points we should watch for as we head into 2023? Thanks.

Hey, John. This is Girish. I'll take that question. So, just to give you a quick overview, we have over 500 partners in more than 50 countries. So, we have different types of partners. We have solution partners who sell or resell our software, implement and customize it for customers. We have technology partners where we do integrations between products. We also have a start-up program, and we partner with multiple institutions. And we also have affiliates who are more like referrers for the business. So, this is in addition to the Tier 1 partners like Amazon, Google, Facebook, etc. And we also have channel partnerships with Instagram, WhatsApp and others. So, we continue to add partners, and partners drive approximately 15% of our new business. I think that number is the same for this quarter as well. And so, we continue to add partners across all of these dimensions.

Thank you very much.

One moment for our next question. Our next question comes from Brent Bracelin with Piper Sandler. Your line is open.

Thank you for taking my question here. Juggling a few calls tonight, apologize if questions have been asked and answered. But I wanted to go back to kind of competition. If I look at Zendesk, for example, their bookings and billings growth rate this quarter did slow meaningfully to about 8%. I was wondering if you're seeing less of Zendesk or if there's been any sort of kind of change in the competitive environment in either smaller customers, international or the larger deals? Any change relative to what you're seeing them in the field would be helpful. And then, I have one follow-up.

Sure. I'll take that, Brent. This is Girish. First of all, we are still seeing Zendesk in deals and we feel positive about our win rates against them. In competitive situations with Zendesk, we tend to prevail more often. However, if they are the incumbent, it can be a tougher, longer conversation to replace them. The customer experience space remains competitive, with some movement toward conversational solutions, where we have recently launched new initiatives like our Freshchat product. We've had some strong wins in North America in the third quarter, specifically against Zendesk. I can share that we're beginning to hear from some customers looking to make a switch, but we also notice Zendesk becoming quite aggressive with their pricing as they strive to maintain their market position.

Great. And then my follow-up here is really for Dennis. Obviously, you've been able to scale several tech businesses in the past. As you look at the Freshworks opportunity here, what are you most encouraged about? I know it's still early days, but is there a great opportunity to really accelerate the scale in the U.S.? Is it international that you're going to be focused on first? Just love to hear where your focus is on, scaling U.S.? Is it going to be bundling? Is it going to be specific products? Any color there. And then specifically, as you think about the Freshservice business, as you look under the hood of that business, do you think that business can scale into the larger environments? Or what part of that Freshservice business do you see having the most success from a swim lane perspective? Thanks.

Thank you for the question. Addressing the last part first, the Freshservice business can definitely scale up into very large accounts. Our current client roster for both Freshservice and Freshdesk includes impressive names like Klarna, Discover, Blue Nile, AMEX Travel, Viessmann, Thomas Cook, and Sodexo, which are all significant and sophisticated buyers. The process to secure these deals is stringent, and we are consistently winning in a competitive environment. Initially, I viewed Freshworks primarily as a small and medium business player, but it’s encouraging to see the progress we have made with larger accounts. That’s why we are continuing to invest, as we become more efficient, in expanding our account executive force and increasing our coverage. There are substantial opportunities in the U.S., and it’s crucial for us to succeed there. Europe also presents a significant opportunity in the long run. Additionally, our home market of India is an interesting place for experimentation and close collaboration with our product team. All these factors are promising. I’m also impressed by the strength of our product team. Our product leaders typically have over 15 years of experience at companies like Microsoft or Salesforce and have a deep understanding of their fields. We benefit from the fact that most of our product development occurs in a lower-cost center, which should enhance our overall operating efficiencies over time. Thus, I believe we are well-positioned for a bright future. While there are various macroeconomic factors at play, so far, it's been great to get in, inspect our operations, and start our progress.

Hey, Brent. To add on to what Dennis said about Freshservice, we have also just announced Freshservice for Business Teams. This initiative extends the modern employee experience developed by IT teams to all other departments within the organization, including HR, finance, legal, and operations. It significantly increases the addressable market for Freshservice and provides a solid opportunity to expand within our existing customer base. The encouraging news is that we already have a proven track record, with thousands of customers using Freshservice internally. With this new capability, I believe we can further expand and accelerate the adoption of Freshservice within enterprises.

Helpful color. Thank you so much.

One moment for our next question. Our next question comes from Rob Oliver with RW Baird. Your line is open.

Great. Thank you, guys. Good afternoon. Dennis, also one for you. Just you had a chance, as you mentioned, to go out and see and talk with a bunch of customers. There's a bit of a narrative evolving particularly among enterprise software companies now around some vendor consolidation, and I think it's still early to call that out in a multi-tenant SaaS world, but some big vendors like Salesforce have called that out. I'm wondering, as you look at the product portfolio for Freshworks, which again, multi-product adoption moving up ever so slightly, but what strikes me is that there's a real opportunity there. And to the extent that some of these headwinds could potentially be tailwinds for that multi-product sale for you guys? Just how you think about that? And then I have a quick follow-up for Tyler.

Thank you for your question. I believe there's another opportunity that you may have hinted at, which is that many companies are seeking to enhance efficiency and reduce costs. From my conversations, it's clear that some of these companies are not fully satisfied with their current CRM solutions. Since the time they signed their contracts, typically three to five years ago, our products have significantly improved. As a result, we are now being considered for these renewals. For instance, a large transportation company in Europe recently transitioned from Salesforce to us, driven by both the value of our products and the overall cost of ownership, particularly when considering the consulting services required to effectively utilize Salesforce. This presents a clear opportunity for us, as there is a customer base that seems dissatisfied with their existing tools. Regarding multi-product strategies, there are various facets to explore. We are noticing numerous small, specialized solutions, especially in customer experience. Our aim is to integrate and enhance these functionalities, such as our comprehensive chat suite, which continues to evolve with new features that increase its value, including bots and other applications. These are the types of solutions where we can excel. As our product offerings grow, we have a strong chance to consolidate spending among our existing customers.

Great. That's super helpful color. Appreciate it, Dennis. And then Tyler, for you, I know one of the things that Dennis had mentioned in his comments earlier was just around some of the awareness of Freshworks in some accounts. I know you talked about lower digital marketing spend. So, maybe can you help us understand a little bit about are you guys able to drive increased efficiencies with the digital marketing spend that you have? Is it about resource allocation? Any change? Is that just relevant to that kind of lower end flywheel-type inbound model? And where do you see the opportunities and other risks to kind of that lower marketing spend, particularly around kind of a need to raise awareness? Thank you.

Hey, Rob. I think that while I'm uncertain about how much digital marketing contributes to awareness compared to actual click-through traffic, analyzing our sales and marketing expenditures reveals a need to balance our spending on brand initiatives and field marketing, which involves direct engagement with current and potential customers, against digital marketing aimed at creating visibility when people search for relevant topics. It's important for us to find this balance. We'll keep focusing on generating inbound interest and refining our strategies to reduce our dependence on digital marketing. Additionally, we'll invest in brand and field marketing initiatives, ensuring a comprehensive approach.

Great. Helpful. Thanks, guys. Appreciate it.

Thanks, Rob.

One moment for our next question. Our next question comes from Nick Altmann with Scotiabank. Your line is open.

Great. Thanks guys. It seems like the messaging is that you guys are going after larger deals, just given the SMB weakness. And I guess, my question is, how does that sort of change your guidance philosophy, just given larger deals maybe were more of an upside driver in the past? I guess, put another way, how do you guys make sure you're not over-indexing on the large deal side of the equation, just given it's a little bit lumpier versus SMB?

Hey, Nick. This is Tyler. I'll address that. First of all, it doesn't alter our guidance approach at all. We aim to provide guidance based on our current observations. SMB does have its seasonal fluctuations, and Q4 is generally weaker for SMBs, but our SMB strategy is still effective and performing well. We are committed to this aspect. It's important for us. We also have a range of products targeted at different customer segments. Regarding the commentary on larger deals, we are already seeing positive engagement with those customers. We have made substantial investments in the field over the past few years and will continue to do so. Dennis and Girish suggest that we should focus on this and strive to better engage with these customers and secure those deals. We believe our products have now reached a level of maturity that customers are responding positively to and achieving success. This is what we mean by this focus rather than overly prioritizing the large deal aspect.

Got it. And then, I guess, just going back to the channel side of the equation, as you sort of lean more into mid-market and enterprise, how does that change your philosophy around the channel or even on the direct go-to-market side? Does that mean trying to work with new partners that are maybe more geared towards mid-market and large enterprise? Does that mean kind of shifting headcount resources out of more hunters on the mid-market and enterprise side, out of the inbound go-to-market salesforce? Just any color around that would be very helpful. Thanks.

Hey, Nick. I appreciate the question. First and foremost, there hasn’t been any significant change in our strategy. To clarify, inbound sales accounts for nearly half of our new business. Our outbound field sales contributes around 25% based on the last two quarters, with partners making up the remaining 25%. This is our current mix. When looking at the overall revenue composition between SMB and mid-market, SMB represents approximately 43%, which includes companies with 250 employees or fewer. The mid-market share has increased over the years and currently stands at 57%. We will maintain this trend, with a bit more focus on pursuing mid-market clients, as Tyler mentioned. We have hired new representatives who are currently ramping up and will continue our efforts in that area. Freshservice is performing well, and last quarter we decided to concentrate more on it due to a more favorable customer profile and potential in the larger market. Regarding our channel strategy, there are no significant updates at this time. To clarify, we are not targeting the $5 million to $10 million deals. We are sticking to our strengths, where we already have established customer relationships, and we have proven product market fit to successfully secure deals in the $50,000 to $200,000 range. Our focus will remain on that segment.

Got it. Thank you.

End of Q&A.

Thank you everybody.