Freshworks Inc. Q1 FY2025 Earnings Call

Welcome to Freshworks First Quarter 2025 Earnings Conference Call. At this time participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Joon Huh, Head of Investor Relations. Please go ahead.

Thank you. Good afternoon and welcome to Freshworks first quarter 2025 earnings conference call. Joining me today are Dennis Woodside, Freshworks' Chief Executive Officer and President; and Tyler Sloat, Freshworks' Chief Operating Officer and Chief Financial Officer. The primary purpose of today's call is to provide you with information regarding our first quarter 2025 performance and our financial outlook for our second quarter and full year 2025. 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 our management's beliefs about our business and industry, including our financial expectations and estimates, uncertainties in the macroeconomic environment in which we operate and market volatility, the timing of future repurchases of our Class A common stock 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 rate to innovate, to reach our long-term revenue goals, to meet customer demand and to control costs and improve operating efficiency. For a discussion of additional material risks and other important factors that could affect our results, please refer to today's earnings release, our most recently filed Form 10-K and 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 Dennis.

Thank you, Joon. Freshworks had another fantastic quarter. We outperformed all our financial metrics for growth and profitability in Q1. We continue to see that our uncomplicated customer and employee service solutions are winning against outdated legacy software vendors. Companies are choosing our AI-powered solutions to remove complexity, improve efficiency, and unlock growth. We continue to demonstrate our ability to drive growth and profitability for the business. In Q1, revenue grew 19% year-over-year to $196.3 million and we delivered a non-GAAP operating margin of 24% and adjusted free cash flow margin of 28%, beating our financial estimates once again. Adding our revenue growth and adjusted free cash flow margin for Q1, we achieved a Rule of 47 in the quarter. In driving profitability, we significantly expanded our non-GAAP operating margin by more than 10 percentage points compared to last year. We added over 1,000 net customers in the quarter, including large customers such as Freudenberg Group and All3Media. We also expanded with our customers as we maintained a net dollar retention of 105% on a constant currency basis, in line with the last 2 quarters. We ended the quarter with over 73,300 customers. We've continued to deliver strong revenue growth each quarter and drive profitability as we execute on our strategy. As a reminder, our 3 strategic imperatives are: one, investing in employee experience, or EX, which is our largest, fastest-growing business in ITSM, ITAM, ITOM, and ESM; two, delivering AI capabilities across our products and platform that drive productivity improvements for our customers; three, accelerating growth for our customer experience or CX solutions. Here's how the ongoing execution of our strategy led to strong Q1 results. First, on employee experience, our focus to drive upmarket growth is paying off. Q1 was another strong quarter for our EX business. We surpassed $420 million in ARR and grew 33% year-over-year on a constant currency basis. We ended the quarter with approximately 18,700 customers in EX. We believe that several factors are driving growth in EX. Our continued upmarket success, our expansion with employee service management, the ongoing demand for Device42 from our accounts and our success in specific industry verticals, such as professional sports and educational institutions. More than 75% of the ARR in our EX business comes from mid-market and enterprise companies. Large companies and organizations like Dave & Buster's, ITV in Europe, the State of Hawaii and Dynatrace have cited the fast time to value that our Freshservice products deliver. New mid-market and enterprise companies like Travis Perkins and the largest homebuilding supply wholesaler in the UK are turning to Freshworks and leaving our IT competitors on a regular basis. Sophos, All3Media, Nexstar Media Group, Kayak, all chose Freshworks over legacy solutions. For example, cybersecurity leader, Sophos, needed a user-friendly ITSM solution with less complexity and a lower total cost of ownership. These differentiators, coupled with the ability to procure via AWS Marketplace, made switching from the legacy provider to our uncomplicated solution an easy decision. Another example, the largest title company in the U.S. chose Freshservice to replace ServiceNow which was their legacy provider of nearly a decade. Frustrated with poor user experience, low adoption and manual inefficiencies, they opted for our uncomplicated intuitive solution that could be easily managed and trusted by internal teams. Since switching to Freshworks, they have noted achieving faster ticket resolution, improved SLA compliance through modular workflows and significant cost savings. The second factor driving our EX business is success in enterprise service management. ESM has become a key lever for expansion and an important component in new and existing deals. Customer adoption for Freshservice for business teams has nearly doubled over the past 12 months. Customers are using Freshservice in other areas of their businesses, including HR, marketing and finance to deliver amazing service experiences. For example, EDF Renewables, a leading power provider with more than 35 years in renewable energy and nearly 5,000 employees in over 20 countries wanted to streamline their IT service management, asset management and change management processes. EDF chose Freshservice because of its ease of use, seamless integrations and codeless customization. They are leveraging workspaces within Freshservice to manage different departments outside of IT like facilities, ensuring that each department has a tailored environment to operate in. The integration with Microsoft Teams and the use of AI Agents reduce manual intervention in routine tasks, resulting in higher employee satisfaction. The third EX growth driver is our advanced ITAM offering with Device42. In Q1, two of the top 5 largest deals had a Device42 component. For example, a large multinational tech company recently chose Device42 with Freshservice for business teams and Freddy AI Agent over ServiceNow. They wanted a scalable, agile AI-native offering that would deliver faster time to value. Our integrated platform, powered by Freshservice and Device42, provides a unified modern experience for IT and employees. Our EX success is also being driven by our momentum in specific industries. We're expanding our professional sports leadership position outside of the U.S. to include top Bundesliga football clubs in Germany, VfB Stuttgart, VfL Bochum, and TSG Hoffenheim. In education, we added Kent State, who has achieved a 95% CSAT with Freshservice and D'Youville University, who has seen improved asset management accuracy and reduced average resolution times to under 24 hours since using our solutions. Simply put, Freshworks helps midsized and larger enterprise organizations scale and compete at a global level. Next, on AI adoption. Customers have moved from AI experimentation to realizing tangible business value and returns on their investments. Freddy Copilot was included in 3 of the top 10 new deals in Q1. Nearly half of all new large deals over $30,000 ARR had Copilot attached in Q1. For new SMB customers, we continue to see double-digit attach rates with increases quarter-over-quarter. We ended the quarter with more than 2,700 Copilot customers, reflecting quarterly net adds of more than 500 or 23% growth quarter-over-quarter. Organizations are adopting Freddy AI because they see Freshworks successfully taking customers from AI experimentation to execution. Bensons for Beds, which uses Copilot with both Freshdesk and Freshservice, saw a 54% improvement in resolution times. Our AI offering has proven to be rapid, measurable, and transformative for a business balancing growth with seamless customer and employee experiences. In education, school administrations are increasingly using AI to handle repetitive tasks and streamline operations so that they can improve student outcomes. San Ramon Valley High, for example, uses Copilot with Freshservice to save 50% of their IT management time every year. Freddy AI Agent became generally available for CX customers in Q1 and represents the next generation of self-service capabilities. We added approximately 250 customers and finished the quarter with over 1,600 customers using Freddy AI Agent. In CX, AI Agents were instrumental in the deflection of L1 queries and creating triage of multiple issues to help improve overall customer service operations for our customers. As Freddy AI Agents became generally available for EX customers in Q2, we expect to see improved momentum in these numbers going forward. We already have approximately 1,000 customers using Freddy AI Agent for EX needs. A leader from a top healthcare company shared that AI Agents cut response times in half from 4 minutes to just 2, while autonomously handling over 70% of inquiries. This allowed human agents to focus on complex issues, boosting first call resolution by 30% and raising CSAT from 82% to 94%, all while cutting operational costs by 25%. Finally, for managers, we launched Freddy AI Insights into public beta at the end of Q1. Freddy AI Insights is an AI-powered intelligence partner for leaders delivering fast, proactive, and actionable insights, enabling smarter decisions, agility, and sustained growth. I look forward to sharing more in upcoming quarters. Here at Freshworks, we use AI to drive performance and accelerate results across our own business. Our finance team uses AI to analyze our cloud infrastructure spend and identify savings opportunities. Our billing team uses Freddy Copilot to summarize billing inquiries. Our engineering teams have developed an AI Agent specifically for highly technical escalations. We continue to push the boundaries on what's possible today because AI is delivering results and driving efficiency and we were recently recognized by Gartner once again as an emerging leader in their innovation guide for generative AI. We are in the next stage of generative AI and have moved from output to outcome. While some other vendors may sell vaporware, Freshworks is the ROI-driven AI solution, turning AI hype into real results. Turning to CX. We saw growth and retention in our flagship business in one of our two core offerings. We ended the quarter with approximately 59,000 CX customers, generating over $370 million in ARR, reflecting 7% year-over-year growth on a constant currency basis, similar to the prior 2 quarters. Our CX win rate against competitors like Zendesk increased sequentially over the prior quarter. We know that exceptional customer experiences drive loyalty, while complexity drives them away. Customers are choosing Freshdesk over others because our product is easy to use, provides a lower total cost of ownership and delivers new AI features to improve productivity and efficiency. Companies of all sizes, such as Tucows, Maisons du Monde, Landmark Group and Cineworld are leaving legacy software competitors and coming to us. NASDAQ Europe has relied on Freshdesk for over 4 years to deliver high-quality support to clients across multiple countries. With several Freshdesk instances, their teams depend on the core automation features and SLA policies to consistently meet their high customer service standards. In 2024, NASDAQ Europe achieved a 97% resolution SLA and a 93% CSAT. Freshdesk's uncomplicated and efficient platform continues to be a critical part of their support infrastructure as they scale and serve complex cross-border markets. Our CX products are expanding in numerous ways. First, CX customers are adopting our AI products. Customers have seen a 40% to 45% productivity improvement due to reductions in ticket resolution and response times from Freddy AI Agents. For example, Panasonic North America chose Freshworks as part of their strategy to drive continuous improvement. Freddy AI Agent handles over 75% of their customer queries, a path to reduce customer effort scores and increase customer satisfaction. Another CX customer, Drive, uses Freddy AI Agents to deliver detailed explanations, relevant article links, and clear and actionable information to their customers which has significantly reduced response times. Another expansion path is CX customers also buying our CX solutions and vice versa. We continued to see cross-sell success with customers like Trinity College; finance company, PremFina, and the popular German football club, VfB Stuttgart, who initially used Freshdesk to provide stellar customer experiences then expanded to EX. On the product front, we launched several improvements to Freshchat in Q1, including enhanced integration with Apple messaging for business. Customers can now use Apple messaging for business as a support channel and provide exceptional customer service with Freshchat, Freshdesk, and Freddy AI Agents. We also released the Freshchat OAuth authorization which makes it easy to integrate apps and reduce security risks. We believe these product improvements drive improved customer experience and retention. We recently announced enhancements to our global partner program with expanded reseller and services offerings designed to give partners more predictability in building long-term Freshworks practices. We have more than 500 transacting partners, including global partners such as Gorilla Services, SHI International, Unisys, Xcession and Climb. In recognition of our growth and innovation, Climb recently named Freshworks its Strategic Vendor of the Year. We're leveraging partners at every step of the customer relationship. For example, we teamed up with a preferred partner to help one of our long-time EX customers drive a major IT operations initiative. Our collaborative approach helped reduce our customers' resolution times by 30%. As partners become a larger part of our business, we expect to see increased efficiencies in our go-to-market efforts and overall business. Once again, I'm excited to capture the opportunity in front of us. Particularly in the current economic environment, we expect our enterprise-grade software to be a strong competitive advantage because it delivers results fast and has a lower total cost of ownership. We'll provide more product updates at our Virtual Refresh Summit in June and updates to our long-term strategic plan at Investor Day in September, where we will expound on our vision to help customers realize their full potential with the transformative power of AI. Thank you to our customers, partners, employees and shareholders for your ongoing support. Now, let me turn it over to Tyler to go through the operational and financial details.

Thanks, Dennis and thanks everyone for joining on the call and via webcast today. As you just heard, we had a strong start to the year in Q1 with robust financial performance that reflects our operational discipline and focused execution of our strategic initiatives. We once again exceeded our revenue growth estimates and improved our profitability measures as we expanded our non-GAAP operating margin nearly 300 basis points quarter-over-quarter to 24% and grew our adjusted free cash flow 43% year-over-year to $55.4 million which resulted in a strong adjusted free cash flow margin of 28%. For our call today, I'll cover the Q1 2025 financial results, provide background on the key metrics and close with our forward-looking commentary and expectations for Q2 and full year 2025. As a reminder, most of our discussion will be focused on non-GAAP financial results which exclude the impact of stock-based compensation expenses, restructuring charges, and other adjustments. We will also talk about adjusted free cash flow which excludes the cash outlay related to the restructuring costs. First, in contrast to the prior quarter, FX changes were a tailwind in the quarter, driven by a weaker U.S. dollar. While Q1 revenue impact was minimal, there was a 1 percentage point positive impact to ARR growth or a $7 million increase to ARR. During the call today, we will include constant currency comparisons to provide a clear view of our underlying business trends. Starting with the income statement. Q1 total revenue increased to $196.3 million, growing 19% on an as reported and constant currency basis. Professional services revenue contributed $2.1 million in the quarter, reflecting the ongoing shift of services revenue to our growing partner network. Our EX business has increased to over $420 million in ARR, representing growth of 33% year-over-year for both as-reported and constant currency and as we continue to drive our upmarket strategy. Our CX business increased to over $370 million in ARR, reflecting growth of 8% on an as-reported basis and 7% year-over-year on a constant currency basis, in large part due to steady execution and positive momentum from our SMB customers to start the year. Moving to margins. We maintained a strong non-GAAP gross margin in Q1 of 86% as we made ongoing improvements in delivering our solutions efficiently and scaling our business. This represents an improvement of approximately 100 basis points compared to the prior year. Our non-GAAP operating income for Q1 came in at $46.4 million, representing a non-GAAP operating margin of 24% and ahead of prior expectations. The improvement in profitability was driven by our top-line outperformance as well as lower personnel-related expenses as some of these costs moved to future quarters. We also had favorable timing of expenses with specific spend expected for later this year. Moving to operating metrics. Our 2 key business metrics are net dollar retention and customers contributing more than $5,000 in ARR. Net dollar retention performed better than our expectations coming in at 105% on both as reported and constant currency basis. Looking ahead, we estimate our net dollar retention of approximately 105% on an as-reported basis and 104% on a constant currency basis for Q2. For our second key business metric of number of customers contributing more than $5,000 in ARR as of the end of Q1, this metric grew 13% year-over-year on both an as-reported basis and constant currency basis to 23,275 customers. This customer cohort continues to represent 90% of our ARR. For our larger customer cohort contributing more than $50,000 in ARR as of the end of Q1, we saw growth of 24% year-over-year on both an as-reported and constant currency basis to 3,217 customers. This cohort represents 50% of our ARR. For total customers, we added over 1,000 net new customers in the quarter as we saw a partial benefit from our free-to-paid initiatives that we began towards the end of last year. We ended Q1 with over 73,300 customers. Now let's turn to calculated billings, balance sheet, and cash items. Our calculated billings grew to $203.3 million in Q1, representing an as-reported growth of 16% year-over-year and 17% growth on a constant currency basis. We saw higher bookings performance and increased pull-in activity that contributed approximately 2 percentage points of growth in Q1. Looking ahead to Q2 2025, our initial estimate for calculated billings growth is 11% to 12% on both an as reported and constant currency basis. For the full year 2025, we expect calculated billings growth to be approximately 13% year-over-year on an as-reported basis and 14% on a constant currency basis which is in line with our expectations from last quarter. Moving to our cash items. We generated $55.4 million in adjusted free cash flow in Q1, outperforming our estimates, thanks to strong collection activities and continued improvements in our operational efficiencies. This resulted in an adjusted free cash flow margin of 28% which represents a 5 percentage point improvement year-over-year. As a reminder, these results do not include a one-time use of cash of $1.5 million related to restructuring costs. For the full year 2025, we are expecting to generate approximately $210 million of adjusted free cash flow with approximately $50 million in Q2 and slightly higher amounts in Q3 and Q4. In Q1, we repurchased an additional $111.8 million of our shares at an average price of $16.60 per share. Since the beginning of the program, we have repurchased more than 7.7 million shares using $127.3 million through Q1. We remain committed to executing on an appropriate capital allocation strategy and delivering long-term value for our shareholders. In addition to the repurchase program, we continue to manage and offset share count dilution by net settling invested equity amounts by using approximately $17 million during the quarter. This activity is reflected in our financing activities and is excluded from our free cash flow calculations. Looking ahead, we will continue to net settle vested equity amounts and expect Q2 cash usage of approximately $13 million at current stock price levels. For the full year, we expect to use approximately $55 million to net settle vested equity amounts. We ended the quarter with cash, cash equivalents and marketable securities of $1 billion. Turning to our share count as of March 31, 2025, we had approximately 325 million fully diluted shares which represents growth of less than 1% year-over-year. The fully diluted calculation includes 298 million shares outstanding which is a slight reduction compared to the prior year and quarter. This calculation also includes 24 million shares related to unvested RSUs and PRSUs and 2 million shares related to outstanding options. We plan to thoughtfully manage share count dilution with net total activities and share repurchases into the future. Now on to our forward-looking estimates. For the second quarter of 2025, we expect revenue to be in the range of $197.3 million to $200.3 million, growing 13% to 15% year-over-year on an as-reported and constant currency basis. We expect non-GAAP income from operations to be in the range of $27.8 million to $29.8 million and non-GAAP net income per share to be in the range of $0.10 to $0.12, assuming weighted average shares outstanding of approximately 299.7 million shares. For the full year 2025, we are raising our revenue expectations to be in the range of $815.3 million to $824.3 million, growing 13% to 14% year-over-year. Adjusting for constant currency using FX rates from Q2 of last year, this reflects growth of 13% to 15% year-over-year. We expect non-GAAP income from operations to be in the range of $139.5 million to $147.5 million and non-GAAP net income per share to be in the range of $0.56 to $0.58, assuming weighted average shares outstanding of approximately 299.1 million. Our financial outlook is based on a few assumptions that we would like to call out. First, our forward-looking estimates are based on FX rates as of April 25, 2025. So any future currency moves are not factored in. Second, as a reminder, we will anniversary the Device42 acquisition in early June. As such, we anticipate revenue growth rates will be higher in the first half of the year compared to the second half. For operating metrics, including customer numbers and net dollar retention, we will anniversary these comparisons in our Q2 results. In addition and consistent with prior years, we expect Q2 expenses to increase in connection with our annual merit cycle as well as shifting of investments in sales and marketing which will impact our operating margin quarter-over-quarter. Lastly, we acknowledge that we're in a period of market volatility and economic uncertainty. While we have not seen meaningful impact to our business from these factors to date, we continue to monitor things closely. If parts of the economy do turn worse, we believe we are well positioned given our value proposition to customers. To summarize, we are pleased with our strong performance in Q1 which reflects effective execution of our strategic initiatives and the dedication of our teams. We are focused on creating uncomplicated and innovative products for our customers while driving long-term profitable growth for the business. Thank you for your continued support and we look forward to updating you on our progress for the rest of the year. And with that, let us take your questions.

And our first question comes from Rob Oliver of Baird.

Appreciate it. Dennis, it seems like from the early software reports here that the resiliency of software as a business model but also as adding efficiency here in tough times is kind of playing out. And it sounds like that's really playing out for you guys. So a couple of parts to my question. One is that Device42. It seems that's now really driving platform wins. Last quarter, you said that the pipeline there had doubled sequentially. And I don't know if I caught a comment relative to pipeline, so I would love to get an update there. And then on CX, I know you made some changes in CX as well and it sounds like that's really starting to pick up also. And I'd be curious if you are still seeing in that business, both growth in agents as well as seats or if you're starting to see some of the efficiency created by the agent purchases start to offset some of the seat purchases. I realize that's a lot.

Thanks, Rob. So let me just go tick through those. I think first of all, in terms of the overall demand and our positioning, we did not see any material change in demand in Q1 from Q4. The trend is pretty much the same. I would say, at the beginning part of the quarter, this quarter, same thing. And if you think about our value proposition and what customers need in tighter times, businesses are going to get need to get more efficient and our AI solutions absolutely help them do that. We've got over 30% improvement in productivity from Copilot. We're seeing deflection rates of 50% to 70% from AI Agents. So that's a positive for us. They want lower cost overall. And if you look at our positioning, our products in general are about half the total cost of a ServiceNow deployment or a Zendesk deployment or a Salesforce deployment. And that's when you take into consideration the time it takes to get the value, consultants you need to get a product up and running and then maintaining the product over time. As those deployments come up for renewal, we're noticing this in our significant victories. Customers are seeking alternatives and are interested in bringing us on board, and we're successfully winning our share of deals. They desire straightforward solutions that can scale and meet enterprise standards, which we have clearly established. Therefore, regardless of market demand, we believe we will be in a strong position. For Device42, we had an excellent quarter. The majority of our business there is from selling Device42 to our existing customers during renewals for upselling, as well as new deals. The acquisition of the company has indeed helped us secure new business, evident by the fact that two of our top five deals were Device42 transactions, enhancing our value to existing customers. This quarter has been the best in terms of the number of deals we've executed. We've only been selling together for about two to two and a half quarters, but it's becoming an integrated sale, which is why, moving forward, we won't be referring to it as a completely separate business. And then on the third point, CX, we continue to see agent count go up. We continue to see adoption of our AI solutions increase both for Copilot and for AI Agent. We're very optimistic about where AI Agent is going. Insights, as I mentioned, has over 500 customers in the beta. I think we had close to 1,000 customers at the latest point. So we're pretty excited about how those products are going to continue to add value for us. And I'm really proud about the investment that we've made and the results we're seeing in AI.

Our next question comes from the line of Elizabeth Porter of Morgan Stanley.

You mentioned some interesting operational efficiencies driven by the internal use of AI. Could you provide more detailed insights into what you're observing and whether you'll be adjusting your internal spending plans based on the efficiencies you are experiencing? Lastly, how confident are you in expanding margins amidst the current macroeconomic uncertainties?

Thank you, Elizabeth. We've been on our AI journey for several years, and currently, we have over 70 AI products, including our own and third-party solutions, that are improving our team's productivity and helping enhance our margins. Over the past two years, our cash flow margin has increased from mid-single digits to our current position, while our overall headcount has decreased by nearly 20%. This change isn't driven by any specific project but is a result of optimizing the business, with AI playing a significant role. We are employing AI in engineering for coding and across our support operations, achieving high deflection rates of over 80% for certain queries. Our Copilot product is also aiding us in billing and customer support. We plan to continue integrating AI throughout our operations, which we believe will drive further margin expansion, as indicated in our guidance.

Yes, I believe the second part of your question, Elizabeth, was about spending in general. We have always taken pride in being relatively efficient. Last year, we implemented actions to enhance efficiency within the business, and we will maintain that approach. It might seem unusual, but we anticipate some increases in spending along with changes in timing for the second, third, and fourth quarters. The rationale behind this is that during uncertain times, we believe we can leverage this to our advantage. We are prepared to seize opportunities to grow more quickly, particularly by investing in sales and marketing.

Our next question comes from the line of Scott Berg of Needham & Company.

It was a strong quarter. I have a couple of questions. I’m not sure if Dennis or Tyler wants to address this, but there was a mention in your press release about a new global partner program with more extensive offerings for resellers. I didn't catch much commentary on that. Could you clarify the changes you are making to your partner program and any potential impacts for fiscal year 2025?

We made a change to our program at the request of most of our partners, moving to a more industry-standard model. We have established a transfer pricing model for our resellers, allowing them to build services around it and set their own pricing. They can choose to price on a per seat basis or include additional services as they see fit. This change was aimed at creating more opportunities for our partners to build ongoing businesses around our products. We've noticed a strong interest from partners, especially in mid-market companies. In Q1, we signed a deal with Unisys and have been actively engaging with them. We also have a solid pipeline of mid-market customers for our EX solutions. I’m optimistic about the opportunities with our partners and look forward to continuing our investment in this area.

Got it. Very helpful. And then your operating margin guidance, Tyler, I know you talked about the timing of some expenses was favorable in the quarter, moving to the back half of the year. The operating margin step down in Q2 is, I guess, a little bit more significant than anything we've seen in the model the last several years. Is it purely just based on timing? Or are there some other maybe investments going on in the model that's maybe worth noting in the quarter?

Yes, it's a mix of factors. There's always a timing shift from Q1 to Q2, primarily related to changes in our compensation structures. Our annual review process concludes at the end of Q1, resulting in an expected uplift each year. Additionally, we experienced some timing delays with spending and expenses that were deferred from Q1 to the latter half of Q2, particularly in sales and marketing. Overall, we are quite satisfied with our efficiency, having exceeded our Q1 forecast significantly, though some of that was due to timing adjustments.

Our next question comes from the line of Pinjalim Bora of JPMorgan.

Congratulations on the quarter. Dennis, could you discuss the launch of Freddy Insights at the end of Q1? I’m not aware of the pricing for that product, so perhaps you could share your thoughts on pricing and monetization for Freddy Insights. Additionally, it appears you are seeing success in the AI sector. When can we expect to see how AI is contributing to overall business growth, particularly in terms of ARR or other key business metrics? I also have a follow-up question for Tyler.

Thank you, Pinjalim. Let me recap our current pricing model for AI. We have AI Agent, and most of the queries are currently on the CX side. For CX, we charge based on consumption. You purchase session packs, either 100 or 1,000 sessions, and as you use them, you buy more. For AI Agent, there is an additional cost of $29 per seat per month on top of the standard license fee. Regarding AI Insights, it's currently in beta for EX, and we're planning to include it in our enterprise plan to promote its adoption, which is our highest-priced plan. We anticipate utilizing a variety of monetization strategies for different AI components. We also expect to try various methods based on customer feedback. Some customers value the stability of a seat license model, while others prefer consumption-based models since they are familiar with them from other services. Currently, AI is a key element of our sales process. Customers are making decisions to switch from legacy providers without fully understanding our AI roadmap and capabilities, which is significantly impacting our business. We need to consider how to discuss this if we decide to separate it, and we'll provide more information at the Investor Day in September.

Understood. Tyler, on the NRR dynamic, it seems like it's been stable. That's great to see. But when I think about kind of the 4-quarter average calculation on that, you're kind of giving up some of the higher numbers but still able to maintain a stable NRR which makes me feel like your in-quarter probably is expanding faster than your reported number. Any way to understand what is that in-quarter at this point? Or am I theoretically correct in that direction? And ITSM, I think you talked about 110% a couple of quarters back. Has that been holding up in that general zone?

Yes, so regarding the net dollar retention calculation, we look back over four quarters. We're seeing good progress on reducing churn, which has remained steady. Our current net dollar retention has been around 105, slightly better than our forecast of 104 for Q2. We have solid data on churn from three quarters, but we need more information on expansion rates and churn for this quarter. Overall, we're happy with the progress we're making and are seeing positive results. Expansion motion on agent addition, we've been talking about that for years in terms of that coming down. And we're starting to see offsets in terms of the other products that we have to bring to our customers to offset the agent addition expansion which is also going positive. The second piece of your question, Pinjalim, can you remind me?

The ITSM...

I'm sorry, the byproduct. We haven't updated that in the last couple of quarters. That's again something we will talk about at Investor Day in terms of looking kind of deeper into the byproduct information, both and net dollar retention will be part of that.

Our next question comes from the line of Alex Zukin of Wolfe Research.

Dennis, aside from mentioning some advances in billings, it seems there are no significant macro changes observed yet. Why do you think that is, and how do you see this evolving? What insights do you have regarding macro discussions for the full year? Tyler, could you elaborate on those billings advances? Were they related to the second quarter or later in the year? Additionally, how have you adjusted for macro uncertainty in the guidance?

Thanks, Alex. So look, first of all, we operate in must-have categories. If you have a customer support team, if you have an IT team, you have to automate their operations. You have to bring AI in and get as much out of the people as you can. And it's just not optional. So a lot of software categories are optional. And so it's easier to defer decisions or not have something or survive with whatever old legacy system you have. So I'd say that's one. I think the second is, a lot of our competitors are way more expensive. And you see that with these big wins that we have like Travis Perkins which is equivalent to the Home Depot of the U.K. It's a big, sophisticated customer. They were a customer of ServiceNow for 10 years plus. And they are looking for something that's easier for them to manage themselves without having experts on staff that just understand the system and can babysit it. And that's what our product does. You can manage it without the kind of overhead that other systems require. So when they're looking to save money, when they're looking to become more efficient, of course, they're going to look at alternatives to their existing providers. And 3 years ago, 2 years ago, maybe when they signed their renewal, our product was not as robust and mature as it is today. So we actually think that, that's a great position to be in going into kind of a tighter time. And I think that, that's just true across the business. Now that can change. But as of now, we really didn't see anything that's recognizable that indicates that the macro is having a big effect on us so far.

Yes. Regarding the timing of billings, we experienced about a 2% benefit in Q1 due to both overperformance and a pull-in, which primarily relates to Q2. This situation occurs every quarter and is influenced by when expansions happen during contract terms, which can be unpredictable, as well as early renewals. This can slightly impact our forecast for Q2. However, for the full year, our billings forecast remains unchanged from what we previously communicated at the beginning of the year. In terms of what is derisked, everything we're discussing is based on the complete information available to us today, including any existing uncertainties. If conditions worsen or buying behaviors shift, we will provide updates, but we are not observing that at the moment.

And our next question comes from the line of Brent Thill of Jefferies.

Can you address the market strength? You called out a number of these enterprise wins. What are you seeing? How would you characterize the pipeline? And just give us an overall sense of what you're seeing and I had a quick follow-up.

The pipeline appears strong. You can see the results from last quarter, highlighting several wins. Kayak has transitioned from Jira, and Kent State, a large public university, has adopted Freshservice. Travis Perkins has switched from ServiceNow, and a significant U.S. technology company has also moved away from ServiceNow. AMEX Business Travel has upgraded to D42. Coherent, Alterra Mountain Company, and ChampionX are all replacing legacy solutions with our products. We are experiencing strong momentum. Looking at our pipeline, it resembles the previous quarter, showing strength in both upsell and new business. There hasn't been a noticeable change since Q3 and Q4 of last year; it’s just continuing to build. And I think for that mid-market customer, like the ideal is 5,000 person but it ranges up to 20,000 people. That segment is not well served by the big enterprise players or the legacy players. They haven't historically had a choice. Now they do. And I think that momentum is starting to build. The customers are starting to talk to one another. They're starting to recognize that there is a choice out there and that we're it. And so that's fantastic on that side of the business and we look to continue that.

Okay, great. And then, just a quick follow-up. Some of your partners have called out some changes in the sales team with Abe departing. Can you just refresh us on what is happening there? Is this a distraction? How do you think about managing that transition?

Abe left the company earlier this month for personal reasons, which we fully respect. He had a significant impact during his time, and we performed well in Q1. Ian Tickle, our Head of International, has stepped in on an interim basis and has taken over seamlessly. He has been an excellent leader since joining us last year, previously serving as the CRO of Domo, and has extensive experience in enterprise sales. We're continuing to see progress in our go-to-market strategy overall, and we haven't experienced any disruptions nor do I expect any.

Okay, Dennis, I just want to clarify, this change, this is an interim change and you're looking for a full-time head of sales. Is that correct?

That's correct. That's correct.

Our next question comes from the line of David Hynes of Canaccord Genuity.

Dennis, AI touch on new deals is obviously doing really well based on the stats you've shared. Maybe you could touch on the strategy for driving even better adoption in the installed base, particularly on the CX side and just how you think you're positioned for that opportunity?

Yes, we can look at the business and see that we have 2,700 customers, which is an increase of 500 year-over-year for Copilot, and over 1,500 for AI Agent. However, I remind the team that we still have 73,000 customers, so there is much room for growth. This is partly due to how businesses are adopting AI, similar to any new technology, where early adopters are more willing to experiment and embrace new tools. Larger opportunities tend to attract early adoption; for example, PhonePe in India is a big customer and an early adopter of AI solutions. Other customers may face different challenges, such as regulatory concerns. They want to feel confident in how we handle information, conduct product tests, and execute proofs of concept before implementing more extensive rollouts. We are actively working through these issues with our customers. Where they're experiencing success, they're expanding their deployments, and that's the work ahead for us as a team. I believe we will continue to focus on the adoption curve. We have several exciting products launching in June at our June 11 Refresh Event. The event will take place in London, and for those who cannot attend, there will be a virtual version on the 12th, where we will introduce various new products that we believe will further accelerate AI adoption. Each quarter, we are improving our ability to sell AI and demonstrate success. We have an increasing number of success stories to share with prospects and existing customers who have yet to adopt our solutions. I think it’s only a matter of time before we continue to drive those numbers up and see wider adoption of our AI products.

Okay. Makes sense. And then, Tyler, a follow-up for you. Do you have an organic growth rate on that EX ARR number? I think you've shared that with us in the past. I'm not sure I caught it this quarter.

Yes, David. Coming into the year, we actually said we're not going to be breaking out organic and inorganic. And the main reason is actually a positive reason that the Device42 kind of co-sell motion has been doing really, really well. And so a majority of the business that we're closing now is all combined. And so some of those numbers don't make sense to break out anymore. We called that out coming into the year that kind of Q4 was the last time we're going to do that.

And our next question comes from the line of Patrick Walravens of Citizens.

And let me add my congratulations. So Dennis, I had another CEO yesterday tell me something, I'd love to hear your reaction to it and see if this is similar for you. He said he's never seen anything go as fast in technology as AI. And 4 months ago, a lot of the functionality was served like science fiction but now it's table stakes. And in particular, he said the RFPs that are coming through now have got all these AI functionality requirements in the RFPs that weren't there 4 months ago. Are you seeing the same sort of thing in your space? Do you even have RFPs?

We absolutely do have RFPs. So typically, in CX or in EX, any customer that's looking for a new solution to replace their existing solution or maybe they don't have a solution, every customer is asking about AI because they understand it's integral to what these platforms need to deliver. And yes, we do have lots of RFPs all the time. And I don't know the exact number but I would hazard a guess that 80% plus, AI is a consideration. I can't remember a conversation I've had in a sales situation or an upsell where AI is not a topic that our customers want to understand. They want to understand the roadmap. They want to understand what we're going to be offering and how we can help benefit their business over time. It's absolutely table stakes.

All right. Great. And then the follow-up is I had a different CEO tell me that one thing that's made life more difficult for him is that he used the word vaporware from his competitors. Obviously, they're pitching his own book a little bit there. But he's like, it's just gotten so noisy because everyone is using the same words, everyone is talking about Agentic AI and Agentic workflows. And we really have it but other people don't really have it but it's just gotten hard because it's really noisy. It sounds like you guys are managing through that. But are you seeing the same thing in terms of the noisiness? And how do you get through it?

Well, I think a couple of things. So for our existing customers, we are one of the first places that they're going to turn for AI related to service automation. And that's the job of our teams to make sure that they understand what solutions they already have, or they already have access to, in some cases, they're already paying for that they can get value from. And so there, we have an unfair advantage in that kind of noisy environment. For a new customer coming in, again, think about the motivation for a new customer coming to us today, whether it's CX or EX, they're not satisfied with their existing platform typically for some reason. And they're looking for a modern AI-first platform that is going to help them scale. Typically, these decisions are multiyear decisions. You're not going to want to switch your ITSM or your customer support platform every year. And so they want to understand what's the history of innovation, what kind of innovation should I expect going forward? Do I believe in the roadmap? Do I believe they can deliver. They're going to talk to customers that are seeing real value from the AI. And that's why the fact that we've got 1,500 on AI Agent, close to 1,000 on Insights and 2,700 on Copilot. That is a huge advantage for us now because we have real customers with real value, tons of case studies that we can point them to. And what I do is I just connect them with the CIO. Don't take my word for it but to talk to our customers because they're seeing the value. So we think we're at that point in terms of our scale where we have a real advantage over some start-up coming in that has, like you said, 1 or 2 customers and a demo. And that's where we have a real advantage and we're seeing it.

Our next question comes from the line of Brent Bracelin of Piper Sandler.

Dennis, new customer logos, I think, more than doubled what you saw during Q1 last year. You've had now 3 quarters where the net retention trailing metrics stabilized in period improved. How much of the strength that you're seeing here would you attribute to the external environment getting better versus maybe some internal things, company-specific things that you're doing around go-to-market, new product, AI? Just trying to better understand the strength that you kind of saw the last 2 quarters? And how much of it is external versus internal?

Yes. I have been CEO for just under a year. While the external environment has seemed relatively consistent, there has been some negativity in recent headlines. However, I believe the external factors have not significantly changed. Our focus has been on moving the company upmarket and creating products that cater to mid-market customers, specifically those with 5,000 to 20,000 employees, who are not well addressed by existing competitors. We have adjusted our go-to-market strategy and established a partner network to target this segment, and those efforts are yielding positive results. ARPA has seen a significant year-over-year increase, along with the customer count. Additionally, we've concentrated on developing AI products that are user-friendly, easy to deploy, and provide quick value, which aligns with our overall value proposition. This approach is reflected in the various monetization metrics, including customer count. These two factors are more significant than the overall market conditions, which I believe have not improved over the past year and may worsen looking ahead.

Very clear there. And then, Tyler, just a quick follow-up for you. OpEx has actually been down on an absolute basis for 2 consecutive quarters that helped push margins above 20% here for 2 quarters. But you did mention the change and appetite to maybe lean in as this external environment maybe gets a little more challenging, try to accelerate share gains. Walk me through how closely you're going to be managing expenses. It sounds like you have an appetite to lean in but also an appetite to watch things closely. Are you watching things on a monthly basis or weekly basis? Just walk me through where you're going to lean in and how closely you're watching it? Yes, we are monitoring the situation closely. Some of the investments we plan to make won’t provide immediate returns, so we are laying the groundwork in those areas. However, some initiatives in our pipeline do have short-term potential returns, and we will diversify our investments. There are two key points to consider: one is timing, as some expenses are being delayed but will still be incurred, and the other is our annual compensation increase which will take effect in the second quarter. As I mentioned, we believe that during volatile times, when companies seek essential products at a good value, we have an opportunity to invest more. Therefore, we will continue to invest in sales and marketing, ensuring our investments are efficient, and we will be monitoring this closely on a regular basis.

Great. Thank you so much everybody for joining us and we'll see you next time. Thanks.

Thank you. This concludes the question-and-answer session. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.