Earnings Call Transcript - FRSH Q4 2023

Operator, Operator

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

Joon Huh, VP of Investor Relations

Thank you. Good afternoon and welcome to Freshworks fourth quarter and full year 2023 earnings conference call. Joining me today are Girish Mathrubootham, Freshworks' Chief Executive Officer; Dennis Woodside, Freshworks' President; and Tyler Sloat, Freshworks' Chief Financial Officer. The primary purpose of today's call is to provide you with information regarding our fourth quarter and full year 2023 performance and our financial outlook for our first quarter and full year 2024. Some of our discussion and responses to your questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on Freshworks' current expectations and estimates about its business and industry, including our financial outlook, macroeconomic uncertainties, management's beliefs, and certain other assumptions made by the company, all of which are subject to change. These statements are subject to risks, uncertainties, and assumptions that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks include, but are not limited to, our ability to sustain our growth, to innovate, to reach our long-term revenue goals, to meet customer demand, and to control costs and improve operating efficiency. For a discussion of additional material risks and other important factors that could affect our results, please refer to today's earnings release, our Form 10-Q from the quarter ended March 31st, 2023, and our other periodic filings with the SEC. Freshworks assumes no obligation to update any forward-looking statements in order to reflect events or circumstances that may arise after the date of this call, except as required by law. During the course of today's call, we will refer to certain non-GAAP financial measures. Reconciliations between GAAP and non-GAAP financial measures for historical periods are included in our earnings release, which is available on our Investor Relations website at ir.freshworks.com. I encourage you to visit our Investor Relations site to access our earnings release, supplemental earnings slides periodic SEC reports, a replay of today's call, or to learn more about Freshworks. And with that, let me turn it over to Girish.

Girish Mathrubootham, CEO

Thank you, Joon, and welcome everyone to Freshworks' earnings call covering our fourth quarter and full year of 2023. A year ago, we outlined our growth strategies focused on product innovation, excelling in the enterprise sector, expanding to drive revenue growth, and enhancing our operational efficiency. Throughout 2023, we launched the Freshworks customer service suite and various AI capabilities such as Freddy Self-service, Copilot, and Insights, all aimed at empowering businesses with AI-enabled software that optimizes work and increases productivity. We secured or expanded partnerships with major brands like Big Lots, S&P Global, Fila, Cineworld, Forbes, L.A. Dodgers, Nucor, Giant Eagle, and Johnsonville Sausage. Our operational efficiency improved significantly, shifting from cash usage for operations in 2022 to generating $78 million in free cash flow in 2023. Turning to the quarter, I want to thank the entire Freshworks team for delivering a strong Q4 as we exceeded our key business metrics. Our revenue surpassed our financial estimates, reaching $160.1 million for the quarter. We exceeded our non-GAAP operating margin and achieved a record free cash flow of $28.6 million in Q4. For the full year 2023, we reported revenue of $596.4 million and a free cash flow margin of 13%. During today's call, I want to emphasize three key differentiators that contributed to a strong Q4 finish. The first is the strength of our Neo Platform, which supports our product portfolio, enabling us to cater to enterprise clients and cross-sell across departments with multiple products. Second, our AI innovations are already helping customers achieve significant productivity gains. Lastly, our skilled product development team in India accelerates our innovation and delivers products to customers more quickly. Our Neo Platform is crucial to our success, providing services that enhance our product analytics and Freddy AI, offering extensibility and interoperability through marketplace apps, and delivering a unified customer data model across our offerings. The development and launch of the Customer Service Suite demonstrate the effectiveness of our platform. It combines three distinct Freshworks capabilities—generative AI bot, conversational messaging, and ticketing—into one integrated solution to meet various customer needs. For instance, ClickFunnels, a provider of sales, marketing, e-commerce, and analytics tools, replaced their previous support system with our Customer Service Suite due to the long development times required for changes. ClickFunnels chose our suite for its integrated AI-powered offerings, leading to improved resolution rates. According to a Forrester Total Economic Impact Report published in Q4, Freshworks CSS customers surveyed could achieve over a 200% return on investment over three years. Our platform also facilitates the rapid adoption of new technologies across all our products. For example, we developed generative AI capabilities in just a few months, starting with Freddy Self-service through bots, then introducing Freddy Copilot, initially for Freshchat and later extending it to Freshdesk and Freshservice. We are optimistic about the AI opportunity and monetization potential, as Copilot recently became generally available and we plan to launch Freddy Insights later this year. Early results show several power user customers achieved approximately a 50% reduction in resolution times for their customer service agents thanks to Freddy Copilot. As our customers grow, many will utilize acquisitions as part of their growth strategy. They can either piece together various inherited software solutions or choose one unified solution like Freshworks. For example, the [Indiscernible] Group in the UK, a retail customer that has evolved over four decades and made multiple acquisitions, now represents 70 store brands across various sectors. After selecting Freshdesk in 2022 to consolidate 16 customer support systems, the company saved over $1 million in software licensing costs. Recently, [Indiscernible] Group added our AI-powered bot, allowing them to handle more than a quarter of their customer interactions through automation, saving both time and money. Our partners are also leveraging Freddy Copilot for developers, greatly speeding up the app development process. In Q4, one partner, Connectify, increased their app publishing from four per month to an average of seven, achieving a 78% improvement in productivity with Copilot's assistance. With the introduction of ChatGPT 4 last year, businesses have had the opportunity to rethink their implementation of AI technology. Our strategic advantage here was our access to top talent in India, allowing our product and engineering teams to swiftly innovate on our roadmap. In 2023, this included integrating generative AI into our platform to take advantage of the latest large language model. This year, we aim to further advance our AI features across our products and platform. In customer service, we expect to migrate more customers to our integrated Customer Service Suite to enhance agent productivity. In Freshservice, we plan to improve ESM, ITOM, and verticalized offerings to drive expansion into larger markets and across departments. Additionally, we will implement significant upgrades to our sales and marketing products to increase inbound demand and cross-selling opportunities. Now, I will hand it over to Dennis to discuss what we are observing in the marketplace, how larger customers are fueling our business growth, and how companies are broadening their use of our products.

Dennis Woodside, President

Thank you, G, and congratulations to the team for our strong finish to 2023. G talked about our enterprise-grade platform, AI capabilities, and the strategic advantage of our India teams. Now, let me spend some time talking about how these played out for us in our go-to-market success. Macroeconomic pressures and a greater emphasis on fast time-to-value are leading enterprise companies to choose a smaller number of platform solutions to build their businesses. We believe Freshworks is well-positioned to continue taking advantage of this trend. In 2023, we continued our progress in winning upmarket. In Q4, we closed the year by adding 229 more customers contributing more than $50,000 in ARR. This represents the highest number of quarterly adds for this customer cohort ever. We also closed a record number of new deals over $100,000 in both IT and CS segments contributing to our strong quarter. These include a US-based footwear and apparel company operating in over 120 countries and a leading wholesaler to millions of restaurants, hotels, and catering firms. As G said, we win with large businesses because of the power of our Neo Platform underpinning our multiproduct offerings. This enables us to rapidly roll out new technologies like AI, all at a third the cost of larger competitors. Customers across a variety of industries are quickly realizing the benefits. In the CPG sector, Tata Consumer Products is a prime example of our enterprise customers leveraging improved automation workflows. As one of India's leading food and beverage companies, they are the world's second-largest tea manufacturer and operate Starbucks in India. Their legacy ITSM solution provided no control over admin configuration, making it difficult to create automation workflows. At the same time, the company faced an overwhelming volume of email and phone calls. Since adopting Freshservice, email queries have fallen by 21% in five months. In addition, Tata Consumer Products is one of the highest users of Freddy Copilot. For industrials, Klöckner & Co. supplies more than 90,000 customers worldwide with steel and metal products. The company is also digitizing and largely automating its supply and service chain. They needed to find a new self-service tool that's easy to use, fast, and a trustworthy daily assistant. Freshservice beat the competition, helping them optimize budget and repurpose funds for other IT initiatives. Shifting to expansion, we have several paths to grow our business with existing customers. These include agent seat additions, product cross-sells, addition upsells, and enhanced pricing. Our recent introductions of AI capabilities, including bot sessions and Copilot add-ons, offer additional opportunities across our 67,100 customers. Digging into our Q4 numbers, we're pleased that our net dollar retention increased by 1 percentage point quarter-over-quarter to 107% on a constant currency basis. We closed several large expansion deals in Q4 as growth expansion improved from the prior quarter and reversed declining trends from earlier in the year. We also continue to improve our dollar-based churn incrementally from the prior quarter. Lastly, our multiproduct adoption increased to 26% of our customer base. For example, we saw higher adoption for Freshservice for business teams as accounts grew more than 50% quarter-over-quarter, ending the year with more than 1,000 customers. One of these customers is Brunel University London, a college highly recognized for its research. They serve up to 18,000 students and more than 2,500 staff across the academic year. Already a Freshservice customer, they saw an opportunity to improve and provide a more consistent service experience to departments beyond IT. These include health and safety, campus service, the student center, and student welfare. By adding business agent licenses and workspaces, they reduced the average ticket resolution time from a previous backlog of several weeks to around four hours and achieved over 85% positive customer feedback. We're also seeing expansion from early Freshdesk adopters to the newer Freshworks Customer Service Suite. For example, Canadian-based Carlson One made the switch and has since achieved a two-hour first response SLA. They are resolving over 1,000 tickets daily and landing a 60% first contact resolution rate through AI and bots. And finally, Freshworks interoperable products give us a natural expansion path across solutions. For example, Agito, a mid-market travel management company in the UK, first bought Freshdesk to replace an on-premise customer support solution that couldn't deliver unified analytics and limited collaboration across teams. Later, they added Freshcaller and Freshchat to unify support channels and more recently, in Q4, they rolled out Freshsales to generate more qualified leads. In addition to our powerful platform and multiple expansion paths, what we believe makes Freshworks unique is our go-to-market motions, which include both inbound, product-led growth and field sales. Our inbound business is primarily marketing-led, while our field business is sales-led. As our company matures, we have hired two proven leaders across these distinct go-to-market motions that can help us scale. In Q4, Mika Yamamoto joined us in the new role of Chief Customer and Marketing Officer to drive greater inbound activity, including responsibility for our customer support, SMB, and commercial sales. Under her leadership, this team will drive our inbound product-led growth motion. Our field sales team will be led by Abe Smith, who I'm excited to announce has joined as our Chief of Global Field Operations this week. He's a sales executive with nearly 25 years of global experience at Zoom, Oracle, and Cisco and will lead our talented field team to scale the business. With these changes in the organization, Pradeep Rathinam, our CRO, will be departing Freshworks at the end of this month. Pradeep stepped up to lead and stabilize our go-to-market teams during a transition period and delivered a strong Q4 to finish out the year. After joining us in 2020 through an acquisition, Pradeep made countless contributions, first as our Chief Customer Officer and later as CRO. We thank him and wish him all the best in his future endeavors. Now, over to Tyler to go through the Q4 and full year financials and talk about how we're driving efficiency.

Tyler Sloat, CFO

Thanks Dennis and thanks again to everyone for joining us. As I reflect on Q4 and 2023, I was really pleased with our ability to adapt to a changing macroeconomic environment to deliver durable revenue growth while also improving our operating efficiency throughout the year. Specifically, we continued our product innovation cycles, injecting generative AI capabilities into our offerings. We retooled our go-to-market approach to more efficiently serve our diverse customer base. We brought on new leaders and team members to help drive additional growth. At the same time, we significantly improved our full year non-GAAP operating and free cash flow margins by 12 percentage points and 16 percentage points, respectively, compared to the prior year. For our call today, I'll cover the Q4 and full year 2023 financial results, provide background on the key metrics, and close with our forward-looking commentary and expectations for Q1 and the full year 2024. I'll include constant currency comparisons for certain metrics to provide a better view of our business trends. As a reminder, most of our discussion will be focused on non-GAAP financial results, which exclude the impact of stock-based compensation expenses and other adjustments. Starting with the income statement. Q4 revenue grew 20% year-over-year to $160.1 million. Adjusting for constant currency, revenue growth was 19% as we saw the positive impacts from currency rates for the euro and pound against the US dollar over the past year. Similar to prior quarters, ITSM continued to drive the majority of our growth in Q4. In addition, we were encouraged to see an improvement in our CS expansion activity quarter-over-quarter. Looking at our margins. Non-GAAP gross margin remained flat compared to Q3 at 84% as we are efficiently scaling the business. Similarly, for the full year 2023, we achieved strong non-GAAP gross margins of 84%, which represents a 150 basis point improvement from the prior year. Turning to our operating metrics. We have two key business metrics, net dollar retention and customers contributing more than $5,000 in ARR. Net dollar retention was 108% in the quarter, which includes a 1 percentage point benefit from FX and came in ahead of our previous estimates of 105%. In Q4, we saw improvements in both gross expansion and churn rates quarter-over-quarter. The higher expansion rate was mainly driven by strong execution from our field teams closing a number of large deals with existing customers. This was despite the overall macro demand continuing to feel pressure in Q4. Looking forward, we are planning for Q1 net dollar retention of 106%. Moving to our other key business metric of number of customers contributing more than $5,000 in ARR. This metric grew 14% year-over-year on an as-reported and constant currency basis to 20,261 customers in the quarter, and now represents 89% of our ARR. For our larger customer cohort contributing more than $50,000 in ARR, we saw strong growth in this cohort of 31% year-over-year to 2,497 customers, and it now represents 48% of our ARR. Adjusting for constant currency, this cohort grew at 30%. As G and Dennis mentioned earlier, we're excited about our ongoing success in winning upmarket deals. For total customers, we added over 500 net customers and ended the quarter with over 67,100 customers. The lower net adds in the quarter was primarily impacted by higher logo churn from smaller customers in the customer service segment, but we continue to see improvement in ARPA as we focus on attracting higher-yielding, more profitable customers. Moving to calculated billings, balance sheet, and cash items. Calculated billings grew 22% year-over-year to $180.4 million and 20% on a constant currency basis. Factors, including timing duration of contracts created a slight benefit of 2% to these growth numbers. Looking ahead to Q1 2024, our preliminary estimate for calculated billings growth is 16%. For the full year 2024, we expect calculated billings growth to be similar to our expected annual revenue growth rate of 18% to 19%. During the quarter, we generated $28.6 million in free cash flow and for the full year, we generated $78 million in free cash flow. This annual figure was nearly $70 million above our initial estimates we provided at the start of the year as we realize efficiencies throughout the year. This improvement was driven by lower-than-expected headcount costs, improvements on our infrastructure spend, and consolidation of vendor spend, resulting in both ongoing efficiencies as well as some one-time benefits. For the full year 2024, we expect to generate approximately $110 million of free cash flow with approximately $26 million of that in Q1. We ended Q4 maintaining a similar balance to Q3 for cash, cash equivalents, and marketable securities with $1.19 billion. We continue to net settle invested equity amounts using $16 million during the quarter and $68 million for the full year 2023. This activity is reflected in our financing activities and is excluded from free cash flow. Since our IPO in 2021, we have used approximately $239 million in net settlement of vested equity. As we look forward to Q1, we plan to continue net settling invested equity amounts resulting in Q1 cash usage of approximately $21 million using current stock price levels. For the full year, we expect to use approximately $80 million to net settle vested equity amounts. Turning to our share count for Q4. We had approximately 326 million shares outstanding on a fully diluted basis as of December 31st, 2023, representing share growth of less than 1% from the prior year. The fully diluted calculation consists of approximately 297 million shares outstanding, 27 million related to unvested RSUs and PRCs and 2 million shares related to outstanding options. Let me now provide our forward-looking estimates. For the first quarter of 2024, we expect revenue to be in the range of $162.5 million to $164.5 million, growing 18% to 19% year-over-year, non-GAAP income from operations to be in the range of $12.5 million to $14.5 million, and non-GAAP net income per share to be in the range of $0.07 to $0.08, assuming weighted average shares outstanding of approximately 305 million shares. For the full year 2024, we expect revenue to be in the range of $703.5 million to $711.5 million, growing 18% to 19% year-over-year, non-GAAP income from operations to be in the range of $52 million to $60 million, and non-GAAP net income per share to be in the range of $0.29 to $0.31, assuming weighted average shares outstanding of approximately 306.1 million shares. We want to provide our best view of the business as we see it today and as part of that, I want to call out a couple of assumptions in our financial model. First, our forward-looking estimates are based on FX rates as of February 2nd, 2024. So, any future currency moves are not factored in. Second, we have seasonality in our business with expenses typically stepping up in Q2 as our annual merit increases come into effect. As a result, we anticipate non-GAAP operating income to be approximately $6 million in Q2 and $15 million in Q3 and the remainder coming in Q4 to add up to the full-year amount. Let me close by saying I'm pleased with all that we accomplished in 2023. We continued our rapid pace of innovation and enhanced our go-to-market efforts, all while making meaningful improvements to our operational efficiency. As we look to 2024, we are focused on our growth initiatives, and we're excited for the many opportunities ahead. And with that, let us take your questions.

Operator, Operator

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

Scott Berg, Analyst

Hi everyone. It was a strong quarter for sales, and I appreciate the opportunity to ask my questions. First, I'd like to discuss what you're observing in the AI space regarding the functionalities currently in beta. There's a concern among investors in enterprise software that as these technologies become more widespread, they could affect seat-based models like the one Freshworks uses. You've mentioned that one of your beta clients experienced a 50% improvement in resolution time. How do you view the role or impact of AI on your business's future? Will it serve primarily as a module that increases average revenue per user, or could it also create opportunities or challenges regarding seat demand?

Girish Mathrubootham, CEO

Thank you for the question, Scott. From the beginning, even before the advent of AI, one of Freshworks' primary goals, like that of many technology providers in customer service and employee service, has been to assist businesses in enhancing automation. For instance, consider how IVR facilitates automation in call centers. Since 2018, we have been supporting our customers in the Freshdesk and Freshchat sectors to increase automation, which has consistently been a critical business driver. With Gen AI and Freddy Self-service and bots, we now have the chance to implement natural language and conversational automation in customer service. Many of the largest B2C companies are currently utilizing Freddy AI for this purpose. We truly believe this will enable Freshworks to excel in promoting better automation while ensuring a smooth transition to a live agent when customer inquiries extend beyond straightforward, automatable questions. Overall, it's essential to consider how businesses can leverage automation as the initial line of defense and then transfer to a human agent for more intricate workflows. We are confident that we offer the leading omnichannel customer service product in the industry today, and we expect to see significant benefits from this.

Scott Berg, Analyst

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

Dennis Woodside, President

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

Operator, Operator

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

Pinjalim Bora, Analyst

Thank you for the question. It's great to hear about the progress in the CX expansion area. I wanted to ask if you could provide more details; are you noticing an increase in seats and are they growing more rapidly? Or is the expansion mainly influenced by the Customer Service Suite or perhaps the pricing adjustments related to bots?

Tyler Sloat, CFO

Hey Pinjalim, this is Tyler. We had strong expansion this quarter, particularly in the CX area. It's a combination of factors, but we specifically saw increases in mid-market enterprise seats that are contributing significantly. Some of this growth came from early renewals in Q1, which is a positive indicator as customers are not only renewing but also increasing their ARR with us. This was encouraging. Additionally, CX has faced pressure in Asia for a couple of years, and we've noted that. Overall, we believe this was a very solid quarter for execution in that area.

Pinjalim Bora, Analyst

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

Tyler Sloat, CFO

Sure. I'll address that in several parts. Regarding guidance, you mentioned net dollar retention. We had been projecting 105%, and we initially did not expect to reach 105% in Q4, as indicated earlier in the year. As we approached Q2 and Q3, one of the reasons we didn't drop to 105% was due to our strong performance on churn. For Q4, achieving our target was a result of both improved churn and a bit of expansion. Now, we are projecting 106% for Q1, and we believe that will be the actual figure. Previously, we thought we would stabilize at 105%, but now we anticipate stabilizing at 106%, reflecting the health of our customer base. Concerning other guidance areas on revenue, our estimate based on current observations suggests growth of about 18% to 19%. For billings this year, we expect it to align with this growth. We noted that in Q1, the timing of renewals may affect our figures; some renewals originally scheduled for Q1 were moved to Q4, which will lead to slightly lower calculated billings in Q1. Overall, we expect billings to track revenue for the full year at 18% to 19%.

Operator, Operator

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

Elizabeth Porter, Analyst

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

Dennis Woodside, President

Thank you for the question. First, in terms of adoption so far, we have thousands of customers who have joined the beta programs for Freddy Self-serve for Insights and for Copilot. Not only have they joined, but the usage rates among these customers are quite high. We track metrics like active usage. We recently released those programs to general availability, so you can purchase Insights or Copilot today on our website if you're a new customer. We are transitioning all beta customers into paid programs over the next month, so we will start to see the monetization begin. For now, our primary focus is on adoption and the value these products provide to our customers, which is an important leading indicator for us. Regarding our outlook for the full year, we have not included a significant upside from AI just yet, as we want to observe how things develop before adjusting our projections.

Elizabeth Porter, Analyst

Great. And then just as a follow-up, I wanted to hit on margin. You had some really impressive expansion over the last year. Looking ahead, guidance implies more minimal expansion despite still some of that solid top-line growth. So, first, just how should we think about the leverage in any incremental areas of investment in fiscal 2024? And then second, should we just be thinking more about some back-end linearity to hit your fiscal 2026 targets? Thanks.

Tyler Sloat, CFO

Thank you, Elizabeth. This is Tyler. Last year, we made significant improvements, some of which were one-time enhancements. We have been consistent, but we do not expect the same level of step-by-step improvement as we enter fiscal 2024. We remain highly focused on efficiency, but we also see areas worth investing in. On the R&D front, we will continue to invest in innovation, which we believe is a major advantage for us. In terms of sales and marketing, we will persist in pursuing opportunities, particularly in field hiring where it makes sense. We have identified some investment areas while also concentrating on increasing margins, driving more dollars to our bottom line, and generating more cash.

Operator, Operator

Thank you. And our next question will be coming from Brent Bracelin of Piper Sandler. Your line is open.

Hannah Rudolph, Analyst

Hi guys. This is Hannah Rudolph on for Brent today. Thanks for taking my questions. It's really encouraging to see you that record 50,000 net adds this past quarter. I guess, what do you attribute that to? I imagine a lot of it is ITSM, but some of it was probably driven by that new CS Suite as well. So, wondering if you could just talk about the dynamics you witnessed in that cohort?

Dennis Woodside, President

Yes. You're correct. A lot of it is driven by ITSM, but we're seeing some promising results for CSS. One of the companies that I talked about in the prepared remarks, Carlson One, that's a new CSS customer, they're a loyalty company up in Canada. Klöckner, one of the larger steel companies in Europe. That's a new ITSM customer. Tata also another customer we talked about earlier, that's another ITSM customer. I think it's not just something that we've done in the last quarter, but the investment that we've made in the product over the last couple of years, where we built out an enterprise-grade ITSM suite, added on ITOM, ITAM, and then more recently, ESM with Freshservice for business teams. That really has driven growth of that product. And then with CSS, our customers have a best-in-class, fully integrated product that covers both conversational and traditional ticketing enhanced by AI. And that's something that really is unique in the marketplace where if I'm an agent in a single pane of glass, I can ingest and see comments from my customer coming in through WhatsApp, coming in through SMS or email or phone and respond. And that has had a lot of positive acceptance in the market so far.

Hannah Rudolph, Analyst

Great. Super helpful. And then Dennis, what do you feel still needs to be done to continue to execute on this upmarket motion that you're on right now? And is it just execution? Or is there more that you still need to do?

Dennis Woodside, President

We are planning to make a significant investment in our partners and partnerships. Recently, we announced a collaboration with AWS, which is helping us secure new deals. One of our largest agreements this year with a major apparel manufacturer was facilitated by AWS. Our customers can use their AWS credits, which they are obligated to spend over several years, to purchase our software. This simplifies the purchasing process for them and accelerates our sales cycle. This showcases how a major partner can help us drive growth over time. Additionally, we are improving our execution. We recently achieved our best quarter ever in North America. About six months ago, we onboarded Will, who is leading our North America sales initiative, and we are already seeing the benefits from the significant hires we've made in the last year. We expect this positive trend to continue with the addition of Abe, who is an experienced field leader and will enhance our market efforts even further.

Operator, Operator

Thank you. And our next question is going to be coming from Brian Peterson of Raymond James. Your line is open.

Brian Peterson, Analyst

Thank you for the question. I wanted to follow up on the seat dynamics, which have shown improvement. You also noted that the overall seat performance has faced some challenges recently. Do you believe we've moved past that, and could the larger market become more favorable going forward? I would appreciate your thoughts.

Tyler Sloat, CFO

Hey Brian, this is Tyler. You're breaking up a little bit, but I think you're asking about seat degradation or expansion pressure and whether it's over. We actually saw really good expansion in Q4. You're right, we've been discussing agent additions being lower over the past year and a half. That hasn't recovered to the levels we saw several years ago, and we don't expect it to recover immediately. There were good signs in Q4, but we’re not banking on a quick comeback. At the same time, the SMB sector experienced some pressure and continues to face challenges, which contributes to the lower net additions. Specifically, in the long tail of SMB, particularly in customer experience, we noticed some churn. Overall, we're focusing on how to expand our customer base beyond just adding seats. If agent additions return to the levels from a couple of years ago, that would be fantastic. However, our main focus is on introducing new products, enhancing features, moving customers up the addition stack, and encouraging them to use more services across other divisions. That’s our current focus. It's not fully back yet, but we had a strong expansion quarter.

Operator, Operator

Thank you. And our next question will be coming from Alex Zukin of Wolfe Research. Your line is open.

Alex Zukin, Analyst

Hey guys. Thanks for taking the question and congrats on a solid quarter. Maybe just the first one, Dennis or Tyler, can you maybe just talk about the macro exiting Q4, like entering the year? Has it changed? Has it gotten better? Is it different by geography in terms of what you're seeing? And to what extent do you feel like this was you guys executing meaningfully better versus the macro changing to the positive? And then I got a quick follow-up.

Dennis Woodside, President

Sure. The trends we observed in Q4 were in line with those from earlier in the year. In the enterprise and mid-market sectors, we are seeing strong momentum, as indicated by the 50,000 ad figure. Part of this success is due to vendors consolidating their spending and seeking platforms that offer more comprehensive solutions. They are also looking to integrate AI into their operations, workflows, and help desks, which we can provide. There's enthusiasm around our AI roadmap and the offerings currently in beta and now available generally. However, the small and medium-sized business segment is facing more challenges. From our customers, we hear that the market is under increased pressure for smaller businesses. There are improvements we can make, such as enhancing product-led growth and better aligning marketing with our SMB initiatives, which we believe will yield positive results. We see potential for SMB to be a growth area for us in the future. Nonetheless, what we experienced in Q4 aligns with previous quarters, where this segment did not grow as quickly as the larger customer base.

Alex Zukin, Analyst

Perfect. And then maybe just a follow-up for G. You've gotten the AI question a couple of times, but maybe just what are you seeing in terms of early adoption or learnings from either. Are you seeing more in SMB versus in mid-market enterprise or vice versa, faster versus slower? And what monetization motions because you have a number of different ones that you're doing in the field, which one of those are working the best early on and that you see potentially kind of getting escape velocity later in the year?

Girish Mathrubootham, CEO

I would respond in two parts. First, our Freddy Self-service is experiencing success with larger B2C companies, as they have fewer scalable use cases across millions of customers, making it well-suited for automation. On the other hand, our Copilot is gaining traction because it enhances agent productivity, leading to enthusiasm and adoption among a diverse range of customers, including SMBs and mid-market segments. I'm optimistic that we will achieve escape velocity in both areas, but it's still early, and we will continue to focus on executing and delivering more value for our customers to achieve that momentum.

Alex Zukin, Analyst

Perfect. Thank you guys.

Ryan MacWilliams, Analyst

Hey thanks for taking the question. I guess I want to note your focus on upmarket customers. So it makes sense that much smaller customers below 5,000 are turning in the customer service segment. But any reason why those customers are leaving now? Are they just looking for cheaper alternatives or is it some change in the competitive landscape?

Dennis Woodside, President

I wouldn't say that those customers are necessarily seeking cheaper options. There is a natural turnover as businesses, unfortunately, either fail or downsize, and we see quite a bit of that in the small and medium business sector. Additionally, we've had customers who try out our product line but find it doesn't meet their needs for various reasons, such as being too small. So, I wouldn't point to any specific competitor that those customers are moving to, if that addresses your question.

Tyler Sloat, CFO

Hey Ryan, currently we're estimating a low point of 106% for Q1, up from our previous estimate of 105%. From what we see now, we believe 106% is the bottom, and we may stabilize from there. To reach 110%, we need to address a few factors. We're making progress on reducing churn, which we had previously noted was in the low 20s when we went public and is now in the mid-teens. We believe we can continue to improve that slowly, perhaps by 100 to 200 basis points over time. Our ability to grow will largely depend on our expansion efforts, and we have several initiatives underway, as we outlined during our Investor Day. One of those points was the potential for macroeconomic improvement, which would naturally boost our growth, but we aren't relying on that happening quickly. Therefore, we are highly focused on finding additional ways to grow our customer base. We believe that in time, we can return to 110%, but it will take some effort.

Operator, Operator

Thank you. And our next question will be coming from Pat Walravens of JMP Securities. Your line is open.

Austin Cole, Analyst

Hi, this is Austin Cole on for Pat. Appreciate you guys taking the question. So, I just wanted to kind of piggyback on the answer given to the incremental kind of operating efficiency guidance implied. And looking at the flip side of that on the top line, with all the kind of unlocks that you guys are discussing and the better-than-expected expansion, improving churn. Why might it not be at this point, prudent to say that this business could grow 20% next year? Thank you.

Tyler Sloat, CFO

Our guidance is slightly below that. We base this guidance on our current observations. We've mentioned numerous initiatives underway, specifically six that we highlighted during our Investor Day, which we believe could contribute positively to a growth rate close to 20%. However, these initiatives need time to materialize. For example, the AI monetization we discussed is expected to show progress in Q4, and we hope to provide an update by mid-year regarding early signs of monetization. We are very excited about these initiatives and the potential long-term outcomes, but we cannot factor them into our projections just yet.

Operator, Operator

Thank you. And our next question will be coming from Brent Thill of Jefferies. Your line is open.

Tyler Sloat, CFO

I understand, Brent. Looking back at last year, we did experience some one-time benefits. Research and development spending remained flat year-over-year, while sales and marketing expenses increased slightly, only about $10 million from 2022 to 2023. We had indicated not to expect the same efficiencies carrying into next year since we made significant adjustments in sales and marketing at the start of last year and needed some time to stabilize. We believe that now is the right moment to invest a bit more. We don't want to give the impression that we are moving away from efficiency; we remain focused on achieving the Rule of 40 by 2025, which we specifically outlined in relation to free cash flow margin and growth. Our guidance shows we're just shy of 16% for the free cash flow margin this year and about 18% to 19% on revenue. This establishes a solid path toward our goals, and we will maintain our focus on efficiency as we grow. However, we believe that if the chance arises to accelerate our growth, we will pursue it, but it requires initial investments.

Operator, Operator

Thank you. And our next question will be coming from Taylor McGinnis of UBS. Your line is open.

Taylor McGinnis, Analyst

Yes, hi. Thanks for taking my question. So, if I look at the high end of the FY 2024 revenue guide, it's only a point below the 4Q exit rev growth rate. So, it implies some stability in top-line growth. So can you talk about what gives you comfort that this outlook still embeds a level of conservatism? Or any change in the guidance framework. I think even despite the pull forward you're expecting, billings growth to remain more stable too. So, maybe you can just comment on what you're seeing in the macro, what your assumptions are for ITSM versus CS growth that's supporting that outlook? Thanks.

Tyler Sloat, CFO

Hey Taylor, this is Tyler. Regarding the guidance, we've aimed for a cadence that you all will recognize. We are guiding based on what we see, and we are not trying to be overly conservative; we are presenting our perspective as it stands and will update it every quarter. For the year, we believe we are at a point where growth rates are stabilizing, and we expect expansion without worsening rates. We previously anticipated a net dollar retention of 105%, but now we are projecting 106% as the minimum. We have a solid understanding of our current business situation. I want to highlight some initiatives we are pursuing to accelerate growth, but we need to allow these strategies to develop before fully incorporating them. It’s still too early for that. Overall, we have a very positive outlook about the business, especially following a strong quarter.

Operator, Operator

Thank you. And the final question for today will be coming from David Hynes of Canaccord Genuity. Your line is open.

David Hynes, Analyst

Hey everyone. Thank you for taking my question. I have another inquiry regarding AI, and I'm not sure if it's for Dennis or G. The value proposition and early adoption examples are quite clear. For those not moving forward, is it due to organizational readiness or are there price concerns in the market? I'm particularly interested in the latter, especially since some of the advanced AI features haven't been released yet. How price sensitive are buyers at this time? Any insights would be appreciated.

Dennis Woodside, President

Yes. So, this is Dennis. So, so far, as I said earlier, there are thousands of customers that have opted into the beta. So, I think to one degree or another, all of our customers have some level of interest. Now, some of those customers are going to be a little more cautious if they have become reliant on a human-driven interaction or let's say, they have a very high-value customer on the other end and they prefer to have a human involved, then they're going to be less likely to adopt Freddy Self-serve, but they may adopt our Copilot product. So, I think it's just a matter of time before all of these opt into some trial of sort. And then it's a question of whether or not they see value in the product. And if they do, that's when we get into a nice discussion about, well, what is the investment that they're going to be making in AI. They're going to provision all their agents or some of their agents and how does that work. So, that's a huge opportunity for us this year. And we're seeing with some of the resolution rates, the improvement in call quality and customer interaction, customer resolution, we're seeing a lot of value come from these AI products. And customers are recognizing that value. So, we're going to have to see how it all plays out, but I'm pretty optimistic that this is a huge opportunity for us that's going to really materialize over the course of the year.

Tyler Sloat, CFO

Yes. Our plan is to be able to get there in the current environment. That's not based on macro coming back.

Girish Mathrubootham, CEO

Thanks everybody.

Operator, Operator

This concludes today's conference call. Everyone may disconnect.