All right, we're gonna get this party started. Welcome, thanks everyone for joining us here today. My name is Scott Berg. I lead our enterprise software and SaaS research efforts here at Needham, for those that haven't met me yet at least. Today, we have Freshworks, a 2021 IPO class. We have the company's CFO, Tyler Sloat with us. Tyler, thank you so much.
Thanks for having me.
As we were walking in, I was just thinking if I count back you and I have probably done this gotta be 10 times now .
I think so.
T hese are fun, both with his prior company and today, this is always a good time. But, let's talk about Freshworks. How about you start off with an overview of the company for those that are less familiar with it?
Sure. Freshworks is about a 12, 13 year old software company. Kind of the name is reflective of what we're trying to do, is essentially kind of provide a different approach to building enterprise software, a fresh approach. Which is building really enterprise-grade products that are number one affordable but really easy to use and onboard. First, our first product was Freshdesk, so customer support software and really kind of what we grew with. Then we added Freshservice, as we were seeing a lot of those customers using Freshdesk, but for internal IT, so we did a purpose-built Freshservice solution for ITSM and then the latest product is Freshsales and Freshmarketer, are more of a full robust CRM solution.
In that space, Freshdesk, we've kind of moved to a Customer Service Suite CSS, a product we launched last year, which is really conversational first and chat first, in recognition of how companies are evolving and the way they're engaging with their customer base. That we think is gonna continue. That along with a lot of injection of AI, we've announced three AI products that we have. Freshservice is actually our fastest-growing product. It is our largest contributor to ARR growth over a number of the last quarters.
T hat's really because it's just number one, a great product and really fully feature-rich and enterprise-grade, but really regarded as the number one product, kind of below ServiceNow in that ITSM space and continuing to do really quite well. We're founded out of India. We're a U.S. company, but founded out of India, which has also allowed us to really be quite efficient in the way we've grown and at coming out of Q3, guided to $75 million of free cash flow for the year after burning about a little bit less than $20 million the year before.
I really pivoted to more efficiencies, but one of the reasons we were able to do that without any big structural changes is because we do have about 85% of our employee base out of Chennai primarily but also Hyderabad and Bangalore. That's also allowed us to have access to a highly technical talent base allowed us to really innovate very quickly and a company of our size to be able to have kind of three products, which has been great.
I wanted to start off with a recap of your Analyst Day. That was back in September, four months or so ago now and the reason why I wanted to start there is all the conversations I've had with, on Fresh the last three, four months, 90% of the questions are coming out of that, 'cause you guys did a great job of detailing extra information there. But starting with Service Desk is most investors I speak with have been surprised, mainly because of the growth rate of that solution.
The growth rate in that solution as of Q2 was greater than 40% but it's in a space that investors have almost forgotten about outside of ServiceNow especially at right below that is why the confidence in ITSM right now in particular, especially in this macro? You guys really conveyed a viewpoint that even in this choppy macro, you feel very good about that ability to sell.
T he market is really large and we're not that large yet and so that gives us confidence in our capability to grow. Secondarily, there's specific dynamics going on in that space, where just not a lot of, kind of, enterprise-grade players. You have a lot of legacy still, which is kind of the Ivanti, Cherwell, BMC Remedy stuff that was historically on-premise, that they've been moving to cloud solutions. But as you force your customer to shift to something, the customers typically will go out and look at new solutions there. ServiceNow continues to move upmarket and are very focused on really large deals which is a great opportunity for us.
They also have a pretty complex software, which is also a great opportunity for us because we can land and get a customer live with very little professional services, if any, in a matter of kind of months to a quarter, as opposed to a year. So the time to value and ROI is really significant. At the lower end, there are players, Atlassian, with Jira Service Management and ManageEngine kind of by Zoho. But they're really focused more on a smaller customer base and Atlassian is really coming up through a developer-centric perspective, where if it's a CIO-led initiative, we feel like we have a great opportunity to win there.
In terms of future growth, like, our capability to grow is gonna be also moving, continuing to move a little bit more upmarket and, engaging with larger customers, continuing to take advantage of the space we're in, which is taking over the legacy, but also thinking about expanding the footprint of our ITSM solution to open up that addressable market for us and one of the things we did last year was launched, Freshservice for Business Teams, which is ESM applications selling into other functions outside of it and that's already started to see great traction as well.
On the flip side of the Analyst Day commentary, your growth expectations for Freshdesk were actually below your expectation for market trend growth. Y ou're expecting that market to grow at maybe a low-teens to mid-teens rate, but your numbers assume a CAGR of about 7%-8% by my math. W hy so much conservatism in your growth on that solution relative to a market? Because most would view that if you're a market leader, you're probably growing at least in line, if not faster than the market.
W hen we did our Investor Days, the kind of projections and looking out, I wouldn't say we tried to layer in a like a film of conservatism on top of everything. What we did is we said, "Okay, this is what's happening today and so if nothing else changes, this is kind of what we would expect to happen." Freshdesk, a couple of things have happened there. Number one, we saw a lot of pressure over the last couple of years on our expansion motion, which was primarily driven by agent addition and the majority of that was in our Freshdesk solution 'cause we would land small and just our customers would grow rapidly.
T hat agent addition had been really, really predictable for years up until kind of a year and a half ago, it really started to slow down. I would put that in the macro bucket, right? You just saw it across the board, companies kind of reshaping their employee base and a lot of layoffs and things like that. I feel like we've gotten through most of that with our customer base. We don't sign long-term deals annual usually at most. I feel like we've already seen a lot of that pain there. The second thing that happened is there's a technology shift, where the way customers were engaging with their end customers has really shifted away from traditional ticketing to more conversational first.
We have made that shift as well and we've been talking about it for a while. You saw some players pop up who are very specifically focused on bots and things like that and/or chat and we have all those offerings. So now it's up to us to really make sure that we are bringing those to market and winning with those solutions that we have and continually to go press forward with new innovations there. That's what we're very focused on. But in terms of growth rate, we're kind of saying: Okay, this is what we see in front of us. We're not super happy with that growth rate. We're gonna do everything possible to grow faster, but the projections are based on what we see.
Lastly, from the Analyst Day, our calculations have suggested a pretty significant shift in ARPU coming from new customers the last several years, but also in your projections going forward. It's actually a pretty interesting exercise to do 'cause it's a big enough growth rate there. But the company is already experiencing significant growth in net new ARPU, partially based on product mix. But is this additional shift coming up maybe more from upmarket assumptions here going forward? Is it more of, bookings mix favoring ITSM? How should we think about that growth rate?
I t's all the above. Again, the projections are based on what has been happening and kind of continuation of that. So we do have a mix shift, that Freshservice has been the larger contributor. Those deals tend to be a little bit bigger because they're playing really in the mid-market and low enterprise, not really in SMB, which Freshdesk plays in SMB. The second thing is that we've been getting pulled into larger deals and this has been happening over the last couple of years and it's reflective of we've earned the right with our technology now, that we can meet those customers' needs and that's gonna continue to happen.
T he one thing that we've been focused on is as we're getting pulled in, let's make sure we have the right skill set internally to go win those deals and we're a little bit behind on that then we've been making adjustments and Dennis has really led those over the last kind of year plus on making sure that we are fully equipped to go engage and win in the deals that we're actually getting the participation at. We've talked on our calls that we're getting more at bats.
That doesn't necessarily mean that the winning percentage is going up, but we're getting more at bats. Now, we're focused on how do we actually go win those at bats? 'Cause we feel like future functionality-wise, we actually can go win those. We just need to go execute on it. So the continuation of increased ARPU is reflective of mix shift as well as reflective of just being pulled into larger deals.
Moving on to product a little bit, it's tough to get away from those two letters called AI in our space right now. You guys are certainly developing product there. But let's talk about how you're infusing it, in particular. Last year you announced the company's Freddy AI product set, which includes Self-Service, Copilot and Insights. Sounds like Self-Service will be a consumption-based kind of bot pricing model, while Copilot will be more of a per-seat upcharge. W ithin all that, can you discuss your monetization strategy for each and why those are kind of the right models there? And how do they, how do you expect them to contribute to your maybe billion-dollar target just your AI modules in general?
You're right, so three products that we've announced, Freddy Self-Service, Freddy Copilot and Freddy Insights. Freddy Self-Service, we are not technically selling Freddy Self-Service. It's actually gonna be AI-embedded within our bot capabilities and that we launched at the back half of last year and so we did two things in terms of monetization. We changed the entitlements for the amount of bots that a customer gets when they buy one of our chat products and then secondarily, we increased the price for the bot add-on packs that you would need to buy once you go through that entitlement.
This is gonna take a while to trickle through. We're pretty excited about those capabilities, but specifically also, even the bot builders, which have been historically one of the biggest inhibitors for bot adoption that small companies without technical capabilities, you can have all the capabilities, but you got to go build the bots and actually have them deployed out there and a lot of that has become a lot easier with new AI features- like no-code kind of building. So that's already out there. It's just gonna take some time for that to filter through to see revenue from that as usage increases, so we're very focused on usage.
Freddy Copilot, which is really across all of our main products is really self-service is about kind of deflection, Copilot's about how do you make your agents much more productive? That is in beta right now. We said it will flip to GA in Q1. That has a price list of $29, specifically for Freshdesk and Fresh service and it's an add-on and so we'll see. I don't expect when we flip it that we're gonna automatically see a surge of orders, but what it's gonna do is enable our reps to go engage with our customer base around productivity features and things like that and will also be a capability for us to win more.
T his is actually becoming something that's table stakes in the industry that you have to have this built in to some capabilities and we are confident that what we have and the feedback that we're getting is gonna allow us, when we go head-to-head with other players, that we can actually say, "We've got our core say support functionality and ticketing and chat and conversational first, but now injected with all this AI capability," and that should allow us to win more. That's gonna take some time to go see, but that's the expectation. So we're pretty excited about it. Freddy Insights is like starting to kind of be in beta really it's like really subtle so far and we haven't announced when a go-live for that would be.
Now a real difficult Freddy question: Who came up with the name Freddy? Did someone like Freddy Krueger or was there trying to give some history.
It's funny because Freddy is not new for us. We've actually had AI for years, right? But it's all built on our own dataset and the legacy chat products have already had this built in.
Freddy has already been our AI stuff. You can go back to our roadshow. It was kind of all over. The actual genesis of it is the moniker is like the little icon's a little dog and like who's man's best friend is a dog, little dog and, like, that's why it's Freddy. Supposed to be your helper.
Fair enough. You also recently released your service suite product, which we've kind of touched on a little bit and you've seen positive trends. Can you provide some insight to the results seen to date versus your expectations and how much or how important that is to your product and sales processes going forward?
I t's really important to answer the last part first because it is reflective of what we think is a true technology shift in the market, that customers are engaging with their. Our customers are engaging with their end customers in a completely different way, specifically on the B2C side. I see it with my kids. They would never pick up the phone and actually talk to somebody. They wouldn't even email, right? Everything's gonna be through chat and all of your resolution for everything that you're doing is gonna be chat first. There has to still be a robust solution behind because there's gonna be things that actually are elevated to a true ticket but what we're seeing is that the whole market is changing and moving away from traditional ticketing.
C ompanies don't even wanna create the tickets. They just want to have a resolution and then kind of move on and that's what CSS is for us. The Customer Service Suite is essentially taking all of our legacy product keeping the robustness of all the deep stuff there but actually moving it and kind of flipping it, so it's all chat and conversational first and then ticketing second. We have customers who are more traditional and they think ticketing, we're still leading with that and so our biggest change is really, okay, how do we educate our field and our sales folks or even the PLG motion of where somebody's landing based on who you are to be able to put in the product and give you exposure to the product that's gonna be most ripe for what you need at that time?
T hat is actually, in some cases, harder than the technology itself and so that is something that we're absolutely working on. But CSS, I think is really important as it's just reflective of where the where the trends are going.
Lastly, on the product side, it's an area that I know a lot of investors don't focus on, but that's Freshsales. Partially because it's just a small portion of ARR today and hasn't been growing fast historically, but you're pretty focused on revamping that product. What does that revamped product look like? 'Cause you're expecting the growth rate to accelerate over the next couple years.
F irst and foremost, we haven't executed there as well as we need to. We re-architected sales and marketing and put them on what we call the Unified Customer Record. CSS has actually moved on to Unified Customer Record as well to make it a more seamless journey from marketing all the way through to support. The interesting thing about that product, it's actually pretty feature-rich and it's actually got a lot of functionality, but the UI and design of it isn't really where it needed to be. Specifically on the PLG motion, the journeys that we're having potential customers land and then go through wasn't in a way that was actually gonna get the conversion rates to what we need. So we are very focused on looking at that.
Girish, our CEO and founder, he's actually personally kind of taking it over and dedicating the majority of his time to that and we'll see it's a huge market and we feel that we should be doing a lot better there and we're very focused on it.
I f we move to go-to-market a little bit, the company has had a lot of changes over the last year. You brought in a new president, Dennis Woodside and you talked about getting it more at bats. Maybe win rates haven't improved a lot, but hopefully they can improve further with some of the changes. C an you articulate some of the changes you've made on the go-to-market side there and the increased focus up-market? Do you have to change your strategy a lot? A t the same time, at your conference you talked about PLG 2.0, which are kind of different ends of a barbell. How do we balance all those changes that you're going through?
The first thing is in your last statement, they are actually completely different motions and the realization internally, "Okay, we gotta treat these things differently." Selling with kind of top of funnel first and through to a true PLG motion is really important and we're not banning any of the SMB things. We have an advantage there in our capability to go attack a global market there, but we just need to be a little bit better at that PLG, which we really hadn't touched in a long time, so we kinda just need to revamp a lot of it.
The field is different, where Dennis is now five quarters in really came on board as like looking at a lot of numbers and kinda stuff that we kinda saw ourselves and could see it, but you need somebody to come in and say, "Wow, a lot of our growth is coming from larger deals. What's going on there?" And the realization, like we're being pulled into a lot of these deals now and that's not gonna go away. That's actually just gonna continue. But are we designed to go execute to go close and get these customers successful? And so a lot of the changes have been around making sure we are ready to go do that and that stuff takes a while, right?
You'll hire a leader and then he'll look at a team and they'll realize, okay, we need new team members and this stuff kinda just filters through. We made a decent amount of changes coming into fiscal 2023. Some structural changes there, where we consolidated some teams that we thought there was some kind of duplicative efforts. We moved our commercial group down to India, realizing that we could service that from India and do it really efficiently and that's done well. W e're still tweaking a lot of that stuff and still making those investments, but I don't feel like there's big structural changes. Now, it's more like tweaking and actually executing.
As you look at your sales opportunities out there, have some of your recent product releases like Service Suite as we talked about or Freddy AI served as a differentiating factor? Can you actually pinpoint on, on certain deals where customers are coming in and say, "Hey, this is the reason why I went to Freshworks"?
D efinitely on like CSS on conversational first and being able to really take that product specifically to B2C businesses and really show them what we can do with that. Freddy's still not GA, right? So that one, you can't really point to that being maybe pushing you over. The feedback is really good and I expect that to be a reason that I'd love to talk about. Maybe in the middle of the year, we have kind of data around that.
O n Freshservice, it's just because that product is just really well designed, built specifically for that CIO and the kind of that size of the company. ESM is actually getting great traction and that again is 'cause it's really easy to put in and use and the journeys there are something that are pretty easy for us to design and build on rapidly. On Freshdesk, T hat 's what we're gonna have to see over time CSS being able to land with s ay traditional support or conversational first and making sure our field, it understands who they're talking to and how to, how to lead with that. But the initial feedback on CSS is a great competitive advantage for the customers who want that.
You talked about moving upmarket and the successes and how you're being pulled upmarket there, but you also kind of drew a kind of a delineation about this market below ServiceNow on the ITSM side. How high do you think you'll ultimately take the solutions or get dragged up there by some of these customers? Where does that fit go to? Because I get the question often $50,000 great level cohort you report, but can you sell a $500,000 contract? Can you get $1 million contracts? And can they be more consistent in the business going forward?
I actually think it probably has more to do now with execution on the sales side than can we? So we do close those deals. Now, we're not closing, like, $1 million deals, but $500,000 deals, yes. We do close those deals. But that's not our sweet spot. Our sweet spot in, like, Freshservice is a $100K deal, $200K deal feels pretty good like pretty big and then tons of $30K deals just like they should just be rapid fire and then those customers will grow. We're trying to like going there before you're ready, you can spend a lot of cycles trying to win a $1 million deal and then not win at the end, maybe because of pure sales execution as opposed to product feature functionality.
We have seen that and so that just lets that we don't have the sophistication yet and until you do maybe you don't wanna spend your time on those, right? Cause if you do, you're sucking resources there and so we're trying to be disciplined about that, but at the same time, putting in the investments to make sure we can go win those deals when we're ready.
From a housekeeping perspective, I have probably a couple, three, maybe four more questions and then we're happy to open it to the audience for Q&A. Let's turn to financials a little bit. We have the CFO here. We have to ask one financial question or two . Your 26 operating margin targets. To get there is this a fairly linear progression or would it be a little bit more back-end-weighted hockey stick approach?
I don't think it's gonna be super back-end loaded, but we did make some really big operational efficiency improvements this year and you're not gonna see the same type of stairstep improvements into next year and so it, like we've said it is gonna be more linear. We don't wanna put a goal out there and say, "Okay, we'll make it right when we get there," right? That 's not what we're trying to do. We're trying to make subtle improvements all along the journey.
You just talked about the big jump that you've had this year. I understand if you've seen the numbers, you're not likely to make the same jump increase this year. But how do we look at cost of customer acquisition? Because it suggests that it's costing you actually more to date to land a dollar of revenue than what it did a couple years ago.
Even with the great margin improvement, CAC actually hasn't come down that much. How do we think about that kind of progressing going forward?
W hen you're including that CAC, you're also looking at expansion revenue in there and that's really the expansion revenue is what we've seen the most pain on which is agent addition which has slowed down. W e have made a pretty good step on kind of what we call GEI - Growth Efficiency Index, this year in terms of what we're spending to get a dollar. I still think we have decent ways to go in terms of efficiency. I still think we can become much more efficient on the sales and marketing line item.
I n getting to what we call Rule of 40 by 2025 and the operating margin goals for 2026, the majority of that leverage is gonna come from the sales and marketing line item.
Cool. Gross margins, currently 82%-83%. They're already kind of best in class in SaaS, real difficult to get above 85%. Why can't you, why can't you do that? Why can't you get to 85% or 90%? Because it doesn't seem like it's that big of a leap from where you are today.
I'm actually really happy where we are right now and I don't expect-
I know you are. I didn't mean to be mean, but I get the questions: "Hey, you're already at 83% and your scale's good, but wait till you get to $1.5 billion. What does that mean?"
I don't think we're gonna expect that number to get much better. Right now, In fact, I'm trying to keep it kind of the same. T here's nuances to the business that as you grow like if you look at us like professional services is immaterial almost, right? We don't even break it out on a main line item. We have to continue to work with our partner network and make sure they can do as much as possible. But as we're moving to larger deals, I could see us having to do a little more services and wanting to engage. That will be a margin drain, things like that.
That's not gonna be like overnight that thing pops up and now it's, like, a significant amount of the business. These are just things that are happening as we're moving to larger deals. The cost of AI, right now, we've built in what we think it's gonna cost and we feel like we have that built into our forecast and whatnot there's a lot of unknowns there, for everybody and so we'll have to see how that plays out. We've gotten a lot of leverage. Our biggest line item there is AWS and we have a great partnership with them. We'll still continue to get leverage there, but it's gonna be like subtle leverages and so could we get to 85? E ventually we can.
Are we going anytime soon? No, I don't expect it. Expect to keep it kind of where it is.
Last question from me. Partner impact. You just mentioned partners. Wanted to follow up on that, is if you look at your bookings and how you measure customer success, how important have partners been in that journey the last couple of years and does that impact change at all with how your kind of product sales mix is shifting a little bit?
T he partner approach has been more, I'd say we have some great partners, but it's been more transactional and on the sales side, as opposed to having, like, these robust channels of partners doing everything for you and that is one area that we actually do have upside that we are trying to inject a whole different level of maturity about how we approach the partners. H istorically, we've been kind of a shotgun approach and transactional meaning like we'll engage with any partner if they're kind of bringing us a lead or a deal and we're trying to shift that to be, "Hey, let's start having some really successful large partners by geo, a couple of them and doubling down on them," but then also doubling down on some broader like channel partner kind of things.
T hat' s gonna take some time, but we are very much focused on it and it's just another work stream within the company.
Excellent.