Good morning, everyone. Thank you again for joining us. My name is Luv Sodha. I'm part of the software equity research team here at Jefferies, and we're super lucky to have Tyler Sloat join us. Tyler is the CFO at Freshworks. We've had a long relationship going back to the Zuora days, but Tyler joined Freshworks back in 2020, and he's led the company ever since. So maybe just to kick it off at a high level, Tyler, if you could just talk about the Freshworks story, where things stand right now, and how things are shaping up for the, you know, for the rest of the year.
Okay, awesome. Well, first of all, thanks for having us, Luv. Best-named analyst in Wall Street, Luv Sodha. Freshworks, so I joined, as Luv just mentioned, I've been with the company for a little over four years, actually. You know, started talking to G almost five years ago. Freshworks started as Freshdesk, a customer support software. Really started with the thought that, you know, SaaS had kind of broken its promise, that SaaS was... You know, the idea of SaaS is just to be software made for the end user, really easy to use, onboard, at affordable prices. So our founder, Girish, referred to as G, started Freshdesk and built it purpose-built for that, and really started with selling to the SMB out of India.
So we're a U.S. company that was kind of founded out of India, which really, with those roots, you know, allowed us with, we have highly, high access to highly technical talent at efficient rates, but also, all of our functions are built out of India, which has allowed us to be really operationally efficient everywhere, which also allowed us to kinda go attack global SMB, which is really, really hard to go do. Freshdesk evolved, had you know, success in early days. Started to see customers using our Freshdesk product for internal IT use. And said, "Hey, you actually, that's great. The ticketing is pretty similar, but you actually need a purpose-built IT solution," and so we built Freshservice.
Freshservice is now, you know, about half of our ARR, and we say has been the largest contributor to ARR growth for a while now. Along the way, we also started Freshsales and Freshmarketer that, you know, we refer to as kind of our, our CRM product, which is our third kind of product base. All of our products are built with the same, you know, thought, to build them for the end user, build them for the actual, say, agent or anybody else who's gonna be in there, which has a common DNA to it, which I already mentioned. That, you know, has to be really easy to onboard, really fast ROI, has to be efficiently priced with a great user experience.
As we've stayed true to that DNA and added feature functionality over time, we've then, you know, been pulled into larger and larger deals. So we've kind of moved away from, you know, just selling to the SMB, but now are very relevant to kind of mid-market, low enterprise, specifically for our Freshservice product, which never really had a huge SMB base because customers don't, you know, SMB customers don't need an IT solution. But really, was selling to the high end of SMB into the mid-market, and now getting pulled into kind of lower enterprise and really competing now with kind of ServiceNow's commercial team. That Freshservice product, you know, we continue to lean in on.
We just announced our first acquisition since we went public, which is Device42, which is really an ITAM solution, IT asset management, and kind of both SaaS and physical, that had been something we had kind of on the light end, but something we knew was a gap competing in that lower enterprise that we think is gonna round out this solution. We've been reselling Device42, actually, for over a year, so we know it works with our product, and we know that we can compete with it, so we're very excited about that. And we're gonna continue to lean into Freshservice. CX in general, our CX is our kind of support product.
That, you know, has seen what I would say, pressures over the last couple of years, specifically on expansion rates, where expansion rates were incredibly predictable for years. And we've said that, "Hey, expansion rates have been coming down for the last two years." Kinda driven, I think, from a lot of disruption in the market, perhaps, but also just in kind of macro, that companies, you know, coming out of COVID, just weren't hiring as much. At the same time, I think that whole market is gonna... is kind of being turned a little bit in terms of AI. We were ahead of this. We always had kind of some AI products. We've always had this. Our, our AI is called Freddy, and you can go back for years, you know, even during the IPO, we talked about Freddy.
But that really has been supersized over the last year, and we came out with what we said are gonna be our main, you know, Freddy products, kind of utilizing the latest and greatest. That's Freddy Copilot, Freddy Self-Service, and Freddy Insights. Freddy Self-Service, which is relevant across, you know, kind of both of our product lines, but a lot of it is CX, is about ticket deflection, on the inbound without human intervention, and it's really through bots that that's gonna be utilized. And then Freddy Copilot is about, hey, make your agents more productive once stuff does come in, and you know, enable them to do their jobs better. Those two products are being sold today. Freddy Insights is gonna be about, hey, the management layer.
At the corporate level, how do you actually manage and look across all of your agent population to be able to make really good decisions? And so we do think that, you know, kind of the future is gonna be around that. We have been selling Freddy Copilot went GA in Q1, and kind of at the end of Q1, we actually had decent amount of bookings there, but nothing super material, and we said we'd hopefully talk about that at the end of Q2. Freddy Self-Service has been out there, but that's one that you gotta, you know, sell, then company's gotta build bots, then they actually have to start to see that bot deflection, then they have to buy more packs of bots, so that'll take some time as it rolls through. So that's the high-level summary.
That's awesome. That's, that's pretty comprehensive. Maybe just to touch on, you know, you mentioned in Q1 that, you know, one of the topics was Dennis taking over as CEO. You know, and it sounds like the transition was in the works for some time, but, you know, just talk about at a high level, what changes Dennis might be planning to make, and how does that change the execution internally?
Yeah, sure. So we announced, you know, really two things at our last earnings. The first one was the Device42 that I just mentioned, which was the acquisition. The second was that G, our co-founder, is stepping aside from as CEO, and he's becoming Executive Chairman. We had hired Dennis Woodside, 18 months ago, a little bit over that now, as our president at the time. But we also put him on the board, and we're pretty clear that when he joined, the entire management team reported to both of them. They were two in a box. And so internally, from an operational day-to-day perspective, it wasn't that dramatic. I got a lot of questions about why now? And maybe we could have done a better job of messaging it, right?
Saying, "Hey, in this period of time..." But internally, we said, "Okay, this is pretty natural." One of the natural things it was really twofold. One, G, he really just wants to focus on products, and he wants to focus on product vision, product execution, and actually culture of the company. And that's what he's gonna be doing. And, you know, a part of that is also spending a lot more time in India. And it also frees up his time from things like this, which he doesn't really relish. The second thing is that, you know, Dennis came on board, and a lot of it, you know, from an execution operations perspective, is really making sure we had the right people in the right places, really reshaped a lot of the management team.
The last piece of that, from the management team perspective, was adding Abe, as our Chief Field Officer. Abe started at the kind of middle to end of Q1. Before that, we had hired Mika as our Chief Customer and Marketing Officer. She started in Q4. And that was really a recognition, those last two pieces of, "Hey, we have two different businesses as the company has evolved." We've got this SMB kinda inbound business that feeds the SMB, and the commercial 100%, and then, you know, falls over a little bit to the enterprise, and mid-market. That's really what we started with, and that's what we've always had, but we also now have this field motion that we need to actually, you know, mature and get much better at. And that's driving a lot of... most of our growth.
And so we kind of, you know, split up the go-to-market, hired Mika, hired Abe. That was kinda last piece. So I think once that was done, G said, "Okay, now I can move to product, and Dennis, you can take over.
Got it. That's perfect. We saw this across a bunch of companies that we cover. It seems like in Q1, at least the macro pressures, especially as it relates to SMBs, sort of got more challenging. You know, you obviously called that out as well. Could you just talk, you know, at a high level, you know, what drove this incremental weakness, if you will? And are you seeing any of that change so far?
Yeah. What, what's interesting for us, it wasn't incremental, right? I mean, we've been talking about pressures in kind of SMB in general, but also in CX, which is kind of synonymous with SMB, or SMB is synonymous with CX, if that makes sense. Meaning that, you know, our CX products or our support products sell from kind of the lowest end all the way up. And our largest customers are CX, but, you know, the majority of our SMB is CX. And so when we talk about those pressures, they kinda go together a little bit. Nothing was incremental in Q1. What we said is those pressures persisted, right? And when we look at Q1, Q1 for CX and SMB, and we look at what happened, it's like, well, we actually had a decent quarter.
It wasn't horrible, but if those pressures persist and they actually continue on this trend, we think for the year, we've got to make some adjustments. The other thing that happened is that Q4 was actually really strong. And for CX in particular, Q4 was actually a really pretty good expansion quarter. But in hindsight, a lot of that expansion was driven by early renewals with expansion and some of that coming out of Q1.
That's one that's not super predictable for us, and so when we came to Q1, we didn't have the same levels of early renewals that what we saw in Q4, which is also kind of more of a testament that we're moving more to a mid-market enterprise kind of field motion, and this is just more natural behaviors as opposed to more of a normal cadence of month to month in the SMB space. And so when we looked at that, I was like: Okay, let's adjust the year based on what we think might happen, and we thought it'd be prudent.
Got it. As you look at maybe the rest of the year, you know, wanted to dig in more on the CX side of the business. Is there any of this, you know, weakness that you're seeing in that business, especially as it relates to the retention rates, if you will? Is that tied to AI at all? And are we seeing any impact, at least of the customers that you do serve, is there any impact on agent count at, any of the customers that you...
Yeah. So I think the question is, "Hey, have you actually seen examples where AI is actually reducing agent counts, right?" And the answer is no. No, I've not seen that. I don't know of a customer that has reduced because, say, Freddy has come in or they're doing something else. That doesn't mean it hasn't happened, but I don't know of any specifically. I think the interesting thing about CX for us is that we've been talking about expansion decline, expansion rates coming down for two years now, and that's well before any other AI influence. And so, I think a lot of that is macro, meaning that the rates were so high going into COVID, and then companies just hired like crazy, and then a lot of them adjusted coming out.
And then there's just a lot of market disruption in that space. What we did see, even before generative AI, is that there was a lot of, say, bot players that came out and specific comp, you know, companies just focused on pieces of your entire CX journey. And some of them got to, you know, $100 million-$200 million in ARR. We know them pretty well. That I think they're all in a lot of trouble now, and because, you know, the kind of, the playing field's been leveled for everybody, and, and you don't really need their technology anymore. And so there's just a lot of shake-up in that industry. We feel that we're really well positioned because we do have a full omnichannel solution, really backed by what we think is gonna be very powerful AI.
We just need to make sure that we get that, even what we have today, into our customers' hands and getting them using it.
Got it. And over, let's say, more asking a more longer-term question, but like two to three years from today, how—you know, still sticking with the CX business, how, how do you view the growth profile of that business? Could it sustain what it's growing at today? And do you see AI potentially... Like, the total ARR that you're generating from these customers, do you see that growing even though agent counts might go down, vis-à-vis other ways to monetize that?
Yeah. So in September, we had an Investor Day, and we kind of put out projections for 2026, and we also said, "Okay, when we get there, this is what we're gonna look like." And we kind of painted out the growth rates, with the assumed CAGR of some of our products, in that, and in there, we said CX is gonna be a high single-digit grower, which is not super exciting, especially compared to Freshservice, which is, you know, kind of a mid-thirties growth. When we put out those numbers, we built that based on what we saw today and then kind of trend lines on where they're going. So it actually presumes that growth rates are actually gonna continue to decrease a little bit.
Do we think that Freddy can actually reverse that trend? We got this question this morning. Yeah, I do think it could, because in two ways. One, not just how we can increase ARPAs by attaching Freddy Copilot, Freddy Self-Service, and eventually Freddy Insights into all of our customer base, but I do think that this is gonna be something that actually just helps us win better. And it, over time, we'll see how pricing for all these AI components go, on whether it's not-- you know, whether it's kind of included, as table stakes in terms of you have to have these capabilities to even compete.
Mm-hmm.
Right? And I think that actually will be something that happens. So then, do you have to build pricing into higher editions and things like that? That could happen. I mean, everybody will have to watch costs over time and see how that happens. But I do think that you're not gonna be able to compete for deals unless you have these capabilities.
Got it. Focusing in on the three SKUs that you have for Freddy, so you have the Self-Service, you have the Copilot, both of which are GA now. The Copilot, you know, $29 per agent per month. Just talk about, you know, the adoption you're seeing there, and I mean, we, you know, we can do the math and see, like, it's a pretty sizable uplift in terms of the spend for a customer. So what, what are you realizing in terms of that uplift, if you will?
Yeah, I think it's pretty, pretty new still. So we actually had decent Freddy Copilot bookings in Q1. We said after Q2, hopefully, we can come out with some metrics on how it's going. Even then, it wasn't like it was super material, and I think the challenge for us is really going into our customer base and making sure they understand all the capabilities. I was sitting... You know, we had a customer advisory board, I guess three or four weeks ago in London, brought in a bunch of our customers from Asia and Europe. And at my table, I said, "You know, these are some of their, our biggest customers and huge users, and they, they love us." Asked: Hey, who... And we'd just done, like, an AI, you know, presentation.
I said, "Hey, before we talk about who's using it, right now," and only, like, one out of eight raised their hands. And I'm like, "Why?" And it's like: "Well, it's just, it's hard to go train the agents. We got to figure out, you know, how, you know, how to retrain them." And, and these are people, customers with pretty big agent populations. All it tells me is, okay, we're not really good at enablement yet because the technology is there, yet the ones who stood up and said they are using it, they said it's fantastic. And I think, you know, as we onboard, we need to make sure that every single customer is just part of the onboarding.
This is just part of it, and that you do that initial agent training there, and then we actually have to build this muscle and get a little bit better at it, which is more an enterprise customer engagement model to go in and teach our customers how to use. 'Cause there is things you have to go enable at the agent level to go do things. That I think is gonna be really, really powerful, and it's gonna change the way all of our agents, you know, kinda do their jobs. And that, you know, that $29, we'll see how it goes along because that's a list price, and you know, we presume that there's gonna be discounts against it on big enterprise deals. But we do think it actually could be, you know, a material thing over time.
Self-service is a little bit different. We sell Freddy Self-Service, but we actually don't, you don't monetize self-service in a product itself. You monetize it through bot usage. And there's actually still a hurdle for bot usage today, which is building the bots. 'Cause once you build the bots, then all the capabilities are behind it, but that building is still somewhat of a hurdle today. So we're actually looking at going in and for our non-technical customers, doing some of that work for them. And then we will be releasing, which is called, something called Flowless Bots, which is actually, you know, removing that capability, that, the requirement to build, that the bots actually just kind of, generatively build themselves.
That is, you know, something we haven't announced a date on, but it actually is kind of in testing right now. And that will, I think, be another game changer.
Got it. I wanted to ask one on the Freshservice business. Obviously, that part of the business is growing pretty well. You know, last time at Investor Day, you'd said low 40s, and obviously, the CAGR implies a pretty healthy growth rate, north of 30%. I guess, what sort of gives you that confidence that this business could grow well into 2026 at, you know, pretty healthy growth rates?
Yeah, Freshservice has been doing really well, and it's a product that we've been, you know, continuing to lean into. The market dynamics, the competitive dynamics, but the market dynamics for ITSM are just really favorable for us. It's a product that we've been able to innovate really, really quickly on. And then, you know, kind of all of a sudden, not all of a sudden, but over the last two years, have really been recognized as kind of the number one SaaS alternative under ServiceNow. In that space, you have a ton of legacy still, which is kind of BMC, Remedy, Ivanti, Cherwell, and you have kind of players that are, you know, really hitting the SMB and kind of lower mid-market, which is Atlassian and ManageEngine built by Zoho.
In that mid-market, low enterprise space, I think we are deemed as kind of the number one alternative. What has happened as we've continued to kind of innovate is that we just start to get pulled into more and more deals. I got a question in a conference a couple of weeks ago. It was like: "Hey, are your win rates against ServiceNow going up or down?" And I said, "I don't know the exact numbers, but I actually anecdotally think they're going down." And it's, it's actually a good thing. It's just 'cause we're actually seeing them in many more deals. Because, you know, you can go back to look at our roadshow stuff, like, we talked about Freshdesk, and we said, "Hey, we have this second product, Freshservice," you know?
And it's really now we kind of have this first product, Freshservice, and we're getting, you know, really pulled into what, for us, is a larger enterprise, which is a 10,000- to 20,000-person company. For ServiceNow, I think it's their commercial team. And, you know, we're seeing them a lot more now. Doesn't mean we win as much, but we're seeing them a lot more because we're getting many, many more at bats. And I would expect that to continue. It's also the reason why we did the Device42 deal. Really an investment in Freshservice, an investment in that entire space that's gonna make us much more competitive, even in that lower mid-market.
The other thing we have there is Freshservice for Business Teams, which we brought out last year, and I really say, like, what we brought out, I think, is version 1.0, where really, you know, architecturally changed the product to allow us to go engage with teams like HR, teams like finance, to really have, you know, kind of apportioned instances within Freshservice that, you know, there's a security and stuff around, which is one of the hurdles. And then now, we will just continue to start building out the, the workflows, the purpose-built workflows for those, for those functions, and that will start to resonate more and more as well.
Got it. Margins have obviously become more important for you. You know, you have that stated aspiration out there of getting to Rule of 40. Could you just talk about, like, even though you are delivering substantial efficiencies to date, what's the plan going forward, and what are the plans to getting to Rule of 40 vis-à-vis the growth versus profitability mix?
Yeah. I mean, ironically, we were rule of 40 in Q1. It's just that more is coming from free cash flow than from growth and what, you know, long term, what we want. So we said, "Hey, yes, we'll be rule of 40 by 2025, half from growth, half from free cash flow margin." We've always been really efficient as a company. In fact, even, you know, before we went public, you know, we were essentially producing some cash. We invested in infrastructure when we went public. Also, building out the field presence is pretty expensive. But now we've kind of flipped back to producing cash, and we're not gonna move back. We started the year saying we'd produce $110 million, and we raised that to $125 million after Q1.
We're gonna continue to do that. The, the thing, though, is that we're gonna also lean into growth where we can, and where we think we will get a good return. We will spend money to go do that. There's some timing on, operating income, from Q1 to Q2, which I've had questions about, and those are just timing nuances on the quarters, and some spend that got kind of pushed out. But we're really happy about how we're doing efficient- on the efficiency side.
Got it. Is there a question back there? Sure.
Have you experimented at all with changing your pricing model assumption as opposed to seat-based pricing?
So bots are consumption, and so that
Outside of the bot.
On everything else, no. That's, we have some aspects of the products that are, you know, in ... Some add-ons are consumption-based, but the majority is all agent-based still.
In your opinion,
I don't know. I mean, I think that... I think you would have to build your product to be able to measure, like, stuff like workflows and things like that really accurately and to not have debates with your customers. Agents, I think, are very predictable. As a CFO, I actually don't love consumption models too much, specifically ones that get out of control. I think that's what you're seeing with some of the companies that have done, like, a bunch of logging and things like that, where they actually hit some growth hurdles because they get a lot of pushback from their customers, right? And so I think you have to have this really nice mix of predictability but also utility, right? I'm paying for what I get.
And so, I think, you know, bots is the first one that I think is... You know, we've had it out there as consumption for a long time, but we would expect that to increase as a percentage over time.
Perfect. One last one, if I may. Just on the net dollar retention piece, if just at a high level, if you just break down what components sort of drive that, and, you know, what, could potentially to the second quarter be sort of the bottom as it-
Yeah. So coming into the year, we said Q1 will be $106. We hit $106. I think the nuance is last year we said we thought we were gonna hit $105 all year long, and every quarter we said I think we're gonna hit $105. I actually did think we were gonna hit $105 at one point. What's happened is that, you know, there's two sides of the coin, right? Churn, we've actually done really pretty good well on as a company. And when we went public, our churn was in the low 20s, now it's in the solid mid-teens. And that is really kind of a testament to, you know, getting much better to engage with our customers.
The products has gotten much better, but also the mix shift has changed, right? Where Freshservice has great, churn characteristics, and moving to larger customers as well. Freshdesk, actually, at CX, the churn rates have actually come down. We've done a really good job on that. So churn's come down, but we're not gonna get a lot more from churn, specifically as we're selling to the SMB. So maybe a couple hundred basis points over time. So it's really expansion rates where we've been kinda hit, that have really been putting pressure on net dollar retention. We didn't hit 105 last year because we kept doing incremental a little bit better on churn.
And, you know, the $106 we saw that Q1 is kind of what we said we're gonna do, and then for Q2, I said it's gonna be between $105 and $106, because it's literally the numbers I have are rounding right in between. And so we'll see where it ends. And expansion is one thing that's not 100% predictable for us, 'cause it often happens at the end of the quarter. Right now, it's kind of that 105-106 is what we are seeing as a bottom point, but we'll update it obviously at the end of the quarter.
Got it. Perfect. Let's give a big round of applause to Tyler for joining us. Thank you again.