All right, I guess we can get started. Excellent. Thanks everyone for joining us today. For those that don't know me, my name is Scott Berg. I lead our SaaS and enterprise software research here at Needham. Today with us we have Freshworks. I don't even have to read your name from my list here. Inside baseball, I always put names on the questions just 'cause when you're running from stuff you don't wanna have the mind blank. Today with us we have the company CFO, Tyler Sloat. Thanks so much for joining us. Those that probably know, I think you and I go back now 13 or 14+ years probably.
Yeah, at least.
That's why I definitely don't need the name, but that's all right. Well, why don't you give an overview of Freshworks for the few people that might not-
Yeah sure.
be familiar with it.
Well presumably everybody knows who we are, but yes. Freshworks. We're really, we've had a little bit of a pivot over, I'd call the last couple of years. We are an AI-enabled, unified service operations, platform software company. What does that mean? Our main product is an EX offering selling into CIOs that really now spans across multiple functions with our ESM offerings. Allowing every single kind of employee to be more productive in their jobs.
And that is Freshservice and what we often refer to as EX. It's a $540 million product growing at mid-20 digit growth rates. And just doing incredibly well right now, with some acceleration in growth this past quarter. We also have a CX offering, which is our Freshdesk product, which is a $390 million desk offering customer support. I really focused on kind of that mid-market to high SMB customer base. Really ranging from kind of like 50-500 employee businesses. That one is growing at kind of low single digits is what we talked about. A very profitable business for us.
Okay. Pardon me, let's go to product and start on the EX side of the business. You mentioned organic growth rate above 20%. It's accelerated 25% in the last quarter, constant currency terms. I guess what's improving with this segment? Because it's at scale, $540 million of ARR that you talked about. We don't see a lot of businesses at $500 million actually accelerating. What's going well there? Is it moving into other segments? Is it just resonating well? Is it moving larger customers? It's probably a combination of all that, but if you kind of look back at the last 12 months, you know, why is it a better business today than 12 months ago?
EX to me is kind of a combination of three different things that's happening. The first is, starts with product and product depth. We now have the capability to go in and service an enterprise organization. We're really not focused on super large enterprises, let's call it kind of the low-end enterprise. Up to 20,000 employee organizations. Number one, get them implemented really quickly. Number two, have a very intuitive and easy to use product. Three, most importantly, have the depth of product in there that they need.
That depth is not just on core ticketing and workflow, which is our Freshservice, but now with the offerings, the adjacencies starting with ITAM, IT Asset Management. Really a requirement to go service a large enterprise company, they have to have that.
We bought a company Device42 two years ago. We've now kind of rewritten the entire CMDB within Freshservice, and now can go offer that capability to our customer base. Which really gives us the right to go engage and offer an enterprise what they need. First is product depth. Second is an enterprise sales motion, that you can have the product but if you don't know how to engage or even get in, you're not gonna be able to sell it. This is something we've been building out for the last couple years, where it really put a lot of the pieces in place last year and now you're starting to see the fruits of that labor.
For us to be able to go in, have the brand recognition, have the relationship with the CIO, but also be able to go close a deal. We talked about in Q1 how we closed the two biggest deals that we have, you know, in company history on the EX side.
I don't think that's gonna be an anomaly. I think you're just gonna start to see a repeated pattern that we're starting to engage with larger organizations. The third thing on EX is really the breadth of portfolio. The depth of the product offering and the enterprise capabilities on feature functionality, but now the breadth. It's a really a four pillar strategy anchored with Freshservice. We move to ESM, which is a capability to go serve other functions, primarily HR. Third is ITAM, where we announced the launch of our cloud offering on advanced ITAM. The initial one, where it's gonna be three releases and the last will be at the end of the summer to get fully featured with our on-prem product.
Lastly, ITOM, which is a company that, FireHydrant, that we bought at the beginning of the year. We haven't announced when that fully integrated product will be. Hopefully by the end of the year. That is going to be incident response and allow us to go kind of, start to go play in the periphery more with the technical operations side of the house of IT. That breadth allows us to grow across EX as well. It's really the three things that's allowing us to go play in that space and really be the leader in that kind of low enterprise market.
Okay. Staying on the theme around ESM, 'cause you mentioned it. At your Analyst Day last fall, I believe you laid out a target for $100 million worth of ARR coming from ESM as a, as a category. Why is that such a natural expansion sell for those customers? You know, today and there's a large competitor of yours that's had success with that. It's been pretty natural. You guys are pretty jazzed and pretty certain you can make that ARR target.
Yeah. Two years ago we spent about, you know, a year rearchitecting the product to allow for seamless, kind of expansion across other functions all on the same platform. Today we can go sell into HR, which tends to be the closest adjacency. Really, they're using Freshservice, but they're using a workspace within Freshservice dedicated to HR that now has security parameters and things like that that allows for one common platform use across other functions. What you're gonna see. It's doing really, really well, because it has all the capabilities that as a shell from what a function needs. What you're gonna see is us adding depth to that.
For example, on Thursday we have our Refresh event, which is our user conference that's really 100% dedicated to EX, and we're gonna be announcing some new products there. One of them is EX AI Agent Studio. Within EX AI Agent Studio is gonna come pre-built with a bunch of integrations, one of them say to Workday. That's your HRMS. 'Cause onboarding and off-boarding is one of the biggest use cases for HR in terms of workflow, but it's tightly aligned with the IT needs as well. Imagine issuing computer or access control and things like that. That's just one example of how the adjacency is selling into another function and makes it really seamless when you're talking about the same product and just being able to add a user onto that product.
It's no it won't start stop with HR though. It's gonna be, you know, typically finance functions like procurement, like workplace resources, like finance, anything, or payroll, anything that has some type of ticketing and a workflow where you have an employee need that comes in and then it needs to be kind of routed to the right parties. It's just a natural expansion. I think we've just started.
Well, I'll be there Thursday. Looking forward to also seeing the product there. You mentioned the acquisition of FireHydrant. If I dial the calendar back to when you acquired Device42, you thought that was super important on the competitive nature 'cause other competitors had that IT, ITAM functionality, right? This was gonna help your win rates, especially as you move up market a little bit. With FireHydrant, does that have the same kind of strategic rationale that it should help your win rates 'cause you have some competitors that might have that functionality today?
Yeah, absolutely. It's, it's a little bit on the adjacency because the buyer for incident response is oftentimes your tech ops buyer, not your CIO buyer, which is somebody who's running the service, so if you're offering, say, a cloud service of some sort. It is an adjacency that flows right into incident management, which then is run by the IT org, but then whether it's fixing, say, an asset management. Having Device42 is really important, having asset management with incident response because oftentimes, the incidents are related to something that's going down on the asset side. FireHydrant is gonna be able to expand out not just on incident response, but also will get us into other adjacencies in the future like AIOps and security ops.
Which is areas that we have not grown into. I don't think it's quite the same as Device42 where it was a required element to just land on the IT side, where we weren't able to go engage with enterprise customers without advanced ITAM, and now we are. This is more of an adjacency that's on the side.
Okay. Moving to the CX side just a little bit, how do I say this in the nicest way? Public investors kind of hate the customer service environment right now, as you know, right? It's not just you, it's other companies that I cover and they're at least that segment. You know, they were just worried about massive amounts of AI disruption and seat displacement, et cetera. You've had some nice traction with Freddy AI. Just like some other vendors in the space that I think investors ultimately will have wrong, I think they'll have the story wrong about what you guys are doing there. What are you seeing from customers around their adoption of Freddy AI relative to the spend that they might have had historically in CX?
Has that been a 1 + 1 actually equals better than 2, or are they consuming Freddy at a rate that they're maybe displacing your CX business? Trying to understand if it's just an offset or that's actually a positive?
Yeah, I wouldn't consider it a displacement. If you think about our Freddy products, you have an agent on the front end, which is really priced as a usage component, which is sessions, session packs. You have a Copilot, which is an add-on to an agent, which helps them be much more productive in their jobs. You have an insights product, which is really about the managers being able to look at their business, specifically agents and how are they doing. The attach rates for Freddy Copilot in particular are really, really strong, and they are that was an 80% grower across the entire company on Copilot growth, in terms of the customer numbers on Copilot.
The actual penetration into the existing install base, it's kind of an anomaly 'cause you have a ton of customers who still aren't you know, they're hesitant to adopt AI. That's really the upside opportunity. For new customers though, it's really clear that it's table stakes at this point.
You have to have great AI capabilities if you wanna win business. That's the way we're selling the product, right? That's why the attach rates on new business, specifically larger deals, are really strong and really high. Over time, you're just gonna continue to see more of that, table stakes needed to be able to go compete. We feel that we're at the forefront of it, and we're you know, innovating like crazy on the AI side. The reality is specifically in CX, there's a ton of disruption. It's becoming a fragmented space. For us, we're being very, very prudent about it. We've re-platformed our entire product. It took us a year to get re-platform the product onto really one new product, which is Freshdesk. That has two editions, Freshdesk and Freshdesk Omni.
We're 80% through migrating all of our customers. They're on effectively five different products in the CX space, migrating them onto the new product. All new customers are signing up for the new product. Will take us probably to the end of the year to get the remaining 20% of our customers, which tend to be the largest customers with the most complexity, onto the new Freshdesk product line. Once we get there, we are have refocused our entire go-to-market motion for CX to be very, very focused on what we are calling kind of the high end of SMB, kind of low end of commercial. Let's kind of call it a 50- 500 employee organization, which that ideal customer profile, we view that we have the right to win.
We're already seeing it because ARPAs are over 2x higher for new businesses that are signing up than historically they have been. We're gonna focus our go-to-market efforts there. We're gonna get our product organization to be much leaner, much more focused. We're gonna run that business incredibly profitably. That's our goal for now.
In ARPA, that's 2x higher. That's a pretty big delta.
For new customers.
For new customers, yeah. That means the expansion opportunity, even if they get rid of some seats on the human side, could be pretty powerful over a period of time.
Yeah, absolutely. I think everything will play out on when we talk about AI capabilities, 'cause yes, a lot of it will move to some type of consumption, or resolution-based pricing that's gonna have some variable pricing to it. We have been pretty pragmatic and conservative on our iterations on pricing and packaging. We've seen a lot of our competitors come out with new AI pricing, like, every six months. I think that can be incredibly confusing for a customer. We've wanted to be kind of innovators on the product side, not necessarily innovators on the pricing side. We also want, whatever we're thinking about pricing by, we wanna put up, like, measurements internally, kind of track it, and then come out with stuff.
Even EX AI Agent Studio, which we'll announce on Thursday, we're gonna announce the pricing, but we're actually not gonna charge for it till October. We just want adoption. We want usage and w ith predictability for our customers to, over time, have predictability, 'cause that's really, really important, that you can't put something else out that's not gonna be predictable.
Yep. In the last quarter, the CX segment grew 4%, constant currency terms, relative to 5%, I believe it was in Q4, and I think it was 7% in Q3, if I got my numbers right off the top of my head. What should be the kind of more durable growth rate of that? Obviously, you're going through a transition. The platform's probably gonna help that. Like you said, existing customers are certainly gonna adopt these things. Is the current growth rate the way that investors should think about that segment, I don't know, for the next couple quarters, couple years, or do you have some opportunity to improve that, do you think?
I think we're being very prudent with our external expectations. We actually said on the call last week, low single-digit growth for CX expectation for the remainder of the year. We have to get through this migration. We have to see what happens there. I'm cautiously optimistic internally.
You know, do we think we can bring it back to some growth? We do, but we're not modeling that in, and we actually don't think it's healthy for anybody to model that in until it actually starts happening. We're gonna be very focused on it, and we also are gonna run it very profitably, where we think we can get this to kind of a really, really good operating margin and have a great contribution from a cash flow perspective to the business. I think we have to prove it out first.
Okay. I know on the call you also talked about not being aggressive in some of the expansion opportunities there until those customers are migrated, which totally makes sense. Why get aggressive on something, then have to change them and basically re-implement or redo whatever, you know, needs to be done is. Do you have expectations on the go-to-market side that you will become more aggressive once the new platform is in the hands of all those customers?
On the go-to-market side, I think what we're gonna see is, number one, we're gonna have a very focused go-to-market that's gonna be inbound only, and really playing against a very tight ICP. That means we're gonna have customers that come in that are gonna be outside of that ICP, and we'll absolutely still serve them, but we're gonna be very disciplined on what we say we're gonna deliver from a future functionality perspective.
The same time, you're gonna have a very focused product and engineering team that is gonna be able to iterate a lot faster. They've been building across five different products. They're gonna have one platform on the CX side that they're gonna be able to go iterate on. I think, both of those teams are gonna be very incredibly focused and just gonna be, you know, kind of back to our roots a little bit there. That theoretically could absolutely lead to growth. Like, we will lean in if we think we can grow faster there, but we're gonna be very prescriptive on what we do initially, until we kind of prove it out.
Okay. The company just announced a 11% RIF as well, reduction in workforce. Common question I'll get from that, it just happened with another company in the quarter is, how do you avoid some of the pitfalls around sales execution kind of waning in the short- term or having disruptions around that to still make the quarters and still drive the growth rate that you all are talking about? As you think about the second and third quarter, just how do you put a wrapper around that so you maybe avoid that?
Yeah. A lot of our reorganization that we just announced last week was driven around go-to-market changes. A lot of those changes are really around our focus on EX being, you know, really 100% field-based. 100% of our field is now EX-focused. A lot of our, you know, marketing priorities and outbound and all of that brand awareness is gonna be EX-focused. Then, like, a lot of discipline around the CX focus. So as we went through all that, okay, yes, there's gonna be organizational changes that happen as a result. Then we're really doing that kind of across the company where, you know, we then went to product and engineering. There's gonna be a lot of focus there.
On the field side, on the EX opportunity, it actually is, like, if anything, we're gonna be spending more. So it's not about what disruption would happen to the field. It's actually gonna be kind of potentially the opposite, right? We want to grow that field motion and the capabilities and the quota capacity and everything else to be able to go service what we view as a huge opportunity on the EX side. I think you're gonna see that over the coming quarters. It, you know, as you perform, we're gonna absolutely lean in to grow faster.
Yep. You might not remember this was at your prior company's customer conference. You held a day after the conference for finance executives, and you were talking about the SaaS business model. For those that don't know Tyler, he is very, very focused on the different metrics within the model, which I was impressed that day 'cause you taught me a couple things that I hadn't considered before, so I thought that was great. The next question revolves around some of the metrics of the SaaS business like, well, you know, LTV to CAC and how you think about profitability at different segments. You're generally trying to move up market to a higher quality customer in general, in both segments, right?
We're seeing on the EX side, kind of talked about on the CX side, high end of the SMB to maybe the, you know, mid-enterprise or so. How much better are those metrics for the business over the long- term if you can successfully sell into those as you.
Yeah. I think about a couple things. I think about, okay, what's your cost to acquire? What's your cost to serve, and then what's your capability to grow? If we look at the changes we've been making when we announced kind of our strategy shift two years ago, this is when Dennis became CEO, and that we were gonna prioritize EX. A lot of it, number one, started with what's a TAM opportunity on EX, which is massive. In the area that we're serving, it's an underserved population. The capability to actually go start is huge. Second, EX is an incredibly profitable business to run. It's really, really efficient and the gross margin capabilities for EX is actually much better than CX.
It comes third, the capability to grow once we're on EX, we now have the, you know, a common platform that we now have a four-pillar strategy. Once we land, and the four pillars doesn't even include AI. It, you know, we start Freshservice, ESM, ITOM, ITAM. Our capability to grow once we land even AI on top of it is significant, and it's actually just gonna continue as we continue to broaden that strategy. Across all of those different things, everything makes sense. The LTV to CAC and our capability to bring in a customer efficiently is really, really good. The risk area is around building out your field motion.
It is more costly to acquire initially if you have a more expensive field motion. That's something that we've been pretty, like, prudent about, okay, disciplined about how you spend. The reality is some of our spend has been diluted across EX and CX, even on the outbound side. A lot of the changes we made will really get very focused on EX and make sure every dollar that we're spending is gonna have the highest return possible. When we look at all that, I still think we have some work to do, but we're actually pretty proud of how we've, what we've done as a company specifically to the bottom line and our efficiency metrics, right?
Even for this year, to be able to go from a point where we were burning cash, you know, just a couple years ago to now, you know, mid-20s cash flow margin and, you know, just raised from $250 million to $265 million on free cash flow for this year, I'm really proud of what we've been able to accomplish. I think you're just gonna see us continue to run a very efficient business while we try to accelerate growth.
Last time I checked, that doesn't happen very frequently in my space.
Yeah.
Very much looking forward to that. You touched on this a little bit earlier around the differentiation of the product. Easy to use. You know, we've had a bunch of customer checks that we've published in the past, and easy use of the platform always comes up. Doesn't matter if it's on the CX side or the EX. I remember the last customer checks we published, there was one on an EX competitor, took them eight to nine months to implement. They moved to you, they were fully implemented in three or four weeks in what they thought was a much better, you know, technology. That, that's been something that's resonated, you know, ever since the first time I chatted with G about the opportunity there.
How do you maintain that ease of use as the platform does expand and add a lot more complexity into it? I think it's super simple when you're a, you know, single product company or maybe a couple product company. On the EX side specifically, you've got four, five, six large modules there. Can you maintain that effectively?
I think that's one of the things that, like, is number one, super attractive about why I joined, Freshworks, that, you know, it I've never seen a company that starts selling to big enterprise and then successfully moves down. If you build for the SMB, keep that in your DNA, which building for the SMB means you have to have a great user experience, you have to have very, very easy onboarding, and have a product that is seamless in terms of all of its capabilities. You add feature functionality that then makes you relevant to an enterprise at some point. I think Freshservice is a great example of that. Now, what are the nuances?
I described on ESM, it took us a year to kind of re-architect the product to make it applicable to ESM. I think about it, we essentially had to move the whole database layer down so that you could add a workspace that had security parameters, but be all on one platform.
It just took us two years to do this for Device42, right? That is like, well, you bought Device42 two years ago. Why do you take two years to get a cloud version of it? We essentially just rewrote the entire CMDB in Freshservice over the last two years. You do it very purposefully, so now you have one platform now that has a cloud offering that you can just turn on, right? FireHydrant shouldn't be that complex when we do it. The discipline as opposed to just kind of bolting on a new solution on the side that makes it look like, you know, oh, you have everything, but when you go into a user, they have very different user experiences 'cause they're essentially having to have, like, a different admin portal or a different, you know, UI because it's really a bolt-on product.
That's what we've been trying to avoid. I think we made maybe some of those missteps on the CX side. That's why I say we have, like, essentially five different products there. On the EX side, it very disciplined approach with one platform that's a unified platform that's allowed us just turn on capabilities when we've done it right. That's why there's so much power in that product.
Okay. The partner sales motion is also becoming, I think, more critical, especially on the EX side of the business today. The partners we've spoken with certainly will talk about that. How critical are they to the business going forward now as you've added that complexity to the platform and as you try to move upmarket even more?
I think the partner motion, I'd still say we're not great at it, but I think it has a ton of upside. We've announced a couple of GSI relationships which are really, like, on the smaller GSI side. It's a little bit complex because for a lot of the big GSIs, they rely on deep heavy implementations to make their money, and our product isn't like that. You already mentioned that we can go into a big enterprise and, you know, get them live really quickly. For a partner, it has to be some type of business transformation or a full stack offering if they're gonna make money on implementation. How do we like, what are we doing instead?
Well, we work with a lot of regional partners, and it's everything from lead flow all the way through to full stack offerings, specifically in, say, non-English-speaking countries where the partners can lead and even provide support offerings or add on other services on top of, say, Freshservice. It's gonna become more and more important. We have to get a little bit more sophisticated about how we approach it. We're working on it. I think that we're doing that in parallel as we build out an enterprise sales motion. You did, you know, see us two years ago say we're actually going to refocus outside of a lot of those geographies and really get focused on some geographies that matter to us, which is really Americas, Europe, and certain parts of Asia.
We're still doing that because the TAM opportunity is huge, and we have everything we need to grow at much faster than we're growing now just by servicing that. Over time, you're gonna see us get a lot more sophistication on the partner side.
Okay. We have the CFO with us, which means I have to ask you at least a couple financial questions.
Sure.
Right? With the change in workforce that you recently announced, you've also talked about high 20s operating margin in fiscal 2027 or exiting fiscal 2027 I should clarify at least. Is confidence level that you can drive, you know, that target, you know, where should we expect to see that leverage come out of? My guess is it's semi-broad-based in the organization, but is there an area, too, that might get a little bit more focus than maybe we can see on the surface?
Yeah, I think we're getting, like, more focus across every single function. The organizational change we made last week actually impacted every single function. We are a little bit different than maybe a lot of our, you know, companies out there that are announcing, you know, reorgs or whatnot. It started with the EX/CX focus, we looked at the org and, you know, maybe because of our roots in India, we've tended to solve problems by hiring people as opposed to truly solving the problems on infrastructure and systems and the right people. We've been making those changes over the last couple years, we've invested a ton on infrastructure.
Now we get to see the fruits of that labor, and a lot of it was, like, in areas that we had built up manual processes that we don't need to have anymore. I think going forward we're just gonna see, you're gonna see the same rigor on efficiencies on how we run the business. Yes, the internal use of AI is changing things for every company if they kind of make it a priority, which we are. We're gonna continue to do that. I do have a lot of confidence on our capability to run a very efficient business while also trying to fuel growth, and that is a dynamic that it's sometimes hard to manage.
We are gonna absolutely optimize for the growth side, and we'd be very open about it in terms of disclosure and everything else if anything would change on the profit side because we would be spending more for growth. We'd only be doing it if we think we could really grow a lot faster.
On the faster growth side from your Analyst Day, you had set out targets to accelerate your organic growth rate this year by, we'll call it a point. Same thing next year in 2027, right? My guess is some of the AI functionality that you have released since then or will continue will be a partial driver to all that. A key question I've been getting a lot over the last quarter or two is around gross margin degradation.
As companies like Freshworks can, you know, they sell more and have their customers use more of the AI functionality, will we see some, you know, degradation around gross margins? 'Cause they might not be able to recapture from a pricing side enough. How do you think about that within your model with around that use? We're not seeing it yet in the model, but is there an opportunity for that to maybe happen?
We're not seeing it yet in the model. Like, we're mid-80s gross margin, which for a company of our size I think is, quite frankly, exceptional, and every single quarter I caution, "Hey, don't expect this. In fact, you're gonna see some, a little bit of variance there." Yeah, we haven't really seen it yet even though, Freddy adoption is increasing, significantly. I think I would expect, both from internal use as well as the product use that, yeah, token costs will come up. But so far we've been able to absorb it through other savings in other areas, and just by running the company efficiently. I think over time the token costs are gonna look a lot like a, your cloud service providers.
I think though over time as long as there can be a couple of different vendors, that it'll become a little bit more commoditized and you'll be able to switch. We have built a product so that we can switch between LLMs and then even use lower cost models for certain things as opposed to everything paying the most higher cost model which runs costs up. You wanna see as much AI usage as possible.
We're trying to drive for that and drive for adoption. We try to model out what the impact of that will be, and it's something we constantly monitor. I think you're gonna see maybe margin degradation for companies, but they're gonna become much more efficient as maybe some other line items so that the overall operating margin stays the same or better.
Okay. With that, happy to open it to the audience for any questions if there are any. We got about four or five minutes. Well, with that, we'll give everyone four or five minutes left.
Awesome.
Tyler-
Scott, thanks for having me on.
Thanks so much for the time. Thanks everyone for joining us.