21st Annual Needham Technology, Media & Consumer Conference

All right. I guess we can get started. Excellent. Well, 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 researcher here at Needham. Today with us, we have Freshworks. I don't even have to read your name from my list here. So inside baseball, I always put names on the questions just because when you're running from stuff, you don't want to have the mind blank. But today with us, we have the company's CFO, Tyler Sloat. Thanks so much for joining us. Those that probably don't, I think you and I go back now 13 or 14 years plus one. So that's why I definitely don't need the name. That's all right. Well, why don't you give an overview of Freshworks for the few people that might not be as familiar with it?

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. But we are an AI-enabled, unified service operations platform, software company. So 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 fresh service 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 fresh desk product, which is a $390 million desk offering customer support. I really focused on kind of that mid-market to high S&B customer base, really ranging from like 50 to 500 employee businesses. That one is growing at kind of low single digits, is what we talked about, and a very profitable business for us.

So, 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. So 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, 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 it 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, so up to 20,000 employee organizations. And number one, get them implemented really quickly. Number two, have a very intuitive and easy-to-use product. But 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 fresh service. But now with the offerings, the adjacencies, starting with ITAM, so IT Asset Management, really a requirement to go service a large enterprise company, they have to have that. And we bought a company, Device42, two years ago. We've now kind of rewritten the entire CMDB within fresh service 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. So 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 going to be able to sell it. And this is something we've been building out for the last couple of 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 in company history on the EX side. And I don't think that's going to be an anomaly. I think you're just going to 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 portfolios. So the depth of the product offering and the enterprise capabilities on feature functionality, but now the breadth. So it's really a four-pillar strategy anchored with fresh service. Then 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 going to be three releases, and the last will be at the end of the summer to get fully featured with our on-prem product. And then lastly, ITOM, which is a company, a fire hydrant 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. But 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. So 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, because you mentioned it, at your analyst day last fall, I believe you laid out a target for $100 million worth of AR coming from ESM as a category. Why is that such a natural expansion sale for those customers today? And there's a large competitor of yours that's had success with that. It's been pretty natural. But you guys are pretty jazzed and pretty certain you can make that AR target.

Yeah, two years ago we spent about, you know, a year re-architecting the product to allow for seamless kind of expansion across other functions all on the same platform. And so today we can go sell into HR, which tends to be the closest adjacency. And really they're using fresh service, but they're using a workspace within fresh service 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 going to see, and it's doing really, really well because it has all the capabilities that, as a shell, from what a function needs, what you're going to 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 going to be announcing some new products there. One of them is EX AI Agent Studio. But within EXAI Agent Studio, it's going to come pre-built with a bunch of integrations, one of them, say, to Workday. That's your HRMS. Because onboarding and offboarding is one of the biggest use cases for HR in terms of workflow, but it's tightly aligned with the IT needs as well. So imagine issuing computer or access control and things like that. This is one example of how the adjacency is selling into another function. It makes it really seamless when you're talking about the same product and just being able to add a user onto that product. It won't stop with HR, though. It's going to be typically finance functions like procurement, like workplace resources, like finance, anything, or payroll, anything that has some type of ticketing and workflow. We 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, and I think we've just started. Well, I'll be there Thursday. Looking forward to seeing the product there.

You mentioned the acquisition of Fire Hydrant. if I dial the calendar back to when you acquired device 42 you thought that was super important on a competitive nature because other competitors had that ITAM functionality right and this was going to help your win rates especially as you move up market a little bit does ITAM have or with Firehydrant does that have the same kind of strategic rationale that it should help your win rates because you have some competitors that might have that functionality yeah absolutely and

And 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 if you're offering, say, a cloud service of some sort. But it is an adjacency that flows right into incident management, which then is run by the IT org, whether it's fixing, say, an asset management. So having device 42 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. Fire hydrant is going to be able to expand out not just on incident response, but also will get us into other adjacencies in the future like AI ops and security ops, which is areas that we have not grown into. I don't think it's quite the same as Device 402 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.

Moving to the CXI 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 in there, at least that segment. And they were just worried about massive amounts of AI disruption and seat displacement, et cetera. But you've had some nice traction with Freddie AI. And just like some other vendors in the space that I think investors ultimately will have wrong, I think they'll have this story wrong about what you guys are doing there. But what are you seeing from customers around their adoption of Freddie AI relative to the spend that they might have had historically in CX? Has that been a one plus one actually equals better than two? 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. So 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. Then you have a co-pilot, which is an add-on to an agent, which helps them be much more productive in their jobs. And then you have an insights product, which is really about the managers being able to look at the business, specifically the agents, and how are they doing. The attach rates for Freddie Copilot in particular are really, really strong. And 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 because you have a ton of customers who still aren't, you know, they're hesitant to adopt AI. And 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 want to win business. And that's the way we're selling the product, right? And so that's why the attach rates on new business, specifically larger deals, are really strong and really high. Over time, you're just going to 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 innovating like crazy on the AI side. But the reality is specifically in CX, there's a ton of disruption. It's becoming a fragmented space. And for us, we're being very, very prudent about it. We've replatformed our entire product. It took us a year to replatform the product onto really one new product, which is Freshdesk that has two additions, 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. It 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. And then once we get there, we 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, call it a 50 to 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 that have been. We're going to focus our go-to-market efforts there. We're going to get our product organization to be much leaner, much more focused, and we're going to run that business incredibly profitably.

And that's our goal for now. In ARPA, that's 2x higher. That's a pretty big delta for new customers, yeah. So 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. And I think

everything will play out when we talk about AI capabilities, because yes, a lot of it will move to some type of consumption or resolution-based pricing that's going to 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. And so we've wanted to be kind of innovators on the product side, not necessarily innovators on the pricing side. And we also want whatever we're thinking about pricing, but we want to put up like measurements internally, kind of track it, and then come out with stuff. So even EX AI Agent Studio, which we'll announce on Thursday, we're going to announce the pricing, but we're actually not going to charge for it until October. We just want adoption. We want usage. And with predictability for our customers that over time have predictability because that's really, really important. You can't put something else out that's not going to be predictable.

So 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 going to help that. Like you said, existing customers are certainly going to adopt these things. But 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?

Yeah, I think we're being very prudent with our external expectations. So we actually sat 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. And, 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 going to be very focused on it. And we also are going to 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. But I think we have to prove it out first.

I know on the call, you also talked about not being aggressive in some of the expansion opportunities until those customers are migrated, which totally makes sense. Why get aggressive on something and then have to change them and basically re-implement or redo whatever needs to be done? 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 going to see is, number one, we're going to have a very focused go-to-market that's going to be inbound only and really playing against a very tight ICP. That means we're going to have customers that come in that are going to be outside of that ICP and we'll absolutely still serve them, but we're going to be very disciplined on what we say we're going to deliver from a future functionality perspective. At the same time, you're going to have a very focused product and engineering team that is going to be able to iterate a lot faster. They've been building across five different products. They're going to have one platform on the CX side that they're going to be able to go iterate on. And so I think both of those teams are going to be incredibly focused and just going to be 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 going to be very prescriptive on what we do initially until we kind of prove it out.

So the company just announced an 11% RIF as well, a reduction in workforce. Common question I'll get from that, it just happened with another company in the quarters. 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. And 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. And a lot of our, you know, marketing priorities and outbound and all of that brand awareness is going to be EX-focused. And then, like, a lot of discipline around the CX focus. And so as we went through all that, okay, yes, there's going to be organizational changes that happen as a result. And then we're really doing that kind of across the company where, you know, We then went to product engineering, and there's going to be a lot of focus there. On the field side, on the EX opportunity, it actually is like, if anything, we're going to be spending more. And so it's not about what disruption would happen to the field. It's actually going to 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. And I think you're going to see that over the coming quarters. You know, as you perform, we're going to absolutely lean in to grow faster.

So you might not remember this. 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. And 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 because you taught me a couple things that I hadn't considered before, so I thought that was great. But the next question revolves around some of the metrics of a SaaS business, like LTV to CAC and how you think about profitability of 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 mid-enterprise or so is. But how much better are those metrics for the business over the long term if you can successfully sell into those as you want?

So I think about a couple of things. I think about, okay, what's your cost to acquire, then 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 going to prioritize EX. A lot of it, number one, started with what's a TAM opportunity on EX, which is massive. And in the area that we're serving, it's an underserved population. So the capability to actually go start is huge. Second, EX is an incredibly profitable business to run. And it's really, really efficient. And the gross margin capabilities for EX is actually much better than CX. So then it comes, and then third, the capability to grow once we're on EX. We now have a common platform that we now have a four-pillar strategy. And so once we land, and the four pillars doesn't even include AI. We start Fresh Service, ESM, ITAM, so our capability to grow once we land, even AI on top of it, is significant. And it's actually just going to continue as we continue to broaden that strategy. So across all of those different things, everything makes sense. And the LTV to CAC and our capability to bring a customer efficiently is really, really good. So the risk area is around building out your field motion because it is more costly to acquire initially if you have a more expensive field motion. And that's something that we've been pretty prudent about, okay, disciplined about how you spend. But the reality is some of our spend has been diluted across EX and CX, even on the outbound side. So a lot of the changes we made were really to get very focused on EX and make sure every dollar that we're spending is going to have the highest return possible. So when we look at all that, I still think we have some work to do, but we're actually pretty proud of 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 just a couple of years ago to now mid-20s cash flow margin, and just raised from $250 to $265 on free cash flow for this year, I'm really proud of what we've been able to accomplish. And I think you're just going to see us continue to run a very efficient business while we try to accelerate growth.

The last time I checked, that doesn't happen very frequently in my space. So very much looking forward to that. You touched on this a little bit earlier around the differentiation of the product. Easy to use. We've had a bunch of customer checks that we've published in the past. And easy use of the platform always comes up. It 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. It took them eight to nine months to implement. They moved to U. They were fully implemented in three or four weeks. And what they thought was a much better technology. So that's been something that's resonated ever since the first time I chatted with G about the opportunity there. But 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 single product company or maybe a couple product company. But on the EX side specifically, you've got four, five, six large modules there. Can you maintain that effectively?

Yeah, I think that's one of the things that is, number one, is super attractive about why I joined Freshworks. I've never seen a company that starts selling to big enterprise and then successfully moves down. But if you build for the SMB, but they can 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. And then you add feature functionality that then makes you relevant to an enterprise at some point. I think Fresh Service is a great example of that. Now, what are the nuances? So I described on ESM, it took us a year to kind of re-architect the product to make it applicable to ESM. I'm going to 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 Device 42, right? It's like, well, you bought Device 42 two years ago. Why do you take two years to get a cloud version of it? We essentially just rewrote the entire CMDB in fresh service over the last two years. But you do it very purposely, so now you have one platform now that has a cloud offering that you can just turn on, right? Fire Hydrant shouldn't be that complex when we do it. But 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 because 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've made maybe some of those missteps on the CX side. That's why I said we have like essentially five different products there. But on the EX side, it is a very disciplined approach with one platform that's a unified platform that's allowed us to just turn on capabilities when we've done it right. And that's why there's so much power in that product.

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 added that complexity to the platform and as you try to move up market even more?

Yeah, I think the partner motion, I'd still say we're not great at it, but I think it has a ton of upside. So we've announced a couple of GSI relationships, but they're really 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 get them live really quickly. And so for a partner, it has to be some type of business transformation or a full-stack offering if they're going to make money on implementation. So 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, fresh service. It's going to become more and more important. So 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 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 America, Europe, and certain parts of Asia. And we're still doing that because the TAM opportunity is huge and we have everything we need to grow at a much faster than we're growing now just by servicing that. But over time, you're going to see us get a lot more sophistication on the partner side.

So we have the CFO with us, which means I have to ask at least a couple financial questions, right? With the change in workforce that you recently announced, you've also talked about a high 20s operating margin in fiscal 27 or exiting fiscal 27, 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 EXCX focus, and then 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. But we've been making those changes over the last couple of years, and so we've invested a ton of infrastructure. Now we get to see the fruits of that labor, and a lot of it was, like, in areas that we built up manual processes that we don't need to have anymore. I think going forward, we're just going to see the same, you're going to see the same rigor on efficiencies on how we run the business. And yes, the internal use of AI is changing things for every company if they kind of make it a priority, which we are. And we're going to continue to do that. And so 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, it's a dynamic that it's sometimes hard to manage. We are going to 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. But we'd only be doing it if we think we could really grow a lot faster.

So on the faster growth side, from your analyst day, you had set out targets to accelerate your growth rate this year. We'll call it a point. Same thing next year in 27, 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 to 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 because 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? Because we're not seeing it yet in the model, but is there an opportunity for that to maybe happen?

So we're not seeing it yet in the model. 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 going to see a little bit of variance there. Yet we haven't really seen it yet, even though Freddie 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 going to look a lot like 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 in the most high-cost model, which runs costs up. You want to see as much AI usage as possible, and we're trying to drive for that and try to drive for adoption. And so we try to model out what the impact of that will be, and this is something we constantly monitor. I think you're going to see maybe margin degradation for companies, but they're going to become much more efficient as maybe some other line item so that the overall operating margin stays the same

With that, happy to open it to the audience for any questions, if there are any. We've got about four or five minutes. Well, with that, we'll give everyone four or five minutes left.

Awesome. Scott, thanks so much for the time.

Thanks, everyone, for joining us.