Freshworks Inc. (FRSH) Earnings Call Transcript & Summary

Hey, everyone. I'm Pinjalim Bora, SMID Cap software analyst at JPMorgan. I'm delighted to have here with me, Dennis Woodside, CEO and President of Freshworks. Dennis, welcome to the conference.

Thanks. Thanks for having me. Thanks, everybody.

So let's start with a little bit of introduction about yourself, you're new into the CRO. Maybe talk a little bit about yourself and a few words on Freshworks for the people in the audience that might not know about the story.

Sure. So I'm Dennis Woodside. I've been at Freshworks now for about 18 months. I've spent a lot of time in technology, spent about 20 years, 11 years at Google, I ran sales in North and South America for Google, ran a company we bought called Motorola Mobility and then was the COO of Dropbox, helped take Dropbox public, grew that business from about $200 million to about $1.4 billion in revenue when I was there. Freshworks. So Freshworks was started in 2010 in Chennai, India. The first product that Girish Mathrubootham built was a Freshdesk product, which is for customer support. That was kind of in the earlier days of SaaS and really took off among SMBs. So the first customers for Freshdesk were international from day 1. As that business grew, the company realized that Freshdesk was being used in IT department. So Girish built a separate product called Freshservice to help desk needs in IT and eventually move from ITSM, added operations management, added asset management and then more recently added ESM for teams outside of IT. So the business initially started as SMB, but companies dragged us into bigger and bigger accounts. So today, we have 67,000 customers around the world. We have a business that's basically equally balanced between our ITSM business, for our service and our customer support business, which is anchored in Freshdesk. We have large accounts like Sony Music, Wiseman in Europe, many others, but we also serve SMBs with larger accounts now being about 60% of our overall business. So that's a quick thumbnail sketch of me and of Freshworks.

That's great. I intended to say this before, but I forgot congratulations on the new CRO. You said 18 months about in the new role. Maybe talk about what is working really well at this point within Freshworks. And where do you think there's some room for improvement?

So what attracted me to the company in the first place is that we build software that every company in the world needs. Every company that has a customer support team, a sales and marketing team or an IT team needs to automate the business processes that those teams have that needs to automate the workflows that those teams use every day. So Freshworks has successfully moved from a single product company to a multiproduct company. And one of the big shifts, which I talked about earlier, is the shift up market. Most of our growth now is coming from accounts that are spending more than $50,000 a year with us. That cohort, which we disclosed is growing at about 29% year-over-year. We categorize our customers into SMBs, which are 250 employees and under and then mid-market enterprise, which is 250 and up. Our business is increasingly being driven by that larger account segment, 250 and up. We've successfully made a shift from an inbound-only sales model, relying entirely on web, try to buy type of sales motion to one that's both inbound and outbound with a global field sales force, primarily based in the U.S. and Europe, but also in Asia PAC. And that motion up market is creating lots and lots of additional opportunities for us to expand to find new opportunities and business to serve them. So an example there is our recent acquisition of Device42, which provides very advanced IT asset management capabilities, which larger and larger customers are asking us to bring in when we're competing. So what's exciting to me is the move-up market is working quite well. That shift into -- from a single product company to multi-product and in particular, in IT continues to work really well that IT business for us is very profitable. All the dynamics are great in terms of expansion and retention. So we like that a lot. And in the meantime, the support business continues to chug along, very profitable business as well, and you see that in the cash flow line for the year.

Yes. So as you go into this new year, talk about some of the priorities that you have more tactically in the near term and maybe strategically over the next 2 years or so?

So one of the things when I joined that we really focused on was that shift and is that shift up market. And one of the things that I realized is that inbound business is very different than that field out -- field driven outbound business. So one of the tactical changes that we've made is splitting leadership of those 2 business units and having 2 leaders assigned to each. Abe Smith joined us from Zoom. He leads field sales and Mika Yamamoto joined us from F5. She leads both marketing and that inbound SMB business. So that is creating greater focus on both of those motions. We're building out all the teams. If you think about field that you need to support a larger and larger scale field operation, larger and larger accounts and customers things like our partner business, professional services and so forth. And then on inbound, we have some work to do to improve the try-to-buy experience, which Mika is leading.

Yes. Got it. So let's take a step back. And this is a question that we hear from some investors. Freshworks is working both in the front office on the support side, helping your end customer -- the customers' end customers as well as working in the back office, helping your customers employees, right? So what -- from your perspective, what is your vision longer term? Does Freshworks become like a one-stop shop across both front office, back office for SMBs? Or would you lean more into the back office? Because ITSM is really working well for you, maybe talk about that.

So we are leaning very much into the back office, because IT is working very well for us. We see a huge opportunity there in that market. You have ServiceNow, which competes very well in very large complex enterprises. And then you have legacy on-prem solutions like Ivanti Cherwell, who have become more cloud-focused and you have Atlassian, who's coming at it from a developer standpoint, but there's a big space in the middle for a company with 20,000 employees or so that does -- that has a sophisticated IT department, has sophisticated needs, but doesn't need the complexity that a ServiceNow brings, needs something that's easier to deploy, faster time to value, overall lower total cost, that's what we provide, and that's where we're having great success. And that market is very large. So we're very much focused on driving success there and continuing to expand their investing there with Device42 as acquisition that will help us win more share there as well as provide a natural upsell to our existing accounts. In customer support, that business for us skews more SMB and much more inbound. That has different dynamics. We are earlier in the shift upmarket there. We are having success in moving into larger accounts like a Stitch Fix, which has about 5,000 employees, moved from a competitor on to our system for the same reasons, easier to deploy, faster time to value, AI-enabled, but that business has different dynamics and that's been more affected by macro around SMB for certain.

Yes. Interesting. I want to go into a debate that we are hearing more on the CX side, but maybe a little bit on the ITSM side, too, but this debate around bots and seats. And it seems like if you have -- you're largely seat based at this point. That's my understanding. But it seems like there's a leaning towards at least from a customer's point of view, with Gen AI being the topic of discussion towards bots over time. Better bot-based deflection lowers the need to have more seats. But then on the other hand, you can probably capture more value using bot sessions versus seats. But the flip side of that is, do we see more competition on the bot-based solutions from third parties outside of the incumbents and that might lower the ability for you to capture more values on the bot side versus the seat side. How do you think all that plays out if you look at, I don't know, the next couple of years?

Yes. So let's step back and just give a quick refresh on our AI strategy. So we have 2 products in market now 1 -- our moniker for AI is called Freddy. So we have Freddy Self Serve, which is the bot product that a consumer would encounter if they're looking for where is my order, that sort of question of a customer of ours. And then we have Freddy Copilot, which is agent-facing, which suggests answers to the agent, enhances the tone of those responses, summarizes conversations for escalations and so forth. Copilot went into GA in the middle of Q1. And Freddy Self Serve has been available since around the summer of last year, but we've had bots for much longer than that. We're just building -- or we just started building in Gen AI functionality last summer. So both of those have traction in very different use cases and markets. In -- for bots and Freddy Self Serve, we're seeing great traction in consumer-facing businesses, as you'd expect. So customers of ours that have millions of customers of their own that have frequently recurring types of queries like where is my order or I need a refund. And the AI-enabled bots handle those queries quite well. The customer satisfaction actually is as high or better than human answered queries. The time to resolve is faster typically. The way we monetize that product is through consumption. So we sell bought packs, you buy 1,000 bot sessions. A session equates to a back and forth with a customer over a 24-hour period. And so as usage of those bots and that AI scales, so does our revenue stream. On the Copilot side, we charge $29 per seat adder on top of the seat license. So we launched that product in beta last summer and offered it for free up until February, saw quite a bit of adoption and now we're converting those customers to paying customers. So in terms of the debate, like how does this play out? Most of our customers, they're looking for a single solution to provide ticket deflection, and we've been in the ticket deflection business for years. We've had bots for years. They're looking to continue that relationship with a provider that provides that kind of support, but they also need the typical escalation capabilities that Freshdesk provides on the customer service side. They need the answer center. They need all the analytics that is built into that. And they want their AI to also be enabled and specific for them and trained on their data, and that's what we do. So you'll get some customers, who might say, build their own or might separate the ticket capacity or ticket functionality from the bot itself. We're not seeing a lot of that right now. Like I said, our customer base tends to want 1 place to buy their customer support software. And the way we've set up our pricing as -- and when seats decline because more and more of that activity is automated, we benefit from the consumption pricing that will be increasing as a result. So that's how we're seeing the market right now, but it's still quite early.

So if somebody is leaning in on bots versus seats from a unit price perspective, is that a little bit positive for you?

Yes. So we've structured the pricing such that if a seat is eliminated, we've calculated what we think the number of queries that a human can handle in a year would be and set the price for the bot, so that we actually wind up making more money, it's basically, from the customer support leaders standpoint, they're looking at a $60,000-plus agent, right? Or they're looking at another $2,000 in software spend. So the trade is pretty straightforward for them and the economic value is there for us as well.

Yes. Not to harp on this point too long, but recently, you talked about some pretty good stats, 40% deflection rates among your customers, I believe, using Freddy Self Service, 30% productivity increases among agents. What are you hearing from those customers when they see such deflection rates, are they reducing agent count at this point? Or are they slowing down hiring of agents? What is their customer -- your customer behavior when they see such deflection?

Really, I mean -- so we serve every industry and customers of all different sizes. So I wouldn't say that there's a singular behavior that we're seeing amongst all of those customers today. So you have some customers that are saying, "I want to redeploy my service reps into more sales-facing roles. I want them to be able to drive upsell and cross-sell." So when a customer calls in, they make that customer more aware of all the other offerings of the company. You have others, who are just saying, no, I want to reduce my investment in support or in people and rely more on machines. And then you have others that are going through massive business transformation, either growth consolidation, and it's a combination of the 2. So I don't think that there's any one singular approach that you can generalize across basically the entire economy at this point.

Yes. Understood.

And then there's a class of customers that have very technical products. What they're looking to do is just use the AI to enhance the ability of the agent to answer those technical questions that often would take a very long time researching and responding to and provide a higher level of service to their customers.

Yes. This entire debate started, because one of your customers who's still a customer in the L2 side created something on the L1 side on their own. And we can discuss about that. But the point I'm trying to figure out is how difficult is it for somebody to go that route? Because most of your customers are mid-market customers, they don't have the capital or the resources to focus on this problem entirely. Just talk about how difficult is it?

Well, let me talk about what we've built. So we have close to 2,000 engineers and product managers, who are focused on building and supporting all of our products for -- we've been building AI products since about 2018. And the current crop of AI products consist of 60-plus separate services. So an example is a summarization of a conversation or suggesting an answer based on what the AI knows about our answer center and prior inbound queries. So 60 discrete services that add up to Freddy Copilot or Freddy Self Serve. We have built 30 machine learning models to actually deliver those services. We partner with not just 1, but I think it's something like 15 different outside providers, both open source and like Azure for our Gen AI capability. So to deliver a service, it's not just build once and you're done. And these models are changing all the time. The models that are available, open source are changing all the time. So that's what our engineers do. They are on top of that. And whenever a new model pops up that's accessible to us that we can use to improve the service that we deliver, we can pop that model into our system. We've architected it such that it's very easy for us to do that to improve the service that the customer experiences. So yes, someone can go out and build a project to deliver a bot, but to keep it current, to keep it secure to keep it safe, all those things are very hard.

And lastly, one thing that I don't hear investors, who are thinking about this as a [ bear ] thesis is the data that you have, right? How -- talk about that data being moved? How significant is that for the L1 side of the business?

Yes. So we have -- every single day, 1 million plus kind of customer inquiries, queries coming in, in the form of questions from our customers' customers. And for our models, we have access to that data to tune them and to make sure that the answer that any specific customer is getting is specific to them and is trained on their answer center data, their prior query data stream, that's not accessible to a start-up. That's not accessible to someone, who's trying to do this for the very first time. That platform really matters, and it allows us to execute quite well.

Yes. So moving on to macro. SMB prints have not been really great overall. In software in Q1, it seems a little bit of a downtick, frankly, and a lot of surveys are saying the same thing. So maybe talk about kind of your sense of the macro environment at this point from talking to customers, how do you characterize kind of the demand?

Well, I would say, remember, 60% of our business is not SMB. It's mid-market and up, and that buying behavior really hasn't changed. We continue to see traction, in particular on that IT side, where IT departments are looking at whatever they've deployed, maybe they made a decision 3 years ago, they're at the end of their contract, 3 years ago, our product wasn't as mature. We're now in the RFP process in those deals, competing for those deals and winning those deals. So that remains the same. SMB has been challenged for a while, and we've talked about this in the past. And we're seeing it in terms of lower net adds. We're seeing it in terms of slightly elevated churn in SMB in particular, and 40% of our business is on that SMB side.

Yes. Understood. So let's talk about the go-to-market changes that you talked about, right? You have 2 different leaders, talk about what has changed exactly in terms of processes? Are you doing more of the same in the outbound channel, in the inbound channel, what needs to be changed? How long it's going to take?

I think on the outbound field sales side, we're just in more and more larger deals. So a year ago, a $100,000 net new deal, new customer, never worked with them before. That was a big deal. Now it's pretty routine and $200,000, $300,000 lands are more the norm. A year ago, a $200,000 expansion was a big deal. Now it's more -- we're seeing more and more of those as well. So that requires a different level of skill, different reps. So we've changed out about 1/4 of our overall team over the last 18 months at the leadership level, bringing in people with more experience at the Salesforces, the Zendesks and ServiceNows of this world, because that complex sell is very different than where we grew up, which was inbound. That is working well. We're now focused on building out our partnership ecosystem. We did a deal with AWS. We're 1 of their preferred partners. They're bringing us into more deals. We can offer retirement of AWS credits when someone purchases software from us, which is a big deal, you buy through the marketplace. And we're expanding our set of service providers that can help with post-sales implementation. So that's also something that's super important when you get into that enterprise. All those things are helping us push into larger and larger accounts like in A&E Networks or Sony Music and win deals that otherwise would be competed for primarily by ServiceNow or like an Ivanti Cherwell player. On the SMB side, Mika has been here now just a couple of months, but we're very much focused on the try-to-buy process. So we have plenty of trialists every quarter where we need to improve is converting a higher percentage of those trialists to buy. And that means reengineering our product to make it easier to discover value and to get the value faster for typically a smaller business. So that's another area of focus for us. And then lastly, on the CX side, moving up market more aggressively. We've created an overlay team that just focuses on CX deals that's had success in winning deals like Stitch Fix. Last quarter, we had a customer called Big Lots, which is a retailer here in the U.S. Those are the kinds of successes that are getting us more and more upmarket success. So those are some of the tactical things we've changed.

Yes. That takes me to the cross-sell point, a quarter of your customers, I think, are using 2 different -- 2 or more different solutions, I believe. But that step, I think, is more around CX than CX plus ITSM is my understanding. You are starting to see, though, some of these ITSM customers buy CX, as Stitch Fix you're talking about. Is there a different motion there? Because those seems like 2 different buyers overall.

Yes, they are 2 different buyers. So over half of our top 20 customers are both IT and CX customers. And typically, what happens is a customer will come in, either the CIO will buy us for Freshservice or the head of support all buy us for Freshdesk or the customer support suite, they'll have success with that product, and we will learn that their contract for the other product set is coming up for renewal. We'll ask for an introduction and we'll get into an RFP that way. So it's more of a referral sale than the same center of power within the organization, making the decision. But we are having success Stitch Fix being an example of a longtime Freshservice customer. I think they were a customer for 7 years on the IT side, referring us in. They weren't happy with their prior provider of customer support software and us getting involved in that deal, getting into a competitive RFP and winning that deal. And that's fairly becoming more and more common as well.

One thing we have not touched is the sales and marketing part of the business, which is pretty small for you at this point. Talk about that part of the business, what needs to be done for that to ramp more quickly?

So sales and marketing is -- or CRM is a newer product line. It's our newest product line. We shared at our Investor Day, it's about 5% of our overall business, so it's quite small. We think that there's promise there in that a lot of our support teams are asking for a sales and marketing tool. They're asking for something that's integrated into the support system, single customer record. There's a lot of work that we need to do to continue to build that product and make it ready for those larger and larger enterprises that are in the support side as well. And it's still early, but I think we have some opportunity there.