Freshworks' drop in net dollar retention rate not a concern, says CEO Mathrubootham

Freshworks reported healthy Q1 numbers despite tight macroeconomic pressures. What were the important growth drivers?

For SaaS companies like Freshworks, the three components of growth are new customer additions, expansion revenue, and the churn that takes away a part of the revenue. And when we say churn, we get both deletions and downgrades – like when customers who have 10 seats downgrade to five seats, there's also churn.

The overall macro environment has been one where most companies aren't hiring a lot of people and that actually puts pressure mainly on our expansion revenue and every company is looking for efficiency today. But what worked really well for us is new business growth… Our Freshservice was doing better than Freshdesk. It has been having a very strong year for the last three to four quarters. I think it has to do with the work the product teams have done and we are a very critical alternative in the market.

Most of our expansion revenue comes from seat additions and so we hope if the macro situation improves, maybe not this year, but next year, we will get back those companies to start hiring again, then there will be more growth from expansion also.

While non-GAAP profit is positive, GAAP operating numbers are a loss. Net loss is about $43 million. What is the path to GAAP profitability?

Usually, companies go from positive free cashflow, then non-GAAP operating profit, and then GAAP operating profit. The difference between non-GAAP and GAAP is basically stock-based compensation because for a public company having all the stock coming in from employee stock that was granted over the years is counted as an expense. We are on the right path and on track.

Your current net dollar retention rate (NDR) has come down and your forecast shows a declining trend. Is this worrisome?

We believe that it (NDR of 105 percent expected in 2Q) is probably going to be the lowest point if it happens and then we are doing all the work to do better than that, obviously. This number is based on our assumption that the macro situation is not going to improve anytime soon. So there could be further pressure on expansion revenue. And there could be a churn situation. However in Q1, we had one of the best quarters… but we are seeing the overall macro situation where companies may still be looking to save money. So it could affect our overall net dollar.

We don't have a crystal ball into how exactly things are going to play out. But I don't think that's a cause of concern, especially in an overall environment where companies are looking to save money….

We offer better value and we are able to save them money compared to some of the solutions. So I think we are well-poised to ride this macro pressure. And if this overall environment changes, we will be able to accelerate even further.

Will the declining NDR take a toll on your numbers in the next quarter? If not, then what measures are you taking to balance this out?

When our expansion revenue is dependent on agent addition and that's not happening because of macro, one of the focus areas for us this year has been to see how we do cross-selling, which is getting our existing customers to use some of our other products, and that is actually working well.

Also, we continue to focus on churn in terms of how we can make sure that we are proactively looking at customers and making sure they're getting what they need. We have a team that works on reducing churn and this team has done phenomenal work over the last two-two and half years.

Are you discounting your SaaS products for customers?

One of the core value propositions for Freshworks, right from day one, is that we are all about value. If you come to Freshworks, you get a well-designed, fully featured product that can actually help you go live faster, and you can get it at a lower total cost of ownership. The price gap between ServiceNow and Freshservice, or between Salesforce and Freshworks products is that we don't actually have to resort to a lot of discounting because our products are right-priced already.

Customers who have been with us, when they have been coming for renewal and if they had a lot of discount, we have been able to talk to them and explain that we will be renegotiating some of that with a small increase in prices and there's been no pushback. So we had to introduce a 4 to 5 percent increase in pricing and many of our customers in Freshservice were willing to do that.

Freshworks bought back stock options from employees worth $100 million in 2022 and $17 million in the March quarter. Only two years since listing, why was there a buyback?

When employees get RSUs (restricted stock units) vested, there is a tax liability for employees and the company actually sells those shares and pays the taxes. Now, instead of selling those shares in the market, we are using the capital on our balance sheet to actually buy those shares back so that those shares don't hit the market. That is why technically there is the effect of a buyback without us actually going and announcing that we're doing a $100 million buyback.

Will you be looking to buy back more shares?

We may continue to do that in the next months as well. However, it is a board-level decision.

Freshworks is adding more India businesses. Is there a shift in your go-to-market strategies?

Usually digital natives like all the new companies used to onboard Freshworks into their system. We have customers like PhonePe and Paytm and all the tech companies. However, now we're seeing traditional brick-and-mortar groups like Mahindra Group, Sonata and others joining our portfolio. We are seeing a lot more activity in India from the more enterprise brick-and-mortar businesses. And so we're excited about that.

A few retail investors have filed a case against the Freshworks board alleging they failed in their fiduciary duties and caused material damage to the company and in turn to its investors. How do you see these allegations? What will be your response?

First of all, we don't comment on ongoing litigation. So personally, if you ask me, I think every public company that has gotten their share price down, is actually being sued. That happens in the US all the time. But I can't comment on ongoing litigation.

One of your early backers Tiger Global has exited. Was this due to the macro environment or was this Tiger’s strategy?

In 2012, Freshworks had $2,000 in revenue and Tiger actually came and made that investment and their entry point into the company was when we were, say, between $10 to $20 million in valuation…

Freshworks has been one of the most profitable investments for Tiger Global and they are super happy about it. I'm super happy that as a CEO, I fulfilled my responsibility towards our early investors who were able to generate superior returns.

So there is nothing unusual about it. As a VC firm, after 10 years, they are supposed to distribute returns and the fact is that they made money and it was a profitable deal for them. I’m still on great terms with them.

You are very excited about artificial intelligence. How much are you betting on AI?

Some technologies are more exciting than others. Generative AI is really more exciting, and it could be more disruptive and it is an opportunity and the uncertainty is what creates all these doubts. So if you think about customer experience, the fundamentals of what a business wants to do have always been the same. Most businesses want to automate the level one support.

What generative AI is doing is it's making it more possible to automate a lot more use-cases. AI is inevitable, and whether I like it or not, whether you like it or not, it's going to happen, right? So we better be ready for that.

The investments that we're making in AI are all around those areas into how we can make the lives of customers better when they can self-serve and help themselves. How can we make the lives of agents better where they're able to offer rich, personalised contextual support? So that is the investment focus. So broadly, it's going to make a lot of people's lives easier, but it is exciting. It is almost like the iPhone moment or the worldwide web moment coming in.

Freshworks announced performance-based layoffs last month due to tight macroeconomic conditions. How are things now?

Every company is adapting to the realities of the markets. When growth was higher, you continued to spend more and I think we can safely say that the last two-three years – especially between COVID to say 2022 – a lot of companies hired a lot more, assuming that growth is going to continue and there's nothing stopping them.

And when the macro environment changed and growth started dropping, this is something that every business will do. The way we are running Freshworks is that we have the levers to turn the company towards profitability. And that's what we have demonstrated in Q1.

In addition, we eliminated a few roles in Q4… We will continue to focus on growing the business. We feel all the changes that we are making are working well. There's a lot of change going on, but we feel confident going into the year.

What are some cost-cutting measures implemented, apart from layoffs?

We looked at everything, we looked at software spend, rationalising all the software we're using, taking out things that were not being used, making sure unused licenses were taken out. We looked at facilities, we looked at the overall marketing campaigns. And we were able to drive efficiencies across the board.

Now, to clarify, we are still hiring, we are not hiring at the same pace that we were doing last year or the year before that. So we are being more selective about where we want to hire and scrutinising the roles and the need for the roles and the location where it needs to be and so on.

Freshworks hasn't had a chief technology officer since Shan Krishnaswamy exited a month ago. Are you looking to appoint anyone?

We have architects for each one of our product units. So Ramesh Parthasarathy is basically the technology head for the customer side of the business. His title is chief architect. He doesn't have a CTO title. And similarly, for the service business, we have an architect… We may hire or we may look at an AI-ML leader to come in as well. So these are all conversations that are happening.