Smartsheet Inc. (NYSE:SMAR) Q1 2024 Earnings Call Transcript June 7, 2023

Smartsheet Inc. misses on earnings expectations. Reported EPS is $-0.53 EPS, expectations were $0.08.

Operator: Good afternoon, ladies and gentlemen and welcome to the Smartsheet First Quarter Fiscal 2024 Earnings Conference Call. [Operator Instructions] And now at this time, I would like to turn things over to Mr. Aaron Turner, Head of Investor Relations. Please go ahead, sir.

Aaron Turner: Thank you, Bill. Good afternoon and welcome everyone to Smartsheet’s first quarter of fiscal year 2024 earnings call. We will be discussing the results announced in our press release issued after the market closed today. With me today are Smartsheet’s CEO, Mark Mader; and our CFO, Pete Godbole. Today’s call is being webcast and will also be available for replay on our Investor Relations website at investors.smartsheet.com. There is a slide presentation that accompanies Pete’s prepared remarks, which can be viewed in the Events section of our Investor Relations website. During this call, we will make forward-looking statements within the meaning of the federal securities laws. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends.

These forward-looking statements are subject to a number of risks and other factors, including, but not limited to, those described in our SEC filings available on our Investor Relations website and on the SEC website at www.sec.gov. Although we believe that the expectations reflected in the forward-looking statements are reasonable, our actual results may differ materially and/or adversely. All forward-looking statements made during this call are based on information available to us as of today. We do not assume any obligation to update these statements as a result of new information or future events, except as required by law. In addition to the U.S. GAAP financials, we will discuss certain non-GAAP financial measures. A reconciliation to the most directly comparable U.S. GAAP measures is available in the presentation that accompanies this call, which can also be found on our Investor Relations website.

And with that, let me turn the call over to Mark.

Mark Mader: Thank you, Aaron and good afternoon everyone. Welcome to our first quarter earnings call for fiscal year 2024. While Pete will provide additional details, I’d like to highlight a few areas of our Q1 performance and share continued progress in our leadership of the enterprise collaborative work management market. Smartsheet revenue for the quarter exceeded our guidance and grew by 31% year-over-year to $219.9 million and billings grew 20% year-over-year to $215.5 million. In Q1, we generated non-GAAP operating margins of 10%, more than double the high end of our guidance range and free cash flow was $31.3 million. We ended the quarter with annual recurring revenue of $886 million and more than 12.8 million Smartsheet users.

We continue to see strength with our larger customers with 59 customers expanding their Smartsheet investment by more than $100,000 and 188 companies expanding by over $50,000 in Q1. These expansions contributed to a net addition of 85 customers in our greater than $100,000 ACV customer cohort. Enterprise expansions for the quarter included Eli Lilly, Motorola Solutions, Foxtel and Novocure, among others and we saw new customer wins at companies such as Liberty Media, Hostess Brands and 811 Group. We also saw strength in our portfolio of capabilities-based products and our Advance offering with 143 customers either purchasing Advance for the first time or upgrading to a higher tier. Additionally, we are on track to launch the self-discovery of two of our most popular capabilities at the end of Q2.

This will lower the friction required for our customers to experience these products, which should result in a faster time to value for our customers as well as for our sales team. A leading financial services company upgraded to Advance Platinum this quarter. This meaningful expansion was driven by employee demand for our core platform as well as the premium security and governance capabilities they received with Advance Platinum. Over the past year, their user growth has increased 52% and they have created nearly 180% more work apps, 240% more Data Shuttle workflows. And the company’s marketing department is now transitioning from another CWM platform to Smartsheet. In addition to the momentum we have seen with Advance and our premium capabilities, we are seeing significant traction with our new Free plan.

In Q1 we launched our Free plan worldwide and the initial results are promising with high engagement and conversion to paid in every customer size segment. These Free engaged users should be a impactful component of our user acquisition strategy going forward. We continue to win due to Smartsheet’s position as the enterprise CWM platform that enables organizations to effectively track and manage three critical dimensions of work, people, content and the work itself. The people dimension reflects the deployment, assignment and capacity planning of those engaged in the execution of work. Content represents the videos, images, documents and other assets that are inputs or outputs of the work being done. And work is the information about day-to-day activities, milestones and workflows that underpin an organization’s projects, programs and processes.

By connecting these three distinct dimensions of work, the Smartsheet enterprise platform enables customers to drive efficiencies across their entire Smartsheet ecosystem and allows them to expand value of the platform to their partners and customers. For example, one of the world’s largest retailers is using Smartsheet to connect work and people management to unlock value. Nearly a dozen business units across 5 countries are using Smartsheet to manage their portfolios and resource management to help them more accurately staff projects. This tighter alignment between managing work and people allows this retailer to adapt quickly to the changing project needs and gives them new insights into their team’s capacity and performance. And a large online travel company chose Smartsheet over other CWM solutions because of our ability to help them comprehensively connect the three dimensions of work.

The company’s global marketing department is going through a major transformation and adding a significant number of employees this year. The combination of our core offering, resource management and Brandfolder will help them manage the transition, establish our new unified process for managing campaigns start to finish and ensure leadership has the right level of insight across the company’s brands, products and programs. They see Smartsheet as an essential way to scale as their department grows, ultimately helping them achieve their marketing goals. To further support our large customers, we continue to make investments in scalability of our platform, greatly improving sheet performance, formula execution and cross sheet data processing.

While every user benefits from these enhancements, they are especially valuable to portfolio managers and their teams using control center. We have enabled control center to support thousands of parallel projects already and we are on track to be able to support tens of thousands of projects per control center instance by the end of the fiscal year. And we look forward to sharing more about how we lead the category in scale and manageability at our ENGAGE Customer Conference in September. Furthermore, we have seen a major increase in data being transferred from other systems to Smartsheet with Data Shuttle. In Q1 of last year, Data Shuttle ran about 25 million workflows importing and exporting customer data. And in Q1 of this year, we executed over 53 million workflows transferring tens of billions of rows of data.

Additionally, we have added unified login support in Bridge, up-level administration capabilities for Data Shuttle and Data Table, and doubled the Bridge workflow scale to support customer demand. We have expanded our content automation offering for our Brandfolder product with a leading self-serve templating capability. This is the result of the successful integration of our acquisition of Outfit, which is enabling customers to innovate faster in content production and distribution at scale. We continue to make improvements in our dashboard capabilities, hundreds of thousands of licensed users create dashboards to inform stakeholders and drive positive outcomes by centralizing, organizing and presenting real-time data and statuses on a customizable canvas.

We have also introduced policy controls for cross-functional collaboration and launched the Plan Insights dashboard, which gives customers a live view of the value they derive from Smartsheet. We are experiencing a significant moment for our industry, our customers and our company. Generative AI or Gen AI tools and technologies are rapidly evolving. The way that work gets done from insights to execution can change materially as a result of Gen AI and we are using it internally and actively developing features to benefit our customers. We believe these changes will create new higher value work for people opening up opportunities for innovation and more impactful work. On the product side, we continue to make progress on expanding the AI-based capabilities on our platform and are well-positioned to enable valuable customer use cases.

This year, we have focused investments in three areas of Gen AI that will help our customers work smarter, faster and more effectively. The first is an intelligent assistant that allows users to quickly find answers that help best use, configure and extend Smartsheet. The in-app assistant will help customers with everything ranging from early product discovery to understanding the full impact of the Smartsheet platform across sheets, dashboards, reports, automations, work apps and more. This will drive adoption of additional capabilities and enhance the overall Smartsheet experience for our users. Second, project and portfolio intelligence, by harnessing the power of large language models, we will further differentiate by allowing users to leverage data within their sheets and use natural language to generate charts and calculate key metrics that they can save to their dashboards with a click of a button.

These features, combined with Control Center’s portfolio capability, to quickly absorb data across thousands of active projects to provide portfolio-wide key metrics, trends and actionable insights. And third is image manipulation, auto generation of video captions and image descriptions. Brandfolder can auto generate image descriptions and video captions and detect various elements within an image. This makes for easy natural language searches and also allows users to separate foreground and background elements to remove or replace it. Brandfolder will be able to comb terabytes of customer-specific content to bring customers high-value capabilities that train AI models and generate content that is unique to their brand. As our customers experience the value of our Gen AI features, we intend to pursue multiple monetization avenues.

Our premium features will serve as a catalyst to compel customers to consider moving to a higher tier of licensing. For these premium Gen AI capabilities, we plan to provide a base tier of consumption beyond which greater volumes can also be purchased. Additionally, we see this as a mechanism to drive user licensing as some AI features will be only available for licensed users. Select customers will be invited to experience our Gen AI features in beta next month, with broader enrollment planned after our customer conference in September. While we have not built any material contributions from Gen AI into guidance for this fiscal year, we do anticipate additional revenue opportunities in FY ‘25. In closing, as the company approaching $1 billion in ARR, we are optimistic about fiscal year 2024 and beyond.

As the leader in enterprise collaborative work management, we will continue to thoughtfully invest in our platform, go-to-market initiatives and Gen AI to capitalize on the sizable market opportunity in front of us. Now, let me turn the call over to Pete. Pete?

Pete Godbole: Thank you, Mark. As Mark mentioned, we excluded our Q1 revenue guidance and delivered Q1 non-GAAP operating margin of 10%, more than double the high-end of our guidance range, showing the strength of our business model. However, the macro environment remains challenging, the effects of which are most pronounced in our higher velocity transactional opportunities that are often associated with our SMB and mid-market customers. We also see the macro impacting the length of sales cycles for our larger opportunities and the demand environment for our marketing solutions. Consistent with our approach from previous quarters, we are expecting to remain conservative with respect to our full year guidance. With that said Mark mentioned a number of areas that would support our growth this year and beyond, including healthy demand for our capability-based products, our newly introduced Free plan and the self-discovery and usage of capabilities.

Additionally, we are making marketing investments that we expect to generate a contribution in the second half of this year. I will now go through our financial results for the first quarter. Unless otherwise stated, all references to our expenses and operating results on a non-GAAP basis and are reconciled to our GAAP results in the earnings release and presentation that was posted before the call. First quarter revenue came in at $219.9 million, up 31% year-over-year. Subscription revenue was $206 million, representing year-over-year growth of 33%. Services revenue was $13.9 million, representing year-over-year growth of 7%. Revenue from capabilities grew 60% year-over-year and made up 33% of subscription revenue, up from 27% of revenue in Q1 of last year.

Turning to billings. First quarter billings came in at $215.5 million, representing year-over-year growth of 20%. Approximately, 93% of subscription billings were annual with 4% monthly. Quarterly and semi-annual represented approximately 3% of the total. Multiyear billings represented less than 1% of total billings. Moving on to our reported metrics. The number of customers with ARR over $50,000 grew 33% year-over-year to 3,343 and the number of customers with ARR over $100,000 grew 42% year-over-year to 1,569. These customer segments now represent 63% and 49% respectively of total ARR. The percentage of our ARR coming from customers with ARR over $5,000 is now 90%. Next, our domain average ACV grew 18% year-over-year to $8,520. We ended the quarter with a dollar-based net retention rate encompassing all of our customers at 123%.

The full churn rate remains below 4%. We continue to expect our dollar-based net retention rate to trend lower into the high-teens by the end of the year. Now turning back to the financials. Our total gross margin was 82%. Our Q1 subscription gross margin was 86%. We expect our gross margin for FY ‘24 to remain above 80%. Overall, operating income in the quarter was $22.8 million or 10% of revenue, which represents a 6 percentage point sequential margin improvement. For modeling purposes, we expect our Q2 and Q3 operating margins to be lower due to the timing of hiring, incremental marketing campaigns, and our ENGAGE conference. We expect the operating margin to expand sequentially from Q3 to Q4. Free cash flow in the quarter was $31.3 million.

Now, let me move on to guidance. For the second quarter of FY ‘24, we expect revenue to be in the range of $228 million to $231 million and non-GAAP operating income to be in the range of $7 million to $9 million. We expect non-GAAP net income per share to be $0.07 to $0.08 based on diluted weighted average shares outstanding of 138.5 million. For the full fiscal year, we are reiterating our revenue guidance of $943 million to $948 million, representing growth of 23% to 24%. We expect services to be 6% of total revenue. We expect our non-GAAP operating income to be in the range of $43 million to $53 million, representing an operating margin of 5% to 6% and non-GAAP net income per share to be $0.37 to $0.44 for the year based on 139 million diluted weighted average shares outstanding.

We are reiterating our FY ‘24 billings growth of 20% and our free cash flow for FY ‘24 of $110 million. Also for modeling purposes, we expect our Q2 billings to grow sequentially by around 6% and then accelerate sequentially from Q2 to Q3 and from Q3 to Q4. To conclude, we are in the early stages of a large enterprise collaborative work management market opportunity and investing appropriately to drive top line growth with a focus in efficiency. Our leading enterprise platform, go-to-market strategy and focused execution, we believe will have a long runway of sustainable growth and margin expansion ahead. Now, let me turn the call over to the operator. Operator?

Q&A Session

Operator: Thank you, Mr. Godbole. [Operator Instructions] We’ll take our first question this afternoon from Terry Tillman at Truist Securities.

Terry Tillman: Yes, thanks for taking my questions. Great job on the cash flow in the quarter. I guess the first question for you, Mark, is the enterprise business does seem like it remains strong. I don’t know how much we should hang our head on kind of $100,000 ACV growth, but it was 42%, so not all much from last quarter. Is that a good proxy for the enterprise business? Do you expect that to stay above 40% and we didn’t get the benchmark on how many customers over $1 million ACV maybe to help us on that? And then I have a follow-up for Pete. Thank you.

Mark Mader: Hi, Terry. Yes, we did add $1 million customers we are at 47 right now. In terms of that being a proxy like 40, the over under on the 40, I would just say we continue to have very good engagement in these larger opportunities. We added net $85,000 over $100,000 this quarter. And when I look at what customers are looking for investing in platforms, it maps really well to the enterprise offering right now. They are looking for both productivity wins for their teams and then how do they climb the curve on things that are higher value and those tie out really well. I talk about these three dimensions of work, right, the people, the content and the work we have offerings in all three of those. And what I will say is people are really trying to gain a high level of confidence before they make a buy decision.

So as you map to larger opportunities, which are multi-faceted, people are asking more questions, wanting to get more comfort and that does play out in an elongation, but I see the hand strengthening in that upper band.

Terry Tillman: Okay. Duly noted. I guess a follow-up for Pete, you did maintain 20% billings growth guidance for the year and you gave a commentary that I don’t think you typically do for each quarter in the progression. But you called out the higher velocity business being sluggish sales cycle lengthening and then maybe some of these marketing-related deals getting a bit tougher? I am just trying to understand the puts and takes in terms of level of conservatism in the 20%, because those sound like things. I don’t know if they are incrementally tougher dynamics that you called out, but then you have the Free plan, you have the discovery dynamics starting at the end of 2Q. Just trying to understand how much kind of battle tested that 20%? Is it more conservative now? Is it about where it was, just a little bit more on kind of risk mitigating the 20% billing? Thank you.

Pete Godbole: So, Terry, the two parts to your question are, one about how we set the guide. It’s a composite on sort of what I call the dynamics we saw in Q1 which there was some softness relative to our expectations and I called out those areas for you. Our high-velocity transactional business typically associated with our SMB and mid-market customers. You’ll remember the same thing happened during COVID when COVID hit us. So that transactional business was an impact area. We’ve seen the rest of our business perform according to our expectation, which was based on what I call the macro that we expected to have worsened. What we did see is the lengthening of sales cycles. And what that means is when you think of that, that means more for opportunities push in to the back half of the year.

And that consistence with the type of customers we work with, which are enterprise customers, which are generally more back-end loaded budgets. So that the reason why we sort of given you the guide that says we’re maintaining our guide on billings, but is the composite of those two effects and the timing of when deals happen.

Terry Tillman: Thank you. Good luck.

Pete Godbole: Okay, thanks, Terry.

Operator: We will go next now to Scott Berg at Needham.

Scott Berg: Hi, everyone. Congrats on a quarter. And thanks for taking my questions. I guess as a follow-up to Terry’s last question there and Pete your answer. As enterprise software companies get larger and sell more to the enterprise. We typically see their businesses more seasonally weighted towards the back half of the year. Do you think this is a 1-year phenomenon or something that you see maybe more consistently going forward with these larger deals having that disposition in the second half of the year?

Pete Godbole: So Scott, you’re going to see that in the enterprise, we will continue to get more back-end loaded because that’s the nature of enterprise budgets and enterprise cycles. But what you have to do is you have to overlay on that, how the macro for a year plays out. A lot of companies are taking the approach of slanting their own budgets to be more back-end loaded. So you’re going to find that weight changes a little bit in how what I call companies are operating in the macro they are in.

Scott Berg: Got it. Helpful. And then, Mark, you spoke pretty positively on the traction within your recently released free plan, getting conversions across every customer segment. I guess, how should we think about that opportunity contributing to bookings or billings this year? Is this going to be a material driver for you? Or is this really about kind of seeing this opportunity. And driving better opportunities into fiscal ‘25? Thank you.

Mark Mader: Hi, Scott, I think it’s a really important what I call sort of a seeding exercise. When I think of – where many of our new customers click in. It’s at a fairly low level of contribution, but what was a really pleasant surprise was as we launched this in a targeted region in the second half of last year, we were surprised to see that a meaningful percentage, like north of third of all organizations that were trialing free and operating in a free environment where companies over 10,000 employees in size. I mean. I wouldn’t have not placed that bet going into this. That is a really encouraging step. The second piece, which is encouraging that the conversion rate of organizations who are in free exceeds the rate of conversion to paid than folks converting from trial.

So we’ve unlocked this opportunity if there is a population of companies and people who want to be in the platform longer before making that decision, seeing that rate higher than our trial conversion rate, very encouraging. And there are thousands of people coming and joining every single week here. We’re talking hundreds of new logos that were added as paid customers in the last couple of months who otherwise wouldn’t be with us today. So again, on a contribution like new bookings contribution, very small, like rounding air but we know how it works, right? You get a 10,000 employee customer contributing a little bit, look 5 years down the road, they are a multimillion-dollar customer. So that is really encouraging. So again, as we focus – and I’ve talked about this in the past earnings calls, we focus on excellence at the enterprise, it’s paired with how do you lower the leading edge?

And I think those will play out very well against each other over time.

Scott Berg: Great. That’s all I have. Thanks for taking the questions.

Operator: We will go next now to Brent Thill at Jefferies.

Unidentified Analyst: Hi, thank you. This is [indiscernible] on behalf of Brent Thill. Maybe two quick ones related to the environment, I am wondering if you could share some more color on the linearity during the quarter, how things progressed and you are doing feel like to real doings and how it looked so far, 5, 6 weeks into Q2? And any color on verticals would be interesting? Thank you very much.

Pete Godbole: So the way the quarter shaped out for us is it was significant contributions from our second and third months. It’s sort of built up as we went through it. The close rates followed the seasonal patterns we have seen from the previous quarter. So you were seeing the close rates sort of manifest themselves as we went and improve as we went through the quarter. And what we’ve seen for May is May looks very much like February in terms of close rates. The pipeline is higher but we are seem to same sort of deal dynamics with its associate deal cycle elongation, deal compression. All of those are very much too same as they were in February probably, bit worse.

Operator: Thank you. We will go next now to John DiFucci at Guggenheim.

John DiFucci: Thank you. I have a question for Mark and then a follow-up for Pete. Mark, you’re obviously seeing some effects on your business from the macro backdrop. It’s just about everybody is. But your business held up better for longer than others, at least from our calculations, it did. When you speak with customers, are you hearing anything different this quarter from previous quarter. Pete talked a little bit about elongated sales cycles for the enterprise. But anything more? And are there any differences in the enterprise versus data you have for the SMB or the mid-market?

Mark Mader: I think one of the things – Hi, John, one of the things that’s worked well for us this past quarter. A couple of examples I shared during my remarks was evidence of companies looking to try and get more workloads over to Smartsheet. So we had one big travel company that was able to retire a different marketing system in favor of Smartsheet. So I think they view that as a double win, right? We get an app that our team is asking for. We’re also able to consolidate, that’s favorable for us. The themes haven’t really changed, though. People are looking to make the bigger the investment decision, the more confidence they want to have and the more they wanted to tie up to quantitative factors. So to what degree can you articulate the return on the dollar spend beyond a qualitative factor, like we like the app or we feel more productive.

I would say, it’s maybe gotten a little bit more pronounced, but I wouldn’t say a major deviation or change from the recent two quarters.

John DiFucci: Okay. Okay, thank you. And Pete, I’m going to go back I’m going to let other people ask the buildings question because that’s the one big question and a couple. But I’m going to ask something else. Free cash flow was really strong this quarter, especially in your case, it’s interesting, right, because you’re not a mature company. You’re still growing a lot. There is a lot of opportunity and you are still increasing your scale. So how much of that growth that strengthen free cash flow has to do with just the leverage in the software model, which we talked about before is wonderful versus active management of the business against sort of a tough macro backdrop. Can you sort of gauge that?

Pete Godbole: Yes. I would say that the first factor, which is the natural scale in the model is coming through. I think it’s coming through loud and clear as you look at the ability to generate cash. We provided a guide for the full year at $110 million. As you recall, that was up from, call it, sub-$10 million in the previous year. So there is natural scale in the model is playing through. We are making improvements in how we come up with that number outside the scale by being efficient. So when we talk about reducing our operating expense for things which are not directly tied to revenue and making operations more streamlined using locals other than the expensive high cost locations we have that a part of it. I would say both our significant contributors with the business model probably the predominant one.

John DiFucci: Okay, okay. Great. Thanks a lot, guys.

Pete Godbole: Of course, John.

Operator: We will go next now to Ryan MacWilliams at Barclays.

Ryan MacWilliams: Hey, thanks for taking the question. I know it’s still early days on Generative AI, and I appreciate your early thoughts on how Generative AI could be added to your platform and pricing, but any early thoughts around you could add Generative AI or ChatGPT to some of your capability-based offerings?

Mark Mader: Yes. I think one of the things that I spoke to in our remarks was how this analytics AI component that we’re going to be releasing shortly, how that plays with control center, which is really the crown jewel of our capabilities offering. Control center is all about aggregating and scaling programs and projects. So the data sets we are using very large, very often consistent, someone who’s trying to replicate a program broadly, and to understand the value of those programs, people build dashboards, they generate widgets, they ask questions against the data sets. And what’s really promising about this one offering is that it dramatically drives the cost of analysis. So I talked about hundreds of thousands of people building dashboards and widgets.

Today, you need to understand how to build a dashboard, how to create a widget, how to add trend, how to style it all those things, you get to now ask a question. So if I reduce the cost of your question by 95%, I guarantee you will ask more questions. You will probably be more successful. You look better internally, and you’ll probably get a budget next time you ask for it. So this is like – it’s one of these huge accelerants. When I saw this recently developed by our engineering team, I asked the question, could I ask a question that you hadn’t prepared for this demo? This is sure fire away. So I asked the question that within 10 seconds, my set of charts with the trend with his specific filters applied was automatically done. That will play really well with customers.

So we know there is a lot of intent already to want to answer these questions. When you pair that with an enabling technology that’s easily understood, it doesn’t require a lot of sales oversight or customer success oversight. So we will launch this with some beta customers next month ramping to our customer engage conference. And I really believe when people see the return that it can provide, I think there will be a very significant appetite. So that’s probably the one that’s most clear. The other piece is around the assistant when I think of 40% of all of our cases that come into our company, being around advanced configuration unlocking greater value on the things that are unique to Smartsheet in terms of what we can pull off from a calculation standpoint, the round trip time on support will fall significantly.

And the benefit to us, call deflection, the benefit of the customer in terms of getting your question answered quickly and correctly. Those are really big deals. So it’s difficult to quantify the benefit of the revenue opportunity for us thus far. But there is no confusion about whether this will add value.

Ryan MacWilliams: I agree. I think driving that knowledge worker productivity definitely accrues the software efficiency. Just one for Pete, were there any deals that slipped out of 1Q and close in 2Q? And any early signs of stabilization within the higher velocity transaction opportunities you talked about? Thanks.

Pete Godbole: So first of all, we always have to use the slip in the quarter to the next quarter. We’ve had consistent close rates on those deals. So the close rate is sort of staying consistent. And as far as the other pieces – other part of your question, which is – are we seeing any trends emerge, there is nothing that’s unusual.

Operator: Thank you. We will go next now to George Iwanyc at Oppenheimer. And Mr. Iwanyc, your line is open, sir if you do have a question.

George Iwanyc: Thank you for taking my question. Pete, maybe could you give us some perspective on sales productivity with the challenges you are seeing in the macro environment? How are you responding from a sales perspective?

Pete Godbole: So George, when we look at sales productivity, as you look at the environment, we are seeing the sales productivity is reflected in that number. So we’re seeing the productivity obviously decline as the macro impacts people’s ability to close business. What we are finding is our sales teams are generating opportunity at a brisk pace, including sometimes faster than earlier quarters. So pipeline builds are working. It’s a close rate in the macro that’s driving sales productivity lower than prior quarters.

George Iwanyc: Alright. And then maybe you can build in on the marketing effort that you’re pointing for the second half of the year. Are those some new direct marketing efforts this something with the ecosystem that you’re planning at partners?

Pete Godbole: So George, we are launching incremental marketing programs to drive to sort of what I call high-value conversions and that is incremental to what we’ve done. So that should reflect itself in second half bookings. We’re doing that on the back of sort of very predictable cohorts that we’ve seen materialize with an approach that we’ve sort of been working on for the last quarter, which gives us confidence in our second half guide that we provided as well.

George Iwanyc: Thank you.

Operator: Thank you. We go next now to Michael Bird at Wells Fargo.

Unidentified Analyst: Hi, thanks for taking my question. Piggybacking off the margin, how can we think about any change in conservatism or assumptions baked into the margin guidance? Then I got a follow-up.

Pete Godbole: So I think our margin guidance appropriately considers the investments we would like to make as well as our overall guide for the year. We feel confident that the $43 million to $53 million op margin guide we’ve provided we raised it from the $35 million to $45 million, which was there before, and we feel good about it. I think some of this is going to be about – it’s early in the year. And as the year progresses, we will be making real-time decisions on sort of how we invest while maintaining our guidance that we have at $43 million to $53 million.

Unidentified Analyst: Great. Very helpful. And then the quick follow-up to that is you mentioned that part of the outperformance on margins in the quarter was due to hiring. I guess, a, where are you on sales ramp or net new quota-carrying rep hiring? And be given what you’re seeing in the macro? Are there any changes to that or like you just said, that’s going to be more of a real-time decision?

Mark Mader: So our – we’ve got some hiring, which is progressing through. It’s not a large part of it on the sales side. We feel good about where we are in capacity. There will be some additions, but it’s not anywhere near sort of where we’ve added in the last fiscal year. So that’s a part of it. There is positions in R&D and other parts of the organization as well, which we’re adding in, which are what I would call in a smaller nature of investment we’re building in. We’re not ramping our hiring engine until we see how the macro looks beyond that.

Unidentified Analyst: Helpful. Thank you.

Operator: Thank you. We will go next now to Alex Zukin at Wolfe Research.

Ethan Bruck: Hey, this is Ethan Bruck on for Alex Zukin. Thank you for taking my questions. I guess two quick ones. One, just help explain some maybe just discrepancy between taking the op margin guide leaving the cash flow unchanged for the year. Is it just leaving some room for kind of investments? And then I guess the other one is just, are you seeing kind of just kind of update from the free stuff or the free offering as kind of a way, a natural way to shift go-to-market efforts, upmarket enterprise things like that. Potential upside to the margin targets for the year? Thank you.

Pete Godbole: I didn’t catch the first part of your question. It looks like you were asking about billings and free cash flow in the relationship? Did I get you right? Op margin?

Ethan Bruck: In terms of the full year guide, re you guys took about margin guide slightly but less free cash flow unchanged for the year. Is that just a kind of leaving room for it, I guess, to invest in capacity in the back half billings starts to pick up?

Pete Godbole: So the op margin – you should think of op margin and sort of revenue going together. So and you should think of billings and free cash flow working together. So we haven’t changed our billings guide. We haven’t changed our free cash flow guide from what we provided as an estimate. We haven’t changed our revenue, but what we have passed through is the efficiencies we found and which we feel comfortable with, which we’ve moved through into the op margin incremental sort of guide we provided.

Ethan Bruck: Now we get. Thank you.

Operator: Thank you. We go next now to Jacob Roberge at William Blair.

Jacob Roberge: Hey, guys. Thanks for taking my questions. Pete, just going back to the billings growth acceleration in the back half of the year, could you talk about the confidence in that? It seems like it’s related to the seasonality of enterprise deals landing in Q4. But is there anything else in the model that’s helping that’s helping that? And then is there any potential risk that some of those larger deals get pushed actually out more into fiscal 2025? Or have you accounted for some of that potential risk within the back half acceleration guide.

Pete Godbole: So, Jake, essentially, we have looked at the deals and we have looked of larger deals, we have looked at the close rates some those deals. We see those close, and which is taking longer – elongated sales cycle. So we know the timing of when these deals now come into our ecosystem if you will. And we know that our budget heavier in the second half. So marrying the deal elongation and sales cycle with customer budgets, we feel good about sort of where that number is in terms of how we set the guide. We always know that there is going to be some level of deal push out that takes place, it’s factored into our guide. The additional item I mentioned was we’ve started incremental marketing program investment based on high LTV customers, with high value and fidelity of return, that’s what we’ve added into the mix as well. So between those factors, we’re pretty comfortable with our guide for FY ‘24 on the billings and revenue side of it.

Jacob Roberge: Okay. Great. Very helpful. And then could you talk more about the demand that you’re seeing in some of your newer products. Seems like Advance had a pretty solid quarter, but could you just provide some more color on what’s driving demand for that product suite? And then just thinking about the broader platform, have you seen any solutions get more or less prioritized just given the uncertain macro environment?

Pete Godbole: Yes. So the – when I think about the products that have gained a lot of traction that I’ve seen sort of really resonate well, I think there is two layers to it. One is we are Advance we gave the stats of143 people either buying Advance or upgrading to appear in advance. So you are seeing that layout where customers are buying packages because they see this simplest way to generate value in an environment, where they know this proven ROI. So I think we are seeing that will our largest customers. We are also seeing traction for individual capabilities. In this current environment people are taking the approach of buying by the drink by the individual capability. And we know that’s fine because a lot of these customers start by buying one capability but it sets them on this ceded journey to buy advanced eventually or buy more capabilities eventually.

So we’re seeing that play out pretty well. I think in general, we’ve seen great traction with some of our capabilities like data shuttles. So we’ve seen sort of what I call great demand for some part of our product portfolio, which we called out here.

Jacob Roberge: Helpful. Thanks for taking my questions.

Pete Godbole: Of course, Jacob.

Operator: Thank you. We go next now is to Shebly Seyrafi at FBN Securities.

Shebly Seyrafi: Yes. Thank you very much. So you beat your fiscal Q1 revenue guidance by about $6 million, and you’re guiding pretty much in-line with consensus in fiscal Q2 for revenue. And yet you kept your annual revenue range unchanged at $9.43, $9.48. So implicitly, you might be lowering your expectation by $6 million in the back half. Is that the right way to look at it?

Pete Godbole: So, what we have done is our approach to guidance over the last several quarters has been to be conservative sort of given the macro we are in. The macro is sort of dynamic for us. So, given this macro, we are still early in the year, we have elected to remain conservative as we thought of guidance. So, that’s why we haven’t changed the guide for the year despite the over-performance in Q1.

Shebly Seyrafi: Okay. And any international call-outs?

Pete Godbole: I think we were sort of – the performance that we had in international was according to our expectations. Obviously, there is more of a headwind internationally, and we saw that come through. We are completely aligned with what our expectations were for those reasons.

Shebly Seyrafi: Okay. Thank you.

Operator: Thank you very much. We will go next now to Steve Enders at Citi. And Mr. Anders your line is open sir, if you have a question. And hearing no response, we will take our next question now from Pinjalim Bora at JPMorgan.

Pinjalim Bora: Okay. Hey. Thanks for taking the question. The sales discovery of capabilities is interesting. I wanted to ask you if you are already piloting that with customers, what are you seeing with that respect? And is there – will that also include kind of ability for the customers to buy the products online on a self-serve basis, or would that still require kind of a sales effort as people look to getting to data settle or something else. And then thirdly are you modeling some of benefit from this as it goes online in the second half in terms of bookings.

Mark Mader: We have not modeled any uplift from that into the second half. What we are solving for what we are releasing in July is the discovery and the usage of. So, someone in a self-directed way we will be able to in context see these, understand how it applies to what they are trying to do, whether it’s in the context of advanced sharing or data shuttle, be able to start using it immediately. It will still engage a member of our team to take the order, but there will be no friction in the identification of it, the utilization of it, etcetera. And that’s a very significant win. We have, as I shared last time, we have well under 10% of our customers buying a second product from us. So, we think this is the launch point to really get cross product attached.

Pinjalim Bora: Understood. One quick follow-up for Pete. Pete, the deferred revenue, I think sequentially was down probably for the first time, at least when I was looking backwards in a while. Is there – can you kind of tease out how much is that because of the SMB weakness, the mid-market weakness versus kind of deals push out because of longer sales cycles, any way to understand that?

Pete Godbole: The way I would characterize it is the large contributor was the high-velocity transactional business associated with what I call generally associated with SMB and mid-market. And then the other elements is it demand for our marketing solutions and the elongation of sales cycle of probably on a similar order of magnitude but next.

Operator: Thank you. We will go next now to Jackson Ader at SVB MoffettNathanson.

Unidentified Analyst: Great. Thanks. This is Kyle on for Jackson. I think we talked a lot about the macro. But maybe could you just give us an update on the competitive environment and maybe how compared to early last year, if you are seeing anyone more lesser than how win rates are looking? And then I do just have a quick follow-up on just kind of – I think Mark, you may have mentioned that there was an expansion where you guys pushed out another tool, if there is just maybe a few use cases that you guys have tended to see be the catalyst for kind of a standardization, that will be great. Thanks.

Mark Mader: Yes. Over a long horizon, I would say, over the last 2 years, we have seen an increase in our conversion rate or win rate one new, so that has progressed. Again from the bookings contribution standpoint, those new wins don’t accumulate too much, but they do service as that planting of seeds. So, that is on pace. In terms of expansion, once we are in the account, there is not a material change to the frequency with which we are seeing people. I would say as we continue to improve how the three dimensions of work that I talk about get more deeply integrated, the greater the return for a customer is to say, I am going to go with Smartsheet for content and work or people and content and work. And I think that does then put a lot of pressure on those providers who are only delivering on one of those dimensions.

So, it’s how do you unify, how do you simplify, how do you get those economies of scale. So, I think again, is at the hand of strengthening on that side. I have not seen anybody in category make moves to talk about those unifying those three dimensions of work within their portfolio through integrations potentially, but that’s very different than having a sole source. So, not a lot – when you look at where most companies still are today, the leading competitor is the status quo, which is not anybody in our category today. It’s still the number one. And I would expect that to be the case prior for the next 2 years.

Operator: Thank you. We will go next now to Jason Celino at KeyBanc Capital Markets.

Jason Celino: Hey guys. Thanks for filling me in. Just two quick ones from me. So, interesting to see the launch of the preplan, I guess but it was the plan to drive interest in those types of customers. Will that be mostly paid marketing driven? And then second, can you just elaborate on the opportunity to maybe convert some of these free users to paid users over time? Thanks.

Pete Godbole: So, I will take the first part of it which is on the marketing effort to after it. As I have said, we are launching marketing programs at the end of last quarter and the beginning of this quarter, which really go after high-value conversions, high LTV customers. But a part of that marketing demand spills over to people getting interested in the free plan. It’s not our focus in going after it, that naturally helps the free plan. The rest of it comes from people discovering those free plans as they look for ways to solve their collaborative work management problem, which really drives this process into high gear. And then Mark will take the second part.

Mark Mader: Yes. And then in terms of the tactics to get an engaged population in free to spend first dollar with you, you have the full portfolio available to us as we start getting our self-discovered feature set introduced to people as we start to deploy Gen AI experiences. We get to make those choices and we will put in front somebody. The good news is that we are already seeing a higher disproportionately higher conversion rate to paid from that population. And as you allow them to experience some of these premium things, some of these innovative elements, I would expect that to be a continued tailwind to getting those people on site. So, it’s an ever-growing population. We are adding a lot of companies to this realm. And we will be watching that conversion rate closely as we introduce some of these new capabilities.

Jason Celino: Excellent. Thank you.

Operator: We will go next now to Josh Baer at Morgan Stanley.

Josh Baer: Thanks for the questions. Mark, I think you gave a great overview of some of the areas that you are intending to release AI capabilities and the ways that you should be able to monetize, I was hoping you could do two things. From the customer perspective, could you talk a little bit more about how your conversations with customers are evolving around AI? Are they looking to you to help bring AI into the organization? Is this something that they are actively engaging around from a time line perspective? And then second, I think it sounds like those three areas of Gen AI are relatively near-term initiatives. Just hoping you could sort of help with our imagination thinking about your platform, the data you have and like the longer term potential for additional AI, use cases are AI outside of those three main buckets that you outlined so far?

Mark Mader: Yes. We serve such a diverse set of companies ranging from manufacturing to education, to health, to technology, to services providers. And I would say that the AI conversations are as diverse. It’s ranging from the very inquisitive well informed prospect or customer who wants to go deep on the topic to the other end of the spectrum, which is can you just give me the basic education of what it means, is it safe, how will you be secure and responsible in terms of how you are planning AI to your realm. Does my data leave your boundary, does it get shipped off to some service provider to improve their model like how does it work. And I think there is a really good opportunity right now to become a trusted advisor.

So, as we talk about our advanced analytics that we are flipping on for people, we focus on the fact that we get to take advantage of the open AI, we get big advantage of these large models. We get to take advantage of having their data not leave our boundary. That’s a huge deal. So, as we think about this opportunity to educate, become the trusted advisor and to have them look at us being able to say, Smartsheet is the mechanism for us to apply AI to our operations safely and securely, like that’s something that they are having to report out internally to their stakeholders. So, I think we can play a very active role in that. I think there are various phases of the game on the AI piece. One of it, now look at sort of the customer journey, someone starting out with us, trying to get educated, trying to unlock the potential, see how they can maximize the value, all the way up to the highly sophisticated, fully enabled control center person deploying a 2,000 wind turbine farm, very advanced situation.

And I think what our duty is, is to be able to help someone at every phase of that journey. And I think it’s very different using AI to help someone convert to paid for the first time versus the person trying to add another seven figures of ARR contribution to us. And when I think of the long-term opportunity for us, it’s – how do you not only provide the convenience of AI to help them move more quickly, but how do you allow them to capitalize on the data set that’s already been stored with you in some cases for years. How do you unlock insights in it. And again, that is more pertinent to someone who has been with you for a long time. But our model is so well set up because we have a clear understanding of intent. So, if you were an ad hoc model that allowed people to collaborate in a fully unstructured way, that’s fine.

We happen to be the huge beneficiaries of knowing exactly what our customers are trying to do. Their data models describe their intent. Their interaction gives us insight into who is pertinent and who is most relevant. We get to use all of that on their behalf to apply AI to it. And I think the – we look at AI in two ways also. One is very much inwardly what can we do within our ecosystem and then what can we do as a partner with other ecosystems. So, when you look about what Microsoft announced a build, how do you use – how do you co-op a Microsoft Teams co-pilot infused experience with the tooling we already have to align with Teams. So, it’s not just how do you apply AI to maximize the Smartsheet feature set, how do you apply it to get maximum utility out of the other enterprise platforms they have today.

And I think customers are looking for coaching on both fronts. So much of our growth over the years has been coming in with an informed point of view and then listening very intently to what customers want. And I think our AI strategy that we have built so far is absolutely influenced by what our customers are doing, the assistant, the analytics, the content generation, it’s all predicated on where we see activity today. And as we deploy this, we are going to get a lot smarter about where people’s sensitivities are, where their needs are. And I think that strategy will emerge very, very clearly as we enter next year.

Josh Baer: Great. Thank you very much.

Operator: We will go next now to Keith Bachman at BMO.

Keith Bachman: Hey team. Thanks and sorry, I do want to go back to the billings guide because I am a little confused. You used a couple of times in the discussion this evening the word conservatism that you usually approach guidance with conservatism. But I think you said that you thought billings would grow by 6% sequentially in July quarter and perhaps I misunderstood that, but that implies something like 11% to 12% year-over-year billings growth. And it puts a lot of pressure on the back half of the year to get to something even close to 20% billings growth. And so the first part of the question is, when you say back half of the year, do you mean both the October and Jan quarter, or are you really sort of pushing everything to the Jan quarter?

And then secondly, just when you say you are being conservative on your guidance, and I think to be fair, the previous question was related to revenue, but it doesn’t seem like you are being conservative on this billings guidance. So, maybe just help me understand a little bit.

Pete Godbole: So Keith, I will first confirm the question you asked in terms of what you are sort of calculating. We did give you a sort of a steer and sort of how we would think of modeling Q2, which was a 6% sequential increase. I think when you look at that number and you say, how does that come about? And what gives you the confidence in the back half. There is two elements I pointed to, which are specific. One, we have an elongation of the sales cycle, but the deals close and we see their closing. We see that we know that the enterprise budgets, as we looked at customers and evaluated what they have, our setup for the back half sort of expenditure rate, which is consistent with enterprises. So, our elongated sales cycles, timing of when they close, intersecting with customer budgets is something we have seen fairly well, and that’s what’s sort of giving us the confidence across both Q3 and Q4.

So, we have sort of built that in. That’s one. The second part of it is we have made incremental and significant investments in marketing programs which are based on high LTV customers that provide high value, so we know that those dollars convert with fidelity to what we expect our bookings – booking contributions for the second half. That’s the way we have built it in. I think our, what you call, our guidance is on billings is thoughtful and we have sort of considered the macro and how we expect that to evolve as well.

Keith Bachman: Alright. Just to – again, sorry, I got to tease this out, but many companies would suggest that if you have billing – excuse me, deal elongation that’s going to continue such that there is just frankly, slippage throughout the year. Are you assuming that there is some, there is an improved close rate so to speak, as you get towards the end of the year that’s facilitating getting to 20 and/or an improvement in the macro?

Pete Godbole: We are not factoring an improvement in the macro. We are assuming on the longer deal cycles with enterprise budgets, our close rates do improve as you think of those, so that’s the key part of the sort of how we are thinking of the guide. And then the other part, Keith, you have got to remember we are dealing with the matter where the comps get much easier as you go into Q3 and Q4. So, when you look at Q3 and Q4 and you look at the growth rate in billings, you are doing it for a comp where the macro already started to manifest itself in our results last year. So, between those two, I think we feel good about sort of how the year plays out.

Keith Bachman: Okay. I assume net of the comps are easier certainly in Q4, but they are – it’s relatively hard compared in Q3 as well. But I will see for it. Thank you.

Pete Godbole: Thanks Keith.

Operator: We will go next now to Robert Simmons at D.A. Davidson.

Robert Simmons: Hey. Thanks for taking my question. So, you guys have been going a bit into your partner ecosystem. Can you update us on how that’s going? How much of your new business is actually driven or influenced by it?

Pete Godbole: So, the partners are a key part of sort of how we go to market because they bring unique capability in markets international, they play an integral part in core selling with us. Our percentage of what I call partner touched revenue, has increased from Q1 of last year to Q1 of this year, and it’s now sitting in the mid-teens in terms of sort of how we think of that contribution.

Mark Mader: In terms of the reliance on third-parties to bring us business where it’s really partner-led entirely, that’s a small minority of the business today. Where they have proven quite helpful is in that co-selling, as Pete said. So, I think you asked specifically about them bringing us business, I would say it’s – that has been substantially less than 15% of our total, but still very helpful to have their participation.

Robert Simmons: Got it. And then what do you see in terms of like the big SIs building out their practices? Is that progressing to plan, or are you going to color there would be helpful?

Mark Mader: Yes. We anticipate having some news on that in the second half. As I reported out last quarter, we have a number of the global SIs who have built practice areas in Smartsheet. And it’s – when I compare that to the large SIs who are doing exclusively system implementation and config on behalf of clients. What’s interesting about two of the large ones that we are working with right now is that they are actually building service delivery practices on Smartsheet. And then after they have concluded whether it’s on an accounting dimension or on an M&A or divestiture dimension, Smartsheet is left behind to help their clients operate. So, it’s very different than being hired to do a system implementation on some – on behalf of the customer. It’s really them delivering their services and leaving Smartsheet with the customer post project. We will have more to report on that in the second half.

Robert Simmons: Great. Thanks.

Operator: Thank you. And we will take our final question today from Fred Lee of Credit Suisse.

Fred Lee: Hey. Nice work on the profitability side of the health and also on free cash generation. I have a question with regard to the introduction of free and the potential impact to the existing install base in that with weaker macro, what we have seen are some customers at other software companies electing to actually downgrade to free in the near-term. How do you protect against this, and because this could potentially elevate risk to the base of the pyramid?

Mark Mader: Yes. When we initiated free last year, we did a lot of design work on this, and we were very prudent, I would say, in our approach to what free provides somebody. While you can use our different views and our dashboards and elements of automation, the constraint is put in, in terms of who you can share your work with. When we look at the sharing need within our organizations, our customers, it’s significant. And it can give you a good case today. You can share it with up to two people, but we have – we obviously had a lot of work in the quarters leading up to launching it globally to understand the impact. We saw no impact to our conversion to our paying plans and we see no evidence of people downgrading to free at our paid customers today of any significance. And that was a key part of our research before we launched it globally. And again, we have seen nothing different since launching it globally from what we saw in those quarters running up.

Fred Lee: Got it. Thank you. That’s extremely helpful. And then just a quick one for Pete, last quarter, you said NRR would end in the high teens towards the end of the year. And I might have missed it, but did you give an update here. And then if you could talk a little bit on pricing or whether it’s been stable, if there has been any degradation sequentially from Q4? Thank you very much.

Pete Godbole: So, I think we – in my prepared remarks, said we expect the net dollar retention rate to end the year in the high teens. So, we sort of reiterated what we have said before. So, we set that out. Now, are we seeing any price degradation in the market, I think we are seeing our prices all we are seeing demand vectors of what I call the high-velocity business where people just decide they are not going to go for the quick project that you can start and sort of go to down with the right away within the short period of time, that’s what we are seeing. We are not seeing a giant price degradation happening.

Fred Lee: Thank you very much.

Operator: Thank you. Mr. Turner, I would like to turn the conference back to you sir, for any closing remarks.

Aaron Turner: Great. Thanks Bob. And thanks everyone for joining us today and we will speak with you again next quarter.

Operator: Thank you, gentlemen. Again, ladies and gentlemen, it will conclude the Smartsheet first quarter fiscal…