Smartsheet Inc. (NYSE:SMAR) Q2 2024 Earnings Call Transcript

Smartsheet Inc. (NYSE:SMAR) Q2 2024 Earnings Call Transcript September 7, 2023

Smartsheet Inc. beats earnings expectations. Reported EPS is $0.16, expectations were $0.08.

Operator: Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Smartsheet Second Quarter Fiscal 2024 Conference Call. [Operator Instructions] Thank you. Aaron Turner, Head of Investor Relations, you may begin your conference.

Aaron Turner: Thank you, Emma. Good afternoon and welcome everyone to Smartsheet’s second 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.

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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 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 second quarter earnings call for fiscal year 2024. While Pete will provide additional details, I’d like to highlight a few areas of our Q2 performance and share continued progress in our leadership of the enterprise work management market. Smartsheet revenue for the quarter exceeded our guidance and grew by 26% year-over-year to $235.6 million and billings grew 18% year-over-year to $243.1 million. In Q2, we generated non-GAAP operating margins of 8%, and free cash flow was $45.5 million. We ended the quarter with annual recurring revenue of $933 million and more than 13.4 million Smartsheet users. 75 customers expanded their Smartsheet investment by more than $100,000 in Q2, and 232 companies expanded by over $50,000.

Additionally, we closed three transactions over $1 million and now have 51 customers with ARR over $1 million. Enterprise expansions for the quarter included Airbus U.S., Hewlett Packard Enterprise, Iron Mountain and Pacific Life Insurance Company, among others. And we saw new customer wins at organizations such as Breville, Equity Group Holdings and New York University. We now have over 9,400 enterprise customers, which we define as organizations with over 2,000 employees. These customers make up over 50% of our ARR and are posting NRRs well above our overall rate. Our execution within the enterprise continues to be recognized by industry analysts and peer review sites. On the heels of being named a leader in Forrester's Collaborative Work Management Tools Wave, IDC published a report in July recognizing Smartsheet as a vendor who shaped the year in 2022.

Additionally, Smartsheet received the distinction of being a Customer's Choice in the 2023 Gartner Peer Insights Voice of the Customer in the Collaborative Work Management Market segment in Q2. Smartsheet received the highest rating and the highest percentage of customers willing to recommend the platform at 98%. Our portfolio capabilities continues to be a core differentiating factor in our success in the enterprise. Our customers leverage our capabilities to attach the Smartsheet platform to mission critical projects, programs and processes. In Q2, capabilities were present in each of our top 10 expansions. Smartsheet Advance, which is a bundle of our capabilities had a strong quarter as well. We closed 216 Advance deals in Q2, an increase of 50% versus Q2 of last year.

To expand on this here's some additional details of our three largest deals this quarter. A big four consulting firm signed a seven figure deal with us to streamline client engagement, simplify internal and client status reporting, and automate a variety of processes across the organization. With Smartsheet Advance enabling the firm's business transformation, this customer estimates they've already saved $7.5 million across 590 projects completed as of May of this year. Importantly, Data Shuttle is allowing them to pull information from disparate data sources to quickly create reports without needing to develop costly direct integrations with proprietary systems. We will also use Smartsheet to more effectively bid on engagements with clients and more efficiently plan, track and manage resources and budgets.

This firm's increasing client facing use of Smartsheet will also showcase our platform to their portfolio of blue chip clients during engagements. We also signed a seven figure expansion with a large global retailer where Smartsheet is being used to drive business transformation across multiple divisions. In its fulfillment centers, Smartsheet is helping leadership manage strategic planning and operations. And as they grow their brick-and-mortar locations, they're using control center to help manage new construction and store remodels. Smartsheet Advance also plays an important role in the company's retail marketing organization where it supports their budget management, marketing and creative operations. Also in Q2, we closed a seven figure Brandfolder deal with a Fortunate 15 company.

This customer will use Brandfolder to consolidate its tech stack, while enabling marketing teams to eliminate manual processes and streamline the storage and management of digital imagery and video content. Brandfolder will help power their websites and mobile apps to reduce version control issues and help the team deliver a better online experience for customers and more efficiently generate millions and online revenue. As the leader in enterprise work management, our customers are running mission critical programs and processes at significant scale on Smartsheet. Whether that's tracking the sourcing of millions of parts for manufacture, or running programs with tens of thousands of projects, the Smartsheet platform continues to be the choice of customers needing to operate at enterprise scale.

Scale will continue to be one of our biggest differentiators. Our platform's ability to scale allows our customers to leverage Smartsheet to build sophisticated solutions that run the kind of complex workloads that enable organizations to achieve their goals. Over the past 12 months, we've gone from supporting hundreds to thousands of concurrent projects with every control center blueprint. Very soon, customers will be able to run tens of thousands of concurrent projects per blueprint. Another element of scale is our commonly use in powerful computational feature cross sheet cell linking. It enables our customers to aggregate data across thousands of active and completed projects to build reports and dashboards to communicate program or portfolio health and progress.

We increase the cell links limit from 30,000 to .5 million per sheet, and we're aiming to achieve another 10x increase in scale next year to get to 5 million cell links per sheet so customers can manage more interconnected projects. Additionally, in Q2, platform improvements resulted in formula computations running 10x faster. In sum, these enhancements enable our customers to now manage significantly larger programs and portfolios, quickly aggregate and compute data at scale and visualize information in real time to achieve great efficiency across their global operations. And recently, we also made it easier for our customers to find and derive value from two of our most used premium capabilities, Data Shuttle and Dynamic View. Through self-discovery, our customers can now easily get hands on experience with these powerful and popular capabilities without needing to engage with a salesperson.

Data Shuttle automates data movement between other systems of record in Smartsheet, so customers can quickly visualize and act on this data in their projects, programs and processes. Dynamic View power secure and confidential workflows across vendors or internal processes by enabling personalized views of the data in sheets and reports. By creating curated views, teams simplify error prone manual work typically done over email and messaging. We commenced the rollout for self-discovery across both Data Shuttle and Dynamic View for our business enterprise customers at the end of Q2. By the end of September, we will complete the rollout. Following the July announcement of Smartsheet's integrated generative AI capabilities, three features are currently being used by customers and private beta.

Our plan is to make these and others more broadly available after our engaged customer conference in September. AI Assistant and AI Solution Builder will be available to all customers to get started more quickly and to deliver value faster. These features enable our customers to continue moving their projects and processes forward without leaving their workflows, leveraging our AI features to create a solution by describing their needs. With respect to monetization, AI formula builder, AI content generation and AI insights will only be available to paid users on enterprise plans. We expect these powerful features to incentivize plan upgrades and expansions. In some instances, we expect customers to also purchase higher usage tiers based on need.

Brandfolder image captioning, people tagging and basic image edit -- image editing will also be available in multiple usage tiers as part of Brandfolder's pricing plans. Over time, these features should become a meaningful catalyst for free to paid license conversion and enterprise plan upgrades. Heading into the second half of FY '24, we remain well-positioned for efficient growth powered by the creativity and energy of thousands of Smartsheet team members and partners worldwide. Our team's dedication and hard work serves to enhance the Smartsheet platform and drives our success with customers. In less than 2 weeks at our Sold-out ENGAGE customer conference, we will unveil how we are changing the way organizations operate and innovate faster at even greater scale.

We are rapidly evolving our entire platform to extend our leadership position from the expansion of features to governance to scale and to Gen AI. And across all these areas, we're looking forward to enrolling our customers in the future of Smartsheet. Now let me turn the call over to Pete. Pete?

Pete Godbole: Thank you, Mark. As Mark mentioned, we outperformed all aspects of our guidance in Q2, demonstrating the durable top line growth and free cash flow inherent in our business model. ARR grew 27% to $933 million, and we are well on our way to surpassing $1 billion in ARR by the end of the fiscal year. In Q2, we saw some signs of macro stabilization, particularly with our enterprise customers and with Smartsheet Advance. However, we are still seeing elements of budgetary caution across our customer base, which is impacting our higher velocity transactions and sales cycle durations. I will now go through our financial results for the second quarter. Unless otherwise stated, all references to our expenses and operating results are on a non-GAAP basis and are reconciled to Our GAAP results in the earnings release and presentation that was posted before the call.

Second quarter revenue came in at $235.6 million, up 26% year-over-year. Subscription revenue was $221.5 million, representing year-over-year growth of 28%. Services revenue was $14.1 million, representing year-over-year growth of 7%. Revenue from capabilities made up 32% of subscription revenue. Turning to billings. Second quarter billings came in at $243.1 million, representing year-over-year growth of 18%. Approximately 94% of our subscription billings were annual, with about 4% monthly. Quarterly and semiannual represented approximately 2% of the total. Moving to our reported metrics. The number of customers with ARR over $50,000 grew 30% year-over-year to 3,552. And the number of customers with the ARR over $100,000 grew 36% year-over-year to 1,665.

These customer segments now represent 64% and 50%, respectively, of total ARR. The percentage of our ARR coming from customers with ARR over $5,000 is now at 90%. Next, our domain average ACV grew 17% year-over-year to $8,863. We ended the quarter with $1 based net retention rate inclusive of all our customers of 121%. The full churn rate was 4%. We expect to exit FY '24 with $1 base net retention rate inclusive of all our customers of around 116% to 117%. Now turning back to the financials. Our total gross margin was 83%. Our Q2 subscription gross margin was 87%. We expect our gross margin for FY '24 to remain at or above 82%. Overall operating income in the quarter was $19.2 million, or 8% of revenue. Free cash flow in the quarter was $45.5 million.

This brings our first half free cash flow to nearly $77 million. For modeling purposes in Q3, we have three large cash outflows that are unique to the quarter. These include expenses related to our ENGAGE customer conference, one extra payroll run in the quarter, and a semiannual contractual payment related to a cloud provider. Given these outflows, we expect our Q3 free cash flow to be around $5 million. Now let me move on to guidance. For the third quarter of FY '24, we expect revenue to be in the range of $240 million to $242 million, and non-GAAP operating income to be in the range of $8 million to $10 million. We expect non-GAAP net income per share to be $0.08 to $0.09 based on diluted weighted average shares outstanding of 139 million.

For the full fiscal year '24, we now expect revenue of $950 million to $953 million, representing growth of 24%. We expect services to be 6% of total revenue. We expect non-GAAP operating income to be in the range of $62 million to $67 million, representing an operating margin of 7% and non-GAAP net income per share to be $0.53 to $0.57 for the year based on 139 million diluted weighted average shares outstanding. We are reiterating our FY '24 billings growth of 20% and raising our free cash flow guidance for FY '24 to $120 million. Also for modeling purposes, we expect our Q3 billings to be 24% of our full year billings. To conclude, Q2 was highlighted by outperformance across all aspects of our guidance. Enterprises across the world continue to leverage Smartsheet to power their most sophisticated workflows.

And we look forward to showing the next evolution of our market leading platform at our ENGAGE customer conference in 2 weeks. Now let me turn the call over to the operator. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question today comes from the line of Terry Tillman with Truist. Your line is open.

Terry Tillman: Yes, thanks. Good afternoon, and nice to see the billings and profit and cash flow upside in the 2Q. I hope you're all well. We've heard about a report and even folks asking us about one of your enterprise customers Cisco, potentially migrating away from Smartsheet. I know they've been a long standing customer. I don't know if you can talk about this. But is there any truth to that? And just generally, what's the health of some of your larger longer standing enterprise customers? And then I had a follow-up.

Mark Mader: Hey, Terry, thanks for the question. Yes, we're aware of that report and it is not accurate. We, in Q2, Cisco signed a multiyear, multimillion dollar extension with us. With respect to the health of the large customers, we had really nice milestone reached in going north of 50 customers contributing over a $1 million of ARR. We had a new high watermark on our over $0.5 million accounts, almost getting to 150 or 149 today. So I really like the stable of customers we have that are growing that are about to become our next seven figure customers plus. So again, really pleased with the progress we're making there. And I think the remarks I had around the improvements we have in our scale and sophistication solutions, I think it plays directly [technical difficulty] support those types of customers.

Terry Tillman: That's great. That's great color there. Thank you so much for that, Mark. And I guess just a follow-up question is, you all have added a lot of sales capacity really going back from last year. And as we look through the rest of this year, how are you feeling about where you are kind of scorecard in terms of the productivity ramp of these new sales reps? Do you see that inflecting more in 3Q or 4Q? Or is this kind of more of a multi-quarter thing, where still there's more benefits and fruit of the labor into next year around the ramping sales force? Thank you.

Pete Godbole: So, Terry, this is Pete. When we look at the sales force productivity, obviously, that suffered because of the macro, we've seen that play out. And primarily because of the high velocity transactional business that has impacted that. So we see continued progress in our enterprise sales productivity, which grew quarter-on-quarter. We are expecting that to continue into the future and maintain.

Terry Tillman: Thank you.

Operator: Your next question comes from the line of Josh Baer with Morgan Stanley. Your line is open.

Josh Baer: Great. Thank you for the question and nice quarter. I wanted to ask one on the billings outlook for the rest of the year, 20% for the year, 24% in Q3, that's like 17% growth, I believe. And then that leaves 24% year-over-year growth for Q4. Anything that you could talk through sort of those dynamics of the step down in billings in Q3 and then the reacceleration in Q4, whether it's the stub, billings dynamic, comps or anything one-time, just kind of thinking about that trajectory?

Pete Godbole: Josh, it comes down to something very simple. It comes down to the comps that we are looking at. If you look at Q4 of last year, if you looked at the year-on-year growth, it was the slowest growing quarter of the year. We grew at 28% year-on-year. That was down from 36% in Q3. So it's just the comps that look to create the impression of acceleration. But when you look at the 2-year stack, like you just go back to 2022, which is a fairly normal year, and you look at what we've achieved in the first half and you take the billings guidance we've provided and you create an implied view, you'll see that, that implies the decel actually in the second half compared to what we've delivered in the first half.

Josh Baer: Okay. That's really helpful. And then I wanted to just ask on the three AI features that are being tested in private beta now. What's the feedback? Any sense for how many customers are using these features? And then also, what's the interest level from the broader customer base on -- around AI. Thank you.

Mark Mader: I think there's real hunger for getting educated on how to apply AI to systems that they already understand. I think the best way to land a new concept with someone is to inject it into something they've already used as opposed to trying to land them on a brand new concept in sort of an ephemeral way. So the interest rate is very high. We've controlled the release of this. We kicked off what 4, 6 weeks ago. And we really look at planning on opening the top on this at ENGAGE. We want to really create a nice curated experience for all of our customers and do that in a very methodical yet expanded way. So I do expect over Q3 for that number to expand to many thousands of customers who are using this. The things we've heard so far are validating.

People are saying that they are seeing a dramatic reduction in cost to doing things like building visualizations with dashboard widgets which is our AI Insights product. And we've started to now also show some of our customers what we are doing on those other premium AI theses around formula building and content generation. The thing I love about these areas is that they have extraordinarily high foot traffic in our products today. Nearly half of our inquiries on our community and our support dimensions are in the context of computation and logic they're trying to build into these workflows, and that's exactly what this addresses. So I think the relevance of the supply to AI that we are introducing is extraordinarily high. I think one of the reasons why ENGAGE Sold-out a month before show time is because people are really interested in some of these things.

So we'll have a lot more to report out on this at the end of Q3 once we get thousands of customers through the shoot on this. I'm expecting quite favorable things.

Josh Baer: Great. Thank you, Mark.

Operator: Your next question comes from the line of Jake Roberge with William Blair. Your line is open.

Jacob Roberge: Hey, thanks for taking the questions. Can you just talk a little bit more about the retention expansion dynamics this year and what's happening at renewal time just given the macro? It seems like gross retention is pretty steady. But when customers are expanding, where are they expanding most? Is that more on the advanced capabilities front or new products like Brandfolder and outfit starting to layer in more meaningfully, just given you called out that seven figure deal on Brandfolder, it would be great to get that commentary.

Pete Godbole: Yes. I think, Jake, what we are seeing is we are seeing expansion sort of coming across both in our seats as well as in our capabilities, a little more of a slant towards capabilities because in solution selling, people need a lot of the capabilities tied to the seat. So you're seeing a little bit more of that. And in general, the dynamic we've had is our expansion rate is the one that fluctuates. Our gross churn has remained fairly steady at 4%. And this expansion is the piece that comes with the sort of macroeconomic forces that come into play. Now we're balancing that with some of these self-discovery of features that we are rolling out in the back half of the year, which I'm pretty excited about.

Jacob Roberge: Okay, great. And then helpful commentary on just AI monetization, how that's going to track with enterprise skew upsells and free to pay conversions. Will you start monetizing that right after ENGAGE? So could we see some incremental benefits in Q4 and maybe Q1 of next year? And then, Pete, is there anything we should keep in mind on the expense side of the house as it relates to AI?

Mark Mader: Yes. Jake, we have not yet set the time or the date for the GA of those features. It's all about enabling customers right now. What we will -- what we are giving our customers clarity on is at what plan level that will be available for them post GA. So we have not baked that into our second half numbers at this time. But again, working very hard to make sure it's positioned well for this upcoming year.

Pete Godbole: And to the second part of your question in terms of what have we baked into the plan, there's no dollars of revenue baked in for AI in the back half that I guided to. But what I would tell you is we've assumed some costs hitting us as customers in beta and other forms start to try out the product. It's very small.

Jacob Roberge: Great. Thanks for taking my questions.

Operator: Your next question comes from the line of John DiFucci with Guggenheim Securities. Your line is open.

Tamjid Chowdhury: Hi. This is Tamjid Chowdhury on for John DiFucci. Thanks for taking the question. My first question, again, like on the billings growth, it's good to see that you maintained the guidance there. Can you maybe talk about like what kind of visibility you have into the second half of the year? If you can maybe talk about renewals, expansion renewals, that would be super helpful.

Pete Godbole: Yes, Chowdhury. When you start to think about some of the indicators we've used to give us that confidence, start with how we closed Q2. We closed Q2 I thought fairly well with improved execution from our field team. That was part one of it. But what we also saw on top of that was the pipeline entering Q3 was healthy. And when you couple both those elements with the fact that our close rate on pipeline we entered the quarter with is strong and maintaining strength, that's what gave us the confidence in the back half guide on billings.

Tamjid Chowdhury: Awesome. [Indiscernible]. And then, Mark, you mentioned about sub discovery starting off with Data Shuttle and Dynamic View. What prompted that, and sort of like what are you trying to achieve from it? And any kind of early feedback that would be super interesting.

Mark Mader: Yes, I think it's all about putting customers in a position to be able to act quickly. One of the wonderful comments from a customer who saw a Data Shuttle through self-discovery called out her customer success manager, and she did thank you so much for releasing this new feature. Feature has been there a long time, but now it's fully visible to that person, and she was able to start benefiting from it. So the purpose is how do you reduce friction and make your median customer available of all of your strengths that you can bring to bear. And if you gate that behind a discussion with the sales rep, it slows you down. So what you'll see it engage in addition to these two features that we've put in self-discovery now is a real push to unify our experiences and to make those available to as many people as possible.

And when we think about serving all the companies we have, the customers we have in the U.S., we are very U.S. centric today. So when you're solving and serving Asia Pacific, Japan, EMEA, the more you can put in front of somebody where it's not dependent on human interaction, the better. So that is the whole thrust behind the self-discovery piece. And again, we are -- it's in front of thousands of companies now. It will be in front of tens of thousands of companies by end of September. And I would expect that to start driving lead growth. And again, as Pete and I plan for second half, we have not baked this into our numbers yet. So neither Gen AI nor self-discovery have been factored at this time.

Tamjid Chowdhury: Great. Thank you.

Operator: Your next question comes from the line of Pinjalim Bora with JPMorgan. Your line is open.

Pinjalim Bora: Hey, thank you very much for taking the question and congrats on the quarter. Pete, I want to go back to the billings guide a bit. Obviously, you had a good ARR quarter. It seems like, billings was healthy. You beat your guide, but you kind of kept the full year. I mean we appreciate it, I guess, given the macro and conservatism in that front. But is that it, is that just a prudent conservatism that we should read into the guide? Or was there any kind of pull forward in the first half versus the second half? Like -- or is there any risk that you see in the second half for some of the renewals that you have coming?

Pete Godbole: So Pinjalim, what I would tell you is there's no pull forward in the business that we reported for Q2. What I would tell you is at the start of the year, when Mark and I set out the guide for billings, we looked at the macro view of it. There's a lot of things that happened within quarter. We got some feedback on that in Q1. We've got a different set of feedback in Q2. But looking at the puts and takes in a composite, we feel good about maintaining the guide at a 20% billings growth.

Pinjalim Bora: Okay. Got it. And Mark, obviously, you have a lot of AI features coming out, and you'll hear more about it. But I wanted to ask you about this large base of free collaborators that you have. I'm wondering as you roll out these AI features and start monetizing them, do you see kind of a big opportunity to accelerate that free-to-pay conversion as you have kind of a second trigger point now with AI.

Mark Mader: I do. I think the more value you present to somebody, the more opportunity you have for them to convert to a paid customer. For many, many years, this notion of a paid license in Smartsheet was predicated on someone's right to create an asset, a sheet, a dashboard report, et cetera. We are now over the next -- in the coming quarters, introducing capabilities that are incremental to what you've been able to do that will be reserved for paid license users. So we are giving people more opportunity to have a reason to subscribe. And when I think about how these Smartsheet deployments are instantiated, you have people who create assets who share them with others, and then you have many analysts who work with that data.

And I think the Gen AI work is quite interesting because it really enables those people who are manipulating, trying to get insights from the data giving them a mechanism to do their work faster and more cheaply. And I think when you have that dynamic, I would say the ability to argue for a license is quite compelling. I mean in the grand scheme of the total cost of an employee the Gen AI license costs or the license is quite trivial. So I really love the fact that we are moving away from this notion of only creators need licenses to if you really want to be effective in the most high impact way, you should also get a license. And I think that will bode really well. We have a huge population measured in millions of people who are actively engaged, who do not pay us today, and we are giving them reasons to subscribe.

Pinjalim Bora: Got it. Thank you very much.

Operator: Your next question comes from the line of Alex Zukin with Wolfe Research. Your line is open.

Ethan Bruck: Hey, guys. This is Ethan Bruck on for Alex Zukin. Congrats on the quarter. I just -- I appreciate the color around the ARR exit rate. I'm just curious if this is also how you think about where ARR trends potentially a troughing if it's kind of a bottom and as you called out, some stabilization you saw in enterprise in the quarter.

Pete Godbole: Ethan, I think when you think of what our future outlook on NDRR is, it really comes down to sort of what is our future projection on growth. That's something that we have to play out essentially this year. We have to see the impact of the actions Mark talked about in terms of AI, self-discovery, and that's really going to determine in a lot of ways where the NDRR goes. So it's a little premature to sort of call out at this point.

Ethan Bruck: Okay. I got it. That's helpful. And kind of a follow-up there, the monetization strategy and the timing around the Gen AI features was very clear. I was just curious, when do you expect that to start becoming an impact on net retention as customers kind of stay more to the platform and just also as well on growth retention, which is still holding very strong.

Pete Godbole: So, Ethan, when you think of the net retention impact of AI features, I think it comes down to people actually getting their hands on those features, using those features in context of the work. So I think when you get more real data on what customers are doing with it, it informs the exact things you're asking about, which is what do I think about net dollar retention rate do I expand? Which people expand, what use cases they expand to all of that comes about as kind of, I call it, the second order impact of them trying the product.

Ethan Bruck: Okay. That’s great. Thank you very much and congrats on the quarter.

Pete Godbole: Thanks, Ethan.

Operator: Your next question comes from the line of Brent Thill with Jefferies. Your line is open.

Brent Thill: Thanks, Mark. I'm just curious if you could characterize the selling environment. I know Q1, it was a little slower of the gate. It seems like that snapped back in Q2 and I mean how much of this is just snap back from things that slipped from Q1 to Q2 versus a better environment, if you will.

Mark Mader: I think the environment plays -- absolutely plays a role. But I would also say, as you go through the year, the account plans that you put in motion and started to define in the Q1 and Q2 should start to produce more fully in the second half. So I think the convenient answer is to always say, well, the macro does this macros that? I think if you run your playbook well, you should see those things that you've set up in the first half start to contribute in the second. So I would say we are benefiting from right now, and we started to benefit in Q2 from some of that planning we had done early in the year. You start solution selling, framing, framing the value of these things, I would expect that to continue in Q3 and Q4.

Brent Thill: And then just a quick follow-on to that. This whole theme of consolidation. There are a lot of point solutions out there. You have COVID effectively bought one of everything. Are you now seeing any tailwind to we've got to get in this consolidation move and move everything over to Smartsheet from the five other tools we cobbled together during the pandemic.

Mark Mader: I would say consolidation, Brent, is more common if an environment has multiple substantial subscription agreements in place. Very often, I would say, our largest transactions are someone basically anchoring on us for sort of their strategy for the next x years. In the context of there being a small deployment of some other provider, that's really not the payoff. The payoff is hey, how can we save $32,000 by powering something down. It's all about how do we drive yield from a very big Smartsheet investment. There have been a few cases over the years where there's been a few hundred thousand dollar deployment of company X and us, where we've won, where it is a displacement. But I would say companies are more focused on making the decision on the platform they want to bet on and then containing the existing usage of another tool as opposed to eradicating it.

The yield on eradication is just not that high. And I think a lot of people don't want to sort of unseat a division or a small team just because the payoff isn't that great. So I would say still hyper focused from our largest clients on making platform choices for future growth. And consolidation, we haven't really seen tick up that much in terms of the theme that's driving these big deals.

Brent Thill: Just a quick follow-up for Pete. Any downsizing in the largest deployment customers are out there? There's been some noise in the channel. I just wanted to clarify that. We've been giving many questions. Simple yes or no is fine.

Pete Godbole: No.

Brent Thill: Very clear. Thank you.

Operator: Your next question comes from the line of Scott Berg with Needham. Your line is open.

Scott Berg: Hi, everyone. Nice quarter. Two questions for me. Pete, I wanted to start with your comment on macro stability. I think you said there was "some macro stability". Can you help us unpack that a little bit in terms of what you meant there, in particular? Thank you.

Pete Godbole: Yes. I referenced the macro stability in the context of the enterprise customers. As I said, some of this is our selling efforts getting sort of more refined in approach, and the second is, as you build out plans with customers, just the enterprise play these things develop as customers put together plans at the start of the year and grow those through the end. So we saw that manifest itself in higher sales productivity and attainment of the enterprise team. So that's what we saw play out.

Scott Berg: Got it. Helpful. And then, Mark, you talked about a lot of several new modules that are coming out, whether they're AI-based or other items here this fall and into next year. But how should we think about what might be the next Advance or the next Data Shuttle or control center, something that will have a meaningful cross-sell opportunity that we can talk about maybe 12 to 24 months.

Mark Mader: I think a few things we've had in the portfolio, Scott, that have not been fully presented to all of our customers will be presented to them in the coming years. So when I think about the value we delivered to certain customers with our advanced resource management, our Brandfolder experiences, you should expect those to come mainline in the coming year. So what I mean by that is the average user who are [indiscernible] with Smartsheet will have a pathway to seeing what those platforms can provide and start to engage with those. And I think the largest -- one of the largest revenue opportunities for us is in getting these capabilities into more hands of our -- into the hands of more customers. Today, we are mid single digits penetrated on our capabilities.

It already produces contributes north of 30% of our revenue. So I think one of the fastest path in our next $1 billion of ARR is to really proliferate this value into the base. So I think we are always tempted by the next newest thing, Gen AI is a great example of the next newest thing that we acted on, and I think it's going to bring a ton of value. But as you're doing that, don't forget about what's in the portfolio and how you maximize that. And I think that will be actually as big a chapter in our history as Gen AI will be.

Scott Berg: Excellent. Congrats and thanks again.

Operator: Your next question comes from the line of Keith Bachman with BMO Capital. Your line is open.

Keith Bachman: Hi. Many thanks and the cash flow performance looks particularly solid this quarter. So congratulations on that. I wanted to go back to the dollar-based net retention, though. You mentioned for a prior question, you didn't want to call the bottom. But what are the contributing factors taken it down from, say, 121 to, I think you said 116, 117? I'm just surprised because a lot of the comments have been stabilization product portfolio is actually improving, may not contribute near-term. But what are the contributing factors from there? And at least how do you want us to think about the puts and takes associated with where that may stabilize because it sounds like the portfolio is getting much richer, but don't want to get too far ahead of yourself, but maybe any puts and takes we should think about? And what are the contributing factors taking it down to the 116, 117.

Pete Godbole: Keith, so when I look at your question and I break it down, I would go back and say you're going to find that there's three elements of it. There's gross churn, which isn't changing a lot, there's reductions which are, I call it, picking up modestly, not a lot, but just sort of moving up with the pace of the economy were in, it all comes down to net expansions and how that's moving. So our view on net expansion is, as you look at the progression of the quarters and the play through, we are going to continue to see net expansions be pressured. Especially, I mentioned elements like transactional business that's growing, that transactional business hasn't recovered. It's still facing the pressures of the macro headwinds we've seen. So that's what's contributing to this.

Keith Bachman: Okay. And anything you want us to keep in mind as we look out over the horizon, again, it just seems simplistically your portfolio is getting better.

Pete Godbole: It is getting better. Keith, the only thing I'd say is the laws of physics apply to anything you put out there. When you think of all the things Mark mentioned, we are super excited about those. Thousands of customers who've never ever purchased the capability, get to experience it. But the time it takes for them to try the capability, experience it, go through their process of how it applies to their work, all of that takes time. So I don't see that as contributing. We haven't built that into the contributions into the back half of the year. That's the wait and see after they've tried it.

Keith Bachman: Okay. Well, let me transition to Mark for my second question though, particularly interested in the free-to-paid scenario. And is there any dimensions you could give us about what that ratio looks like? In other words, what is your installed base in total and how much of that is paid? And how should we be thinking about -- you mentioned Gen AI. I agree could be a contributing factor to maybe changing that rate to get greater conversions. But anything you want to call out? And if you could give us some more specifics on what does that installed base look like today?

Mark Mader: Yes. I think what I'd be comfortable sharing is that the majority of the people who engage on the platform today are free collaborators. So those people have been invited to paid instances of Smartsheet and they are contributing. Many of them contribute actually changing data, not just viewers, but actually participating in workflows. We see that population as the most I guess the deepest vein we could probably tap in getting them to flip to paid. We don't give a hard ratio. I think it is useful to see that it is the majority of people engaged in Smartsheet today. So we've run this play for, what, 18 years now, where we've had the paid creator who -- or the paid licensee who can create and everyone else is basically free participants.

I think the reason we're able to make this move now is because the portfolio has just gotten to the point where so much value is available. And we've made a decision on certain things that deliver a ton of value. It just doesn't make sense to have that just freely distributed to everyone. So -- but this is really the first time we are doing it. And I think there's -- we will remain, I'd say, leading in category in terms of what those participants can do. But we are also -- we also very much believe that we should get [technical difficulty] value for the -- paid for the value we delivered. And I would say in the next two quarters, we are going to learn a lot about the reaction. Your question around when shouldn't you start benefiting from that?

I think we will benefit from that. But again, it comes down to timing, right? We give a guide for NDRR for end of the year. We also shared that we aren't going to be flipping GA likely in the second half of the year. So it really is in FY '25 on type opportunity. And we will articulate that as we head into next year.

Keith Bachman: Okay. Fair enough. Many thanks. Look forward to seeing you guys in a couple of weeks. Cheers.

Mark Mader: Thanks.

Operator: Your next question comes from the line of Michael Berg with Wells Fargo. Your line is open.

Michael Berg: Hi. Thanks for taking my question. Just one quick one -- philosophically on guidance. You had a very strong quarter across the board, but didn't raise billings guidance at all and only raised by the beat for the rest of the metrics. Maybe just help us understand are you incorporating incremental conservatism just given what you're seeing in more stabilization on macro? Just would love to get your thoughts on if there's any change in the guidance philosophy. Thank you.

Pete Godbole: So Michael, no change in the guidance philosophy. Obviously, given the macroeconomic forces we've seen, we've just embedded that conservatism into our thinking. Now you mentioned that we haven't raised the guide. If you think of the two ends of that guide, we actually raised our guide on op income quite significantly, if you notice, we beat by about $11 million this quarter, and our raise at the midpoint is about $17 million. So we are taking that approach as we think -- thought about [technical difficulty] raise as we sort of progress through each quarter.

Michael Berg: Thank you.

Operator: Your next question comes from the line of Jackson Ader with MoffettNathanson. Your line is open.

Jackson Ader: Hey, good evening, guys. First question is for you, Pete, on the improvement in the enterprise or on the macro environment. Should you -- or should we, I guess, expect that if that improvement were to continue, would that show up in a rebound maybe of net customer additions? Or would it show up more in maybe the enterprise segment NRR.

Pete Godbole: Jackson, I think that would show up more dominantly in the enterprise NDRR that we would see internally.

Jackson Ader: And then as far -- just to follow-up, as far as what we could see in the public metrics, and I guess I'm really getting after the -- should we expect net additions in any of these kind of customer strata, whether it's $5,000, $50,000, $100,000 in spend to reverse and start to see some year-over-year growth in the net additions in a particular quarter.

Pete Godbole: We are seeing net additions. If you think of our largest customer sizes, cohorts $100,000, we saw 30% growth there. I think as you start to go through the build of the future quarters, I think you're going to see that progress continue because customers are going to rely more on us and come up with more projects that they give us. Mark mentioned the customers which are even larger. I think he mentioned customers who pay us more than 0.5 million, that population is going to grow as we go through the year. That's the way you'll see it. We don't report on all those metrics all the time. But as we get more data, we'll be sure to sort of think of sharing that.

Jackson Ader: Sure. Okay. Thank you.

Operator: Your next question comes from the line of Jason Celino with KeyBanc. Your line is open.

Jason Celino: Great. Thanks for taking my questions. Maybe first on the high velocity side, I think you said you are still seeing some pressure there. Maybe to ask us more plainly, in the quarter compared to last quarter, did you see it get marginally better or worse? Or is it pretty much the same as last time?

Pete Godbole: Just as about the same.

Jason Celino: Okay. And then last quarter, you also talked about increasing marketing efforts to offset some of the weakness you're seeing on this side -- velocity side. I'm curious how the effectiveness of these marketing efforts are going.

Pete Godbole: So, Jason, we didn't describe that as last quarter as a -- to support the weakness. We just talked about things we are doing incrementally. So let me give you a quick status on how we've done. We are pretty pleased with the quality of the leads that have come out of the program. But given that this was focused on our largest enterprise customers and the fact that the timing is fairly recent. If you look at the conversion dynamics for these enterprise customers, we'd expect to see a small benefit this year, but a larger benefit as we go into FY '25. So that's the way this is likely to play out.

Jason Celino: Okay. Thanks for the clarification. [Indiscernible].

Pete Godbole: Of course.

Operator: Your next question comes from the line of Robert Simmons with D.A. Davidson. Your line is open.

Robert Simmons: Hey, thanks for taking the questions. So it sounds like enterprise maybe got a little bit better, while the online velocity [ph] business was still kind of weak. Could you also give us some color by geography and by vertical?

Pete Godbole: Robert, so if you think about our top , what I call it four verticals in book this quarter, they were, I think, manufacturing, health care, finance and retail. And I think that's just the size of the verticals. But if you look at the ones that got all which were strong year-on-year, I'd probably say it's consumer goods and education. You'll see those in live entertainment kind of sign of the times. And probably the ones that weren't strong relative year-on-year growth, you're looking at media and production and technology.

Robert Simmons: Got it. Got it. That makes sense or is helpful. And then so you raised your income guide by more than you raised the revenue guide for the year. I guess, are there specific areas that you're cutting back on or just kind of like trimming your sales a little bit? And which areas are you kind of pouring more money into?

Pete Godbole: So, Robert, if you think about the delta between sort of how we've increased our margin versus the actual revenue outperformance, I'd say some of the margin improvement comes from the fact that we are just flowing revenue beat straight into margin. But on top of that, what we are also doing is we are being extremely thoughtful on operating efficiency. It's when we hire, whether we replace a role or not, where we hire and looking at every nonrevenue sort of investment and scrutinizing it. Kind of the -- I was laughing to telling Mark the other day. I think that's just the role of a CFO and the finance org in what they do. So this is what I call no fault cost reduction that plays out into margin. That's what you're seeing play through.

Robert Simmons: Got it. Thank you very much.

Pete Godbole: [Indiscernible] Robert.

Operator: Your next question comes from the line of Steve Enders with Citi. Your line is open.

Unidentified Analyst: Hi. Thanks for taking the question. This is George on for Steve. Just wanted to follow-up Brandfolder. Last quarter, I think you called out some demand headwinds, but in your prepared remarks called out a pretty significant win. So just an update on the demand environment there. Thank you.

Pete Godbole: So, George, if you think of that we called marketing solutions and Brandfolder is the major part of it, our quarter-on-quarter, if you looked at it, that performance improved. And we did call out a big deal, which was the largest in Brandfolder history that we booked in Q2 as well. Brandfolder is a part of the market which is experiencing obviously, the impacts of the macro environment, but we are learning to sort of go after that business by listening to customers and trying to fit how we've described the benefits in an ROI way. So we are seeing that pay off a little bit for us. And we are being very smart about even how we think of pricing and packaging. More of that to come when we get the ENGAGE conference.

Unidentified Analyst: Great. And then a quick follow-up. You called out some stabilization in the macro. Anything notable on the linearity through the quarter? Thank you.

Pete Godbole: There's nothing unusual. We always see our first month be the smallest and our last month is the biggest. There was nothing unusual about the linearity, if you will.

Operator: Your next question comes from the line of Ryan MacWilliams with Barclays. Your line is open.

Pete Newton: Hey, thanks for taking the questions. This is Pete Newton on for Ryan MacWilliams. I'm pleased to see that the sequential customer adds improved across all sizes, the 5,000, 50,000. What would you say drove that step up? And then how would you characterize those conversations with customers that you're moving from one of those positions to the higher one?

Mark Mader: I think customers are looking for a conversation that goes beyond, do you need more seats? And when I think of what our teams are able to present to them now, it's really a portfolio of solutions. Do you want to talk about how you set yourself up to strategic transformation. Do you want to talk about how to drive efficiency into your marketing realm. Do you want to talk about how to execute modern project management and now starting to inject the Gen AI pieces. So you have multiple themes that are hitting. And the way we monetize both through the licensing of seats, and through these capabilities, we have more opportunities to deliver value and get paid for that. So I think the -- we are starting to -- we are continuing to see the benefits.

I spoke to the progress on the advanced sales. It was great to see that people are seeing value across that entire portfolio and saying, hey, I'm going to step into that bundle and get the benefits from all. So I think the greater -- the degree to which we can continue to see success on the capabilities, combined with seats, I think will manifest itself in this 50,000, 100,000, 500,000 levels stepping up. Yes, I think that's probably the key driver that I would point to.

Pete Newton: Perfect. That's very helpful. And then if you could comment just on average deal size closed throughout the quarter? Was there any differences later in the quarter versus earlier, or any comments there?

Pete Godbole: The average deal size, I want to make sure I understand your question. Is it the deal size that played out as we went through the quarter? Or was it the deal size in comparison to some other period?

Pete Newton: You trended through the quarter. Just trying to get a glimpse at how that linearity looked.

Pete Godbole: Yes, the deal size, typically, as you would think, the larger deals book more towards the end of the quarter. The deal size did grow, but it grew sort of consistent with our seasonal expectations.

Pete Newton: Okay. Perfect. Thanks for the color, guys.

Pete Godbole: No problem.

Operator: This concludes our Q&A session for today. I turn the call back to Aaron Turner.

Aaron Turner: All right. Great. Thank you for joining us this quarter, and we will speak to you again soon.

Operator: This concludes today's conference call. You may now disconnect.