Smartsheet Inc. (NYSE: SMAR) Q2 2023 earnings call dated Sep. 01, 2022
Corporate Participants:
Aaron Turner — Head of Investor Relations and Treasury
Mark Mader — CEO
Pete Godbole — CFO
Analysts:
John DiFucci — Guggenheim Partners — Analyst
Robert Dee — Truist Securities — Analyst
Michael Turrin — Wells Fargo — Analyst
Brent Thill — Jefferies — Analyst
George Iwanyc — Oppenheimer — Analyst
Rishi Jaluria — RBC Capital Markets — Analyst
Scott Berg — Needham & Company — Analyst
Jake Roberge — William Blair — Analyst
Keith Bachman — BMO Capital Markets — Analyst
Pinjalim Bora — JP Morgan — Analyst
Steve Enders — Citi — Analyst
Josh Baer — Morgan Stanley — Analyst
Andy DeGasperi — Berenberg — Analyst
Robert Simmons — D.A. Davidson — Analyst
Presentation:
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 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
Aaron Turner, Head of Investor Relations, you may begin your conference.
Aaron Turner — Head of Investor Relations and Treasury
Thank you, Emma. Good afternoon and welcome everyone to Smartsheet’s second quarter of fiscal year 2023 earnings call. We will be discussing the results announced in our press release issued after the market close 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 in 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 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 US GAAP financials, we will discuss certain non-GAAP financial measures. A reconciliation to the most directly comparable US GAAP measures is available in the presentation that accompanies this call, which can also be found on our Investor Relations website.
With that, let me turn the call over to Mark.
Mark Mader — CEO
Thank you, Aaron and welcome, everyone to our second quarter earnings call for fiscal year 2023. Q2 was another strong quarter for Smartsheet. Revenue in the quarter grew 42% to $186.7 million and billings grew 40% to $205.6 million, as enterprises across the globe continue to deploy Smartsheet at scale to solve their mission-critical workflows. In Q2, 62 customers expanded their Smartsheet investment by over $100,000 and 201 expanded by over $50,000. We also added three more customers to the $1 million ARR tier and now have 36 customers over this ARR threshold. We ended Q2 with ARR surpassing $736 million and now have over 11.1 million Smartsheet users.
Q2 was another great quarter for our new business motion with new business booking setting another quarterly record. We saw new wins at companies such as payment processor, REPAY, United Health Services hospitals, Bloomberg Industry Group, IMAX, Midwest Vision Partners, the broadcast management platform, Operative, Larch Consulting and Affinity Health Partners. However, we are not immune to the changing macroeconomic condition. In the month of July, we started to see macro impacts on our business, including longer sales cycles, some deal compression and additional approval layers. These impacts resulted in lower expansion rates.
Additionally, our previous guidance assumed a ramp time for sales reps we hired at the beginning of the year to be consistent with what we’d experienced in the past. However, this ramp time has been slower than we anticipated. We’re investing in new enablement tools and training to improve productivity. Given these factors, we’re taking a thoughtful approach to guidance and are electing to lower full year billings and revenue guidance with the assumption that the current macro environment persists.
While, Pete will provide more details about how the changing macro economy is impacting our financials for the remainder of the year, I want to update you on the status of our key growth drivers namely our portfolio of capabilities products, our success in the enterprise and Brandfolder. Our portfolio of Smartsheet premium add-ons that we refer to as capabilities, continues to drive deep attachment within our customer base and further differentiates Smartsheet from the rest of the CWM category.
Whether these capabilities are bundled in an advanced package or purchased individually, they power our customers’ most important workflows from data shuttle, which lets users act on data across multiple systems to control center that lets users build and operate a system of work across hundreds to thousands of projects or workflows to our Brandfolder digital asset management platform, our portfolio of capabilities lets customers connect to a range of workloads unmatched in the collaborative work management space. These differentiated offerings give our customers the keys to unlock massive value within their organizations.
An example of this is Infoblox, the leader in next generation DNS management and security that has increased its Smartsheet usage by close to 4 times since 2019. As more teams in departments at Infoblox adopted Smartsheet, they began to see opportunities to create more integrated centralized workflows using premium capabilities. Over time, they deploy data shuttle to set up a sync between their CRM and Smartsheet plus advanced reporting capabilities that help summarize their data and enable faster, more informed decision making. In Q2, Infoblox upgraded to advance to access the full value of Smartsheet’s premium capabilities. And they plan to implement a scalable, automated and secure OKR solution using control center and dynamic view.
We’re seeing more large customers deploy advanced to access multiple capabilities such as data shuttle, control center, data match and bridge for complex workflows that need to integrate with other systems in their organization. For example, the technology and consulting provider, NV5, implemented control center to automate the creation of their primary customer engagement templates to save time and achieve consistency while still allowing for changes over time. They are also using work apps and dynamic view to create custom views for field teams that only show them the information that is relevant for their role helping ensure data security at scale.
And revenue from capabilities continues to grow rapidly and now accounts for 28% of our subscription revenue compared with 22% in Q2 of last year. Advance, which packages various capabilities was included in 300 deals in the first half of this fiscal year, including those with biopharmaceutical companies Sobi, Crown Roofing & Waterproofing and Elligo Health Research. The growth potential for capabilities remains very strong. Through Q2, only around 7,000 of our more than 1,000 customers had deployed at least one capability. Those customers are realizing significant ROI on their Smartsheet deployments and are expanding at a rapid pace. This value realization naturally gets the attention of senior executives who are increasingly involved in the decision-making process.
This value based enterprise go-to-market motion has demonstrated an increase in executive leader selecting Smartsheet as their CWM platform of choice. I’d like to highlight a few Fortune 100 companies where that’s happening. In Q2, a Fortune 100 entertainment company expanded its Smartsheet investment by over $700,000 taking their total ARR to over $3 million. With this expansion, they migrated to the next tier of connected users for their advance gold deployment. This company has doubled the number of paid licensed users over the past year, adding roughly 3,000 enterprise licensed users and has now tens of thousands of connected users and that number is expected to increase further, as Smartsheet is now the central component in the company’s effort to consolidate the work management solutions it uses. An executive in their IT department suggested that other CWM platform used in the organization will be retired in favor of Smartsheet.
A Fortune 50 pharmaceutical company more than doubled its ARR or to almost $1 million, as its teams launched [Phonetic] Smartsheet to help them manage the spin off of one of its divisions and will continue to use Smartsheet in the resulting two companies. Most important, the company’s expected ROI of its Smartsheet deployment is $3 million in just year one. We also won an RFP at a Fortune 50 food and beverage company to become their global standard for collaborative work management. While this company has a low six-figure customer today, this RFP win sets the table for rapid growth over the next few years. RFPs are still rare for our business, but this shows that in a rational head-to-head comparison, Smartsheet won, thanks to our years of investing in our platform to delivering extensibility, scalability and security that businesses demand.
One more example I’d like to share from Q2 is a Fortune 10 technology company that expanded by over $1.7 million in Q2, accelerating our growth within this organization to a total of $7.6 million in ARR. Last year we became a globally approved CWM platform for the company. This approval has helped fuel significant adoption of Smartsheet across several dozen large departments. Previously, I’ve emphasized the importance of our Brandfolder digital asset management platform as key to cementing our leadership in the CWM space. Naturally, we spent a lot of time understanding how to optimize workflow management for marketers.
One of our insights is that marketers need to distribute content across more channels at higher velocity, while ensuring brand consistency. Marketing teams are being asked to do more and more with fewer resources. To meet customers’ expanded content distribution needs, we’ve acquired the leading brand management templating and creative automation platform, Outfit. Outfit will turbocharge Brandfolder’s content distribution capabilities, making us a leader in the content automation and management space. We’re looking forward to introducing Outfit and the many other exciting new Smartsheet features and capabilities to thousands of users at our ENGAGE 2022 Customer Conference taking place September 19 through 22nd in person for the first time since 2019.
In closing, the new economic reality organizations are facing has impacted a portion of our business, yet we remain confident in our ability to deliver long-term durable growth and profitability. This confidence is due to our position in the market, our differentiated suite of capabilities and our market-leading presence in the largest companies in the world. We are carefully managing our resources to drive improved margins and we remain on track to achieve breakeven free cash flow by end of this fiscal year.
And now, I’ll turn it over to Pete. Pete?
Pete Godbole — CFO
Thank you, Mark and good afternoon, everyone. As Mark mentioned, Q2 was a strong quarter that reflected durable growth, a product set that powers how work gets done in the largest enterprises around the world and a resulting business model that shows sustained progress to profitable growth. We saw this in 40-plus percent revenue and billings growth, dollar-based net retention rate greater than 130% and gross churn that is at a record low of less than 4%. In July, we began to see macro-related headwinds in the form of elongating sales cycles, procurement policy changes, deal compression and lower pipeline close rates. This trend has continued into August. We have incorporated those macro headwinds into our updated full-year guidance and I will provide additional details towards the end of my prepared remarks.
Regarding the composition of our customer base, approximately 50% of our ARR now comes from enterprises with over 2,000 employees with only a quarter coming from SMBs. Our ARR also remains very diversified with only 13% coming from our largest vertical. As Mark mentioned, we recently acquired Outfit to enhance our Brandfolder offering. We expect the revenue and billings contribution from Outfit to be around $1 million each for the rest of the fiscal year. 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 $186.7 million, up 42% year-over-year. Subscription revenue was $173.5 million, representing year-over-year growth of 43%. Services revenue was $13.2 million, representing year-over-year growth of 24%. Turning to billings, second quarter billings came in at $205.6 million, representing year-over-year growth of 44%. Approximately 91% of our subscription billings were annual with 4% monthly. Quarterly and semi-annual represented approximately 4% of the total. Multi-year billings represented approximately 1% of total billings.
Moving on to our reported metrics. The number of customers with ARR over $50,000 grew 48% year-over-year to 2,738. And the number of customers with ARR over $100,000, grew 63% year-over-year to 1,220. These customer segments now represent 58% and 44%, respectively of total ARR. The percentage of our ARR coming from customers with ARR over $5,000 is now 88%. Next, our domain average ACV grew 28% year-over-year to $7,557. As a reminder, we continue to experience healthy growth of new customers.
New customers typically begin their Smartsheet journey at small dollar values than our overall average ACV. These initial lands put some pressure on our domain average ACV growth rate in the near term, but provide a healthy base for expansion in the future. We ended the quarter with a dollar-based net retention rate of 131%. The full churn rate dropped further and is now below 4%. Given the current macro environment, we see a scenario that would cause our overall dollar-based net retention rate to be in the mid to high-120s by the end of the year.
Now, turning back to the financials. Our total gross margin was 82%, our Q2 subscription gross margin was 87%. We continue to expect our gross margin for FY ’23 to remain above 80%. Overall, operating loss in the quarter was negative $16.1 million or minus 9% of revenue, which represents a 5 percentage point sequential margin improvement. The margin improvement was the result of cost saving initiatives we discussed last quarter, which included moderation of our hiring plan and cost rationalization. Additionally, we let a significant portion of our revenue outperformance drop to the bottom line, demonstrating the operating leverage inherent [Technical Issues].
Free cash flow for the quarter was positive $7.1 million, bringing our free cash flow total in the first half to negative $2 million. Looking ahead in Q3, we have three large cash outflows that are unique to the quarter related to our ENGAGE Customer Conference, one extra payroll run in the quarter and our semi-annual contractual payment related to a cloud provider. Given these outflows, we expect our Q3 free cash flow to be negative $20 million.
Now, let me move on to guidance. As we mentioned previously, towards the end of July, we saw macro-related headwinds begin to emerge. These headwinds continued in August and that impacted our sales productivity and ramp time for our newer sales reps. Given these trends and our preference for prudence, we are taking a thoughtful approach to our full year guidance and electing to guide under the assumption that the macro pressures continue through the end of the year.
For the third quarter of FY ’23, we expect revenue to be in the range of $193 million to $194 million and non-GAAP operating loss to be in the range of $21 million to $19 million. As a reminder, in Q3 we will host our first in-person customer conference in three years, which we believe will result in incremental expenses for around $5 million on our sales and marketing line. We expect non-GAAP net loss per share to be between $0.16 and $0.15 based on weighted average shares outstanding of 130.5 million. For the full fiscal year ’23, billings are expected to be in the range of $870 million to $880 million, representing growth of 32% to 33%. We expect our revenue to be $750 million to $755 million, representing growth of 36% to 37%. We expect services to be 7% of total revenue.
We are improving our non-GAAP operating loss to be in the range of $75 million to $65 million and non-GAAP net loss per share to be between $0.56 and $0.49 for the year based on approximately 125 million weighted average shares outstanding. This improvement in our profitability is due to cost reductions and efficiencies identified in non-revenue generating areas of our business combined with a more measured investment posture we articulated earlier this year and a careful evaluation of our expenses and policies. We are maintaining our free cash flow guidance for the year of breakeven.
To conclude, Smartsheet is a system of work able to scale for the largest most demanding businesses in the world. With ARR approaching three-quarters of $1 billion and revenue growth in the high-30s, I believe our value proposition positions us to deliver long-term durable growth with improving margins and outsized cash flow.
Now, let me turn it back to the operator for questions. Operator?
Questions and Answers:
Operator
Thank you. [Operator Instructions] Your first question today comes from the line of John DiFucci with Guggenheim Partners. Your line is now open.
John DiFucci — Guggenheim Partners — Analyst
Thank you. I have a question for Mark and then a follow-up for Pete. Mark your commentary about the strength of the quarter that sort of agrees with our calculations anyway for new business in the period. I realize there were some things that you’re seeing in the macro environment. It makes sense to me to be as you and Pete both said more prudent regarding your outlook. But just a clarification on the ramp time for new reps. Is the time required growing simply because of the macro backdrop or has the job gotten more difficult as you build out your platform?
I mean I think about Smartsheet years ago when I first became acquainted with you and it’s Smartsheet, the applications, just, it’s a much more sophisticated, it’s still easy to use, but it’s a more sophisticated and complex application. I’m just wondering if that job has just gotten more sophisticated, the requirements for the sales job?
Mark Mader — CEO
I think the requirements have John, but I’ve also seen the support mechanisms we have around enablement and the tooling dramatically improve from the early days. So, I think with that larger surface area of the offering and more value we can deliver, I think we have put good support structures in place for that. So, I would point to macro as being the largest impact. And when you look at bringing in many new sales reps the beginning of the year where they’re being assigned existing accounts, most of our bookings motion is expansion. Those new reps are going to talk to existing customers and I think that relationship between the new rep who is trying to articulate value to an experienced customer, I think during these times there is a more pronounced effect [Phonetic]. But we’re supporting our reps, we’re investing in new tooling and I think it’s going to result in capacity that we get to carry next year as well. So, I think there will be a pay-off.
John DiFucci — Guggenheim Partners — Analyst
Okay, good. And so it’s just good to hear you, you’re not going to give an out to say it’s a harder job. That’s great. Pete, listen, this looks like to us anyway a really strong quarter and a big uptick from last quarter at least from the way we look at it. And again, I get the prudent guidance here, but I’m just wondering when you gave the guidance, are you assuming the macro backdrop just sort of stays as it is or that it continues to soften through the rest of the year?
Pete Godbole — CFO
So, our assumption John is that the economic backdrop stays fairly consistent and slightly weakens as we go through the year.
John DiFucci — Guggenheim Partners — Analyst
Okay, great. Thanks. That makes a lot of sense to me. Okay, thanks a lot guys.
Mark Mader — CEO
Thanks, John.
Operator
Your next question comes from the line of Terry Tillman with Truist Securities. Your line is now open.
Robert Dee — Truist Securities — Analyst
Great. Thanks so much for taking the question. This is Robert Dee on for Terry. My first question relates to macro positioning. I’m curious, how does the playbook change if at all for continuing to drive new logo strength amid a tougher macro environment and what are some of the assumptions for new logo adds implied in the current guide? And then I have one follow-up. Thank you.
Pete Godbole — CFO
So, our assumption as you looked at your question was on looking at sort of where we are seeing the macro changes in our environment, I think we’ve seen it across the board. We’ve seen it in all segments of our business. And what I would say is that it’s not in any particular vertical, it’s spread across all elements of it and that’s what we’ve assumed in our forward-looking guide. We’ve extended what we saw in July and August, all the way through the year.
Mark Mader — CEO
And on the new logos, we continue to see with quite a low-entry point in terms of dollars. You know both the volume and the velocity has remained. And as I speak to peers and other SaaS businesses, it’s what many of us are seeing, is that we’re seeing on the more a critical eye coming to the larger expansion opportunities where maybe there are additional layers of approval coming into play. But on the sub-couple thousand dollars new business logo, those are still flowing quite well.
Robert Dee — Truist Securities — Analyst
Okay, great. Thank you. And then as a follow-up, nice to see some impressive benefit stats on Brandfolder out of Forrester last week. How has Brandfolder’s ROI proposition been resonating with customers, both for those who have adopted the solution and for folks who haven’t and how might that evolve with the addition of Outfit? Thank you.
Mark Mader — CEO
While the addition of Outfit is an interesting one, because it’s a response to what we’re hearing from some of our larger enterprise opportunities where they have larger teams who have a larger production needs and that need for content automation really ties out to the enterprise opportunity. So, I think it’s a really strong — it’s a very favorable impact to Brandfolder’s ROI statement. But even if — even a mid-sized companies, I think there’s still a lot of learning in the market right now about graduating from simply having your digital assets available to you to be able to tag them, distribute them, measure of the usage of them and when people take the time to read that ROIs and hear from a rep, we’re seeing very, very positive response. We’re still in that early phase of getting Brandfolder ramped on all of our reps so that co-selling motion between our Brandfolder team and our mainline reps that’s something which we would expect to continue to strengthen throughout the year.
Robert Dee — Truist Securities — Analyst
That’s great, thanks so much.
Mark Mader — CEO
Yeah.
Operator
Your next question comes from the line of Michael Turrin with Wells Fargo. Your line is now open.
Michael Turrin — Wells Fargo — Analyst
Great, thanks. I appreciate you taking the questions. First is just kind of a higher level question, it ties into some of what you’re saying and it’s a consistent with what we’re hearing more broadly across software, just signs of elongation, more scrutiny and sales cycles, deal decisions. I’m just wondering if you’re finding tangible stats around ROI or efficiency gains or just how well equipped your sales team is to raise their hand and position as these conversations just kind of just continue to layer on across software?
Mark Mader — CEO
Yeah, I think, I think especially when we’re introducing our premium capabilities, those capabilities either advance, which is the package of them or the one-off capabilities, I think those lend themselves most strongly to an ROI statement and when people can move from qualitative to quantitative measures, the confidence goes way up in the sales cycle. I think what we’re looking to do is, how do you get more of those capabilities exposed to more people earlier. So, part of what we’re doing on the engineering side over the next year is figure out how we can get more of that portfolio exposed to people on a self-directed basis as opposed to a human-assisted sales basis.
So, I think it’ll be very interesting to see next year how that more self-direct digital motion can open up more of the portfolio. But when you talk about things like control center and data shuttle and content automation lifecycle, it is grounded in doing more things, letting the system do more things in an automated way that can tie up directly to a human being or set of human beings not needing to be as involved and that’s where people feel very confident in the formula. And so my aspiration is, how do we get more of those capabilities driven into the median buyer as opposed to 7,000 of our more than 100,000 customers.
Michael Turrin — Wells Fargo — Analyst
That’s super helpful. I think you’ve already gotten some questions just around the metrics on Q4 looks strong. You’re talking about low churn and the expansion rates holding in relatively well. In terms of what you’re guiding for just, is it fair to assume that more of those impact show up on the net new side of your business and we know there is generally a 4Q heavy billings dynamics. So, just anything you can add around visibility you have into the existing base there given some of the uncertainty you’re seeing?
Pete Godbole — CFO
Yeah, Michael, it’s, if you look at the change in our billings guidance, which is the key part of the conversation, it is all in the existing expansion business and it’s really net expansion side of it where this is playing out and if you sort of break it down into a few categories, you would say, of the total change, 1% of it probably comes from FX, 1% of it is almost tied to Europe. And the economic weakness we’re seeing in Europe and of the balance of the numbers, there’s probably 2% of it tied to just taking this large class of sales reps and getting them to the median level of productivity for our experienced reps and then the rest of it is in the macro changes and out there. So hopefully, that gives you the color you’re looking for.
Michael Turrin — Wells Fargo — Analyst
I appreciate you quantifying like that. Very helpful, thanks.
Operator
Your next question comes from the line of Brent Thill with Jefferies. Your line is now open.
Brent Thill — Jefferies — Analyst
Pete, just on the margin, how are you thinking about the environment we’re in, in the expenses that you’re carrying going forward? Are you still holding your plan for quota reps and investments that you had planned in early year? Are you topping their rates a bit there as well there to time up that approach?
Pete Godbole — CFO
Brent, I think what we’re focused on is driving operational efficiencies in what I call the non-revenue generating growth that we’ve got. We’ve moderated our hiring plan, focusing on ancillary and support roles that aren’t core to revenue generating sort of activities, if you will. We’ve also taken the approach of what I call hiring in different locations and really focusing on things which every expense dollar is important and taking the approach of, we’ll review every dollar and find efficiencies there. As it relates to the sales rep and the quota class, we feel really good about the capacity we are carrying in and it’s going to set us up really well, not just for this year but the way we think of FY ’24 and how that appears. Now, we will make changes to our sales capacity based on sort of management adjustments of, as we onboard reps, but that’s the plan.
Brent Thill — Jefferies — Analyst
Okay and then just a quick follow-up, when you guys talk about some of the pressure you’re seeing, is it more seat-based? Are you seeing more on seats or this upsell to higher value inside the installed base? What are you seeing there?
Pete Godbole — CFO
I think we’re seeing it in two forms. I think we’re seeing it, I would describe it in terms of customers who are earlier in the journey are seeing more of it. So, that could be a seat-based expansion or their ability to buy capabilities in packages, you’re seeing some of that. But I think you’re not seeing it as much in customers who are way down the journey with us and has seen the full value and they I would say expanding at rates which were consistent with what we planned.
Brent Thill — Jefferies — Analyst
Thanks.
Operator
Your next question comes from the line of George Iwanyc with Oppenheimer. Your line is now open.
George Iwanyc — Oppenheimer — Analyst
Thank you for taking my question. So, maybe following up on this sales investment priorities that you just talked about Pete, can you give us some perspective on the R&D priorities and how you’re looking at the near-term investment that you’re prioritizing now?
Pete Godbole — CFO
Yeah, you know, we’ve thought of R&D as, we hired a large class of our R&D kind of capacity we needed early in the year and we continue to build that through Q2 in sort of very targeted areas we knew we needed to grow in. So, that’s been the playbook. We’re going to be looking at opportunistic hiring in R&D as we go through the year, but we’re certainly not sort of indexed to the same level of hiring we had in the first half.
George Iwanyc — Oppenheimer — Analyst
Okay. And maybe Mark following up on that, can you give us a sense, like you talked about the self-surface investment. Are there other areas, either from an M&A perspective or a roadmap that you’re really focused on?
Mark Mader — CEO
As we head into ENGAGE, we’re going to be announcing a number of things in late September and they really go across the entire portfolio from enterprise control and governance capabilities to scale capabilities in our control center line to experiential things that impact every new collaborator and every new person who signs up for our service. And I think one of the things, one of the benefits we get from operating at scale is that we don’t have to make choices at the expense of one of those important areas. So, I really feel good about the investment balance we’ve achieved. And we have not had to eliminate focus from any one of those important themes.
George Iwanyc — Oppenheimer — Analyst
Thank you.
Operator
Your next question comes from the line of Rishi Jaluria with RBC. Your line is now open.
Rishi Jaluria — RBC Capital Markets — Analyst
Wonderful, thanks so much for taking my questions. Maybe first I wanted to start just doubling down a little bit on Brandfolder and Outfit, it does feel like you’re maybe and please tell me if I’m wrong on this interpretation, it does feel like you are kind of doubling down on the marketing use case. I know this is a horizontal platform. There is virtually unlimited use cases. But can you maybe talk a little bit about the feedback that you’ve been getting from our customers and prospects that led to kind of this motion to go deeper on the marketing side? And then I have a follow-up.
Mark Mader — CEO
Yeah, I think when you can identify a pattern of requests especially within the enterprise class buyer, it’s a huge gift when you see a pattern emerge in terms of what multiple people want. And this notion of being able to store and classify and distribute content everyone gets that. I would say the importance of not just being able to create a template which is, here’s my digital asset, I need to overlay some content on it, but saying I need to do that at scale because I’m running a campaign with 300 different assets that needs to be created. If you don’t have that you’re basically telling someone build it manually, do 300 assets and what content automation does for you, it says define your frame, have your content, which will live in a Smartsheet and then merge that and you do — you can eliminate a lot of manual load within your design team, like that is a really easily understood concept.
What we’re seeing within Brandfolder is that the resonance of digital assets is starting to expand beyond marketers. So, when you have people within health, within construction, within tech, all keying off on that. I think it’s still early. But we are definitely seeing signs of relevance outside of the marketing function. But I think the content, we’re as we talk about quantifying value, the absence of this content automation I think puts you back in the — force you into sort of a manual discussion, which is really counter to our thesis. So, I think it’s a really nice complement to what our, what our brand promise has been.
Rishi Jaluria — RBC Capital Markets — Analyst
Wonderful. It’s really helpful. And then look I appreciate all the commentary around expense control, obviously the prudent thing to do in this environment, but maybe one that I’d like to drill down a little bit more on is the stock comp, right. It definitely continues to get elevated, right. SBC is now about 25% of revenue, you’re tracking close to 4% annual dilution. I mean I know it’s obviously a massive way to analyze it. But maybe taking a step back, can you talk a little bit about your philosophy around stock comp and any kind of longer-term or medium-term plan you may have to kind of get stock comp down over time? Thank you.
Pete Godbole — CFO
So Rishi, this is Pete. You know, your question on stock comp, let’s talk about the texture of how stock comp is created, you’re generally carrying a cohort of multi-years of grants, which all there into sort of annual compensation levels, they become a part of the stock grant calculation. We are extremely mindful and controlling and managing this expense and it starts with how we think of stock and how we think about leveraging it. So, we haven’t taken the approach of what I call re-greening our entire population. We’ve taken a very thoughtful approach as saying, we’re going to focus on selective number of hires coming into the business, granting them stock on what we consider is a reasonable basis and really managing that the total stock grants first and then driving that into compensation expense and ensuring that we have outcomes are acceptable to us. So, that’s been a part of a deliberate effort Mark, myself and the management team have gone through.
Rishi Jaluria — RBC Capital Markets — Analyst
That’s really helpful. Thank you, Pete. Thank you, Mark.
Mark Mader — CEO
Thank you.
Operator
Your next question comes from the line of Scott Berg with Needham. Your line is now open.
Scott Berg — Needham & Company — Analyst
Okay. Hi, everyone. Thanks for taking my questions. I guess I wanted to pivot and talk about Outfit a little bit more. Obviously, small purchase price here, you’re not obviously buying customers here, you’re getting product on this, help us understand a little bit more of the fit with Brandfolder and from our pricing product perspective, is this something that can really drive ARPU in a significant way over time is to develop the product as you want or is this more of a maybe a smaller add-on that just helps straighten you some modest differentiation from the risk, the competitor set?
Mark Mader — CEO
I think first Scott, it would, I really see it as an opportunity to improve our win rates with Brandfolder. So, I think that’s the primary benefit. There is evidence within their customer portfolio that larger organizations assign significant value to this. Now this, it is, it is, that is an emerging set of evidence but we see at scale, some of those, some of their customers being multiples of size of the average revenue that Brandfolder customer would have stand-alone. So we will, we will integrate it. We do see it as an add-on for which we will charge as opposed to having it be a freebie. The degree to which they will manifest itself in a meaningful adjustment to our revenue, early days. But I absolutely see this as a buy-up opportunity for customers because there’s such value associated with it.
Scott Berg — Needham & Company — Analyst
Got it. Helpful. And then following up on Pete’s comment earlier about sales rep hiring this year, most of the, I guess not necessarily cost reductions but delayed hiring is a non-kind of sales or revenue revenue generating positions you’re going forward and the rest of the half is, should we take that kind of the same way around the rest of the sales kind of ecosystem within the company outside of just the quota-bearing sales reps?
Pete Godbole — CFO
Yeah, I think you know we’ve taken the approach of the quota-carrying field carriers, there’s many of them in those roles. But generally leaving that capacity sort of as the capacity we want to deal with and help us for ’24, but there is support roles in sales which are a part of like our moderated hiring plan. In terms of infrastructure roles that support sales systems, those I consider more in the boxes, what I call the rest of the folks who support the sales organization.
Scott Berg — Needham & Company — Analyst
Got it. Very helpful. Thank, again.
Operator
Your next question comes from the line of Jacob Roberge with William Blair. Your line is now open.
Jake Roberge — William Blair — Analyst
Hey guys, thanks for taking my questions. I was just wondering if you could talk more about the demand that you’re seeing in some of those newer products like work apps or data shuttle and Brandfolder? And have any of these been more or less prioritized given the uncertain macro environment and some of the headwinds that you experienced over the last month?
Mark Mader — CEO
Yeah, I would say the ones that are really resonating are the ones where there’s such a clear economic return on the decision, so data shuttle is a great example. Do you want to be manually managing ingress-egress of data in your system or do you want to put it on rails and hit the go button. I mean this super-simple value prop. So, that one is probably the highest-velocity simplest to describe. I would say on the control center one where it’s analogous to data shuttle in the sense that, do you want to have a program and replicate it manually and do all of the portfolio management hand to mouth or do you want to put it on rails in control center and have it do it for you. Those are concepts which are landing really well.
I would say on the Brandfolder side, the degree to which a company has big distribution needs, the degree to which it has content automation needs, the degree to which it has a templating need, that drives the degree to which there is a strong ROI case for Brandfolder. If it’s simply I’d like to store my assets in a more digital, more beautiful digital way, that’s not really carrying the data fully. So, we’re really mindful of understanding what that need is from the customer before we make that ROI promise. But again back to those back to the data shuttles, the control centers and the Brandfolders, the ability for us to get our reps in a position where they can present that value is really, really landing well to folks right now.
Pete Godbole — CFO
And one of the, second part of your question was what’s changing in the demand environment. So you know, we’ve seen people really appreciate the impact of our premium apps called capabilities that really help us. We are happy, we want to sell people the package because it’s easier for them to consume and it helps them long term. But you know we’re open in this environment and we are seeing customers elect in cases to buy the [Indecipherable] because that’s the way they want to consume them. So, we have the flexibility in our model to do both. And we’re going to take the total addressable market in the way — the ways customers want to sort of use it.
Jake Roberge — William Blair — Analyst
Great, thanks. That’s really helpful. And then can I just double click on some of the sales headwinds that you’re experiencing? Is it really just a macro and training issue or are there any territorial or quota restructurings that you plan to complete over the balance of the year?
Pete Godbole — CFO
So, I think the headwinds we described were three-part. There was an elongated set of sales cycles we were seeing. We’re talking about seeing some deal compression and then there was an additional level of approval layers that were being introduced into the process. So those are the, what I call macro elements that we were seeing across everything we were sort of experiencing in our entire base, if you will. The second part of your question was what was additional is we had taken sort of a very large class, introduced that into the field and what we found is that there was more ramp time needed to get these folks to be productive, not — they are productive today, but there could be more productive relative to our experienced trips and that’s the effort we are driving with single-minded focus to get to them.
Jake Roberge — William Blair — Analyst
Sounds great. Thanks for taking my questions.
Operator
Your next question comes from the line of Keith Bachman with BMO. Your line is now open.
Keith Bachman — BMO Capital Markets — Analyst
Yes, thank you. I have a couple really focused on margins and I want to kind of build on the previous question on SBC. If I look at the, your operating loss is improving pursuant to your new guidance yet even if I kind of look at Q4, it’s still guessing a little bit here but negative 5% kind of operating margins and the broader question I want to start with is as we reflect on our models here, how do we get to improved profitability? What’s the key attribute because your average ACV is still pretty small relative to your client base $700,000 and so your sales and marketing is certainly high relative to most software companies. So, the question is how do you improve your reach and grow your ACV, but at the same time I think satisfy investors that in fact you can improve your margins? Not only improve but start to generate non-GAAP operating profit dollars. But if you just, is it simply scale? But how do you solve that sales and marketing riddle and really reach the operating profitability?
Pete Godbole — CFO
So, Keith, your question has two components to it and I’ll speak to both. I think the first thing we’re seeing in our business is our largest customers are driving the greatest profitability for us. So, as we get bigger, just a natural migration to the model, larger percentage of our business coming from these larger customers there is an inherent lift in profitability. The second part of that is when you think of like introducing newer products like Brandfolder what we do is we leverage our mainstream sales force in what we call our core prime — prime core prime model where we’re not adding pro rata sales and marketing dollars but we’re leveraging an existing base to farm demand and using that as a uplift to our margin profile. So, think of those as the two drivers, which would you think as drivers as examples in the sales and marketing efficiency camp. And then there are things which we achieve is scale. The larger we get, the more we get to use location, geographic hiring, efficiency and automation which we get to build in. We’ve taken a single-minded focus in doing that effectively and efficiently. And between those elements we have a story we’ve built out for this year, but we don’t expect it to stop here. We expect it to continue into future years as well.
Keith Bachman — BMO Capital Markets — Analyst
Okay. Okay. Yeah, I think investors would like to understand what the roadmap looks like, but I assume we’ll find out your guidance in a few quarters on 2023 or FY ’24, excuse me. But you led into my second question is really how do you think about M&A and if you — are there parameters that you think about in terms of willingness to do deals that might possibly or tentatively negatively impact your operating margin trajectory? Are there is any boundaries that you would not do a deal in terms of the margin impact? If you could just talk a little bit more about the philosophy on M&A as it relates to the impact of margins.
Pete Godbole — CFO
So, Keith our signal that we’ve used in the past has historically always been where customers and enterprise buyers are telling us that there is a demand and there is a clear established signal. And why that’s important is because you’re establishing that into where you can eke out a return in terms of top line sales dollars and growth. So, we are looking at adjacencies, which fit that profile. That’s the first thing we’ve done. Even with the most recent acquisition of Outfit, it really helps our Brandfolder sales perspective in future fiscal years and that’s what we’ve indexed on. So, you asked me about the boundary condition. We’re being extremely thoughtful about returns that acquisitions give us and that’s been the metric we’ve been using. What’s the dilution impact it has. What’s the accretion I expect in the top line and how am I trading against those.
Keith Bachman — BMO Capital Markets — Analyst
Right. Okay, all right. Well, congratulations on the result given the backdrop seemed pretty solid. So, congratulations. That’s it for me. Many thanks.
Pete Godbole — CFO
Thanks, Keith.
Operator
Your next question comes from the line of Pinjalim Bora with JP Morgan. Your line is now open.
Pinjalim Bora — JP Morgan — Analyst
Great. Hey, thank you for taking the questions. I wanted to go back to the elongated sales cycles comment. Could you give us maybe more texture around if it was more enterprise/small and mid-market business driven? Was there any difference between the various geos and was the elongation largely around larger size deals versus smaller?
Pete Godbole — CFO
So, when we looked at it, there was a general elongation of sale cycle. But I think it was more pronounced in the enterprise, because you think of the sophisticated buyer that looks at every deal and the mechanisms they have to react to things before they are fully trends in the their business, we saw that. So, that’s kind of what we would represent as being elongating sales cycles by segment or tier.
Pinjalim Bora — JP Morgan — Analyst
I see. Understood. Okay. And the other question I guess, when I’m looking at the billings guidance, I did this math is pretty quickly, but it seems like the second half slows about 10 points versus the first half and it seems like the slowdown was more pronounced during during 2020 when you had to take the billings guidance off the table at that time. Maybe compare the two environments. What are you hearing — what you are hearing from customers or seeing in the deals now versus what was in the — that July, April-July timeframe in 2020?
Mark Mader — CEO
I think what we’re seeing is the — I think the conditions that we saw in 2020 were quite new to people, right. There were set of variables that many people had to face before. So, I would say there was, while there is some lack of certainty on what — how the conditions are improving or worsening, I would say we’re dealing with slightly more recognized set of variables that we did in 2020. What’s changed for us internally, what’s different than 2020 is, we had, we had a different set of inputs we were dealing with. So this year we brought on the largest class in company history in the first half. We didn’t do that in 2020. So, how we’re reacting is fundamentally to a different set of conditions.
In terms of what the buyers are going through where the commonality does sit is, they’re asking for, what’s the value, what is, what has changed a little bit this go around is not only what’s the value, what’s the return. But I would say there is more focus now on how quickly can you get that return to me. So, I’d say the time horizon around the return on the investment is probably more pronounced than it was in 2020.
Pinjalim Bora — JP Morgan — Analyst
Understood. Thank you.
Operator
Thank you. Your next question comes from the line of Steve Enders with Citi. Your line is now open.
Steve Enders — Citi — Analyst
Hi, great, thanks for taking the question. I just want to ask a little bit more on some of the go-to-market aspects of the business. I think you mentioned that you thought there is more you could do on the sales enablement side to try and — to try and turn things around. But how are you going to feel about the levers that you could potentially pull in some of the different marketing strategies to put in place to try and — to try and drive better penetration expansion rates and accounts?
Mark Mader — CEO
I think one of the things that’s really welcome change is, in past years, our ENGAGE Conference has been a big driver in terms of customer education, understanding the possibilities and also spending time with our most valuable teams in person to develop account plans. The first time we’re doing in three years. Registration for an in-person event is going well. That will be, that will be, that will be an event where we have thousands of people in Seattle. So, we have some of our largest teams, our largest customers already signed up. You have teams of people showing up representing those company. So, that’s a really positive variable.
I would say other things that we’re doing is improving our product marketing and how we cross-sell and cross-introduce the portfolio that we know is single digit penetrated today. So, a big product marketing push in the second half is around developing new materials, not just for enablement but also to educate customers at the right time on what they could be doing with Smartsheet. And I think part of that is through we brought on a new CMO at the end of last year. Andrew and his team are hitting stride, they’re developing new things, they’re hiring new product marketing team members and I expect that to start benefiting us in the second half. So, we have some changing variables that should be positive as we exit this year and head into next.
Steve Enders — Citi — Analyst
Okay, that’s helpful. And then I guess kind of beyond the marketing area and what you’re doing with Brandfolder there. I guess how do you think about other verticals, other core use cases you could go after and really kind of simplify the solutions that kind of more tailor it for some specific, specific areas?
Mark Mader — CEO
Yeah, we are doing work right now on identifying commonality around use cases within our largest customers. So, we just presented to our Board this last week, the approach we’re taking on how to have a more recommendation based set of use cases that we can introduce to our sales team. So, this commonality in the core value prop, not so much just like PPM and marketing, but like more specific granular functional use cases in certain industries where we’ve been very successful. So, that is something which is very much in flight right now.
I think the — in terms of how our customers are responding to use cases, I would say we continue to see requests for more sophisticated capabilities. I’ll give you an example. For years, we saw the ability to manage projects of scale and when we talk about applying resource to them, which we do very well, we have given people, the ability to track resource allocation across their work. Great. The largest companies in the world also saying, help me understand the forecasting of that. Don’t tell me how I’m assigned but what type of capacity do I have looking forward across the skill sets I have. There is a whole set of capabilities in project and portfolio management and the management and utilization of resources that is being developed today, which is going to be coming out in the coming quarters. So, we’re extending the depths of some of these capabilities as opposed to saying what are other simple things we can do in adjacent spaces.
So, I think the differentiation in our category. The winner, long term will not simply be a very broad-based set of capabilities that are simple, but have very, very discrete differentiating enterprise capabilities that are deeply understood and in demand. So, as we build our portfolio, it’s not about just broadening, it’s by deepening. And so far we’ve seen those capabilities work really well.
Steve Enders — Citi — Analyst
Perfect. Thanks for — thanks for taking the questions.
Mark Mader — CEO
Yeah.
Operator
Your next question comes from the line of Josh Baer with Morgan Stanley. Your line is now open.
Josh Baer — Morgan Stanley — Analyst
Great, thanks for the question. I think with billings linearity, I would assume weighted toward the end of the quarter, just wondering why the macro impacts that surfaced in July didn’t have a more significant impact versus the 44% billings growth and billings outperformance in the quarter?
Pete Godbole — CFO
You know the impact that we saw in July was partly through July, so you saw some impact of it. And frankly, without that impact we would have an even bigger quarter in how the quarter would have played out in billings. So, that’s the trend we saw and I think we saw that trend play out or extend itself out as we went into August as well and which became the basis of our guide.
Josh Baer — Morgan Stanley — Analyst
Okay, that makes sense. So, was, would you say May and June were sort of in line with your expectations or what — like kind of thinking month by month were those actually extra strong?
Pete Godbole — CFO
No, I think, month by month they were fairly consistent with what we would have expected. And what we’d historically seen, so there was no, nothing unusual about May or June.
Josh Baer — Morgan Stanley — Analyst
Okay, great. Thank you.
Operator
Your next question comes from the line of Andy DeGasperi with Berenberg. Your line is now open.
Andy DeGasperi — Berenberg — Analyst
Thanks for taking my question. I guess, I mean, first just a follow-up on the employee side, I mean has employee retention been an issue since the realignment, particularly on the quota-carrying side or have you not seen any changes?
Mark Mader — CEO
We have not seen a meaningful change in attrition rates.
Andy DeGasperi — Berenberg — Analyst
Great. And then secondly, just on given the change in market conditions, I just wondered if you’ve seen an improved competitive environment, particularly from the smaller CWM players? Or is it, has that been unchanged as well?
Mark Mader — CEO
It’s, we don’t — there’s not a lot of head to head. As I said, when we have those — like those rare but notable RFPs, we’re talking single digits in the quarter, right. So, it’s difficult to say what the others are experiencing. Again, most of our deals are not contested. Most of our business is grounded in expansion where they’re really committed to Smartsheet already. So,it’s, it’s difficult to say what they’re saying. I think what we’re benefiting from is where a lot of our demand comes from the usage of our product where we’re not overly reliant on the new marketing mechanism like advertising mechanisms. We are seeing through our analysis that there has been a little bit of a raise in cost of people having the battle it out for the next new dollar and that’s something that we fortunately, don’t have to participate in this heavily.
Andy DeGasperi — Berenberg — Analyst
Understood. Thank you.
Operator
Your last question today comes from the line of Robert Simmons with D.A. Davidson. Your line is now open.
Robert Simmons — D.A. Davidson — Analyst
Hey, thanks for taking our questions. First to clarify one thing on the headwinds that you’re experiencing. Are you seeing increased client downgrades or use of contraction clients or is it really just on the economic suspension side of things?
Pete Godbole — CFO
Robert, we’re seeing it entirely on the net expansion side. Our churn remains at a record low level and I shared that our churn rate is now below 4%. So, it’s all on the net expansion side that we’re seeing these headwinds.
Robert Simmons — D.A. Davidson — Analyst
Got it. Great. And then have you built in any revenue benefits this year from holding ENGAGE in person or would that be upside to numbers?
Pete Godbole — CFO
So, you know we’ve built in some level of what I call, what we would expect a modest amount of an improvement in our close rate based on what we are experiencing with ENGAGE in September, but we haven’t built in a big upside.
Robert Simmons — D.A. Davidson — Analyst
Got it. That makes sense. Thank you very much.
Pete Godbole — CFO
You’re welcome, Robert.
Operator
This concludes today’s Q&A. I now turn the call back over to Aaron Turner.
Aaron Turner — Head of Investor Relations and Treasury
Great, thank you so much. And thank you all for joining us today. We will speak with you again next quarter.
Operator
This concludes today’s conference call. Thank you for attending. You may now disconnect.