Smartsheet Inc.

Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I would like to welcome everyone to the Smartsheet third quarter fiscal 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. It is now my pleasure to turn today's call over to Mr. Aaron Turner, head of investor relations. Sir, please go ahead.

Thank you, Brent. Good afternoon and welcome everyone to Smartsheet's third quarter of fiscal year 2023 earnings call. We will be discussing the results announced in our press release issued after the market closed today. With me today are Smartsheet CEO Mark Mader and our CFO Pete Godwold. Today's call is being webcast and will also be available for replay on our investor relations website at investors.smartsheet.com. There's 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, and we do not assume any obligation to update the 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. 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.

Thanks, Aaron. Hello and welcome to our third quarter earnings call for fiscal year 2023. Today I'd like to focus on three topics. Our solid performance in the quarter, how we're improving our operational efficiency in the current macro environment, and how delivering measurable ROI for customers drives our durable long-term growth. While Pete will provide additional details, I want to call out some of our strong financials from the quarter. Revenue for the quarter was $199.6 million, up 38% year-over-year. We added $56 million in annual recurring revenue, bringing our total ARR to more than $792 million. We added many new customers in the quarter, such as recruiting software provider SeekOut, Monster Energy, the social good empowerment platform Bonterra, and Arizona Beverages. And we expanded Smartsheet's footprint significantly at Picasa, AGC Biologics, and Seattle Children's Hospital, among others. Our strong expand and climb motion within our customer base continued, with 235 customers expanding by $50,000 or more and 79 customers expanding by $100,000 or more. We also now have 40 customers with ARR over $1 million. And we ended the quarter with more than 11.7 million Smartsheet users. Last quarter, we discussed how our new sales reps were ramping more slowly than sales reps from previous years. This quarter, we saw improvements in quota attainment and pipeline generation from our newest reps. We exited the quarter with a record pipeline and saw our pipeline conversion rate improve after macro-related softening in Q2. We also made significant improvements to our profitability in Q3. Our Q3 non-GAAP operating loss was negative $4.3 million significantly better than our guidance and a seven percentage point sequential margin improvement from Q2. This improvement is a function of the adjustments we've made to our hiring plan for the year, a heightened focus on operational rigor and financial policies, and inherent economies of scale in our business model. We expect these margin benefits to persist, allowing us to improve our non-GAAP operating income and free cash flow guidance for the year and beyond. The growth we experienced in the quarter came in large part from Smartsheet's ability to provide measurable ROI for customers as they navigate the macro backdrop. For example, in Q3, a Fortune 50 healthcare company expanded its Smartsheet investment by over half a million dollars, bringing their total Smartsheet ARR to nearly $2 million. Since moving to Advanced Gold a year ago, they've seen a 56% increase in license growth as more teams across the organization leverage advanced capabilities to manage programs and processes at scale. Their data shuttle usage has increased almost 300% over the past year, and they now have 85 workflows powered by our Bridge integration product. One of the biggest benefits this customer is seeing from Smartsheet is improved efficiency, leading to measurable ROI. For example, one team used a workflow powered by Bridge to automate a complex manual process for managing staff changes and application requests. decreasing the amount of time spent on it by more than 50%. We also saw a leading provider of customs brokerage and logistics upgrade to Smartsheet's enterprise licensing and advanced gold platform after determining that advance would save them nearly 3,000 hours of labor each year. Those hours saved are delivering more than $300,000 in ROI for the company, while giving it the ability to handle a larger volume of quick win transactions and improve employee engagement. In another Q3 advanced deal, the leading integrated reporting platform provider, Workiva, moved up to advanced so the professional services group could leverage Control Center and the Smartsheet Salesforce connector to implement a new project and portfolio management solution. They chose Smartsheet as their PPM platform because it offers both introductory and professional grade tools for project management that can scale to enterprise levels. The solution also gives project managers insight into project risks and timelines and makes it easy for them to see all assignments in one view, helping reduce project cost overruns. They estimate that in over three years, they will earn a 340% return on their Smartsheet investment. On the innovation front, we launched several Smartsheet capabilities and experiences at our September Engage conference, where we welcomed thousands of Smartsheet customers and partners in person for the first time in three years. It was incredibly energizing and gratifying to connect with customers face-to-face and hear their Smartsheet stories. HP, WebEx, AbbVie, and many more presented during breakout sessions and shared how Smartsheet is empowering them to solve tough problems, deliver on promises, and drive tangible results. At Engage, we launched Portfolio Work Apps, which combines the power of Control Center for managing large portfolios with the end-user simplicity of Work Apps. A global food services company recently chose Portfolio Work Apps as the PPM solution for its global transformation initiatives. The company has a complex global operating model, and Portfolio Work Apps gives its portfolio managers the ability to create portfolio views tailored to specific organizational roles that span multiple regions, countries, and segments. By leveraging Portfolio Work Apps, the company now has a clear line of sight into any given initiative across its global matrixed environment, allowing leadership to drive a strategic roadmap and achieve KPI targets. We're also deepening our investment in the PPM space by launching new resource management capabilities such as Capacity View that gives resource managers increased visibility of their capacity for planning and deploying talent. We're continually refining our governance and security controls to meet customers' current and future needs. At Engage, we share details on data egress, a new layer of control over how Smartsheet data can be exported outside of an organization. Such robust security and governance capabilities, which protect confidential information via granular control, are a key reason many companies choose our platform. For example, in Q3, a large mortgage lender chose Smartsheet over another CWM solution when the competitor's solution was unable to comply with certain mandatory requirements. This customer was impressed with Smartsheet's enterprise-grade security and liked how easy it was for teams across various lines of business to start using the platform. Ultimately, they felt Smartsheet was the best platform to help them meet their COO's goals for managing the business more securely and efficiently. We also announced our new desktop application, which was enthusiastically received by people, as were the new ML-powered home and reimagined search functions. These investments streamline the daily Smartsheet experience for all users by enabling them to find and act on their work quickly. On last quarter's earnings call, I mentioned our acquisition of the Outfit brand management templating and creative automation platform, which we have integrated with Brandfolder. The synergy of the Brandfolder output solution is already providing its value for customers in a meaningful way. In Q3, we landed a $300,000-plus deal with a major appliance manufacturer that will be using Brandfolder Plus Outfit as their single source of truth for digital asset management and production. Each brand within the company will use Brandfolder to track and manage assets, helping reduce asset sprawl. Outfit will provide a self-service model for building automated asset templates that they can distribute to wholesalers and retailers to ensure consistent brand marketing. This outfit-powered content automation solution will help the company reduce a 14 to 16-week creative and distribution process to four weeks, driving a 400% faster time to market for their marketing campaigns. By providing transparent and efficient content creation, distribution, and tracking capabilities, the new system allows the company to utilize its existing in-house creative team while eliminating significant outside agency-related costs. As you've heard today, despite the current macro environment, we had a strong quarter and remain well positioned for continued growth. Just last month in their Q4 2022 report, Smartsheet was named the leader in the Forrester wave for collaborative work management tools. The report recognized that Smartsheet continues to provide an extremely broad set of use cases among the leaders in this Forrester wave, and that Smartsheet strengths are the extensive availability of work types, flexible use case creation, and end-user automation capabilities. With people under greater pressure to choose the right CWM solution for their needs, reports like this are important in helping guide their decision-making. In closing, Q3 was another solid quarter for our company, especially considering the global macro headwinds. With our performance in the quarter, a continued focus on operational efficiency and the way we're delivering ROI for customers, I remain confident in our ability to deliver long-term, durable growth with improving profitability. Now, let me turn you over to Pete. Pete?

Thank you, Mark, and good afternoon, everyone. As Mark mentioned, Q3 was a strong quarter that reflected durable growth and improving profitability. We exceeded our guidance on both the top and bottom line as customers continue to turn to Smartsheet for their diverse set of mission-critical work management needs and we benefit from improving economies of scale and an intense focus on operational efficiency. We saw particular strength among our enterprise customers as these customers continue to deploy our capability-based products to streamline their most mission-critical workflows. Capabilities grew to 29% of subscription revenue in Q3, aided by strong growth in our advanced offering and brand folders. I will now go through our financial results for the third 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. Third quarter revenue came in at $199.6 million, up 38% year over year. Subscription revenue was $186.1 million, representing year-over-year growth of 40%. Services revenue was $13.5 million, representing year-over-year growth of 12%. Turning to billings, third quarter billings came in at $219.6 million, representing year-over-year growth of 36%. Approximately 92% of our subscription billings were annual, with 4% monthly. Quarterly and semiannual represented approximately 3% of the total. Multi-year billings represented less than 1% of total billings. Moving on to our reported metrics. The number of customers with ARR over $50,000 grew 43% year-over-year to 2,962, and the number of customers with ARR over $100,000 grew 55% year-over-year to 1,346. These customer segments now represent 60% and 46% respectively of total ARR. The percentage of our ARR coming from customers with ARR over $5,000 is now 89%. Next, our domain average ACV grew 25% year-over-year to $7,951. We ended the quarter with a dollar-based net retention rate of 129%. The full churn rate remains below 4%. Given the current macro environment, we expect our overall dollar-based net retention rate to be in the mid-120s by the end of the year. Now turning back to the financials, our total gross margin was 81%. Our Q3 subscription gross margin was 87%. We continue to expect our gross margin for FY23 to remain above 80%. Overall operating loss in the quarter was negative $4.3 million, or negative 2% of revenue, which represents a seven percentage point sequential margin improvement. The margin improvement was the result of cost saving initiatives we discussed in previous quarters, which included moderation of our hiring plan and cost rationalization. Additionally, we let portion of our revenue outperformance drop to the bottom line. demonstrating the operating leverage inherent in our business model. Based on our improved gross retention, we also moved to our four-year amortization period for our commission-based commission expense from a three-year amortization period. This accounting change contributed about three points of margin improvement in Q3. Free cash flow in the quarter was negative $4.6 million. Now, let me move on to guidance. Before I go into the details, a few comments on our approach to guidance. The macro environment remains dynamic, which impacts near-term visibility. We are therefore electing to remain appropriately prudent as it relates to our top-line performance. For the fourth quarter of FY23, we expect revenue to be in the range of 205 to 207 million dollars. and non gap operating loss to be in the range of negative two to zero dollars. We expect non gap net loss per share to be negative two cents to zero cents based on weighted average shares outstanding of one hundred and thirty one point five million. For the full fiscal year twenty three, we are raising our billings guidance to eight hundred and seventy eight to eight hundred eighty five million dollars representing growth of 33% to 34%. We are also raising our revenue guidance to $760 to $762 million, representing growth of 38%. We expect services to be 7% of total revenue. We are improving our non-GAAP operating loss to be in the range of $45 to $43 million, and non-GAAP net loss per share to be 31 cents to 30 cents for the year based on approximately 130 million weighted average shares outstanding. We are raising our free cash flow guidance for the year to $5 million. To conclude, Q3 was another strong quarter. We continue to demonstrate our ability to drive durable growth with improving profitability as the most demanding businesses in the world turn to Smartsheet for their mission-critical and data-intensive work management needs. Now let me turn it back to the operator for questions. Operator?

At this time, if you would like to ask a question, press star followed by the number one on your telephone keypad. Your first question comes from the line of John DiFucci with Guggenheim Securities. Your line is open.

Thank you. Thanks for taking my question. I wanted to dig in on your comment about improved pipeline conversion, given the softening macro backdrop. You raised buildings guidance for the year modestly, which is certainly positive. As we think about next year, are you assuming that pipeline conversion stays at current levels or improves throughout the year? How should we think about pipeline conversion relative to workforce productivity? Some of the investments you've made on the front and the sales force continues to ramp. Sorry for the long question. That's my bad habit.

John, this is Pete. I'll take your question in parts. The first part of your question was pipeline conversion. Essentially, what I talked about last time was ramping our new reps. We saw pipeline conversions related to rep productivity improve. from that sense. And what we saw in terms of the physical view closing and pipeline, October was a strong month for us as it related to pipeline closing. So those were the two elements of dimension on sort of how pipeline conversion looked, one from a rep standpoint and the other from the business deals and how they closed. Can you repeat the second part of your question you asked about? So I just want to take them in sequence.

Let's see. As we think about next year, should we assume that pipeline conversion stays at the current levels, or should we assume it gets better, or who knows, macro backdrop, maybe that changes for the worse too. How should we think about it? How do you think about it, Pete, as it relates to guidance?

We haven't come up with guidance for next year, but what I would tell you is two things. It's going to be a function of sort of what the macro is, because that's going to decide sort of the number of deals and how those are progressing. We will go into the year with a sales team that's very ramped, and that's going to be positive to conversion.

Okay. That all makes sense. Well, thanks. Nice job, guys.

Thanks, John.

Your next question is from the line of DJ Hines with Canaccord Genuity. Your line is open.

Hey, guys. Congrats on the nice set of numbers here. Mark, one for you. I'm curious how, if at all, you've evolved the go-to-market messaging in the current environment. I mean, obviously, ROI is important in any sale. You mentioned it several times in your prepared remarks. I'm wondering if there are certain products or use cases that get more emphasis in a tougher environment.

I think when you break it down in its most simplest terms, we're helping companies drive revenue or achieve cost savings. And when you can apply a program, a process, something in scale to one of the things that they're trying to achieve and using plain speak like that, you typically have an opportunity to have a conversation. So when we think about things like control center, data shuttle, moving information more quickly and efficiently across systems, we think about having fewer hands on things so you can get, you know, shorter cycle times. These are all very hard ROI calculations you can make. So I think the shift, the continued shift from the soft benefits in terms of employee engagement, which is super important, but harder to calculate a benefit from, customers are responding to how we've oriented ourselves into such discussions. And I think that goes across not only selling seats to somebody, but also introducing our capabilities, which are really the underpinnings for a lot of those calculations.

Yeah, that's helpful. And then as a follow-up, look, I mean, Strong quarter, improving conversion rates, record pipeline. Does it at all make you kind of rethink the moderation and hiring plans that we've talked about? And I realize this stuff doesn't whip around in 90-day cycles, but I guess I'm getting at kind of the commitment to longer-term margin expansion based on what you're seeing.

I think we had a really robust start to the year. We brought on a healthy number of team members, and we have not gone through a massive layoff of our company. So we have retained really good strength. We've invested in ramping those individuals. And as Pete just said, I think going into the end of the year with a ramp team, a larger ramp team than we had a year ago, that actually gives us quite a bit of confidence to go out and execute. So I think we would be in a different position had we finished the year with a very, had we jettisoned all of that great talent we brought on at the beginning of the year. So I feel like we're still the beneficiaries of some of those earlier in the year moves.

Yep. That's great to hear. Well, congrats, guys. I appreciate the call. Thank you.

Your next question is from the line of Brent Phil with Jefferies. Your line is open.

Mark, you were in the CRO last time we went through the recession. Obviously, you're in a completely different position, but any learnings, parallels that you're seeing in KPIs you're monitoring going into calendar 23?

Yeah, I think one of the big lessons, Brent, is just being quick. And I know this whole notion of survival of the quickest. I think you have to pair that, though, with being thoughtful. And it's like, we're not just solving for Q3. We're not just solving for Q4. FY24 is right around the corner. Pete and I are starting talking about FY25. So it's like these are all important dimensions. And I think one of the learnings is not to get too over-rotated on that next 90-day window. And I think Pete's been a good partner to me in helping manage some of that balance. So I think that's probably the largest takeaway.

Yeah, I mean, Pete, just as a quick follow-up on the rep productivity, I mean, it's kind of counter to what we're hearing at other companies. What do you think inverted the quota attainment for you? What changed there? Was something that happened in the demand environment? Was it one particular product? you know, geography? Was there anything you can put your pulse on? Because that's kind of counter to what we're hearing at other companies right now.

Yeah, the rep productivity that I was describing was for our newer reps. We had a series of what I call well-timed and absolutely meticulously defined initiatives of how we would ramp the newer rep into territories they had never managed, accounts they had never managed. And I think we're seeing the dividends of that play. So we've seen the productivity of those reps climb. Now, remember, We had a significant class that we ramped in. So when you're looking at the weighted average of the impact of that many people getting ramped up with a systematic set of plays, that's what we're seeing.

I think it's also important, Brent, to recognize that we're making a relative statement. We were not pleased with where we were last quarter in terms of productivity on certain cohorts. We're seeing improvement there, so heading in the right direction. I think that as a statement, though, against what we saw last quarter, as opposed to we are exceeding at all levels on all fronts. I think we still have a good room to go to continue to improve.

Thank you.

Your next question is from the line of Pinjalum Bora with JP Morgan. Your line is open.

Oh, great. Hey, thanks for taking the questions and congrats on the quarter. Mark, I just want to understand a little bit, I guess, It's a great quarter, seems like numbers are great, but we are hearing a lot of consternation from other companies as well, right? Last quarter, you had faced some difficulties. So I'm trying to understand how does the macro feel for you? Is it the improvement that you did within some of these messaging plays that helped you this quarter versus the normal discussions on a macro front? Is that kind of similar to last quarter? or does it feel a little bit better or worse?

I think it feels quite similar. I think the way we're engaging in those conversations are starting to produce yield for us. But I would say that the tone, the tenor within the customer environment is quite similar. I would say how we're responding to that has proven to be positive. And I think that is a function of reps feeling more confident, us being able to present these solutions in ways that resonate with them. But I would say it is as much getting yourself higher in that priority list for customer consideration as opposed to the amount of budget customers have starting to swell again. So I think it's really our placement in that stack ring that's helping us.

Got it. One follow-up. I wanted to ask you about work apps. We had had some conversations with some of your customers who are talking about consolidation, not just around work management applications, but consolidation of other third-party apps, in-house apps, scheduling apps, or something else, right, which are being built on top of work apps. Are you seeing that? Is that kind of a driver for the enterprise plan skew at this point where people are trying to save money to more with less?

Yeah, I think anytime you have a, the beautiful thing about the platform as opposed to a point tool is that it can be utilized in a multitude of ways. I think anytime someone sees a set of technologies that they can utilize across multiple use cases and drive a higher yield for an amount of spending, that's a good thing. So I think Work Apps is a contributing force there. I wouldn't say Work Apps is the tip of the spear. It's one of a whole multitude of things that we're presenting to clients. I think in the coming years, I think Work Apps will continue to gain steam. The release we had at Engage by connecting it to Control Center, which has been a really successful offering for us, Customers are really happy to see that. I think we'll see some benefits of that marriage between control center and work apps in the quarters to come.

Got it. Thank you so much. I'll get back in the queue. Your next question is from the line of Josh Baer with Morgan Stanley.

Your line is open. Great. Thanks for the question, and congrats on a strong quarter. I wanted to ask one on macro and sort of in relation to guidance. You know, we can see the deceleration in the implied Q4 billings guidance and the commentary just around the decline in the net retention rate. So I was hoping you could talk about some of the macro assumptions that's embedded in that guidance. And when you talk about prudence, you know, what does that mean, if you could add some details there?

Absolutely. So, Josh, you know, the growth decel implied in our billings guidance, is a function of the strong comp from Q4 from a year ago. And we've combined that with sort of a prudent outlook given the macro environment, which includes an expectation of lower customer budget spending sort of compared to prior periods. And that's what substantiates the macro in your question, which is we're seeing a macro that's worsening, but the good news is when I gave you guidance a quarter ago, I gave you a composite guide of Q3 and Q4. And we had projected that Q4 would be softer given a worsening macro that was built in. So that's the basis of the assumption.

Okay, great. That makes a lot of sense. And then if you could just add any commentary on the linearity of sort of demand trends month to month throughout the quarter and into November. Have you been seeing things get worse over the last months? you know, leading into Q4? Thanks.

So the, you know, October was a strong month for us relative to the, what I call the close rates and the pipeline close rates we saw. And, you know, November turned out steady to our expectations. You know, we expected the macro cycle to be in play and it produced results that were very consistent with our expectations. So remember in Q4, there's a great deal of business to be booked in December and January. So that's what's built into our assumption as we've guided to the core.

Great. Thank you. Sure, Josh.

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

Hi, everyone. Congrats on a good quarter. And I guess two questions here. First of all, Pete, you talked about capabilities where I think it was 29% of revenues in the quarter. As the company continues to move up market more, what does that mix look like at kind of, I don't know, peak levels? And then how should we think about the ARPU lift that you're gaining from those customers that are adding on some of these capabilities today?

So I'll make a meta statement of sort of where we see capabilities. And I think when you talk about a percentage of capabilities of total, it sort of implies that there isn't going to be as much growth on the user license part of it. We see both as really solid drivers. We see the width of our use case, if you remember the information Mark provided on the latest reports, we have a wide variety of use cases that drive what I call our expand motions. Think of capabilities as the client piece of it. We think of that number as growing over time because they are fast growing relative to our core license business. And we gave some guidance during our last analyst day on how big they could be. But, you know, we're scratching the surface on that part of it. So I do feel like if customers start to unlock the scale that they need after they've deployed the solution, you're going to see more and more customers, small and large, start to use them in the most demanding ways.

Got it. That's helpful. And then from a follow-up perspective, maybe this is for Mark. I wanted to see if you could talk about the competitive environment a little bit. And I asked the question in the framework, you had a competitor report their results tonight that were not nearly as strong as yours. We'll go with that. Are you seeing anything different out there that might be driving the strength of your business versus others maybe not competing as well today? Thank you.

It's harder for me to make a relative statement, Scott. I think as I said earlier, I can share what customers appear to be responding well to in our offering. And I think the capabilities alongside the core licenses, that is a composite that people are responding to. And it manifests itself not only in growth, but also retention. If you have multiple value points that you can deliver to somebody, I think you have a healthier relationship. And I think that's helping drive our business.

Great. That's all I have. Congrats on the good quarter. Thanks, Scott.

Your next question comes from the line of George Iwanich with Oppenheimer. Your line is open.

Thank you for taking my question and also my congratulations. Mark, maybe could you give us a bit of perspective on the desktop app and what kind of feedback you're getting from this launch at this point?

Yeah, George, I think one of the things that's always I find funny over the many years we've been doing this is Sometimes software companies get so excited about the next most extremely high-value obscure feature, and then someone says, but I really want the easy thing. And I think the desktop app is just such a beautiful example of that, where people want to see it in the tray on their machine. They want to be able to get quick access to it. They don't want the tabs that represent all their work in Smartsheet commingled with a bunch of other tabs in their Chrome or Safari browsers or Microsoft browser. So these are very simple things that people respond to. And I think when someone is living in your app and you can make their life easier, either through a better design or more quicker access, they're thankful for it. I think some of our team members were surprised at Engage. And this is something which you just can't substitute with a digital conference. When you look at the number of people queued up at a booth wanting to learn about this thing versus many other things, you really get that palpable sense for, wow, this matters. And the desktop app is one of those. It's been something we've been working on for some time. Thousands of people, many thousands of people are using it today. I think it's still an EAP. It'll be released shortly, broadly. So we'll continue to invest behind that.

And with that, maybe could you give some perspective on when people are in the app, are you seeing them engage with multiple products in a more flexible broad way with the overall platform.

When you say more products, you mean more elements of our product or integrations?

Yeah, more elements of your product.

Yeah, and I think as we dovetail things like brand folder into the experience and our resource management more into our core experience, by lowering that hurdle height for people to easily traverse, yes, we are seeing that happen. The one thing that I'm quite looking forward to, and I shared this on a prior call, as we remove, further remove the friction from people being able to explore our entire portfolio, as Pete said a second ago, today, a lot of those capabilities are really, are a consultative sale. And what Praired and the engineering team are working on is continue to let people discover, explore, realize the value, and then ultimately buy those in a self-directed manner. So I think in the coming two years, you're going to see a much greater diversity in people using more things in our product because we're lowering that friction.

Thank you.

Your next question comes from the line of Alex Zukin with Wolf Research. Your line is open.

Hey, this is Ethan Brock on for Al Zucan. Congrats on the quarter. I wanted to ask, I appreciate the call for where NRR will go next quarter, but as you think about looking to next year, is like mid-120s range the right way we should think about, I guess, where NRR will stabilize? And if we look to next year, is high 20s growth the right way we should be thinking about it?

Ethan, you know, we're not talking about next year because, you know, that's a part of the whole construct of how we see next year. It's related to what we see bookings, billings, all those elements. So it's a little premature to talk about sort of where that number will be. I think, you know, longer term, we see great capability for that number to grow just based on our history and sort of the products we've got in the pipeline. So that's the way I'll leave it.

Great. And then congrats also on showing the great increment in incremental margins, going from like negative 20 to negative 3%. I guess, is this the kind of the pace and rate we should think about margin improving going forward? And I guess, how are you thinking about balancing, I guess, with this margin, this growth, so there's a little bit more, can we expect a little bit more on the margin side? And also, I just want to ask, is the 10% precaution margin for calendar 24 still on the table?

So Ethan, I appreciate the question. You know, we've made significant strides by really focusing on operational improvements and moderating hiring. So we've seen that play out in the margins you've just seen. What I would tell you is we're going to continue that effort by trying to go after efficient growth. And that's going to be something we'll continue for several years as we go through it. That being said, you know, we're not going through specific call-outs of how much margin improvement there is and what rate it clips at. There's a little bit of work to be done before we get to that point.

Thank you, guys, and congrats again on the good quarter. Thanks.

Your next question comes from the line of Rishi Jaluria with RBC Capital Markets. Your line is open.

Hi, this is Richard Poland. I'm for Rishi Jalura. Thanks for taking my question. I guess just in terms of the macro environment versus what you saw 90 days ago, is there any way to kind of bifurcate what you're seeing between S&B and enterprise and just kind of, if there are any pockets of either demand improvement or demand softening that you'd call out within that?

So, Richard, this is Pete. You know, what we've seen is we've seen, if you would have parse the segments of the market differently. I would say in the U.S. mid-market, we've seen sort of global impacts, more broadly so. I would say we've had strength in the enterprise based on just the number of transactions we've been able to book with these enterprises. So those would be like the texture on it. I think you're looking for that level. I think in terms of verticals, we've seen strength in manufacturing, global energy, architecture construction, if you will. And some of the weaker, you know, verticals for us have been technology, probably consumer goods, and media, if you will.

Great. That's very helpful.

And then just as I think about SBC, I mean, stock-based compensation came down nicely in the quarter. Should we expect that to continue to trend down and just kind of any update on your thoughts around how you think about stock-based comp?

Yeah, stock-based comp is really important to us because it's a key element of how we look at the business. I think you should expect a few things to happen. I'll answer your question right at the outset. Do we expect stock-based compensation in the future to decline? As a percent of revenue, yes, it should decline. That's the way the results will come out. Now, when you think of stock-based compensation, think of it as a number of people times how much you offer them being the driver. We've essentially going forward moderated our hiring plan because we don't need to hire at the same pace. We're doing this very differently. So what you're going to see is a positive impact in the number of people we're bringing in and the impact it has on stock comp. That being said, stock comp is dictated by the history of what you've done in the past. So when you look at it, you say large part of it is already set by the prior hires that we've put in place. So those are the two effects that play into the total stock comp that gets created, and we're focused on making sure that it goes down year over year as a percent of revenue.

Wonderful. Thank you. Of course.

Your next question is from the line of Terry Tillman with Truist Securities. Your line is open.

Great, thanks for taking the questions and congrats on the quarter. This is Robert Dion for Terry. Curious to get an update on the newer onboarding experience and some of the other recent initiatives around helping users start quickly. Have you all started to see greater usage and penetration with newer customers today versus newer customers from, say, a year ago? And what have been the specific drivers of that, if so? Thank you.

Yeah, we have a number of measures there, Robert. And one of the things that we've seen a nice uptick in is the percentage of new participants who are successful in creating their first solution, their first thing that they're starting to try and work with. We saw a really nice improvement in that. That was one of the early success factors that we were trying to solve for. There are a number of other designs and elements that are being rolled in later this quarter targeted for Q1 and Q2, which I think will also have beneficial results in terms of conversion rate. But really pleased with what the team has put out there in terms of improving that experience. One other really nice benefit from what the team put in, we have greater visibility into what somebody's intent is. And that can come on a few fronts. The more we understand someone's intent, the better we can serve them, both in terms of consulting, advising templates to them, how we support them. So overall, helps us serve better, helps someone get navigated and started better. So pleased with the improvements.

That's great. And just one quick follow-up. I'm hoping to dive a little deeper on brand folder. How have the tax rates and penetration for the solution been performing relative to expectations? And what trends are you seeing in the overall digital asset management market from a demand perspective? Thanks so much.

So, Albert, you know, we were pretty pleased with our performance with Brandfolder. You know, we're seeing broad resonance as people look at the combined Brandfolder Smartsheet solution together. I think what's really helped is, one, the customer impact, which comes from both those solutions together. And this year, we launched a model where we basically turned on our core Smartsheet sellers to help in selling Brandfolder, and that's paid pretty good dividends for us as well. As far as the digital market and brand flow, I'll let Mark speak to that a little bit.

I think there's still a huge opportunity for us to educate our customers and prospects about what's available to them. And I think when we have examples that we can point to, like this big appliance manufacturer who's doing pretty impressive stuff in terms of content automation, a lot of times when we share those stories with people, they're unfamiliar that that's even possible. So I think while digital asset management's been around and sort of many, some customers are fluent in it, the majority are not. And it's still in an education phase. I think with our, as we talked about ramp of reps, we talk often about our newest cohort. I also think about ramping and productivity with our existing reps on new lines of business like brand folder and outfit. And I think I would say the median rep on our team who's experienced is much better suited today to speak to that value proposition. So, again, I think it's a very different phase in terms of a stage in terms of market understanding, and we're leaning into it.

Appreciate it, Keller. Thanks again.

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

Hey, guys. Congrats on the great results. Steve, you've talked a lot about cost rationalization and the moderation of your hiring plan helping on the margin front. Given you beat by over $16 million on the operating margin front, could you dig a little more into the areas you're finding leverage in the model? And then when we think about the moderation in the hiring, do you expect that to continue into next year when comparing it to this year's hiring plan?

So the $16 million beat you're referencing is for the quarter, right? So I just want to make sure I answer your question. Yes, for the quarter. Great. So I'd say the two elements of that beat are coming from, I'll lay it out for you, probably half the beat is coming from the revenue leverage that we've had as we've moderated and controlled costs. So revenues have gone up. We've moderated our hiring and people-related costs that go with it. That's produced sort of more than half the effect. About three points or three percentage points of it have come from, you know, we've looked at the customer duration that's associated with a greater gross retention rate, and that's meant a lower commission expense. That's accounted for about 3% of it. So that gives you some texture, and the rest of it is just hardcore operational cost containment. looking at every dollar that you're spending and asking whether it has value in terms of the priorities you've set up. That's the first part of it. And the second part of your question was on hiring in the future. We don't expect to have a similar sized hiring class coming on board and hiring expectations in the future will be significantly smaller. So we're going to see the benefit that we've created this year in a continued manner next year as we think of the operating leverage.

That's really helpful context. And then some of your peers have called out some headwinds from a user perspective, given slower hiring rates and some layoffs at tech companies. Have you seen any large customers reduce headcount as a result of those headwinds? Or just given your enterprise customer base and that focus, are you more immune to those issues than some other peers?

I think for the last, I'll call it five years, our whole mindset about penetrating the enterprise has been what we call the earned enterprise. So what we don't do is we don't go in and sell what we think at the time is a big ARR deal and go wall to wall. We say, how can we mobilize? How can we deliver value? And then we grow over time with them. Because very few of our large customers are, quote, wall to mall, where your dollar of expansion is reliant on the next person they hire, we're actually somewhat insulated from that. The other piece that's helpful to us is because some of our ARR is grounded in value components that we call capabilities, it's actually not tied out to a user license. And if you want to keep benefiting from that, you will keep subscribing to it, but it is not hinged on that next hire. And I think that's where our mixed model or hybrid model is turning out to be quite helpful.

That's really helpful. Congrats again on the great quarter, and thanks for taking my questions. Thanks.

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

Hi, thanks for taking the question. This is George. I just want to echo congrats on great execution in a difficult environment. I wanted to circle back on the discussion earlier about rep productivity. I think when you were talking last quarter, you were talking about expected improvements over the forward three to six month timeframe. So I'm just curious, obviously, we've seen improvements over these first three months. What are you thinking about? How are you viewing improvement potential in Q4? And is there any of that baked into the guidance?

George, this is Pete. I just wanted to quickly say, you know, really pleased with how the field teams have sort of gone about you know, improving productivity of newer reps who've started. We've seen the benefits of it as they've become productive. Our expectation is we will continue to see productivity improvements in those reps because our plans involve multi-quarter changes in how we get them productive. That's baked into our guidance. You should think of our guidance as an overlay of improving new rep productivity combined with a macro that we've, you know, thoughtfully and prudently considered.

Got it. That makes sense. And then just one quick follow-up on the billings upside came in quite ahead of at least what we were modeling. I'm wondering if you could just dig into kind of what drove that upside and if there's anything unusual or one-time in nature that we should be aware of. Thank you.

George, there was nothing unusual or one-time nature in those numbers. So it's, you know, organic bookings, which translates into billings.

Great. Thanks for taking the questions.

Of course.

Your next question is from the line of Michael Turin with Wells Fargo. Your line is open.

Hi, this is Michael Berg on for Michael Turin. Thanks for taking our question. Congrats on a great quarter. I want to dive into expansion rates again quickly. They have been pretty nicely in the quarter. I know the exit rate expectations are still the same. Maybe with a discussion on potential seat expansion issues, you could walk us through the mix of seats versus capabilities on driving that expansion rate number and if that's changed meaningfully over the past quarter or two. Thank you.

You know, I'll start with the question and then from a meta standpoint, Mark will chime in in terms of how that's operating. You know, we're not seeing a big difference between the seats and the what I call capabilities. Obviously, capabilities are still growing faster than the seat part of it. And that's factored into the expansion rates we see. We gave you some stats on capabilities. We said that they're 29% of revenue. And if you looked at them sort of a year ago, they were 24%. So clearly, people are expanding with capabilities. But you're seeing a healthy mix of people with seats as well in that mix. So that's kind of a meta point of like how expansion rates are moving.

Yeah, I don't think I have much to add to that.

That's it for me. Thank you. Thanks, Michael. Thanks, Michael.

Your next question comes from the line of Jason Ader with Moffitt Nathanson. Your line is open.

Hi, guys. This is Kyle Dillon for Jackson Adder. Thanks for taking our question. Just to dig a little bit deeper onto that expansion, kind of the timeline that you guys are seeing, is the timeline for expansion slowing at all? Or do you kind of see that slowing in the near-term future here? Or has that kind of remained constant to what you've seen historically?

So if you think of expansions and you convert them into its core fundamental, you're talking about bookings and how quickly they materialize. Obviously expansions are a key part of bookings and billings. So you should think of it as being, we've seen an elongation in sales cycles and we've seen deal compression. So let's talk about how that actually plays itself out. The way we've seen elongation is people just take longer with the number of potential reviews that take place for any purchase. Those are happening. The second part of it is the deal compression. The way that would happen with these capabilities and expansion is you can either buy a package, which is nicely packaged up value in advance, or you can still buy pieces of it. We don't tell customers how they should buy it, but they buy a la carte capabilities that hit a specific need. those represent if you buy the alipay capabilities you're getting a smaller bite in bookings obviously over time you're going to get all the bookings but it means a different size so that that's how expansions play out okay great that's helpful and then i guess just in terms of next year's i.t budgets um you know historically are you able to attribute

a decent or a majority of revenue growth to IT budget expansion? How do you see it playing out if IT budgets kind of come down next year? Do you see that as having a meaningful impact on the top line growth?

So I would say that the budgets for our funding, remember you're dealing with, this isn't one purchaser in one department. There are hundreds and thousands of people in enterprise who are buying it. So you have as much of people with line of business budgets that are buying it as there are IT folks in there. So I think it's fairly broad-based in terms of budget.

That makes sense. Thank you. Of course.

Your next question comes from the line of Fred Lee with Credit Suisse. Your line is open.

Thank you, gentlemen, for taking my question. Very nice quarter, particularly in this environment. I was wondering if you were seeing any change in behavior from your competition, specifically privately held companies that might be slowing down their investment and marketing spend. And then a quick follow-up after that.

No, I mean, given the thousands of transactions we do in a quarter, the median transaction is still really helping someone progress from their status quo, which isn't grounded in a CWM player and getting into CWM for the first time. So it's difficult for us to speak. It would not be really well grounded for us to speak to these huge patterns that we see. We have seen, you do see it manifest itself in some other ways in terms of you definitely get a sense that those companies are hiring less. I think some of the people who joined companies who have now been let go obviously talk to people in the community. And I think there's less chatter around people considering going to such companies. I think that's one of the things that more established tech companies will benefit from in the coming quarters. In terms of what we're seeing in market, nothing that we've really heard from customers on that front.

Thank you. And just a quick follow-up on the net retention metric. You mentioned mid-20s by the end of the year. I was wondering if you could drill down a little bit on what's contributing to the sequential decline in the metric.

So, Fred, you know, the net dollar retention rate metric is a full year look back. So, we look at what happened over the full year, if you will. So, when you think of what comes into the calculation when we report out at the end of Q4, is you're going to be replacing a very strong quarter with a macro that was very different, expansionary that was very different, with now something that's in a different macro phase. So, you're just swapping out one quarter for the other, and that's where you see you know, the look back of a full year and expansion rates dropping to where we've guided.

Understood.

Thank you very much, and great quarter. Of course. Thank you.

There are no further questions at this time. I will now turn the call back to Mr. Aaron Turner.

Great. Well, thank you for joining us, everyone, and we will speak with you again next quarter.

Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now.