Smartsheet Inc

NYSE:SMAR

Earnings Call Transcript 2022-Q1

[Operator]

Good day and thank you for standing by. Welcome to the Smartsheet First Quarter Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Aaron Turner, Head of Investor Relations. Thank you. Please go ahead.

[Aaron Turner, Head of Investor Relations]

Thank you, Mike. Good afternoon and welcome, everyone, to Smartsheet's first quarter of fiscal year 2022 earnings call. We will be discussing the results announced in our press release issued after the market closed today. With me today are Smartsheet's CEO, Mark Mader; and our CFO, Pete Godbole. Our Chief Strategy and Product Officer, Gene Farrell, will also be available during the Q&A.

Today's call is being webcast and will also be available for replay on our Investor Relations website at investors.smartsheet.com. There is a slide presentation that accompanies Pete's prepared remarks, which can be viewed in the Events section of our Investor Relations website.

During this call, we will make forward-looking statements within the meaning of the federal securities laws. We have based these forward-looking statements largely on our current expectations and projections about future events, financial trends and our expectations around the impact of COVID-19 on our business. 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 these statements as a result of new information or future events, except as required by law. In addition to the U.S. GAAP financials, we will discuss certain non-GAAP financial measures. A reconciliation to the most directly comparable U.S. GAAP measures is available in the presentation that accompanies this call, which can also be found on our Investor Relations website.

With that, let me turn the call over to Mark.

[Mark Mader, Chief Executive Officer]

Thank you, Aaron, and thanks, everyone, for joining us today for our first quarter earnings call. I want to start off by thanking our customers, whose belief in our vision motivates us and our team members who inspire me every day with their drive and dedication.

Q1 was a strong quarter. Revenue grew 37% to $117.1 million. Billings grew 48% to $132.8 million, and our dollar-based net retention rate improved by 2 points to 125%. We ended the quarter with over 8.5 million users.

In Q1, our average domain annualized contract value or ACV grew 41% year-over-year to $5,461. And expansion within our base included 305 companies increasing their annual recurring revenue or ARR by more than $25,000, up from 173 companies in Q1 of last year; 116 increasing their ARR by more than $50,000, up from 51 in Q1 of last year; and 29 increasing their ARR by more than $100,000, up from 15 in Q1 of last year.

We also continue to see strong growth within enterprises, including UnitedHealth, Amazon, Home Depot, McDonald's, Netflix, CrowdStrike, Meditech, Stanford University, Hewlett Packard, Peloton, VMware, Rivian Automotive, California Department of Transportation, Verizon, AbbVie, Arthrex, Cardinal Health, Under Armour, Vertiv, Sony Pictures, Comcast, Workday, United National Food, Dexcom, Airbus, Intuit, AstraZeneca, Disney, Roche, TBS, St. Jude Children's Research Hospital, Honeywell, Kaiser Permanente, Sage Group, Google, Booz Allen Hamilton, United Therapeutics, Equinix, Stanley Black & Decker, Charter Communications, HubSpot, Bed Bath & Beyond, VF Corp., McGraw Hill, F5, BlackRock and salesforce.com, to name a few.

Our enterprise customer deployments demonstrate Smartsheet's momentum in serving the strategic needs of those customers. Enterprise customers demand and deserve capability-rich platforms that can scale to support mission-critical workflows while also meeting their requirements for advanced security and administration.

With the Smartsheet platform, customers can manage execution and change at scale, run workflows across disparate systems and bundle these enterprise-wide workflows into curated experience to support a broad range of use cases that cross departments and functions. And we delivered this while also providing customers with the security, compliance, manageability, control and trust that they expect from their enterprise partners.

Over the course of this fiscal year, we will continue to invest in our offerings, executing on its platform strategy that delivers even more value for our customers. This is something that we are well positioned to do based on our 15 years of operating experience, 15 years that have yielded thousands of insights and a deep understanding of the enterprise. We've taken this unique experience and perspective to evolve the Smartsheet platform and our vision for the future.

Q1 was also a strong quarter for our government business, with expansions coming from agencies such as the GSA, NASA, the U.S. Department of Veteran Affairs, the Department of Commerce, the U.S. Department of Health and Human Services and the Department of Defense.

NASA's Jet Propulsion Lab deployed Smartsheet to support its Mars Perseverance Rover, choosing our platform for the scheduling and tracking of the 2,700 parts and 17,500 machining operations moving across 18 departments. With Smartsheet, this NASA team deploys process flows to drive efficiency, compound systems to streamline customer communications and resource allocation as well as dashboards for management visibility of the frequent changes in priority involved with such a significant endeavor.

Notably, NASA's flow of manufacturing data is supported by an integrated workflow connecting Smartsheet to other key systems like Oracle ERP and Power BI.

Since day 1, customers have relied on Smartsheet to empower individuals and enable teams to not simply get work done, but to re-imagine and transform how work gets done. Today, that means customers are able to rapidly build new solutions that benefit the whole organization and enable them to do their best work, like managing corporate OKRs at Intuit or delivering an end-to-end marketing solution at Snap.

And as a category-leading software company, we paid attention, we listened and we've improved our solution to solve even bigger challenges. In fact, this year, we're evolving the design of Smartsheet to offer a cleaner, more modern and accessible look, further simplifying the entire user experience.

We've also introduced WorkApps, Smartsheet's no-code platform for building intuitive web and mobile apps, which further amplifies the power and usability of solutions our customers are creating on the platform every day. Many enterprise customer solutions that previously required resource-intensive development or modifications to costly legacy systems can now be quickly and efficiently solved using Smartsheet.

Customers choose Smartsheet for our ability to deliver at scale, respond to and deliver on change, manage workflows across systems and build curated experience to solve strategic business problems. Uber uses Smartsheet across critical business units, including facilities, real estate, engineering, legal and marketing. And by employing WorkApps, Uber's performance marketing organization has been able to clarify and standardize team processes.

In addition, the streamlined user experience that WorkApps provides has made it easier than ever for these teams to locate their priorities and take action. As we touched on last quarter, we've also taken a new approach to packaging to make it even easier for companies to acquire and deploy Smartsheet's premium capabilities at enterprise scale.

We call this Smartsheet Advance. Smartsheet Advance responds to the demands of our growing customers by combining the ability to scale easily across departments and functions with access to premium capabilities that solve high-value business problems.

The business receives robust no-code tools to automate workflows across systems, align global teams and build scalable solutions while giving IT the control to manage risk and maintain compliance. From skills-based resource and content management to core systems integration, Smartsheet Advance is enterprise-ready, IT-endorsed and built to unlock the true power of business: its people.

Initial customer reaction to Smartsheet Advance has been very positive. Recently, Smartsheet Advance drove our expansion with a regional academic health system with over 13,000 employees and 1,500 doctors that serves the population of 1.9 million across New England. Over the past year, departments, including QA, pharmacy, finance, M&A and IT, have used Smartsheet to improve process efficiencies and automate manual efforts.

With Smartsheet Advance, this medical center's IT PMO will continue to leverage their Smartsheet investment to help manage the significant system implementation projects that have resulted from organic growth and acquisitions. We plan to provide additional details on Smartsheet Advance at our ENGAGE conference on June 8.

To be the enterprise CWM platform of choice, Smartsheet is focused on building meaningful integrations that integrate critical systems that most organizations depend on to deliver and differentiate their work. In May, we further bolstered our enterprise offering with a new McAfee integration, a product partnership that leverages McAfee's cloud security platform to provide threat detection and to comply with data loss prevention policies.

As Smartsheet's customer base continues to expand within regulated industries, the need for insight into specific risk-related activities and data input is paramount. Customers need a way to identify and flag sensitive data across their entire Smartsheet environment in an easy and intuitive manner to help find and remediate sensitive data violations. Integrating with tools like McAfee provides assurance to our customers, including CIOs and IT leaders, that their Smartsheet environments are secured and in compliance.

In closing, we've started the year off with strong momentum and a clear vision for our growth ahead. Now let me turn the call over to Pete to provide additional details on our financial results. Pete?

[Pete Godbole, Chief Financial Officer]

Thank you, Mark, and good afternoon, everyone. We entered 2021 with continued momentum. Our Q1 outperformance relative to our guidance was a function of solid sales execution, large deal volume and a demand environment that has been approaching pre-COVID levels.

Many of the pressures we saw last year are dissipating. For example, relative to Q1 of last year, our sales cycle lengths have shortened, pipeline conversion has improved, and we saw significant growth in deals of all sizes.

Another important milestone to call out, as disclosed in our 10-K filed after our last earnings call, all SOX material weaknesses were remediated as of the end of fiscal year 2021.

I will now go through our financial results for Q1. 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 the presentation that was posted before the call.

As previously mentioned, first quarter revenue came in at $117.1 million, up 37% year-over-year. Subscription revenue was $108 million, representing year-over-year growth of 40%. Services revenue was $9.1 million, representing year-over-year growth of 9%.

Turning to billings. First quarter billings came in strong at $132.8 million, representing year-over-year growth of 48%. Approximately 88% of our subscription billings were annual with over 7% monthly. Quarterly, semiannual and multiyear billings represented over 4% of the total.

Moving on to our reported metrics. We now have 12,655 customers paying us $5,000 or more per year; 1,674 paying $50,000 or more per year; and 661 now paying us $100,000 or more per year. These customer segments now represent 83%, 48% and 33%, respectively, of total ARR.

Next, our domain average ACV, annualized contract value, grew 41% year-over-year to $5,461. We ended the quarter with a dollar-based net retention rate of 125%, a 2 percentage point improvement from Q4. The full churn rate improved further and now rounds down to 6%. Through the remainder of the year, we expect our dollar-based net retention rate to trend moderately higher.

Now turning back to the financials. Our total gross margin was 80%, 1 percentage point lower than the previous quarter due to a lower professional services gross margin. Our Q1 subscription gross margin was 85%, in line with the previous quarter. We continue to expect our gross margin for fiscal year '22 to be between 79% and 81%.

Overall, operating loss in the quarter was negative $12 million or 10% of revenue, an improvement from 16% of revenue a year ago. This margin improvement was a function of scale across our sales and marketing line inherent in our model. Free cash flow was negative $8.2 million, which overachieved against our guidance.

Now let me move on to guidance. For the second quarter of fiscal year '22, we expect revenue to be in the range of $125 million to $126 million, billing to be in the range of $133 million to $134 million, non-GAAP operating loss to be in the range of $18 million to $16 million and non-GAAP net loss per share to be between $0.14 and $0.13 based on weighted average shares outstanding of $125 million. Our net free cash flow is expected to be in the range of negative $7 million to negative $5 million.

Given our strong Q1 results and continued momentum in the business, we are raising our full year '22 revenue and billing guidance. We now expect revenue to be in the range of $510 million to $515 million, representing growth of 32% to 34%. Billings are expected to be in the range of $599 million to $604 million, representing growth of 33% to 34%.

We expect non-GAAP operating loss to be in the range of $55 million to $45 million and non-GAAP net loss per share to be between $0.44 and $0.36 for the year based on approximately 125 million weighted average shares outstanding. Our free cash flow margin expectation in fiscal year '22 is to billing guidance. We now expect revenue to between negative 6% and negative 4%.

Consistent with Q4, this quarter has exemplified the strength in customer signal manifested in billings growth. This signal is about empowerment of work execution by users with enterprise-grade extensibility. This quarter saw excellent enterprise traction in larger deals with bigger volumes and so early resonance with our Smartsheet Advance offering and the curation of workflows via WorkApps. We continue to see significant opportunities to invest behind this signal while managing the cash burn effectively.

Now let me turn it back to the operator for questions. Operator?

[Operator]

[Operator Instructions] Your first question comes from Mark Murphy from JPMorgan.

[Mark Murphy, JPMorgan]

Yes, thank you very much. Congrats on a very strong results and guidance. Mark, the list of enterprise logos you rattled off at the start is pretty spectacular, from Amazon to Home Depot, to Verizon and Airbus. And then you mentioned, it sounded like a handful of huge government agencies that you had done business with on top of that. How are you feeling about that depth of penetration there in the enterprise? And I guess I'm just wondering, when we consider that list of customers, are you actually finding relatively less competition up market than you see whenever you're down at the SMB level?

[Mark Mader, Chief Executive Officer]

I think where we find ourselves in the journey, Mark, is we're still early in the journey. And we have now 15 customers paying us over $1 million, seeing increased value. I think that flight group that's coming up right behind them is indicative of us are messaging landing and then seeing value in what we're building, so most of these companies still represent massive opportunity for us to deliver more value to them.

The things that I look for is continued penetration into the Fortune 1 and the Fortune 5. Those numbers continue to go up, where we almost have full coverage now. And now our job is to present value and deliver. So we're really pleased to see it. When we highlight a handful of customers, it's in the context of thousands of customers that expanded with us in the quarter. So those happen to be some familiar names. The list is long beyond that as well.

[Mark Murphy, JPMorgan]

Okay. If I may, a quick follow-up, maybe for Pete. We had noticed, I think it was last month, that you had commissioned a survey. And it showed 71% of technology decision-makers are kind of rethinking commissioned a survey. And it showed 71% of technology around workforce technologies. So I guess my question is, are you sensing that somehow in the pipeline and with the billing strength, are you sensing that companies decide on a hybrid workforce and then kind of in tandem them with that, they see that as a reason to use Smartsheet more broadly?

[Pete Godbole, Chief Financial Officer]

Mark, this is Pete. As I look at your -- what you asked, we would describe our pipeline for this quarter as being very strong. We found that the number of deals we did was larger. The conversion rates we found were stronger. What exactly the drivers are sort of hard to piecemeal out, but we definitely saw traction this quarter in how this played out.

[Mark Mader, Chief Executive Officer]

Yes. Mark, let me add one comment. Let me add one comment, Mark, to what you asked in terms of what we see at scale. I think the number of people who can offer the controls and security and the functional scale elements, that's something that we built over the last few years. And when you're at that level, there are really hard requirements that you need to have a sort of past go. And I think we're really fortunate in that we believe we're the leaders there. And the innovation keeps happening fast and furiously.

We have ENGAGE coming up on June 8. We're releasing a bunch of stuff that's going to be super relevant to those super-large environments. But I think what's interesting about Smartsheet Advance, it's not just for the super large, it's how do you enable those growing companies who are not super large yet to capitalize on all that innovation. And I think Smartsheet Advance is going to be a really interesting offering to cater to both smaller-growth companies as well as those who are very established already.

[Operator]

Your next question comes from DJ Hynes from Canaccord.

[DJ Hynes, Canaccord]

Thanks guys. Great quarter. Maybe, Mark, just building off that last comment on Smartsheet Advance. Just given the momentum with larger customers, maybe a slight shift towards kind of more strategic bundled sales, do you see the composition of your sales force changing at all, who you're hiring? Just curious how you feel like your staff to take on that kind of selling?

[Mark Mader, Chief Executive Officer]

We continue to have real diversity in that group. I think when you have -- the way we organize is across a commercial business, we have a large enterprise business. We see appetite for these solutions across both of those areas. I would say that as we look to fully capitalize on the opportunity with the super large, hiring in the large enterprise space is very important to us.

And the areas that we're focusing on now is not just creating product and pitching product, but also helping people understand the journey of how you go from starting out with CWM to actually scaling with it. And that is not just a selling motion. That is also a services motion, really almost a consulting advisory role, in helping people hit those different stages at the right time with the right tools. This is not a self-directed go-on-your own and hope it works type approach. And I think that's what we're getting really dialed in right now.

[DJ Hynes, Canaccord]

Yes. That makes sense. And maybe I could follow up with just a very big-picture question. So look, obviously, there's another vendor in the space going through an IPO process now. I think a lot of investors are contemplating competitive differentiation in the space. And you've hit on some of this. But since it's a conversation I'm having a lot, maybe I could just throw it to you, like what would you highlight as kind of the two or three key areas where you think Smartsheet is really differentiated in the market?

[Gene Farrell, Chief Strategy and Product Officer]

Yes. DJ, this is Gene Farrell. I'll take this one. For us, as Mark and Pete both have talked about in their prepared remarks and answers, we've been very focused on being the enterprise leader in the CWM space. And we really feel like our ability to execute project, program, process, workflow at scale and across a diverse set of departments and use cases that really can support the entire enterprise is really a key part of our differentiation. And I think that doesn't mean we don't continue to serve teams and small departments and smaller companies really well to help them be more effective in driving work. But for us, it's really about having that ability to scale and then do it securely and with compliance.

[Operator]

Your next question comes from Stan Zlotsky from Morgan Stanley.

[Stan Zlotsky, Morgan Stanley]

I wanted to go back to the very impressive list of logos that, Mark, you mentioned at the very beginning. Maybe help us to contextualize just the scale of the new logo acquisition and the -- especially these large logo acquisitions that you're seeing on the platform now versus what you were seeing -- obviously, through 2020, it was a challenge. But what are you seeing from as far as just large logo lands now versus a year ago?

[Mark Mader, Chief Executive Officer]

Well, I think, as we've shared in previous quarters, when you serve the vast majority of companies in a certain segment, like the Fortune 5, for example, it's really not about landing more logos. It's about serving them more fully.

So again, when you look at those mega caps, you look at diversifying into new departments and adding more value. But it's -- so it's almost more like departmental lands as opposed to logo lands. So that's really our run book in terms of how we're diversifying, how we're looking for reality within companies and how we coach and enable those mobilizers. That's really our primary run book.

I think logo lands in terms of those next generation of mega caps, we target very carefully in terms of where we spend our capital on who we try to bring to the platform, try and identify those fast growers and get them to choose us early. And we feel good about how that's going as well.

[Stan Zlotsky, Morgan Stanley]

Got it. Got it. And that makes a ton of sense. And maybe a question for Pete just on the back of -- the core selling motion for Smartsheet is all about landing with the departmental deals and then expanding within them. It certainly sounds like the expand motion is really up ticking very, very nicely with -- and net revenue retention going up to 125. How should we be thinking about net revenue retention as we go forward through the rest of the year? And do we think that there's a chance that maybe back half of this year or maybe into fiscal '23 that we start to get back to like pre-pandemic levels as far as net revenue retention?

[Pete Godbole, Chief Financial Officer]

Dan, we're really pleased with where our net dollar retention rate came out for the quarter. It's the first quarter where the net retention rate has gone up quarter-over-quarter. That being said, as I stated in my prepared remarks, we expect that to trend up moderately as we go through the year. And that includes the fact that there's potentially a headwind in Q3 as we bring on Brandfolder, which will be lapping its first year of about 1 to 2 points. So we expect that to grow through the year.

[Operator]

Your next question comes from Alex Zukin from Wolfe Research.

[Alex Zukin, Wolfe Research]

So I'll start with -- it's kind of the same question but maybe a little bit different, depending on the segment. But take us into what you're seeing right now in those sales cycles around why -- is it as simple as the pandemic kind of created a pause that has now become more clear in terms of the strategy these companies are taking with respect to their approach to the new way of working? Or is it something you found that's really working now post pandemic in the sales cycle both at the enterprise level, but then also on the federal side? This is a vertical we've talked about a lot and you guys are, I think, much further ahead than some of your competitors getting traction here. It seems -- has this kind of unlocked, in a sense? Because we're hearing federal has meaningfully quickened their pace of digitization over the past few months and even quarters. And it seems like that's coming to bear and coming to fruition from your results, but wanted to get more color on those two aspects.

[Mark Mader, Chief Executive Officer]

Yes. I think in terms of last year, Alex, I would class it as expansion rates went from extremely robust to robust as opposed to a pause. They were still very favorable. So business continued to expand. It was really good to see in the last quarter across the major industries we serve, see acceleration in expansion rate tick up similar to our net dollar retention.

So I would say the clarity around and confidence that people have in investing in technology that seems to have improved. But again, it was not moving from a standstill. It was moving from already moving to something to be at a higher rate.

I would say the -- what's also helpful is when you have the ability to present to people a more cohesive story as to how they can derive value from something, they tend to buy more as opposed to having to navigate 20 premium capabilities, when you can say, okay, here's -- choose one of three paths. And here are the benefits and here's how quickly you can move, it's easier for people. So I think it's as much as market condition as it is to the inputs we're providing.

I think on the government side, it remains a small but growing part of our business. What I was happy to see is the diversification in who was buying. It wasn't just an agency or 2. We saw diversification -- or diversity across some of the nonmilitary agencies and our first DoD transaction, which was on the backs of our IL-4 authorization recently.

So again, I think the table is setting up nicely there for continued growth. We're committed to that market, and that's been a multiyear investment. And I would expect that to hit new heights this year.

[Alex Zukin, Wolfe Research]

Perfect. And then, Pete, maybe just as a follow-up; first, congratulations on filling -- on getting rid of those material weaknesses in kind of the 10-K, the disclosure that you gave. I wanted to ask, given the strength in billings, given the commentary in terms of the renewal base from last year, how should we think about billing seasonality as we go this year? You gave the full year number. Was there anything either onetime or an item to consider as we kind of look at our models for the balance of the year with respect to billings that we should take into account?

[Pete Godbole, Chief Financial Officer]

As in my prepared remarks, as I stated, I've given you guidance for this quarter and for the full year. The only thing that I would tell you is, the seasonality that you've seen historically has changed. We don't have seasonality that we can predictably count on which is historical that you carry forward.

The only thing I would tell you is in Q3, we acquired Brandfolder. And you'll remember that as a part of the billings pickup in Q3, there was one-time deferred revenue billings that we got, which won't repeat again in Q3 of this year.

[Alex Zukin, Wolfe Research]

Perfect. Congrats on a great quarter.

[Pete Godbole, Chief Financial Officer]

Thanks, Alex.

[Operator]

Your next question comes from Rishi Jaluria from RBC.

[Rishi Jaluria, RBC]

First, I wanted to start with going back to large customers, and again, Mark, very impressive list of new logos and expansions. Pete, last quarter, you gave us some really interesting data points on the penetration rates and opportunity within large customers. And I think you talked 10k-plus employees. Obviously, we won't ask for an update on that every quarter. But can you maybe give us a sense for what progress you're starting to see with some of the initiatives that you laid out last quarter to grow the opportunity within these customers? And then I've got a follow-up.

[Pete Godbole, Chief Financial Officer]

So Rishi, as I mentioned last time, our investment was slated into what I call three areas. One of them hits the 10,000 employee customers. So it was about adding sales capacity. We have added sales capacity, as we planned to, for Q1, focused on all elements of enterprise sales team and across all our other sales team. That goes to quota-carrying capacity.

We've also invested in resources that support those sales teams, including people who help with the customer outcomes and journey part of that conversation. We've invested in those two, on the sales and go-to-market side of it.

Additionally, we've also invested in product capabilities, and those investments are progressing. Where we're product capabilities, widen the competitive moat, as Mark described in the things where we're just completely differentiated from our competition. So we're making excellent progress on all elements of the -- of what I articulated last quarter.

[Rishi Jaluria, RBC]

Got it. Got it. That's helpful. And then wanted to go to just a comment that was in the deck, which is around the ramping head count in services. Putting margin implications aside, can you maybe talk a little bit about where the -- I guess what's driving that increase in services head count? Are there certain areas that you want to focus on? Or is this primarily just services? Or it was running hot and you're trying to get it back to a normal level? Thanks.

[Pete Godbole, Chief Financial Officer]

Rishi, the simple answer to that is we finished Q4, as you remember, with a very sort of significant billings number. And that translates into just pure demand and needing to fulfill that demand. So hiring head count on the services side is the way to fulfill that demand. And this quarter was about ramping that head count. So we're seeing broad-based demand, which was not only in Q4 but in Q1 as well, as I noted in my prepared remarks.

[Operator]

Your next question comes from Arjun Bhatia from William Blair.

[Arjun Bhatia, William Blair]

Congrats on the quarter. Mark, I wanted to ask about WorkApps a little bit. I think you gave some pretty impressive adoption metrics last quarter. And in light of the enterprise strength that you're now starting to see, I would just be curious to know if this is playing a role in the conversation with your enterprise customers at all. Is it still too early to tell? And then how should we just think about the monetization that might result from WorkApps adoption?

[Mark Mader, Chief Executive Officer]

Yes. I'll let Gene speak to that. I guess the one comment I would start with is, it's an element and it's an important element, but it by no means is the only thing that's driving it. And I'll have Gene speak to how it coincides with Smartsheet Advance as well.

[Gene Farrell, Chief Strategy and Product Officer]

Yes. So Arjun, the way to think about WorkApps is it really is the ability for a business user not having to rely on IT to build more curated app experiences, whether it'd be a desktop or mobile. And so what we're seeing -- we launched in mid-January. What we're seeing is -- early signal from customers is they really love the ability to package a workflow into kind of a complete app-like experience and bring in both elements of the Smartsheet platform as well as elements of third-party platforms, whether that'd be a dashboard from Tableau or a Google Docs into that overall experience.

And so it really is at the solution level is where they're seeing the most value. And we're seeing continued enthusiasm and adoption as customers are understanding, building and then starting to deploy solutions. And we have a number of things in the road map that are going to enable that -- our customers to actually scale that even more broadly through integration with Control Center and other new capabilities that we're hearing feedback from customers on.

Importantly, WorkApps is that enabling technology that capabilities that enable workflow and consistency at scale, change management at scale, connecting workflows across systems and not just in a data synchronization way, but also with things like data validation and more complex workflows across those systems via Bridge or the launch of Data Shuttle, which recently -- we recently announced, which gives you the ability to both upload and offload data between Smartsheet and other big systems. Those capabilities included in Advance combined with WorkApps really give us a pretty broad canvas to build solutions for customers across a really broad set of use cases.

To speak to your monetization question, the thing I would just add there is the way that Smartsheet Advance is designed, it's really designed to eliminate friction as customers grow and expand with us. But over time, as the number of users that they have using the platform increases, the cost of Advance goes up in connection with those connected users.

[Arjun Bhatia, William Blair]

Perfect. That's very helpful. And then if I can follow up on Rishi's question around the services business. Obviously, as you go deeper into the enterprise with WorkApps and Advance and a lot of these more sophisticated capabilities that you're building, I'd just be curious how you think the role of your partners changes over time? And would love to hear just where you are today in developing that partner ecosystem, especially for those larger enterprise customers that may want some more consultative services as they deploy Smartsheet?

[Mark Mader, Chief Executive Officer]

I think one of the things that Pete highlighted was with this demand wave that started in Q4 and that's continued, it's been an amazing opportunity for us to get our 600 partners activated. So when we think about delivery, we don't think about just Smartsheet delivering stand-alone. We think about an opportunity to bring those people within the family and deliver alongside of us, seeding all of those -- seeding many of those services companies.

So in some cases, those are on our services contracts. We are paying them at a very good rate, and we're seeding that knowledge within those teams, which then can go out and deliver standalone. We do have other partners like Slalom who are developing capabilities where we fully expect them to be delivered high-value, large-scale deployments on Smartsheet.

So I think this demand and any concern in terms of tightening margins on services is muted by the fact that we're enabling those partners. And I think next year, we're going to be in a very favorable position, where you're going to have hundreds of partners delivering on our behalf.

[Operator]

Your next question comes from Scott Berg from Needham.

[Scott Berg, Needham]

Congrats on a fantastic quarter here. I guess I have two questions. First of all, I don't know who wants to take this, but on the enterprise strength and I guess general upsell strength. We saw the net revenue retention obviously tick up two points. If you look at the Company historically, most of that movement was around seat expansions as you penetrated your customers more. Mark, you spent a lot of time on some of the new modules and some early adoption there. But we look out two or three years, how does that net revenue retention or upsell the customer shift from all what was mainly seat-driven before to something that's more of a mix of module-driven along with seat-driven?

[Mark Mader, Chief Executive Officer]

I think it's going to be a blend, Scott. I think what we're not doing is putting a quote on ourselves saying we must adhere to certain amount coming from users, a certain amount coming from capabilities, like listen to the customers, see where they assign value. The approach that we've taken to scaling WorkApps and monetizing is different from how we have licensed users in the past based on customer signal.

So I think we will continue to monitor it. We will continue -- I fully expect us to continue to growing the capabilities elements further. I think when you start introducing things like 10,000ft and Brandfolder and you have those elements selling alongside, those are big tailwind opportunities for diversifying the revenue streams. So it's, again, early days on Smartsheet Advance, and we'll be able to more fully report on that in the coming quarters.

[Scott Berg, Needham]

Great. And then if I look at the income statement in the quarter, your sequential increase in sales and marketing is the largest in the customer -- in the Company's history, excluding conference impact in prior third quarters. How should we view that increase in spend? It's about $6.5 million. If we were to break that up, how much of that is head count versus maybe new marketing programs that you're targeting today?

[Pete Godbole, Chief Financial Officer]

Scott, you should think of this as sequential. First of all, it's a seasonal element of how these dollars come out. So in Q1, typically, there's a fair number of expenses, which are quarter-related. I think you would see that over time, you're going to see the head count parts of this increase because sales and marketing is quota-driven. A large part of that's going to happen. And we're going to see associated demand gen spend, which is going to make -- as you think about the sales and marketing as a percent of revenue climb as we go through the year.

[Operator]

Your next question comes from Brent Thill from Jefferies.

[Joe Gallo, Jefferies]

It's Joe on for Brent. Really appreciate the question. Mark, it was an interesting point you made on the McAfee integrations. I'm just curious of recent security breaches and concerns about third-party security postures have spurred an upsell to some of the tiers that include the access controls and governance capabilities and if you view that as a competitive differentiator against some of your peers.

[Mark Mader, Chief Executive Officer]

I think some of these elements are relatively new to the portfolio, but we -- I would expect this to be an increasing frequency of conversation, as you noted, based on what's happening in market. Some of these things are difficult to respond to quickly. So again, in terms of things we got right, a few years ago, when we started investing in these areas, it's put us in a strong position to have a really strong engagement when security and that high IT bar is presented to us to have to clear.

It's -- as someone who's been with the business for over 15 years now, I remember vividly when especially some of the institutions in the financial realm were quite tentative in terms of adopting SaaS. And now that some of these controls and security measures are in place, we're starting to see movement. And that's a really great sign to see those very, very critical companies giving us a passing grade and moving forward.

[Joe Gallo, Jefferies]

That's awesome to hear. And then, Pete, maybe just a quick one for you. Any sense of what Brandfolder contributed billings-wise in the quarter?

[Pete Godbole, Chief Financial Officer]

We were just pleased with our Brandfolder performance. We're not breaking our Brandfolder because we've generally done that for the first year of acquisition, but in general, really pleased with Brandfolder's performance.

[Joe Gallo, Jefferies]

Okay. Was it higher or lower than 4Q?

[Pete Godbole, Chief Financial Officer]

In general, I think Brandfolder really well. And I would say it exceeded plan, in line with a lot of our other businesses. As I said, we were sort of reporting a really strong quarter, and it was consistent with that kind of a performance.

[Operator]

Your next question comes from Michael Turrin from Wells Fargo Securities.

[Michael Turrin, Wells Fargo Securities]

The 50,000 customer adds really stands out as does the list of expansions previously referenced Mark went through on the call. I'm not going to ask you to read through all those again, but the strength certainly seems unique for Q1. So just wondering if there's anything you can add around what drove that uptick. And then the Q2 billings guide calls for roughly flattish growth versus Q1. And so I'm just wondering if there's anything abnormal in the strength you saw here to call out that informs that sequential outlook or if there's just maybe some conservatism in the Q2 outlook as well. Thank you.

[Pete Godbole, Chief Financial Officer]

Michael, I'll start with the billings guide. So just as a recap, when we started the year, our year-on-year growth for Q1 represented approximately, call it, 30% to 31% year-on-year growth. And based on our guide for Q2, we're calling a 37% to 38% year-on-year growth.

And the reason we see this confidence is because of what I've stated in my prepared remarks for Q1: larger number of deals in the pipeline, shorter cycle times to close and just a general strength across all what I call customer sizes and transactions.

So that's the way we're seeing it. And what we're also sort of emphasizing is when you look at the annual guide on billings, we've actually raised that in excess of the beat, and that's because we see this confidence parsing through the rest of the year. So the second part of it, I'll let Mark take that one.

[Mark Mader, Chief Executive Officer]

Yes. And on the customer expansion side, it's really a continuation of what we saw in Q4. And I think the -- during -- as we talked about last year, how our sales teams started to present value to people, when people really were far more demanding in terms of being able to articulate the value that one derives from doing CWM implementations. I think the performance in Q1 is that we have multiple quarters now under our belts where we're talking and presenting in that way.

And again, as I said quarters ago, I think that never goes out of favor. So now when you have confidence growing in business, combined with the presentation of value that leads to better things. But I think there was nothing -- I wouldn't say there was nothing out of the ordinary. We've had thousands of customers expanding every quarter for the last few quarters. We simply shared some of those names with you today.

[Operator]

Your next question comes from Steve Enders from KeyBanc Capital Markets.

[Steve Enders, KeyBanc Capital Markets]

I just wanted to check. I know the new UI has been out now for a couple of months. But I guess, have you seen any kind of early impact from that out of market, either driving better top-of-funnel conversion or driving existing customers tend to use cases and quicker expansion there, anything that would help?

[Gene Farrell, Chief Strategy and Product Officer]

Yes. Steve, I'll take this one. And I would say that Phase 1 has launched. We view the UI modernization as starting with kind of a multiphase approach over the course of this year and then will be ongoing. And the biggest uptick we've seen has really been in engagement -- user engagement and overall kind of speed of learning and understanding the platform. And I think we'll continue to see that as a net positive as we continue to make improvements and enhancements. But that's really the big benefit that we've seen so far.

[Steve Enders, KeyBanc Capital Markets]

Okay. Great. And I know you made a few acquisitions in the past couple of years, particularly focused on the marketing side and roll out some newer modules there. But I guess what have you kind of seen as you go back into customers and try and drive into the marketing department since you made those acquisitions? And what kind of strength have you seen specifically for marketing use cases since these new products have been rolled out?

[Gene Farrell, Chief Strategy and Product Officer]

Well, I think you heard one of the examples in Mark's prepared remarks talking about Uber and using WorkApps in their marketing group. We've got countless other examples of customers that are using us for marketing use cases. And as we have rolled out integrations with Brandfolder, improved integrations with 10,000ft, we're seeing a lot of interest. And it's obviously a very top-of-mind space. There's a lot of folks going after that segment, but we feel really good about our offering and the unique value that we of the capabilities we've added through proofing and content management and workflow.

[Operator]

Your next question comes from Brett Knoblauch from Berenberg.

[Brett Knoblauch, Berenberg]

Thanks for taking my question. Maybe on the margin front, and I guess it kind of goes to the revenue mix. How should we think about that panning out for the rest of the year? Should we assume services growth at a similar level to what we saw in this quarter and maybe reinvest incremental gross profits from higher subscription gross margins in the business?

[Pete Godbole, Chief Financial Officer]

Brett, I think you've asked two questions. I'll try and answer both of them. One is about the outlook on margins. I'll start with that one first. We reported a quarter where we beat our op margin and our free cash flow guidance for the quarter. But the quarter also gave us a lot of signals in terms of the size of the opportunity. We fully intend to invest based on our original guide for the year and take this amount we've over-performed and put it towards the investment capital we intended. So that's one part of your question.

The second part of your question was on services margin. I think you should start -- you should see our services margin as we get through this initial period of ramping of headcount start to approach where we've historically been. And that should take a few quarters to get through our ramp and utilization sort of new people and teams.

[Operator]

Your next question comes from Terry Tillman from Truist.

[Joe Myers, Truist]

This is Joe Myers on for Terry. You've owned Brandfolder for a bit now. I'm just wondering -- circling back to the question about how M&A has progressed and how that's helping you. How are you thinking about M&A going forward with your appetite? How's the pipeline? And how do you think about valuations right now?

[Gene Farrell, Chief Strategy and Product Officer]

Joe, we acquired Brandfolder in, I guess, it was the third quarter -- end of our third quarter of last year. And we feel really good about the integration. We feel really good about the way the team is performing. And it's -- we feel better and better about all of our acquisitions as we continue to see them kind of come into our product offering and the synergy we get with customers. So we feel really blessed there.

I would say from a -- M&A going forward, we will continue to view M&A as both a lever to accelerate value delivery for customers where we see key capabilities that enhance the utility we can deliver to customers and improve engagement or overall customer experience. But we're also evaluating constantly and looking at are there more strategic M&A moves that we could make to accelerate growth in a more exponential way, I guess, is the way I think about it and create more of a step change.

And so I would say that none of that is off the table. It's kind of all of those things fit into how we think about our growth strategy over time. But we're also -- we also think that part of the value of M&A is ensuring both strategic fit and deals that make sense from a value perspective.

And so the last part of your question, how do I feel about valuations, I think in some situations, there's great value we had; in other situations, some of the multiples are pretty lofty right now. And you really have to be thoughtful and clear on what the combined entity is going to create for you long term in order to really get comfortable with spending at those levels. So -- and I'm not signaling anything, just saying that's kind of how we think about the landscape today. And -- but you'll continue to see us be active.

[Operator]

Your last question comes from Boyoung Kim from Citigroup.

[Boyoung Kim, Citigroup]

This is Boyoung on for Tyler Radke. Just given the importance of advisory and consulting role that you mentioned for sales to just both landmarks and drive upsell, how do you feel about the sales ability for sales to execute in international markets? And how would you characterize sales productivity in international markets relative to what you've seen in more established U.S. markets?

[Mark Mader, Chief Executive Officer]

Yes. I think one of the things that's a real attribute of these types -- of this platform approach is that when you engage with someone initially in a comprehensive way, they become trained on how to deploy it. So when we think about investing in services team with one of our large customers who's scaling with Smartsheet Advance, that team becomes operators. So you don't have to go back to the services well every time you want to make the configuration or expand with another workflow. So that's a big plus.

As we think about international, we have a very good coverage on our partners today and that's combining a partner coverage with our 200 employees who are today based in the U.K. and Australia and New Zealand. So when we think about the seeds that have been planted, those have been planted over the next two years. And now it is really focusing on scaling.

Next -- sorry, in June 8, we will be introducing Smartsheet Regions, which will be the first of which outside of the U.S., which will be on the continent in Europe, is one of those things that further lets us unlock opportunity in those markets. And Smartsheet Region's plural. We don't anticipate spending with Continental Europe.

We will continue to go to other regions and pair that with our on-the-ground sales teams and services capacity. I think it is likely in international that we probably skew a little bit more towards partner as opposed to direct. But again, that will unfold more fully in the next year.

[Operator]

I will now turn the call back over to the presenters.

[Aaron Turner, Head of Investor Relations]

Great. Thank you for joining us today everyone. We'll speak to you again next quarter.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.