WalkMe Ltd. (WKME) Q1 2022 Earnings Call Transcript

WalkMe Ltd. (WKME 1.52%)
Q1 2022 Earnings Call
May 23, 2022, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen. Welcome to the WalkMe's first quarter earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr.

John Streppa, head of investor relations. Please go ahead.

John Streppa -- Head of Investor Relations

Hello, and thank you for joining our first quarter 2022 earnings call. I'm John Streppa, head of investor relations at WalkMe. And today, I'm joined by Dan Adika, CEO and co-founder; Rafy Sweary, president and co-founder; and Andrew Casey, our chief financial officer. Certain statements we make today may constitute forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the safe harbor provisions of the U.S.

Private Securities Litigation Reform Act of 1995 that relate to our current expectations and views of future events. These forward-looking statements are subject to risks, uncertainties and assumptions, some of which are beyond our control. Actual outcomes may differ materially from the information contained in the forward-looking statements as a result of a number of factors, including those set forth in the section titled risk factors in our annual report on Form 20-F filed with the Securities and Exchange Commission on March 24, 2022, and other documents filed with or furnished to the SEC. See our press release dated May 23, 2022, for additional information.

In addition, certain metrics we will discuss today are non-GAAP metrics. The presentation of this financial information is not intended to be considered in isolation or as a substitute for or superior to the information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe that these measures provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to key metrics used by management in its financial and operational decision-making.

Further, throughout this call, we provide a number of key performance indicators used by our management and often used by competitors in our industry. For information on the non-GAAP financial measures and key performance indicators, including the reconciliation tables see our press release dated May 23, 2022. And with that, I'd like to hand it off to Dan.

Dan Adika -- Co-Founder and Chief Executive Officer

Thank you, John. Hi, everyone, and thank you for joining us today. I'm pleased to share that in the first quarter of the year, WalkMe grew subscription revenue 34% year over year to over $51 million. We continue to work on strategic deals with a leading organization, utilizing our digital adoption platform to leverage data, to take action, and to simplify user experiences.

We saw strength in the growth of DAP customers, adding eight new DAP customers in the first quarter, and the average ARR from DAP customer grew to $650,000. DAP customers are those who have embraced a data and outcome-driven approach to their digital transformations. While growing our revenue, we were also able to show operating efficiency with a non-GAAP operating margin of 33%, besting our initial guidance for the quarter. We are on a mission to fundamentally transform the productivity of humanity by unleashing the power of technology.

We pioneered the digital adoption platform to guarantee that every user utilizes enterprise software to the fullest and that every organization maximizes the success of digital transformation. How do we do it? Through the three key components of our platform: data, action and experience. With our unique data capabilities, what we provide organizations visibility into all of the digital touch points from existing workflows. Our deep proprietary technology understands any user interface like a human would, unlocking every aspect of software and user interaction.

Using this data, our customers know what needs to be fixed in the digital journey and can utilize a no-code editor to enhance workflows and build beautiful experiences for the end users, delivering a best-in-class enterprise user experience through our web, desktop, mobile and a new unified interface called Workstation. Workstation is a central hub for all employees' digital needs. The success of the end users to complete workflows has a direct impact on the business outcomes to drive the bottom line for enterprises, such as workforce improvement, risk reductions, compliant and productivity, providing a massive ROI. This is the value achieved by WalkMe's platform.

The DAP market category continues to receive greater market recognition with two recent reports from Gartner and Forrester's, I will discuss later. Our ecosystems continues to grow. This quarter, we had a record attendance at our user conference Realize. In addition, we signed new partnership, one with HCL and a technological partnership with Celonis that we will review later on.

The evolution of the current macroeconomic and geopolitical environment has driven an accelerated mindset for efficiencies across the IT stack. Organizations are looking to drive more value from their existing application and empower users to make the most of these tools, instead of putting incremental budget dollars into these problems. WalkMe's DAP is purpose built to help businesses extract more value from their existing software driving revenue and reducing costs. Our ongoing focus on Global 2000 enterprise and commercial customers with over 500 employees continues to drive our growth and validates our platform's value.

As we deepen our focus on the larger customer segments, we are seeing some variability in timing of these deals, materializing in our ARR, which was the case at the end of Q1. Since then, we've seen great momentum in April and May and remain confident in our pipeline for the rest of the year. We believe that we are at the tipping point for our category, ecosystem and demand, and see multiple levers that will give us the capability to grow more than 30% for the next three to five years, as we continue to penetrate deeper into enterprise organizations. We intend to drive that growth with prudent investment, as we strive to balance growth with scalability, as we push toward the Rule of 40.

I would like to take this opportunity to invite everyone tomorrow to our first ever Investor Day in New York, where we'll outline our company's vision for the future ahead, our product road map, detail our go-to-market focus, and how we believe we can build a scalable, durable business, while delivering real ROI and value to our customers. You can join us virtually as well. Now I'd like to dive deeper into our most important growth driver, which paved the path to scalable growth, as highlighted in previous earnings calls. We believe that we are at the tipping point for our category with greater recognition and rising demand for digital adoption platforms.

Digital adoption is increasingly being highlighted as mission critical for driving employee productivity and adapting to changing work environment. These are crucial elements of success of digital transformation, change management and operational efficiency. In April, Gartner published the Digital Workplace Innovation Impact metrics. Application leaders can use this tool to streamline decision-making according to business value, feasibility and organizational ambition.

Digital adoption solutions rank as the leading technology when classified by business value and feasibility. Digital adoption solutions are listed as a core ambition to digital workplace innovation strategy. Furthermore, last week, WalkMe was recognized in the late-stage vendor maturity segment in Forrester's new tech digital adoption platform's Q2 2022 report, which is the first market landscape of the DAP category. According to the Forrester report, global software decision-makers reported in more than 40% of their organization's software spending in 2021 went to new software licenses and new custom software solutions.

DAPs are emerging as catalyst for managing digital transformation with purpose-built features to enable users to do more with enterprise applications. We are thrilled with the recognition by leading analyst firms of the category that we created and we expect more recognition to come over time and forward-thinking CIOs and organizations focus on driving ROI with their software investment. As the world becomes increasingly connected, so do business processes and workflows. Digital adoption platforms are the way to align organizational goals, digital investments, and improving and enhancing the employee experience.

Our customers are the foundation of our business and our top priority. We just concluded Realize, our annual user conference, with record-breaking attendance. I'm excited to share that over 4,000 professionals and global technology leaders registered to attend, up four times from our last event in 2020. During the event, we had a record number of customers and partners share their journey to digital adoption.

We also shared three key product updates on our road map for 2022. We highlighted WalkMe Enterprise, our approach to enterprise-level digital adoption, where DAP is used in outcome-driven platform through data, action and experience. WalkMe Enterprise is designed as a solution and methodology for digital adoption. Business processes and digital transformation cannot be viewed in isolation.

They must have a platform on which to be deployed, measure and iterate on. WalkMe Enterprise is best platform for our customers, and we're excited to continue to advance our platform offerings for our customers. We also introduced key enhancements that we're making throughout 2022 to WalkMe Workstation. Workstation amplifies digital transformation through the employee user experience.

It enables WalkMe customers to accelerate the digital adoption strategies by enhancing employee productivity. Workstation is where employees can initiate workflows, simplify and personalize information, discovery, communication, and application usage data. Think of it as a search across the enterprise digital experience. This is where you start your journey and potentially get the job done.

The new Workstation enhanced our existing offering to include capabilities such as enterprise search, new integration with enterprise software, which enables employees to initiate workflow and retrieve information without opening the underlying application. Employees can also complete processes through our natural language chat interface, complete personalized onboarding and stay in the know through our desktop notification with personalized and segmented announcements. With Workstation, employees know exactly where to go to find the information and starting point for whatever they need to get their job done. Lastly, we introduced digital transformation intelligence, DTI.

DTI is designed for organizations to understand, measure the digital transformation initiatives. Through integration with various data sources and using WalkMe cutting edge DTI technology, DTI unlocks visibility into the organization tech stack from App discovery through deep usage insight across departments and users. With enhanced visibility and data, organization can plan a successful digital adoption strategy or directly take action with WalkMe to create experiences that drive users to success. As our category and majority of our customers are early in their life cycle journey to reach a full DAP deployment, we believe that speed to value and value realizations are critical.

We invested in our customer-facing teams to support the build-out of our world-class enterprise sales force to better serve our customers and help them realize the value of WalkMe faster. I'd like to take a moment to highlight how we partner with the Fortune 500 auto parts retailer, achieving tangible business results in just 60 calendar days after the deal was signed. In Q4, this customer was a new customer to WalkMe. We immediately understood the vision and strategic importance of WalkMe and signed as a DAP customer.

They've invested millions in digital transformation and are now hyperfocused on accelerating and delivering on their promise of digital transformation investments, including creating a dynamic employee experience, especially important in highly competitive retail labor market. We worked with their executive leadership team to identify use cases that are projected to have meaningful impact to revenue and margins, either in time saving, first-mover advantage or upsell opportunities. In just 60 calendar days, the customer deployed their first implementation, which focused on solving a top of mind challenge, accelerating the time it takes to build, cost and fill a new job listing. Why does this matter? In today's labor market, speed is critical, especially for frontline retail employees and even more so for this customer, who adds thousands of positions each year.

To enable managers to act quickly and meet the increased volume, the customer decentralized hiring to the store level. With this shift, store managers needed to post and fill their own roles, which was something they had never done before. In other words, they needed to learn an entirely new, complicated and time-consuming process during the mission critical time. We worked hand-in-hand with their newly established DAP team to launch WalkMe under HR system, and they've automated 60% of the steps to create a new job listing and enables managers to post tracks 85% faster.

The benefits of the WalkMe implementations are twofold. Manager can now post roles and fill their hiring needs faster and focus on revenue-generating activities, while increasing customer experience. And this is just the beginning for our partnership and their expected DAP journey. They are on track for the second release of their HR system within 45 days of their last deployment.

Their next platform implementation will focus on driving in-store upsells, which are expected to generate additional higher margin revenue. We believe that we partner on a strategic level with our customers. Outcome like this will continue to multiply as our customers advance in the life cycle of digital adoption and realize value connecting data, action and drive the employee experience. Let's shift to our growth drivers fueling our go-to-market and revenues.

Our journey to add more experienced market leaders to lead our organization to the next level is underway. Today, I'm very excited to share that we have signed a new chief revenue officer, who will join us in July. Our new CRO is aligned with our focus on scaling and enterprise like sales force and will help drive sales execution and higher efficiency, as we strive to build deeper and more strategic relationships with our customers. We will continue to invest in our leadership team as we go forward.

As discussed in previous calls, we're focused on international expansion of our business. We continue to monitor and track the event unfolding in Ukraine. As a company, we support our fellow employees who have called Ukraine home. During the first quarter of 2022, we took a swift action to help our coworker base in Kyiv to evacuate the area if they wish to do so.

Previously, we operated a small support engineering team out of Kyiv, we saw no interruption in our ability to service our customers and most importantly, all of our coworkers are safe. We'll continue to support them and their families during this time. We have not seen a material impact or slowdown on our business in the Europe region. We do not have nor do we plan to establish any relationship with organization based in Russia or any other regions under U.S.

sanctions. In the EMEA region in the first quarter, we had new and expansion deals with 59 customers and our pipeline remains robust. In our last earnings call, we highlighted that we are investing in our global enterprise sales force, and we continue to invest in building out the teams and capabilities to serve a global customer base. In the first quarter, my co-founder, Rafy Sweary, opened our office in Singapore, to better serve our customer base in that region.

As a global company, we are excited about the opportunity to expand our presence internationally. Another area of focus for us in 2022 is on the federal market. We invested in the teams and technology to be able to sell into the U.S. government.

It is a long process and requires some unique investments such as U.S. engineers in U.S. soil to serve our technology as well as containerizing our cloud-based solution in the Gulf cloud. In the first quarter, we made a great progress building out the team, and we're on the target with our plan to pursue federal start to moderate in the second half of 2022.

We've been working diligently to sign new partnership with key influencers in the government. Recently, we were vetted for Federal By Decode, a tech accelerator connecting innovative tech companies with federal thought leaders and buyers. We believe that the federal market is vastly underserved and right market opportunity for digital adoption. Our approach to driving the employee and user experience is directly in line with President Biden's executive orders on consumer experience and modernization.

We're investing in the teams and technologies to be able to advance this market and expect to share more throughout the coming quarters. Expanding on the recognition of the importance from the category by industry research analyst firms, our partners are increasingly coming to us for guidance on how to help drive digital transformation for their customer base and focus on driving employee digital experience, change management and software utilization at scale. Another sign for our category maturing our partners, who invest in building their businesses and practices centered around digital adoption and WalkMe as their platform. In the last two quarters, we have announced partnership with Accenture and Deloitte.

Today, I'm pleased to announce that we expanded our partnership with HCL, a leading IT consultant firm, to create more go-to-market opportunities. We've already had early traction with HCL, and we're looking forward growing our relationship further, as they help their customers reimagine their businesses for the digital age. Our partner program, while still very early, has already seen the pipelines from these channels continue to grow as we expand our combined go-to-market strategy. Our partnership with Accenture is already starting to bear fruit.

And now I'm thrilled to announce an exciting innovative new partnership with Celonis, the leader in process mining and execution management. Celonis' strength in having deep log level data of users process combined with WalkMe's ability to use this data to drive action and ultimately, the employee experience will help our mutual customers drive deeper engagement from their employees. Customers that deploy WalkMe and Celonis together can identify and prioritize processes that are not being executed under full potential and either fix them automatically or if needed, guide employees to take action at the precise moment their input is required. Business processes can be automated either via WalkMe's front-end automation capabilities or via Celonis' back-end API integrations.

Together, WalkMe and Celonis will help customers gain better understanding of how work moves across the enterprise, applies those insights to accelerate digital innovation and take the right action to reach new levels of business performance. In summary, our momentum continues to accelerate, and I cannot be more proud of our amazing team of individuals around the world, driving working forward to the future of digital adoption and to our customers, partners, DAP enthusiasts, industry analysts and community for being with us and supporting this ground journey. With the progress we've made in our growth drivers in the first quarter, we continued positive momentum from our category and enterprise class sales force, and growing diversification of ISVs and GSI channels, I'm confident we have a capability to grow 30% plus over the next three to five years. Now I'll hand it over to Andrew Casey, our CFO.

Thank you, everyone, for listening.

Andrew Casey -- Chief Financial Officer

Thanks, Dan, and thanks to all our customers, partners, employees and industry analysts for the continued support of our vision for driving digital adoption forward. As Dan mentioned, we saw strength in our revenue and operating leverage throughout Q1 of 2022. We've seen early strength in April and May, and have confidence in our full year 2022 plan, and we're reiterating our full year revenue guidance. I want to take this opportunity to remind you that given our focus on the Global 2000 enterprise and commercial customers with greater than 500 employees, quarter-to-quarter new ARR can shift as we pursue larger deals.

Longer term, as we gain scale, we expect these quarter-to-quarter movements will have a decreasing impact on our growth. We continue to see strength in our enterprise segment, where ARR from customers of greater than 500 employees is above 92% of our total ARR, whereas we continue to face short-term headwinds from churn in our less than 500 employees segment. But we expect those headwinds to abate in 2023 and beyond as we continue to focus on revenue from customers with greater than 500 employees. As we shift toward the greater than 500 employee segment, we expect to see better unit economics, as the customers continue to own their life cycle journey from a single application deployment to a DAP deployment.

We consider DAP customers as those who are deployed on four or more applications or have an enterprisewide agreement. Our DAP customers count grew by eight customers in the first quarter to 134 in total, up from 88 in the first quarter of 2021. Average ARR from this customer cohort grew to $653,000 in the first quarter of 2022, and total ARR from this cohort is up 56% since the first quarter of 2021. We believe that this cohort highlights the value that we can bring with organizations embrace an outcome-driven approach through their digital transformation strategies and the opportunity that we see for all of our G2K enterprise and commercial customers.

We are also executing on our strategy to expand our sales channels by building out our existing partner program. I'm thrilled with the progress that we've made, partnering with Deloitte, Accenture and HCL. We believe these expanded relationships will allow us to grow our footprint with the world's largest companies and in some of the biggest digital transformations underway. We continue to invest in the teams and structures to allow these relationships to scale.

Today, they represent less than 10% of our total ARR, but we are beginning to see the early signs of the growth potential, as Dan indicated earlier, regarding our pipeline from these partnerships. We believe these channels will also allow us to build leverage in our business model, as the cost to service the partner channels is less than it is for our current sales model. At scale, we believe the partner channels can contribute over 40% of our total ARR. Lastly, we are managing our business to be able to capture share in the emerging growth of our category with building a scalable model that can push to the Rule of 40.

We believe that the investments we're making today can show scale in 2022 and beyond, as we show increasing operational efficiency as evidenced by our decreasing operating loss margin percentage throughout 2022. We do this by managing our investments in the highest ROI areas. Last quarter, we outlined our investment plans to support expanding our reach within the enterprise and large enterprise customers by investing in our international sales force, our emerging federal practice, and to support our partner channels. As we focus on larger enterprise customers, we believe that our business model will become more seasonal in nature with a larger percentage of our net new ARR coming in the back half of the year.

With that in mind, we expect Q1 and Q2 to be the slowest in terms of growing ARR. Now let's review the numbers. Total revenue for the quarter was $56.8 million, an increase of 33% year over year. Subscription revenue in the first quarter grew 34% year over year to $51.4 million.

Remaining performance obligations, or RPO, ended the quarter at $318 million, representing growth of 34% year over year and current RPO, which is contracted subscription revenue expected to be recognized over the next 12 months, grew 30% year over year to $185 million. Long-term RPO, which is contracted subscription revenue expected to be recognized after the next 12 months, grew 41% year over year to $134 million. Annual recurring revenue at the end of Q1 was $230 million, representing growth of 30% year over year, compared to 29% growth in the first quarter last year. The momentum in large enterprise continues.

ARR growth from customers with more than 500 employees continues to outpace the rest of our business, growing 32% year over year. Our dollar-based net retention for customers over 500 employees was 121% for the trailing four quarters. Before turning to gross margins, expenses and profitability, I would like to note that I will be discussing non-GAAP results going forward. Gross margin was 77.6% in the first quarter, up 242 basis points year over year.

In the first quarter, gross profit was $44.1 million, up 38% year over year. We continue to see improvement in gross margin due to a larger proportion of our revenue coming from subscription revenue, which carries a higher gross margin profile. We expect our overall gross margins will increase over time as we continue to see a positive mix of subscription versus services revenue, and optimization of our hosting operations and improved services engagement model, leveraging partners wherever feasible. Turning now to operating expenses.

We remain focused on investing for growth to capture share as recognition of the category we created continues to expand. Sales and marketing for Q1 was $38.3 million, compared to $24.3 million in Q1 last year. This represents 67% of total revenue in the first quarter, compared to 57% in the first quarter of last year. These increased sales and marketing expenses are a result of our investments in sales coverage across all geographies, partner expansion and the burgeoning federal market.

As these resources increasingly become more productive, we expect to show operational efficiencies. R&D expense in Q1 2022 was $13.9 million, compared to $10 million in Q1 last year. This represents 24% of total revenue versus 23% in the same period last year. We continue to make investments in our platform to drive innovation and plan to continue to invest in R&D as we extend our product and invest in our ecosystem in 2022.

G&A expense was $10.5 million for the first quarter of 2022, compared to $7.3 million in the first quarter last year. G&A was 19% of revenue versus 17% in the first quarter last year when we were still operating as a private entity. We are investing in the infrastructure of our business to continue to drive long-term scale in our business. Going forward, the primary areas of investment for us will be R&D in sales and marketing as we look to capture the growing market opportunity.

Operating loss in the first quarter of 2022 was $18.6 million, compared to a loss of $9.5 million last year. Operating margin of negative 33%, compared to a negative 22% in the same period of last year and negative 35% in the fourth quarter of 2021. We expect to see continued improvement in our operating margin sequentially throughout 2022, as our investments scale and will begin to see leverage in the coming quarters. Net loss per share in Q1 2022 was $0.22 using 84 million weighted average shares outstanding.

Free cash flow was negative $20.3 million in Q1, compared to a negative $4.1 million in Q1 last year. Free cash flow margin was negative 36%, down from a negative 10% in Q1 last year, a reflection of the tight expense policies we implemented during the pandemic. Turning to the balance sheet. We ended the quarter with $326.8 million in cash, cash equivalents and short-term deposits.

Given our sizable cash balance with an expectation of improving margins throughout 2022, we are well-capitalized to continue to support our growth goals. Turning now to guidance. First, I want to remind you about the inherent seasonality of our business. Seasonality in our revenue reflects a classic enterprise SaaS model where revenues increase sequentially throughout the year, a reflection of our customers' demand patterns.

Meanwhile, our expense structure as a percentage of revenue is typically higher in the first half of the year and as we invest in headcount early on, with the expectation that those investments be increasingly productive throughout the year. As we focus on large enterprises, we expect the seasonality to be more pronounced. With that said, for the second quarter in 2022, we expect revenue in the range of $59 million to $60 million, representing growth of 26% to 28% year over year. Non-GAAP operating loss in the range of $19 million to $20 million.

For the full year 2022, we are reiterating our top line revenue guidance and lowering our expected operating loss range. We expect revenue in the range of $251 million to $255 million, representing growth of 30% to 32% year over year. Non-GAAP operating loss in the range of $78 million to $74 million, reflecting a gradual improvement in operating leverage in the second half of 2022, as we see continued returns from our investments. With that, Dan, Rafy, and I will take your questions.

Questions & Answers:

Operator

[Operator instructions] We'll take our first question from Scott Berg with Needham. Please go ahead.

Scott Berg -- Needham and Company -- Analyst

Hi everyone, thanks for taking my question here. Just a couple. Dan, let's start with your comments on larger deals taking longer to close. I guess a couple of questions here.

First, it sounds like you had some of your larger deals in the quarter slipping into the second quarter. I guess, first of all, can you confirm that? And then secondly, have those deals that you expected to close in Q1, have they already closed here in either April or early May?

Dan Adika -- Co-Founder and Chief Executive Officer

Hey Scott, thanks for the question. So yes, I confirm that. As I said, we had a great April and May. I would say a few of the deals that pushed, majority of them already closed, and we're looking forward to close all of the deals that pushed.

This is why we're reiterating our guidance. And -- but yes, you're correct.

Scott Berg -- Needham and Company -- Analyst

Got it. Helpful. And then from a follow-up perspective, you all mentioned new CRO starting in July. I know the organizations went through a lot of changes on the sales side over the last year.

Obviously, new partner ecosystem seems to be doing well as part of that. But what does this new CRO bring maybe in a background or quality qualification standpoint that we should look for that may make some changes to your sales organization going forward?

Andrew Casey -- Chief Financial Officer

So first, Scott, this is Andrew. I'd tell you, we're very -- we're thrilled with our new CRO. I think he brings an enterprise level focus and rigor to our sales processes that as we transition to focus on more enterprise, large enterprise clients, he brings the capability and the know-how and frankly, the rigor and sales process that we really need as we scale and roll out. So we're very -- we're thrilled about that and looking forward to the capability to help bring to the executive team.

Scott Berg -- Needham and Company -- Analyst

Thank you for taking my questions.

Operator

We'll take our next question from Michael Turrin with Wells Fargo Securities. Please go ahead.

Michael Turrin -- Wells Fargo Securities -- Analyst

Hey, great. I mean you referenced some impacts from the timing of deals, but it did sound pretty clear not seeing any signs in the demand environment overall changing. Can you just spend some time on the data you're looking at that informs that perspective? And maybe also just if there's a view around WalkMe's approach to just getting better efficiency around software spend and if that could it all help buffer any macro headwinds in an environment where we could see some degree of spend rationalization?

Dan Adika -- Co-Founder and Chief Executive Officer

Sure. So what we're seeing actually is we're going up market and we're selling digital adoption platform as a platform, some of the deals are becoming larger and bigger, and they're a little bit more complex. We're all about fair exchange of value between us and our customers. And that sometimes require some education from our side.

As you know, it's a new category. And we moved from selling point solutions to selling a wide platform that impacts their digital transformation strategies. So yes, sometimes, some of those bigger deals can slip and move toward obviously a different quarter or a different week. The metrics that we're looking that give us the confidence is the pipeline.

The pipeline is growing. We're getting more G2K pipeline. We're getting bigger deals. The average deal size is growing.

So overall, our pipeline for the rest of the year actually grew compared to what we expected. So that gives us a lot of confidence. And it's not just that the pipeline is growing, the quality of the pipeline is growing and the deals and the people that we're talking with are meaningful conversations and meaningful deals that actually impacted the line of our customers, so we are actually very, very excited about. In addition, we're seeing huge momentum with our partners.

And obviously, our partners that drive digital transformation with the largest companies in the world. When they're bringing WalkMe in, obviously, that's something that our customers are happy about. And obviously, it leads to very good deals and bigger deals. Regarding the software spend that WalkMe is saving, yes, you're absolutely right.

I think an economy like that and with the fear of recession having a digital adoption platform is key. Companies are spending so much money on digital transformation. And without real adoption, they're basically not just getting the ROI, they're wasting money and wasting resources. So actually, companies are coming to us and asking us how we can help.

So we're actually seeing it as a great opportunity for us.

Michael Turrin -- Wells Fargo Securities -- Analyst

That's all really helpful color. Andrew, we know you pressed pause on some sales investments during COVID and saw some impacts both on the growth profile and just quicker profitability improvements. Are there any lessons learned from that exercise you can point us toward? And what's the current mindset from the team around investing in the things like sales capacity currently as we head toward the back half of the year?

Andrew Casey -- Chief Financial Officer

So a couple of things, Michael, thanks for the question. I think that first and foremost, given the macroeconomic backdrop, I mean we are laser focused as an executive team here at WalkMe to make sure that as we're investing our dollars, we're getting the right levels of the return that we expect. And we're taking that approach, call it, a nest-curve approach, if you will, to the ways in which we're investing is that we're starting to see the early returns on small levels of investment we're making. And we're holding back, if you will, on the larger investments until we really see the efficiencies and the returns from them.

So that's the way I'm approaching -- as we go forward in 2022. I think we've done a really good job in advance of this year to really position our sellers in the right places with the right clients. And that gives us confidence that we don't need to do a whole lot of investment in the second half of the year. In fact, most of our investments have occurred during the first half of 2022.

Like any other major enterprise software company, who tries to make sure that the sellers have a full year of ramp capability, at least enterprise SaaS companies do. And so that's the way we think about it as well, Michael, that we've done some major investments in our sales team. We started to support them with key resources around them, like our partner managers and our sales engineers and a host of others. But the way I think about it right now is that we're -- we've got the capacity in place.

Now it's upon us to execute and drive the efficiencies associated with those investments.

Michael Turrin -- Wells Fargo Securities -- Analyst

Thanks very much.

Operator

We'll take our next question from Kevin Kumar with Goldman Sachs. Please go ahead.

Kevin Kumar -- Goldman Sachs -- Analyst

Hi, Thanks for taking my question. I wanted to ask about your DAP customers. You added eight in the quarter and now DAP customers represent about 28% of your $100,000-plus ARR customer base. My question is, can all of your $100,000 plus customers become DAP customers over time? I guess that another way, what needs to happen for customers who are already spending six figures to go all in and become a DAP customer?

Dan Adika -- Co-Founder and Chief Executive Officer

Great question. So we believe that every company above 500 employees can be a DAP customer. So to your answer -- to your question, yes, we believe that we can get most of our customers today to that level, and that's what excites us the most. The potential that we have with just our existing installed base is massive.

Now what it takes in order to get to be a DAP customer, one is value. Again, we're a new category usually when company is coming to us, they're coming to us with one project. For example, they have a Workday deployment or a SuccessFactor deployment or Salesforce deployment, you name it. And then from there, they're seeing how much value what we can bring to the table, so they're starting to expand with us.

As I mentioned in the call, in Q4, we actually saw a customer landing as DAP customer and now even expanding with us. So obviously, there's a lot of market education that we need to do, going after market, talking with obviously the CIOs, the CTOs of an organization. And this is why the partners is such a key component for us, because they are -- the CSIs are the ones that drive the digital transformation with those enterprises and bringing WalkMe in to get faster to DAP. But I would say the number one for us is to bring value to our customers once they see the value they're expanding.

So yes.

Kevin Kumar -- Goldman Sachs -- Analyst

That's helpful. And then last year, you had some elevated churn, I think, coming from the SMB customer base. Has that started to stabilize at all? Just curious if the overall churn of the business where you would like it to be at this point.

Andrew Casey -- Chief Financial Officer

That last one, so I would tell you that we still got 8% of our total annual current revenue in that less than 500 employee category. And as you indicated, as we continue to focus our coverage and our sales efforts around marketing to G2Ks, enterprises and commercial clients, who are greater than 500 employees, that the amount just will drop or would become less and less. And the fact of the matter remains that in that class, we do see a much higher churn rate rather targeted customer classes. So I think we're going to continue to deal with it for -- throughout '22 to a lesser degree.

But as we move into 2023, I see that, that percentage becoming one that's almost immaterial. And it comes from customers -- value proposition or we'll just move away from that type or itself. They'll become less and less track.

Kevin Kumar -- Goldman Sachs -- Analyst

Great. Thanks for taking my question.

Operator

We'll take our next question from Michael Turits with KeyBanc. Please go ahead.

Michael Turits -- KeyBanc Capital Markets -- Analyst

Hey, guys. Congrats on DAP customers and on the solid growth. Understandable that as move up market, things get lumpy. It's the nature of the business.

But maybe you could drill down, if you would, into what was behind some of the pushouts? Was it longer sales cycle in general, because the deals are getting larger? Was it anything to do with macro and in terms of the tighter budgets? Anything you can give us there would be helpful.

Dan Adika -- Co-Founder and Chief Executive Officer

Sure. So let me explain you how it works. When we actually get into the enterprise license agreement and the DAP deals, as we call it, the organization basically move WalkMe to a centralized budget, right? So if we sold to the sales department or to the HR department, now when we're doing an enterprise license agreement, they're actually need to pay for it from a centralized budget. As DAP is a new category, they don't have DAP as a line item budget.

So this is usually where it's becoming a little bit more challenging for us, because they want WalkMe. They already use WalkMe, because usually, DAP built on expansion deal. And then when we're talking with our procurement, it's like, OK, so who is paying for it, which budget it is coming from, and then they're going and allocating budgets from the different departing in order to get to that bigger deal. That usually takes us a little bit longer because we need to educate them, they need to educate themselves and they see exactly how to execute the deal.

Because we're bringing tremendous value to those customers, we're not willing to cut our pricing just to close the deal. And because of that, if it will take three, five weeks longer to close the deal, we will wait at that time. Because at the end of the day and what's excite us is how we're building the category. And the signs that we're seeing that the category is growing, because in order for us to grow at that scale for the next five years and even more, we need DAP to be a category.

We need DAP to actually be something that is a line item budget for every CIO, CDO, and that's what we're pushing. And this is why we're very excited from this quarter, because of the partnerships that we made, the technological partnership that we made, obviously, new GSIs that we're signing. But I would say, budget owner would be what slow us today.

Rafy Sweary -- Co-Founder and President

We can -- I can add, this is Rafy. I can add. This is Rafy. In some of the deals that were pushed, we see early indicators for the conviction they have, and it is a budgetary thing insight.

So for example, assigning the team that's going to work on the cross DAP collaboration. So those are things that are really encouraging for us.

Michael Turits -- KeyBanc Capital Markets -- Analyst

Great. That's helpful. And then, Andrew, obviously, it sounds like this is the peak of investment in the first half. And obviously, you're not giving long-term guidance at this point.

But can you talk about something that would give us some sense of beyond '22 in terms of whether or not you see a dollar reduction in losses, both EBIT and cash flow?

Andrew Casey -- Chief Financial Officer

Yes. So let's talk about a couple of the areas, Michael, because -- and I certainly will encourage everybody, who's listening, to attend our Analyst Day tomorrow, where we're going to go through some of these things. But from a gross margin perspective, we talk about the increasing percentage of our subscription revenue, which has a much higher revenue margin profile than the services revenue component. And as that happens, you'll see a natural progression of a higher gross margin.

We're also increasingly better managing our support and hosting costs. That will drive higher subscription gross margins. And then finally, as we shift more and more of our services to our partners, who are more efficient at delivering those services, we'll be able to drive toward a much more optimized services profile that results in a lower drag on the overall gross margin. So that's at the gross margin line.

On the operating expense side, the sales and marketing efficiency is probably at a low point for us as we continue to progress toward driving greater operational efficiencies. And once again, I will tell you, as we invest and expand more with our partners, we'll be able to drive a much more efficient go-to-market model, which will result in a low -- at a much higher sale of efficiency and better LTV CAC ratio, which I'll talk about in detail tomorrow.

Michael Turits -- KeyBanc Capital Markets -- Analyst

I'm sorry.

Andrew Casey -- Chief Financial Officer

So I was just saying those are some of the examples of the [inaudible] we think we have in our model. That's how we can drive toward increasing operational efficiency.

Michael Turits -- KeyBanc Capital Markets -- Analyst

Great. Thanks , everybody.

Operator

We'll take our next question from Vinod with Barclays. Please go ahead.

Vinod Srinivasaraghavan -- Barclays -- Analyst

Hi. Thanks for taking my question. I wanted to touch on the U.S. government opportunity you brought up on the call.

You mentioned the FedRAMP certification and moderate status can be coming in the second half of 2022. And in the past, have talked about kind of having the right sales teams and partners in place. Can you maybe just talk about where you are with each of these factors versus where you need to be to start driving more incremental revenue contribution? And kind of when do you expect this to happen on each of the items I mentioned?

Dan Adika -- Co-Founder and Chief Executive Officer

Sure. So on the FedRAMP moderate status, we're aiming to Q3, Q4 this year. Obviously, it's a long and complex process, but we're on track. And as you know, that's a must in order to do business with the government.

One of the things that we did and -- in the previous earnings call, is that we already have the team in place. So we have a full team operate, building opportunities, working with the government agencies, the demand that the government needs for employee experience, and digital transformation is exactly like the private market. And this is why -- those agencies are anxious to start working with us. We're getting the demand from them.

So overall, it's looking really, really well. I would say that we're already signing deals with authorities and states, which is not federal. But obviously, we're seeing the same theme and the same demand. So obviously, this year, probably it's not going to be huge for us on that, because we'll start in Q3, but the pipeline is stacking up and we're really happy that we made those early investments.

So this is where we are there.

Andrew Casey -- Chief Financial Officer

Yes. Maybe just to add to that, Dan. There's -- when you go through -- in advance of getting the certification itself, when you're starting to -- when the agencies recognize that you're actually going through the process and that you're -- you've been approved into that process, it starts the phase of where you started get included in the RFP discussions. And I will tell you that we -- the good positive momentum that we're seeing in the space is we're getting the acknowledgments of the agencies.

We're starting to get included into the RFPs and we did recently get a validation from a key partner within -- in the federal space that we're validated for federal business. So all those things are just little milestones. It says our investments in there are going to pay off, and it's just about being diligent and focused on our execution.

Vinod Srinivasaraghavan -- Barclays -- Analyst

That's helpful. And then I just also wanted to touch on Deloitte and Accenture. And can you just talk about where they are in terms of building out their practices and how long does that take for them to kind of really build out full-fledged practices, where you'll really start to see momentum and kind of move toward that longer-term 40% target coming from partners? Thank you.

Andrew Casey -- Chief Financial Officer

So we're really happy with the progress there, I will tell you. You'll have to ask them what they can [inaudible] train consultants or dollar value. But we're very happy with the pipelines we are starting to create. And frankly, some of the wins, we actually had a couple of wins score, our key partnerships with each of them were cited as the reasons that customers chose WalkMe that they had confidence in the delivery capabilities and the vision that our partners have for WalkMe in their environment.

So we're starting to see, I think -- obviously, I think it's one of the most important investments we're making for our long-term growth, and frankly, for our future sales efficiency. So it's -- look, it's one of those areas when you're trying to do a major design win and change the way in which people are delivering their digital transformation services that you've got to do it in a very methodical and thought out way but the pipelines are growing, the wins are accruing and we're increasingly appealing to more and more GSI partners as evidenced by our agreement with HCL this quarter. So we're happy with the progress.

Vinod Srinivasaraghavan -- Barclays -- Analyst

Great. Thank you.

Operator

We'll take our next question from Pat Walravens with JMP Securities. Please go ahead.

Joe Marincek -- JMP Securities -- Analyst

Hi. This is Joey Marincek on for Pat. I'd love more color on the strategic partnership with Celonis. What was the genesis for it? And what do you think it provides WalkMe? Thank you so much.

Dan Adika -- Co-Founder and Chief Executive Officer

Thank you so much for this question. I waited for it. That's super exciting partnership. This partnership is a game changer of what the combined solution can do for digital transformation.

So let me explain what we did there. So obviously, Celonis is an amazing company, and they have the ability to get and extract the back-end data from logs from all the transactions, if it is CRM, ERPs and so on and discovering efficiencies and processes. What they're lacking is the ability to actually create action. So you figure out that something is not working, great, how you fix it.

The integration between us is that once Celonis identified inefficiency in the process, we can activate a WalkMe action that will pop up on the employee computer, and we show them exactly what to do, even automate it in real time. And everything is happening without any configuration. So they're actually identifying the problem, activating an API, and then WalkMe takes over in the action, pops up and show the user exactly what to do. That's actually pushing real results with our joint customers.

And actually, the way this partnership was born was from our customers. Our customers are like, hey, why you're not connecting, why are not connecting and one of our customers introduced me and Alex in a superfast fashion, who were able to create a very complex technology integration that is in production now and happy to obviously announce it. As we started to talk with more and more customers, every CIO, we presented a solution were blown away. So this is exactly what we need.

So we're looking forward to this partnership and see more and more of our joint customers using that.

Joe Marincek -- JMP Securities -- Analyst

Super helpful. And then on the hiring front, I just want to clarify. Have you named any changes to your hiring plans for the year or any updates just with all the uncertainty going on? I'd love to get your thoughts there.

Andrew Casey -- Chief Financial Officer

The only thing I would say is that our hiring plans remain consistent with and what we stated was that most of our hiring happens in the first half of the year. Now having said that, I will tell you that we are watching every dollar we spend, and we're making sure that we're achieving the ROIs that we expect from those investments. That may cause us to look at individual hires and delay, pause or reallocate based upon where we see investments between higher level versus a lower level. So I wouldn't want you to take away that we are changing our expectations on where we're investing, but I will tell you that the scrutiny with which we're applying our expectations for return are at a heightened level.

Joe Marincek -- JMP Securities -- Analyst

Thank you both.

Operator

We'll take our next question from Keith Bachman with Bank of Montreal. Please go ahead.

Keith Bachman -- BMO Capital Markets -- Analyst

Yes, thank you. =I had a couple. Andrew, just to start with you. I wanted to come back to an earlier question and trying not to steal from the event tomorrow, but could you talk about when you think you would realize cash flow breakeven? Is that going to be during a quarter in CY'23?

Andrew Casey -- Chief Financial Officer

So we're not giving that long-term guidance, Keith, but I think that what we will do is we'll show you the pattern through which -- when we talk about growing -- our ability to grow 30-plus percent over the next three to five years, and the way we're actually driving toward our long-term operating profitability that you'll be able to come up with a model structure that will best facilitate that answer. But right now, we're not giving that long-term guidance. Frankly, too, it's the situation of how will the second half of this year really profile out. And although we certainly are mindful of the backdrop and the macroeconomic issues, I want to reiterate something Dan mentioned earlier and that is, we're not seeing any substantive change in our demand pattern.

And frankly, if we position WalkMe the right way, we could actually take advantage of some of those more macroeconomic situations as well. So take away, it's a little uncertainty associated with that. But the reality is that, we're not giving that long-term guidance yet, and we're going to try to map out a way for you to understand that and to keep [inaudible] tomorrow.

Keith Bachman -- BMO Capital Markets -- Analyst

OK. But you did say that the operating income loss was at the low watermark. So can I assume that the free cash flow loss was also at a low watermark?

Andrew Casey -- Chief Financial Officer

The predominance of our free cash flow is generated from our operating loss. So you're not going to see big capital expenditures or other items would negatively impact free cash flow from us. We're just not type of business. So as op income loss goes, so does free cash flow profitability.

And it will -- and given that we bill annually in advance, you see that happen as a precursor to operating profitability. So -- the other thing you can take away, we're laser-focused on driving operational efficiencies sequentially as we go forward.

Keith Bachman -- BMO Capital Markets -- Analyst

OK. My second question is, I want to talk a little bit about the threat of competition and pricing. And I was going to break it into a few pieces. A, when you're trying to procure new logos, in particular, is that still mostly so sourced? Are the competitive bids, B, when you're in those type of situations, how is the pricing environment? And C, then just more broadly, you did mention that as you're trying to move upmarket, you indicated the unit economics get better.

And I just want to make sure I understood that correctly, because I assume the pricing is a bit more, shall we say, scrutinized at the larger enterprise, but I just wanted to hear you flesh out those kind of components on competition and pricing.

Dan Adika -- Co-Founder and Chief Executive Officer

Sure. So I would start. So the way we're seeing it, so there is digital adoption platform when we're selling the solution for organizations that we're helping them drive their digital transformation. And there is the point solution, like when you buy guidance website or you have a specific on onboarding or something like that.

This is usually where we'll see the competition. And obviously, they're coming in a lower price. But that's not the promise of WalkMe and that's not what we're selling. At the end of the day, we're helping companies realize the value of their digital initiatives, and we're helping them with their bottom line and revenue.

So yes, there is competition. There will always be competition. But for us, what we're doing, we're focusing on the category and the value that we're creating to our customers. So right now, we believe that we are, by far, the most advanced platform.

So this is on that. Regarding the scrutiny on the pricing, I wouldn't say there is a scrutiny on the pricing. I think it's more understanding how they're budgeting it. So at the end of the day, we think we're still leaving some money on the table.

We don't think that WalkMe is expensive at all. And I don't think our customers think that as well. I do think that as they plan their budget and now they need to pay for it as an enterprise license, they need to figure out how they're budgeting it and how they're allocating it. And that's what's slowing us down.

I don't think it's on the -- or the pricing is too high. I hope it answered the question.

Andrew Casey -- Chief Financial Officer

Yes. Maybe just to add to that a little as the -- when you refer to pricing, I'm assuming you meant deal sizes and value. The issue that we often see is that we're rationalizing the value of the platform across to a whole new set of stakeholders at a whole new level. And that in itself is where we are showing the capabilities that our clients can really gain from an investment in a WalkMe platform.

So it's one where Dan was referring to earlier. As we go into some of these larger deals, we want our fair value exchange. If we're generating $5 million in business savings that we expect that we can have a lower multiple on that is part of our fair value exchange. And in some cases, that's an education process.

And that in some cases, if you're dealing with procurement, they'll push down as much as you can, but if we're not willing to go there, because we think we create better value, then that's the rub. I often talk to our sellers about the differences between a taxi and rideshare service. No one will compare the two to each other, because the rideshare service gives you a much higher value. It gives you information to provide your destination.

So WalkMe is no taxi. We offer greater value to our clients, and we should expect to be paid for it.

Rafy Sweary -- Co-Founder and President

I think that also, if you look in the most recent comparison coming out of the Everest peak, you see that there are 18 vendors. WalkMe is more than 45% of the market. So we're definitely seeing that we maintain this leadership. And from our perspective, the more small -- the more competitors coming in would just benefit us.

Andrew Casey -- Chief Financial Officer

And then the last one, Keith, real quick, and I'm happy to get into this in more detail tomorrow on the LTV to CAC ratios. We think that in terms of, we're paying the same price for a direct sales model for a customer with -- that is less than 500 employees, which has a much higher churn rate and a lower LTV than the enterprise clients, who signed longer-term contracts, have a much higher renewal rate. So that's the major difference. And when we add partners into that mix, we change sales expense into -- a sales expense line item into a partner discount line item.

Operator

And ladies and gentlemen, this will conclude today's question-and-answer session. At this time, I'd like to turn the conference back to Dan Adika for any additional or closing remarks.

Dan Adika -- Co-Founder and Chief Executive Officer

Thank you, everyone, for joining the call, and I appreciate the questions. As Andrew said, just a reminder, we have our Analyst and Investor Day tomorrow, and we'll go deeper our product vision and go to market, we will be thrilled to see you there. And thank you so much for the time.

Operator

[Operator signoff]

Duration: 63 minutes

Call participants:

John Streppa -- Head of Investor Relations

Dan Adika -- Co-Founder and Chief Executive Officer

Andrew Casey -- Chief Financial Officer

Scott Berg -- Needham and Company -- Analyst

Michael Turrin -- Wells Fargo Securities -- Analyst

Kevin Kumar -- Goldman Sachs -- Analyst

Michael Turits -- KeyBanc Capital Markets -- Analyst

Rafy Sweary -- Co-Founder and President

Vinod Srinivasaraghavan -- Barclays -- Analyst

Joe Marincek -- JMP Securities -- Analyst

Keith Bachman -- BMO Capital Markets -- Analyst

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