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

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

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

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

Aaron Turner: Thank you, Emma. Good afternoon and welcome everyone to Smartsheet’s second quarter of fiscal year 2024 earnings call. We will be discussing the results announced in our press release issued after the market closed today. With me today are Smartsheet’s CEO, Mark Mader; and our CFO, Pete Godbole. Today’s call is being webcast and will also be available for replay on our Investor Relations website at investors.smartsheet.com. There is a slide presentation that accompanies Pete’s prepared remarks, which can be viewed in the Events section of our Investor Relations website. During this call, we will make forward-looking statements within the meaning of the federal securities laws. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends.

These forward-looking statements are subject to a number of risks and other factors, including, but not limited to, those described in our SEC filings available on our Investor Relations website and on the SEC website at www.sec.gov. Although we believe the expectations reflected in the forward-looking statements are reasonable, our actual results may differ materially and/or adversely. All forward-looking statements made during this call are based on information available to us as of today. We do not assume any obligation to update these statements as a result of new information or future events, except as required by law. In addition to the U.S. GAAP financials, we will discuss certain non-GAAP financial measures. A reconciliation to the most directly comparable U.S. GAAP measures is available in the presentation that accompanies this call, which can also be found on our Investor Relations website.

And with that, let me turn the call over to Mark.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Q&A Session

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

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

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

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

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

Terry Tillman: Thank you.

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

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

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

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

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

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

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

Josh Baer: Great. Thank you, Mark.

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

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

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