Smartsheet Inc. (NYSE:SMAR) Q3 2023 Earnings Call Transcript

Smartsheet Inc. (NYSE:SMAR) Q3 2023 Earnings Call Transcript December 1, 2022

Smartsheet Inc. beats earnings expectations. Reported EPS is $-0.01, expectations were $-0.15.

Operator: Ladies and Gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Smartsheet Third Quarter Fiscal 2023 Earnings Conference Call. . It is now my pleasure to turn today’s call over to Mr. Aaron Turner, Head of Investor Relations. Sir, please go ahead.

Aaron Turner: Thank you, Brent. Good afternoon, and welcome, everyone, to Smartsheet’s Third Quarter of Fiscal Year 2023 Earnings Call. We will be discussing the results announced in our press release issued after the market closed today. With me today are Smartsheet’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’s a slide presentation that accompanies Pete’s prepared remarks, which can be viewed in the Events section of our Investor Relations website. During this call, we will make forward-looking statements within the meaning of the federal securities laws. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends.

These forward-looking statements are subject to a number of risks and other factors, including, but not limited to, those described in our SEC filings available on our Investor Relations website and on the SEC website at www.sec.gov. Although we believe that the expectations reflected in the forward-looking statements are reasonable, our actual results may differ materially and adversely. All forward-looking statements made during this call are based on information available to us as of today, and we do not assume any obligation to update 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: Thanks, Aaron. Hello, and welcome to our third quarter earnings call for fiscal year 2023. Today, I’d like to focus on 3 topics: our solid performance in the quarter, how we’re improving our operational efficiency in the current macro environment; and how delivering measurable ROI for customers drives our durable long-term growth. While Pete will provide additional details, I want to call out some of our strong financials from the quarter. Revenue for the quarter was $199.6 million, up 38% year-over-year. We added $56 million in annual recurring revenue, bringing our total ARR to more than $792 million. We added many new customers in the quarter, such as recruiting software providers seek out, Monster Energy, the social good empowerment platform, Bonterra and Arizona Beverages.

And we expanded Smartsheet’s footprint significantly at Picasa, AGC Biologics and Seattle Children’s Hospital, among others. Our strong expanded climb motion within our customer base continued with 235 customers expanding by $50,000 or more and 79 customers expanding by $100,000 or more. We also now have 40 customers with ARR over $1 million. And we ended the quarter with more than 11.7 million Smartsheet users. Last quarter, we discussed how our new sales reps were ramping more slowly than sales reps from previous years. This quarter, we saw improvements in quota attainment and pipeline generation from our newest reps. We exited the quarter with a record pipeline, improved after macro-related softening in Q2. We also made significant improvements to our profitability in Q3.

Our Q3 non-GAAP operating loss was negative $4.3 million significantly better than our guidance and a 7 percentage point sequential margin improvement from Q2. This improvement is a function of the adjustments we’ve made to our hiring plan for the year, a heightened focus on operational rigor and financial policies and inherent economies of scale in our business model. We expect these margin benefits to persist, allowing us to improve our non-GAAP operating income and free cash flow guidance for the year and beyond. The growth we experienced in the quarter came in large part from Smartsheet’s ability to provide measurable ROI for customers as they navigate the macro backdrop. For example, in Q3, a Fortune 50 healthcare company expanded its Smartsheet investment by over $0.5 million, bringing their total Smartsheet ARR to nearly $2 million.

Since moving to Advance Gold a year ago, they’ve seen a 56% increase in license growth as more teams across the organization leverage advanced capabilities to manage programs and processes at scale. Their Data Shuttle usage has increased almost 300% over the past year, and they now have 85 workflows powered by our Bridge integration product. One of the biggest benefits this customer is seeing from Smartsheet is improved efficiency, leading to a measurable ROI. For example, one team used a workflow powered by Bridge to automate a complex manual process for managing staff changes and application requests, decreasing the amount of time spent on it by more than 50%. We also saw a leading provider of customs brokerage and logistics upgrade to Smartsheet’s enterprise licensing and Advance Gold platform after determining that advance would save them nearly 3,000 hours of labor each year.

Those hours saved are delivering more than $300,000 in ROI for the company while giving it the ability to handle a larger volume of quick win transactions and improve employee engagement. In another Q3 advanced deal, the leading integrated reporting platform provider, Workiva moved up to advance, so the professional services group could leverage Control Center and the Smartsheet Salesforce connector to implement a new project and portfolio management solution. They chose Smartsheet as their PPM platform because it offers both introductory and professional-grade tools for project management that can scale to enterprise levels. This solution also gives project managers insight into project risks and time lines and makes it easy for them to see all assignments in one view, helping reduce project cost overruns.

They estimate that in over 3 years, they will earn a 340% return on their Smartsheet investment. On the innovation front, we launched several Smartsheet capabilities and experiences at our September ENGAGE conference. where we welcome thousands of Smartsheet customers and partners in person for the first time in 3 years. It was incredibly energizing and gratifying to connect with customers face-to-face and hear their Smartsheet stories. HP, Webex, AbbVie and many more presented during breakout sessions and shared how Smartsheet is empowering them to solve tough problems, deliver on promises and drive tangible results. At Engage, we launched portfolio WorkApps, which combines the power of control center for managing large portfolios with the end user simplicity of WorkApps.

A global food services company recently chose portfolio WorkApps as the PPM solution for its global transformation initiatives. The company has a complex global operating model and portfolio WorkApps gives its portfolio managers the ability to create portfolio views tailored to specific organizational roles that span multiple regions, countries and segments. By leveraging portfolio WorkApps, the company now has a clear line of sight into any given initiative across a global matrix environment, allowing leadership to drive a strategic road map and achieve KPI targets. We’re also deepening our investment in the PPM space by launching new resource management capabilities such as capacity view that gives resource managers increased visibility of their capacity for planning and deploying talent.

We’re continually refining our governance and security controls to meet customers’ current and future needs. At ENGAGE, we shared details on data egress, a new layer of control over how Smartsheet data can be exported outside of an organization. Such robust security and governance capabilities, which protect confidential information via granular control are a key reason many companies choose our platform. For example, in Q3, a large mortgage lender chose Smartsheet over another CWM solution when the competitor’s solution was unable to comply with certain mandatory requirements. This customer was impressed with Smartsheet’s enterprise-grade security and like how easy it was for teams across various lines of business to start using the platform.

Ultimately, they felt Smartsheet was the best platform to help them meet their COO’s goals for managing the business more securely and efficiently. We also announced our new desktop application, which was enthusiastically received by people. As worth of new ML-powered home and reimagined search functions. These investments streamline the daily Smartsheet experience for all users by enabling them to find and act on their work quickly. On last quarter’s earnings call, I mentioned our acquisition of the Outfit brand management templating and creative automation platform, which we have integrated with Brandfolder. The synergy of the Brandfolder Outfit solution is already providing its value for customers in a meaningful way. In Q3, we landed a $300,000 plus deal with a major appliance manufacturer that will be using Brandfolder plus outfit as their single source of truth for digital asset management and production.

Each brand within the company will use Brandfolder to track and manage assets, helping reduce assets for all. Outfit will provide a self-service model for building automated asset templates that they can distribute to wholesalers and retailers to ensure consistent brand marketing. This Outfit powered content automation solution will help the company reduce a 14- to 16-week creative and distribution process to 4 weeks, driving a 400% faster time to market for their marketing campaigns. By providing transparent and efficient content creation distribution and tracking capabilities. The new system allows the company to utilize its existing in-house creative team while eliminating significant outside agency-related costs. As you’ve heard today, despite the current macro environment, we had a strong quarter and remain well positioned for continued growth.

Just last month, in their Q4 2022 report, Smartsheet was named a leader in the Forrester Wave for collaborative work management tools. The report recognized that Smartsheet continues to provide an extremely broad set of use cases among the leaders in this Forrester Wave. And that Smartsheet strengths are the extensive availability of work types, flexible use case creation and end user automation capabilities. With people under greater pressure to choose the right CWM solution for their needs, reports like this are important in helping guide their decision-making. In closing, Q3 was another solid quarter for our company, especially considering the global macro headwinds. With our performance in the quarter, a continued focus on operational efficiency and the way we’re delivering ROI for customers, I remain confident in our ability to deliver long-term durable growth with improving profitability.

Now, Let me turn you over to Pete. Pete?

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Pete Godbole: Thank you, Mark, and good afternoon, everyone. As Mark mentioned, Q3 was a strong quarter that reflected durable growth and improving profitability. We exceeded our guidance on both the top and bottom line as customers continue to turn to Smartsheet for their diverse set of mission-critical work management needs, and we benefit from improving economies of scale and an intense focus on operational efficiency. We saw particular strength among our enterprise customers as these customers continue to deploy our capability-based products to streamline their most mission-critical workflows. Capabilities grew to 29% of subscription revenue in Q3, aided by strong growth in our advanced offering and Brandfolder. I will now go through our financial results for the third quarter.

Unless otherwise stated, all references to our expenses and operating results on a non-GAAP basis and are reconciled to our GAAP results in the earnings release and presentation that was posted before the call. Third quarter revenue came in at $199.6 million, up 38% year-over-year. Subscription revenue was $186.1 million, representing year-over-year growth of 40%. Services revenue was $13.5 million representing year-over-year growth of 12%. Turning to billings. Third quarter billings came in at $219.6 million, representing year-over-year growth of 36%, approximately 92% of our subscription billings were annual with 4% monthly. Quarterly and semiannual represented approximately 3% of the total. Multiyear billings represented less than 1% of total billings.

Moving on to our reported metrics. The number of customers with ARR over $50,000 grew 43% year-over-year to 2,962 and the number of customers with ARR over $100,000, grew 55% year-over-year to 1,346. These customer segments now represent 60% and 46%, respectively, of total ARR. The percentage of our ARR coming from customers with ARR over $5,000 is now 89%. Next, our domain average ACV grew 25% year-over-year to $7,951. We ended the quarter with a dollar-based net retention rate of 129%. The full churn rate remains below 4% given the current macro environment, we expect our overall dollar-based net retention rate to be in the mid-120s by the end of the year. Now turning back to the financials. Our total gross margin was 81%. Our Q3 subscription gross margin was 87%.

We continue to expect our gross margin for FY ’23 to remain above 80%. Overall, operating loss in the quarter was negative $4.3 million or negative 2% of revenue, which represents a 7 percentage point sequential margin improvement. The margin improvement was the result of cost-saving initiatives we discussed in previous quarters, which included moderation of our hiring plan and cost rationalization. Additionally, we led portion of our revenue outperformance dropped to the bottom line, demonstrating the operating leverage inherent in our business model. Based on our improved gross retention, we also moved to our 4-year amortization period for our commission base — commission expense from a 3-year amortization period. This accounting change contributed about 3 points of margin improvement in Q3.

Free cash flow in the quarter was negative $4.6 million. Now let me move on to guidance. Before I go into the details, a few comments on our approach to guidance. The macro environment dynamic, which impacts near-term visibility. We are, therefore, electing to remain appropriately prudent as it relates to our top line performance. For the fourth quarter of FY ’23, we expect revenue to be in the range of $205 million to $207 million and non-GAAP operating loss to be in the range of negative $2 to $0. We expect non-GAAP net loss per share to be negative $0.02 to $0.00 based on weighted average shares outstanding of 131.5 million. For the full fiscal year ’23, we are raising our billings guidance to $878 million to $885 million, representing growth of 33% to 34%.

We are also raising our revenue guidance to $760 million to $762 million, representing growth of 38%. We expect services to be 7% of total revenue. We are improving our non-GAAP operating loss to be in the range of $45 million to $43 million and non-GAAP net loss per share to be $0.31 to $0.30 for the year based on approximately 130 million weighted average shares outstanding. We are raising our free cash flow guidance for the year to $5 million. To conclude, Q3 was another strong quarter. We continue to demonstrate our ability to drive durable growth with improving profitability as the most demanding businesses in the world turn to Smartsheet for their mission-critical and data-intensive work management needs. Now let me turn it back to the operator for questions.

Operator?

Q&A Session

Operator: . Your first question comes from the line of John DiFucci with Guggenheim Securities.

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

Pete Godbole: John, this is Pete. I’ll take your question in parts. The first part of your question was pipeline conversion essentially, what I talked about last time was ramping our new reps, we saw our pipeline conversions related to rep productivity improve from that sense. And what we saw in terms of the physical view closing and pipeline, October was a strong month for us as it relates to pipeline closing. So those are the 2 elements of dimension on sort of how pipeline conversion looked. One, from a rep standpoint, and the other from the business deals and how they closed. Can you repeat the second part of your question you asked about, so I just want to take them in sequence.

John DiFucci: As we think about next year, should we assume that pipeline conversion stays at the current levels, or should we assume it gets better or who knows macro backdrop, maybe that changes for the worst, too. How should we think about it? How do you think about it as it relates to guidance?

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

Operator: Your next question is from the line of DJ Hynes with Canaccord Genuity.

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

Mark Mader: I think when you break it down in its most simplest terms, we’re helping companies drive revenue or achieve cost savings. And when you can apply a program or process, something is scaled to one of the things that they’re trying to achieve and using plans speak like that, you typically have an opportunity to have a conversation. So when we think about things like control center, Data Shuttle moving information more quickly and efficiently across systems. We think about having fewer hands on things so you can get shorter cycle times. These are all very hard ROI calculations you can make. So I think the shift, the continued shift from the soft benefits in terms of employee engagement, which is super important, but harder to calculate a benefit from.

Customers are responding to how we’ve oriented ourselves into such discussions. And I think that goes across not only selling seats to somebody, but also introducing our capabilities, which are really the underpinning for a lot of those calculations.

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

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

Operator: Your next question is from the line of Brent Thill with Jefferies.

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