Smartsheet：Solid Quarter Marked by Strength in Large Deals and Capability-Based Offerings, Multiple Growth Vectors on the Horizon

P&L Above Consensus Across The Board. Revenue came in ~3% above consensus and guidance and grew 26% y/y, marking a deceleration from 31% growth last quarter. The beat relative to consensus expectations was driven entirely by Subscription revenue, which grew 28% y/y vs. 33% growth last quarter. PF operating margin of 8% came in 5 points above consensus, led by the revenue outperformance along with a favorable OpEx profile. Specifically, the company beat revenue by $6M, while beating PF operating profit by ~ $11M, underscoring the operating leverage in the model. Free cash flow in the quarter also landed well above consensus at $45M vs. $15M expected.

FQ2 Billings Lands Ahead, FY Growth Guide Reiterated. Calculated billings grew 18% y/y, landing ~7 points above consensus growth expectations and implied growth guidance. While billings growth of 18% y/y marked a deceleration vs. 20% y/y growth last quarter, the year ago comp for billings was 8 points harder. We think the outperformance was partially driven by solid large deal traction, evident in the 50% y/y growth in Advanced deals, while number of million dollar ACV customers also grew sequentially by 4 as compared to 2 last quarter and 3 a year ago. The company also noted that Capability-based offerings had a strong showing, attaching to all the top 10 deals in the quarter. Despite the Q2 beat, the company maintained its 20% y/y billings growth for the year, but called out Q3 billings to be 24% of FY billings, implying a downtick in sequential growth, with the implied Q3 billings number landing ~4% below consensus.

Net-New ARR Growth Improved. ARR grew 27% y/y, marking a deceleration vs. 30% y/y growth last quarter. Net-new ARR of $47M, marked a very strong seq growth even as compared to the year ago period, which was a quarter not impacted by macro (+27% seq growth in Q2 FY24 vs. 25% in Q2 last year). The y/y growth for net-new ARR also improved (-12% y/y vs. -28% y/y last Q). Post Q2, we see the 2H ARR build as very achievable in order to get the full year ARR growth close to the full year billings growth, and even easier if the historical relationship of ARR growth landing below billings growth holds.

Gross Churn Stable But Dollar-Based Net Retention Downticks. Dollar-based net retention rate (DBNRR) contracted 200 bps sequentially to 121%, while gross churn rates remain stable at 4%, although likely deteriorating some basis points from the last quarter comment of “below 4%”. Management also pointed to “healthy” pipeline entering Q3 and pointed to 116%-117% DBNRR exit rate for the year, fine tuning its earlier comment of “high-teens” exit rate for the year.

FY24 Guidance For P&L And Cash Flow Resets Higher Across The Board. Management raised the FY24 guidance across the board. FY24 revenue was raised by the Q2 beat in the quarter or $6M and now implies 24% y/y growth. PF gross margin expectation was raised by 200bps to 82%+, which along with revenue upside and improving OpEx profile should drive PF operating income of $62-67M or 6.8% margin at mid-point, an increase of 170bps. PF EPS was raised by 15c to 55c for FY24. Additionally, while full year FCF was raised by $10M to $120M or ~13% implied FCF margin, Smartsheet now expects Q3 FCF to be $5M, below consensus, due to cash outflows related to Engage customer conference, payroll expenses in the Q and semi annual contractual payment related to a cloud provider.

Cisco Signed a Multi-Year Multi-Million Dollar Extension Deal. During the last several weeks, we heard a bear case start to take hold as a couple of interviews on Tegus indicated that Cisco, which was considered one of the early Smartsheet customers, might be churning off. In the Q2 earnings call, the company indicated that Cisco in fact is not churning off and that the company signed a multi-year, multi-million dollar extension deal in Q2. Our understanding is that Cisco is not one of its largest customers and we estimate its ARR as closer to mid-single digit or less than half of 1% of FY ARR.