Denys Yelmanov/iStock via Getty Images

Denys Yelmanov/iStock via Getty Images

Smartsheet Inc. (NYSE:SMAR ) closed an especially good FY23 Q2 quarter with the end of July, proving that topline growth momentum at the company is still strong. With experiencing slight softness in the business in July and August, they decided to take a guidance cut for FY23. This was accompanied by a detailed explanation by management on the earnings call that followed, showing that current slowdown in business activity is far from serious. However, if we look at current valuation of the shares a more negative scenario is priced into them in my opinion. Taken all this together I think the shares of Smartsheet provide a very good investment opportunity for the long-run at current levels.

Smartsheet is a leading name in the highly competitive Project Portfolio Management (PPM) software space with strong roots in the enterprise segment. The company offers an easy-to-use PPM software platform, which makes workflow management more effective.

Besides developing several additional services itself Smartsheet acquired Brandfolder, a digital asset management company at the end of 2020 further differentiating its service from competitors. Together with its FY23 Q2 earnings release, the company announced the acquisition of Outfit, a brand management, templating and creative automation platform, which is intended to further enhance the content experience of the Brandfolder service.

In the following, I will focus on FY23 Q2 earnings results, for further information on Smartsheet's products and services see my previous articles on the company: "Smartsheet Stock: Still Unjustifiably Cheap" and "Smartsheet Vs. Asana: The Valuation Gap Is About To Close".

After a material dip in calculated billings growth in FY23 Q1 investors became worried, that the underlying growth momentum of Smartsheet's business could decelerate soon. In my previous article on the company, I have outlined that management seemed credible in explaining that this was just a one-time dip resulting from the timing of different factors. Furthermore, the growth of remaining performance obligations was convincing.

With the publication of FY23 Q2 numbers, it turned out that Smartsheet's business is still doing very well. Revenues came in at $186.7 million (+42% YoY) delivering the usual 3-4% beat investors got used to in recent quarters:

Calculated billings, the preferred forward looking top line metric of management came in at $205.6 million, growing 44% YoY after previous quarters' surprisingly softer 36%. This shows that there's no need to worry for investors, that some business specific slowdown occurred. This is illustrated on the following chart:

Created by author based on company materials

Created by author based on company materials

Looking at customer numbers in different annualized contract value (ACV) cohorts shows that both new client acquisition and the expansion at existing customers remained strong:

It's worth to note that in all of the cohorts the company added more customers than in the quarter before, which also shows that the FY23 Q1 slowdown was really just a one-off.

Smartsheet's net retention rate (NRR) remained above 130% for the 4th consecutive quarter showing some deceleration from previous quarters:

As this indicator has by far the most lag by its nature due to including the results of previous 4 quarters, I advise investors to stay focused on revenues, calculated billings and customer counts in order to gauge the current momentum in the business.

Based on the above it seems that Smartsheet's underlying business momentum remained quite strong in Q2. In the light of the fact, that management flagged in the Q2 earnings call that they witnessed some macroeconomic related softness in July (last month of Q2 quarter), this is especially encouraging. However, this softness continued into August, so management decided to take a prudent approach and extrapolate this to the upcoming two quarters. This led to a guidance cut for FY2023 of the following magnitude:

Created by author based on company materials

Created by author based on company materials

As we can see from the table above revenues are not affected to a great extent, which is explained partly by the $6 million beat in the Q2 quarter and the nature of the subscription business model, which locks in future revenue streams early.

However, if we look at calculated billings, which is ultimately the best gauge for future business momentum as it contains the change in deferred revenues as well, Smartsheet mad a cut of 6.5%-points at the midpoint, which seems significant. This implies that after calculated billings growth of ~40% YoY in H1 management currently expects billings growth of ~27% YoY for H2. If we factor in that Smartsheet will beat its billings guidance by ~5% in H2 (conservative estimate based on FY22 beats) this would mean a ~7%-point deceleration from H1 levels, where comparables were quite favorable.

I think in the current uncertain macroeconomic environment, where most SaaS companies talk about elongated sales cycles this is not a serious slowdown, especially in the light that management extrapolated recent weakness throughout the whole fiscal year and tried to be conservative in my opinion.

The reason behind Smartsheet's guidance cut was not exclusively related to general macro pressures, as management noted that the ramp-up time for the many sales representatives hired at the beginning of the year proved to be slower than previously expected. Furthermore, the further strengthening of the dollar and the more pronounced economic weakness in Europe had a negative impact on billings as well.

I really appreciate the transparency of Smartsheet as management shared the approximate extent to which these factors contributed to the billings guidance cut. I've summarized these in the following chart:

Created by author based on management comments on Q2 earnings call

Created by author based on management comments on Q2 earnings call

Compared to many other SaaS companies Smartsheet has a relatively low exposure to non-U.S. countries with only ~17% of revenues coming from non-U.S. countries in recent quarters. This makes the company more resistant to the current economic downturn, which can be evidenced from the relatively lower impacts from economic weakness in Europe and dollar strength. The 2%-point negative impact from the elongated sales-ramp-up period will be only transitory in my opinion, while the 2.5%-point cut resulting from general macro uncertainty is the most structural negative factor in my opinion.

In the light of all these, I think that the underlying momentum in Smartsheet's business is generally holding up well even after factoring in the current uncertain macroeconomic environment. The big question is whether the currently experienced elongation of sales cycles and lower pipeline growth rates will stabilize at present levels, or if things are to get worse. This remains to be seen in the upcoming quarters, but even if things would get worse from current levels, the conservative valuation of the shares more than reflects this in my opinion.

Smartsheet is one of the most conservatively valued companies in the SaaS space in my opinion, a theme on which I've elaborated quite much in my recent articles on the company. Here I just want to highlight one chart from Seeking Alpha depicting the companies' TTM EV/Sales ratio over time:

Despite the fact, that Smartsheet managed to maintain its 40%+ revenue growth rate in recent years, its valuation compressed far below previous historic lows. The current TTM EV/Sales ratio of ~6 is around the half of the pandemic low in March, 2020, although there was no significant negative change in the business since then. Furthermore, during 2018, when the 10-year U.S. Treasury rate was at comparatively higher levels, valuation found its bottom around 14x TTM EV/Sales. Either way the current ratio of ~6 seems to be very conservative in my opinion, especially in the light that reaching permanent profitability is not far on the horizon.

Looking at recently reported profitability metrics we see the following picture:

With a non-GAAP operating loss of $16.1 million in Q2, operating margin improved 5%-points sequentially to negative 9%. Besides the revenue outperformance this was the result of the companies' cost saving efforts and the slower pace of hiring within the sales function. Even with the revenue guidance cut for FY23 Smartsheet raised its operating performance guide for the fiscal year from negative $86-$76 million to negative $75-$65 million. This shows that the company is approaching operating profitability faster than previously expected.

Looking at free cash flow we could have observed a positive figure of $7.1 million for Q2 resulting in a positive margin of 4%. There is a good chance that due to some one-off items and timing issues this will turn negative in the Q3 quarter again but will improve afterwards further. The company maintained its breakeven free cash flow guide for FY23 and expects to steadily increase its margin in the upcoming years.

With bearing in my mind that based on recent management comments the same level of sales rep hiring that characterized the beginning of the year isn't expected this year or next, margins could significantly improve further in the quarters to come.

With presenting excellent Q2 results Smartsheet reassured investors that underlying strong business momentum is still intact. However, the current macroeconomic uncertainty began to affect the companies' business to some extent, which partly led management to lower its FY23 topline guidance. Taking a closer look at different headwinds shows that long-term, structural growth is still strong even in the current uncertain environment. This, coupled with a quite conservative valuation calls for a good long-term entry point into the shares at current levels. I would find a possible drop in the share price after the guidance cut an especially good buying opportunity.

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Disclosure: I/we have a beneficial long position in the shares of SMAR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.