Smartsheet: The Good, The Bad And The Ugly

Summary

• Smartsheet is a great generator of revenue growth and gross profit.
• Trying to keep up with growth has stripped away cash flow and profitability.
• But it has a plan to become profitable over the next five years. The current environment may nix those plans.

Smartsheet Inc. (NYSE:SMAR) provides cloud-based platform for execution of work. It enables teams and organizations to plan, capture, manage, automate, and report on work. The company offers Smartdashboards that provides real-time visibility into the status of work to align individuals, managers, and executives; Smartportals to easily locate and access from any device the resources available for a project without IT assistance; Smartcards to organize, share, and act on workflows; and Smartgrids to keep teams on task by easily tracking multiple moving parts. Company provides applications that integrate functionality with companies, such as Google (GOOG) (GOOGL) and Microsoft (MSFT).

Below is the year-to-date performance. We can see the downturn due to COVID-19 and the recovery. Note that huge drop in stock price right at the end of the chart. I know it is scary and we will review what caused that precipitous drop.

Data by YCharts

The Good

I heart companies that have a strong revenue growth future and fat margins. We are in luck, because SMAR has both. The table below is from its 2020 earnings presentation.

The revenue growth and total billings are just a thing of beauty. It is firing on all cylinders with organic growth, building deeper relationships, signing larger contracts and strong retention rates.

This table is for the subscription segment, which is the largest of the two segments.

There is an increase in wallet share and strong organic growth with current customers. Now Smartsheet can cross-sell other applications and services. This stuff makes the company happy.

I mentioned this earlier, but here is a nice pic of its gross margin performance.

Total revenue in FY20 was $271MM and SMAR has a goal to reach $1Bn in revenue between FY23 and FY25. That is a lofty goal, but its historical performance provides support that this can be done.

This table is from the October 2019 Analyst day and outlines its near-term goals.

This is all awesome stuff. Reasonable revenue expectations, a shift to profitability and free cash flow (something the company currently does not have).

The Bad

I just teased about profitability and free cash flow in the chart above. This is a fast growing company and its growth at all costs. SMAR is bleeding cash to support that strong growth. Through FYE20, investors have supported SMAR even though other companies were punished for growth at all costs measures. I find that interesting.

We discussed the strong revenue growth to ad nauseam and highlighted the wide gross profit margin. So profitability after gross profit is something left to be desired.

All cash flow is being zapped away in operating expenses to create new products, services, find new customers and to support operations. That is all fine and good, but now investors are worried about profitability.

The Ugly

Remember the YTD stock chart with that massive decline? Well, that was in response to the 1Q21 earnings report.

Before we delve into the report, I want to share the 1Q21 and FY21 outlook laid out in the 4Q20 earnings presentation.

This looks like an improvement for FCF. This is great news for investors.

In reality, the 1Q21 performance did not meet expectations except for revenue, which was $85.5MM in 1Q21 and was higher than the $83MM expected. Operating loss of $28.8MM was ~$2MM more than expected due to lower GPM due to higher personnel costs and outsourcing to fulfill the services backlog. Cash flow of negative $24.3MM was better than expected by ~$3MM.

The impact of the pandemic really took a bit out of the company's performance and outlook. SMAR is still trying to manage expenses as it relates to growth. I think that this quarter epitomizes that there needs to be a shift in strategy. Growth at all costs has to change to profitable growth. The expectations for $1Bn revenue by FY2025 should be pulled back. I think investors would like to see more profitability than continuous cash burn.

Due to the pandemic, SMAR withdrew its previous issued FY21 guidance. Below is the updated guidance.

The high-end of the growth rate is now lower than the previous guidance of $373MM-$378MM. However, there is an improvement expected in operating loss due to operational efficiency.

Despite these recent novel changes, management believes it is still on track with its 2023-2025 goals, but may not come into fruition until 2025.

During the 1Q21 conference call, an analyst asked about cash flow goals. Mark Mader, CEO, responded with:

I think as Jenny remarked, as we look at our -- passed to [a billion] [ph] within our three to five year frame, I think what COVID has done, it pushes a little deeper into that three to five year frame. But I mean, we remain -- have high conviction on our ability to generate operating margin at that level. We are fully invested in this.

I do not know what to think about his conviction in his goals. Yes, he does have some runway, but it would be nice to see some near-term improvement before I jump aboard.

Valuation

The company does not have earnings or free cash flow. The prospect of near-term free cash flow does not seem imminent. The dizzying chart below outlines EV/Revenue and Price/Sales.

Data by YCharts

Given the historically poor operating performance and the nasty 1Q21 financial performance, I do not think these current valuations are reasonable. At some point, the cash burn will become too much to support with cash on the balance sheet. Either SMAR will raise money through another equity offering (doubtful) or a convertible note to support operations.

Conclusion

SMAR is an interesting company that provides products and services that do have a demand - it is shown in the revenue growth. The near-term revenue prospects are intriguing, but operating performance is not. 1Q21 performance really struck a chord with investors. Management has to rethink its strategy to become a profitable growth company. I understand it is trying to grab market share and defend itself from competitors. The huge decline in price in reaction to the earnings should be a wakeup call to management. Right now, I think the stock is overvalued. If the company can present a clearer thesis to near-term profitability, I will listen. Until then, I will step aside.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Comments

[Cardsany1]

I agree with the concerns over cash burn if this continues longer term. But for argument's sake, let's say SMAR has ($100mm) cash burn pa as a round number. That would still give them ~5 years of runway given their current cash balance to ride out the downturn underway and/or to invest in growth initiatives. Not bullet proof but relative to most growth companies, the cushion looks reasonable (and assuming their accounting issues have been addressed).

[Nick Perez]

Reasonable statement. The point I was trying to convey is that investors may seek better operating performance rather than continuous losses and pushing back revenue and cash flow targets to 2025.

[HardytheTrader]

"Historically poor operating performance." Growing at 50%+ with moderate cash burn is poor? Give $SMAR a break. There are very few high growth companies which are profitable.
The only thing to worry about right now is the depressing billings guidance for Q2. I am fine with slow improvement of operating margin as long as they manage to reaccelerate growth once the economy is out of recession

[Nick Perez]

There is cash burn from core operations. The saving grace is the non cash addbacks. They can do a better job managing the income statement.