Sprout Social, Inc. (NASDAQ:SPT) Q2 2023 Earnings Call Transcript

Sprout Social, Inc. (NASDAQ:SPT) Q2 2023 Earnings Call Transcript August 4, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Sprout Social Second Quarter 2023 Earnings Call. I would now like to turn the call over to Jason Rechel, Vice President, Investor Relations and Corporate Development. Please go ahead.

Jason Rechel: Thank you, operator. Welcome to Sprout Social second quarter 2023 earnings call. We will be discussing the results announced in our press release issued after the market closed today and have also released an updated investor presentation which can be found on our website. With me are Sprout Social’s CEO, Justyn Howard; CFO, Joe Del Preto; and President, Ryan Barretto. Today’s call will contain forward-looking statements, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include among others, statements concerning financial business and customer trends, our expected future business, financial performance and financial condition, our expectations concerning the benefits of our acquisition of Tagger, performance against our multi-year financial framework, our market size and opportunity, our plans, objectives and expected results from our future operations, growth, products, investments, initiatives, pricing and partnerships or strategies and our guidance for the third quarter of 2023 and the full year 2023, and can be identified by words such as expect, anticipate, intend, plan, believe, seek or will.

These statements reflect our views as of today only should not be relied upon as representing our views at any subsequent date and we do not undertake any duty to update these statements. Forward-looking statements address matters that are subject to risks and uncertainties that could cause actual results to differ materially. For a discussion of the risks and other important factors that could affect our actual results, please refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 filed with the Securities and Exchange Commission on February 22, 2023 as supplemented by our quarterly report on Form 10-Q for the quarter ended March 31, 2023 filed with the SEC on May 3, 2023 and our quarterly report on Form 10-Q for the quarter ended June 30, 2023 to be filed with the SEC as well as any future quarterly and current reports that we filed with the SEC.

During the call, we will discuss non-GAAP financial measures, which are not prepared in accordance with Generally Accepted Accounting Principles. In particular, references to profitability and margins refer to non-GAAP operating margin, non-GAAP operating income, non-GAAP net income, and non-GAAP earnings per share. Definitions of these non-GAAP financial measures, along with reconciliation to the most directly comparable GAAP financial measures are included in our earnings press release, which has been furnished to the SEC and is available on our website at investors.sproutsocial.com. And with that, let me turn the call over to Justyn. Justyn?

Justyn Howard: Thank you, Jason and good afternoon everyone. Thank you as always for joining us. Late last year, we initiated several strategic changes that we believe are now beginning to materially improve our long-term growth and efficiency and we will cover more of our progress throughout our discussion this afternoon. Today, I am also excited to share our entrance into the influencer marketing category, which broadens our reach, expands our market, creates more value for our customers and further differentiates Sprout as we uniquely define our industry. Our product advancements, strategic alignment and broadening set of capabilities have further established a highly differentiated value proposition for customers and have positioned Sprout at the beginning of an exciting new chapter in our journey as Sprout paces towards our new $1 billion subscription revenue target.

In Q2, record new business ACVs drove ACV growth to a record 29% year-over-year as our success up-market continues to progress ahead of plan. We are pleased to see 48% year-over-year growth and customers paying us $50,000 or more in ARR and 130% year-over-year growth and customers paying us $250,000 or more in ARR. Leading indicators like RPO and cRPO each continue to materially outpace our ARR growth rate. RPO growth of 62% underscores the momentum we were seeing up-market. And Q2 RPO represented more than 63% of our total ARR up more than 2,000 basis points over the past 2 years. The significantly improving quality of our business was further evident in record non-GAAP operating margins during Q2 and more than 140% growth in cumulative year-to-date free cash flow.

While we are seeing everything we want to see from our strategic shift late last year, structural improvements in our business and accelerated momentum up-market, the unpredictability at the very low end of our business has remained difficult to forecast in Q2. So we view this as a positive trade-off and have deliberately deprioritized and removed resources from this part of our business. We are ultimately committed to high competence projections. For that reason, we have elected to remove non-core ARR from our plan for the remainder of this year and our modeling to have it cycled out fully heading into 2024. We believe this change provides investors with the greatest visibility into our performance and positioned Sprout to execute with the level of consistency that you have come to expect from us.

Meanwhile, the upside of our strategic shift is becoming even more pronounced. We are beginning to see if structurally positive impact on net dollar retention of our core customers and our enterprise business further accelerated during Q2, yielding the highest new LTV for enterprise compared to all prior quarters. Enterprise grew nearly 50% year-over-year and represents a record 43% of total ARR. Enterprise new business was up more than 50% year-over-year and total net new ARR from this segment also grew greater than 50% year-over-year. Multiple factors are contributing to our success and this quarter premium module attach rates were very strong. Total premium module attach rates increased by 160 basis points from Q1 2023, nearly double the uptick we saw on average in 2022.

During Q2, we further accelerated our roadmap in social customer care and AI. Our product team has already delivered 16 material care related releases in 2023, including reply suggestions by AI assist. We have also made structural and organizational changes to rapidly expand our investments in AI and accelerate the work already underway to make AI pervasive across our platform and deliver significant new value to our customers. The emergence of Generative AI enhancements to large language models and new training techniques favor the most skilled product teams and we believe will allow us to outpace anything being done in our space today. Our early momentum in this area, including language detection, AI assist, enhanced sentiment and content detection and filtering, lay the foundation for an extensive roadmap of exciting product capabilities to come.

All of this progress brings me to our most important update today, our announced acquisition of Tagger. Influencer and creator marketing has quickly increased in customer demand given how critical this category has become to a brand’s awareness and brand strategy. In fact, we currently see influencer marketing in more than half of our enterprise RFPs. While the advanced signal is very strong, brands have up to this point struggled to fully harness its potential, because influencer marketing has been siloed with little connection to their core social marketing strategy and no ability to manage discovery approvals, workflow and reporting. We believe Sprouts brand and scale position us to pull ahead in this market. For anyone unfamiliar, influencer and creator marketing is today the third leg of the stool for social strategy and one of the most important and fastest growing.

As traditional media and paid advertising continue to be disrupted, influencers, creators and short-form content are beginning to take priority for brands, along with demonstrably higher ROI. Indeed, industry analysts have estimated that nearly 50% of CMOs are growing their spending on influencer marketing in 2023, representing the third fastest area of budget growth. We believe the combination of Tagger and Sprout will allow us to create a market leader in both social media management and influencer marketing. We developed a thesis on this space in 2022 and Tagger very quickly became our target for three primary reasons. First, the team is world class, a smart, innovative and customer obsessed group. Second, we found the technology; infrastructure and products were built with the same emphasis on quality, elegance, approachability and scale that Sprout focuses on.

And third, Tagger’s product has been recognized as industry-leading by both G2 and the global influencer marketing awards and has been chosen by iconic brands across the mid-market and enterprise. Similar to why we brought social listening into Sprout several years ago, we have identified silos that exist today in influencer marketing and an opportunity for Sprout to step in and provide a unified platform for executing a comprehensive social strategy. Together, we will deliver the next generation of social insights to few business strategy execute end-to-end campaign management, faster authentic customer engagements, and deeply understand and measure the full ROI of holistic social investments. We believe our capabilities will further differentiate Sprout in our core market and will make Tagger the category winner in influencer marketing.

The combination of our ongoing breakout of market strengthening partnerships, expanding use cases for our software and an accelerated entrance into the influencer marketing category have Sprout at the starting line of our next great growth chapter. We are excited to outline our path above $1 billion in subscription revenue. Our strategic changes have positioned us to deliver an even faster pace of margin expansion and free cash flow growth than previously anticipated and we are excited to share more of our vision and financial future in Investor Day next month. I have never been more energized by our team’s momentum and alignments deliver incredible results and value to our customers, partners and stakeholders. With that, I will turn the call over to Ryan.

Ryan Barretto: Thanks, Justyn. The focus and momentum in our core business combined with the exciting new edition of Tagger have me incredibly excited about the second half of this year in 2024. I would like to begin with some perspective on several of my most topical conversations with customers and investors this quarter before digging into the opportunity we have to change the game with influencer marketing. Research this quarter from the Harris Poll in partnership with Sprout found that Social’s importance within an organization is only growing. 80% of business leaders anticipate their company social media budget will increase over the next 3 years and 44% of leaders expect their social media budget will increase by more than 50% even in spite of macroeconomic pressures on their total company’s budget.

Underlying these trends, business leaders nearly universally agree that Social has become the primary channel for customer care, customer retention and customer feedback. Social is where your customers are and it has become imperative for brands to meet them there. We can see this imperative in our partnership with Salesforce, which has accelerated momentum as we further capture the Social Studio opportunity and align ourselves as the standard social platform for all Salesforce customers. Our product alignment went even deeper this quarter with a native integration into the Salesforce marketing cloud, allowing marketers to personalize their customer’s journey based on social data. We onboarded a record 176 logos in Q2 and we continue to expect contributions to grow meaningfully and linearly over the course of 2023 building to a very strong Q4 as the largest and most complex deployments begin to make their migration over to Sprout.

In total, we grew with an amazing list of customers this quarter, including PACCAR, Cintas, Klaviyo, Irving Oil, Heartland Financial, Jollibee Foods, Cedars-Sinai Medical, Arnott’s, Bobcat, Salix Pharmaceuticals, and the Federal Deposit Insurance Corporation or FDIC. We also saw and heard some incredible things from our customers this quarter. The FDIC used Sprout listening data as part of congressional testimony on the banking sector in the wake of the SVB collapse. And one of our new enterprise customers shared with us, I am thrilled by the new AI assist functionality. As far as AI content generators go, this maybe the best one I have seen so far. In a recent not-for-profit webinar, I was invited to present at, the host introduced us by saying, as the CMO and marketing leader, I spent over two decades buying enterprise software and investing in technology that would help me understand how to grow and social media engagement was always a top priority.

In 2023, time on social media continues to scale and business leaders are tasked with not only driving engagement, but elevating their constituent experience and support to meet the bar that has been raised by the commercial sector. I have evaluated every tool in the market and Sprout has been my preferred platform for over 10 years. We know from our customer interest to market diligence that the influencer marketing category is converging with social media management. In a recent briefing and industry analysts shared if you aren’t working with influencers today, you can’t really say you have a real social strategy. With this as a backdrop, it’s been incredibly exciting to get to know the Tagger team and software over the past several months, knowing that we could solve multiple customer pain points together.

We knew immediately that Tagger would make for an incredible fit with Sprout. The software is powerful and elegant and the team is hungry to design a category. We believe our depth and scale will allow Tagger’s product to innovate and grow at an accelerated pace and our go-to-market motion is perfectly suited to accelerate Tagger’s growth and drive even more customer success. Joe will later share that we have made no cross-selling assumptions and our commitments to you. But influencer is a customer requirement showing up in more than half of our enterprise conversations. Tagger’s ACVs are meaningfully above Sprouts and we believe we will now have the most comprehensive and competitively differentiated set of solutions in each of our markets.

We believe the cross-sell opportunity for Tagger’s product is massive in orders of magnitude larger than Tagger today. We also believe our new business win rates and ACVs are set to move higher in our core business as we combine forces. It’s this combination of factors that has our teams inspired to go big together. Our alignment around the most sophisticated tiers of our market has our teams motivated for the future, with Tagger poised as a new strategic catalyst that we expect will deliver significant value for our customers. We have executed a similar playbook before when our acquisition of Simply Measured accelerated our value proposition and our momentum in social listening and advanced analytics, which are now foundational to our success.

We have long shared that we aspire to be the best place to be an employee and the best place to be a customer. After receiving multiple product awards from G2 and others last quarter, I was incredibly excited that this quarter, Sprout was recognized by great place to work as the best place to work in Chicago and is the best place to work for Millennials. Our commitment to our core values and our people continue to make Sprout an exciting career destination on our journey past our $1 billion revenue target. And with that, I will turn it over to Joe to run through the financials. Joe?

Joe Del Preto: Thanks, Ryan. I will now walk you through our second quarter results in detail before moving on to guidance for the third quarter and full year 2023. Revenue for the second quarter was $79.3 million, representing 29% year-over-year growth. Subscription revenue was $78.7 million, up 30% year-over-year. Services revenue was $0.6 million, down more than 10% year-over-year. Core ARR from existing customer spending greater than $2,000 in ARR, with 33% now represents 96% of our total ARR. Total ARR exiting Q2 was $326.1 million, up 27% year-over-year. The number of customers contributing more than $10,000 in ARR grew 27% from a year ago. The number of customers contributing more than $50,000 in ARR grew 48% from a year ago.

And the number of customers contributing more than $250,000 in ARR grew more than 130% from a year ago. Q2 ACP growth was 29% year-over-year again decelerated from Q1 2023. Record new business deal sizes, the exit from a number of low-value logos and ongoing execution on our pricing changes each compounded healthy, underlying seat expansion in premium module attach rates. We continue to expect that ACV growth will further accelerate through Q3, but now expect faster than previously expected ACV growth over the medium term. In Q2, non-GAAP gross profit was $61.9 million, representing non-GAAP gross margin of 78.1%. This is up 150 basis points compared to a non-GAAP gross margin of 76.6% a year ago. Non-GAAP sales and marketing expenses for Q2 were $32.1 million or 40% of revenue consistent with 40% a year ago.

We were fortunate to hire well throughout the quarter. Non-GAAP research and development expenses for Q2 were $14.6 million or 80% of revenue, down from 20% a year ago. We continue to make transformative R&D investments, particularly around platform, AI and automation and social customer care. Non-GAAP general and administrative expenses for Q2 were $13.3 million or 17% of revenue, down from 20% a year ago. We expect to deliver consistent G&A leverage as a percentage of revenue moving forward. Non-GAAP operating income for Q2 was $1.9 million for a positive and quarterly record 2.4% non-GAAP operating margin, improvement of more than 500 basis points year-over-year. Non-GAAP net income for Q2 was $3.8 million for net income of $0.07 per share based on 55.5 million weighted average shares of common stock outstanding compared to a non-GAAP net loss of $1.9 million and $0.04 per share a year ago.

Turning to the balance sheet and cash flow statement, we ended Q2 with the $192.4 million in cash and cash equivalents and marketable securities. This is up from $187.2 million at the end of Q1. Deferred revenue at the end of the quarter was $116.7 million. Looking at both our billed and unbilled contracts, RPO totaled approximately $206.4 million, up from $187.8 million exiting Q1, up 62% year-over-year. We expect to recognize approximately 74% or $153 million of total RPO as revenue over the next 12 months and implying a CRPO growth rate of 47% year-over-year. Operating cash flow in Q2 was positive $6.3 million compared to $1.3 million a year ago. Free cash flow was positive $6.0 million, up meaningful from a year ago. Ongoing focus on unit economics and quality of our customer base is beginning to deliver structural improvements to our cash flow generation.

Shifting to our financial expectations of the Tagger acquisition. We acquired Tagger media for a cash consideration of $140 million. We financed acquisition with cash on our balance sheet and liquidity from our newly established revolving credit facility. We believe this to be an efficient use for our balance sheet and an attractive cost of capital. We expect that Tagger will be accretive to our ARR and ACB growth rates and accretive to our gross margins. In addition, we anticipate that Tagger will be moderately dilutive to our non-GAAP operating margins in 2023. And upside to our margins in 2024 and beyond, as we aim to efficient accelerate growth inside our distribution model. We have incorporated approximately $3 million of revenue into our guidance for the remainder of 2023.

Because there was no customer cross-sell, and we anticipate meaningful growth in 2024. Shifting to formal guidance, our core business continues to perform very well. As a reminder, we have removed our loan customer report from our forecast. By the third quarter of fiscal 2023, we expect revenue in the range of $84.1 million to $84.2 million or growth rate of 29%. We expect services revenue to decline year-over-year. We expect non-GAAP operating loss in the range of $2.8 million to $2.7 million. This accounts the timing of our one-time global employee event in Q3 this year, the timing of sales hiring in Q2, then temporal impact of the absorption of Tagger expenses. The sum of the non-GAAP operating margin was negative 3.2% at the midpoint. We expect a non-GAAP net loss per share of roughly $0.05.

This assumes approximately $56.5 million weighted average basic shares of common stock outstanding. For 2023, we affect total revenue in the range of $328.6 million to $328.7 million. It is expected overall report a growth rate of 30%. We expect services revenue will be lower than 2022 levels. For the full year fiscal 2023, we have decisively modeled our lowest customer tier ARR to decline to zero as in 2023, which we believe reduce forecast risk of this business that has been strategically de-prioritized. With this change, we believe investors can more clearly assess our outperformance upmarket and expect that total ARR as in 2023, will be growing at the same pace as reported revenue. This implies that Q2 will present the lowest pace of ARR growth this year.

For 2023, we now expect non-GAAP operating income in the range of $1.4 million to $1.5 million. This implies annual non-GAAP operating margin improvement of 200 basis points compared with our prior margin expansion forecasts of 225 basis points to 235 basis. On an organic basis, we expect to outperform our prior plan and we expect that Tagger will become a net benefit to operating margin expansion in 2024. We now expect non-GAAP net income per share of approximately$0.07, compared to our prior range of $0.07 to $0.08, and assuming approximately $56.0 million weighted average basic shares of common stock outstanding. To conclude, I’d like to preview our Investor Day next month. We believe that we will be low in ARR from our forecast allows investors to most appropriately focus where we are focused and for Sprout to continue to execute on our goals.

We have introduced our new medium-term financial plan expect to exceed $1 billion in subscription revenue in 2028. We can exceed this target sooner if our mid-market and enterprise segments further accelerate, if Salesforce builds further upside, if we are successful in cross-selling Tagger to our customer base, if we are able to execute additional future strategic M&A. We expect to deliver 20% non-GAAP operating margins at $1 billion in scale. We expect free cash flow margins of 20% to 22% in 2028 to deliver a meaningful amount of free cash flow over this horizon. We look forward to sharing further data details and assumptions with you next month in Chicago. With the starting point of the next great growth chapter in Sprout’s journey, we are grateful for your support as we continue to scale the category defining social media management company.

With that, Justyn, Ryan, and I are happy to take any of your questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Raimo Lenschow from Barclays. Please go ahead.

Raimo Lenschow: Hey, thank you. And could we just go one more through – one more time through like, the changes we are seeing today, so basically, you are removing the low end ARR from the ARR calculation, which kind of makes more sense with that kind of pressure ARR. How does that impact revenue or what’s driving the change in the revenue guidance? And that’s my first question. And have one follow-up.

Joe Del Preto: Yes, Raimo, this is Joe. I can probably help you, model that a little simpler, I think the way we’re thinking about it is if you look at the comments I made around if you assume that ARR exiting Q4 is in line with our revenue growth, exiting in Q4. And you can imply from our guidance, that’s probably in the 28% to 29% range. So if you use that as the ARR kind of growth, right year-over-year, you can kind of back into the ARR, we plan to add in to the back half the year. And then from there, you can kind of get the revenue that flows through your model.

Raimo Lenschow: Yes. And then just remember, last quarter, we talked about like, the low end kind of maybe exiting you quicker than expected. And you can talk about some stabilization trends in April. How does quarter play out? And where are we on that journey?

Justyn Howard: Yes, great question. This is Justyn. So yes, I mean, the loan of the business has been obviously a bit challenging for us over the last couple of quarters. When we spoke last, we saw some signs, some really positive signs of stabilization early in the quarter, in the second quarter, and then kind of reverted back to what we had seen in the back half of first quarter, shortly after that. And so while we’re optimistic that there’s future stabilization there, we wanted to make sure that we’re just eliminating that risk from the model, as it’s remained fairly unpredictable, both on the contraction as well as the new business side with not only the pricing changes, but also just the organizational alignment, and prioritization, that we’ve put further up market, that that segment of the businesses just remained a bit more challenging.

Raimo Lenschow: Okay, perfect. Thank you.

Operator: Our next question comes from the line of Arjun Bhatia from William Blair. Please go ahead.

Arjun Bhatia: Perfect. Thank you, guys. One, maybe for Joe. I think you called out that medium term, you expect ACV growth to be faster than expected? Can you maybe just walk us through some of the drivers there? What are you seeing what’s going to get that ACV growth to be higher and accelerate through the rest of this year?

Joe Del Preto: Yes, good question there. For us, I think it’s some of the momentum we’re seeing up in the – definitely in the enterprise space, some of the data points we gave out, the enterprise business growing 50% year-over-year, new business growing over 50%, the deals that are coming in are just much larger these days, and they were last quarter or the quarter before that. And so I think as we continue to move up into this mid-market and enterprise business, we can just see larger and larger ACBs. If you look at the stat on the 50,000, cohort growing over 48%, that 250,000 cohort to grow over 130% Arjun, we’re just seeing larger deals across the organizations that we’re doing business with. So it gives us a lot of confidence that that momentum up market will continue throughout the year.

Yes, and I probably just also add in from a premium attach rate perspective, we’ve seen a lot of progress, they’re up 160 basis points. Now, 24% of our total customers have one of those products, but we see a lot of headroom there with the products we have previously and when we think about the fact that only 6% of them have both of those products. And then we add in something like Tagger, there’s additional growth to come in the future for us there. So we feel really good about the quality of those customers coming in and the ability to attach some of these other products from an ACV perspective.

Arjun Bhatia: Okay. Got it. And then on Salesforce, it seems like there’s a pretty good quarter in Q2 in getting migrations. What do you see in the pipeline, Ryan, and how do you think the cadence of that partnership kind of progresses through this year and even into 2024?