Sprout Social’s $SPT Q4 2020 Earnings Recap

As a former Sprout Social employee who still owns the majority of his shares, I figure it’s important to review every earnings report to see if I believe the company is still on the right track or if I should re-allocate those investment dollars elsewhere.

Yesterday, Sprout Social ($SPT) announced their Q4 ’20 earnings report and wow, was it everything that I expected and then some. Having reviewed every report since their IPO, I definitely think this was their best report yet and I think there will be more good news in the future.

Let’s walk through their Q4 FY ’20 performance:

  • Revenue: $37.3 M +32.7% YoY and 10.9% sequentially, while I like the acceleration in the YoY comparison (27.3% –> 27.4% –> 32.7%), the sequential revenue growth is huge and is their best QoQ growth in the past 3 years. If they can continue to execute and grow around 7-9% sequentially for 2021, they will grow 35%+ in 2021 which is up a lot from the 30% they saw in 2020.
  • Annual Recurring Revenue (ARR): $158,268 +34.3% and up 11.5% sequentially. All solid growth. Organic ARR was up 35% (Simply Measured acquisition resulted in negative growth apparently, but I think it was more for the tech).
  • 10K+ ARR Customers: 3,149 +44.1% YoY and 12.9% sequentially, so a further acceleration both YoY and sequentially QoQ. Since Sprout is a SaaS business, it’s important that they land these enterprise type of customers since they are generally more sticky and churn a lot less. Plus, there’s opportunity to “land and expand” (i.e. sign them up and sell more solutions to them). This was a huge metric that made me incredibly happy to see since while I was at Sprout, they definitely were still ramping up their Enterprise sales strategy.
  • Annual Contract Value (ACV): $5,924 +19.1% YoY. This is great news since it looks like their add-on products such as Listening and Premium Analytics are definitely adding to the overall total contract value.
  • Subscription Gross Margin: 74.7% +600 bps YoY. A giant increase to their subscription GM, granted it was strangely very low in Q4 of last year compared to the average, but it’s good to see they’re making progress in improving it. Their LT goals per their investor deck is 78-81%, so good progress for sure.
  • Operating Cash Flow: -$174k vs. -$4.7 M, they are just about cash flow positive and I would expect that this number turns positive sometime next year. No more cash burn soon!
  • Free Cash Flow Margin: -5.3% vs. -17.5% LY. Definitely an improving trend, so very happy about this. They’ve improved their FCF margin every quarter since the start of the year: -15.8% –> -14.5% –> -12.0% –> -5.3%
  • Non-GAAP Net Income: -$3.3 M vs. $5.9 M which doesn’t seem to be a huge improvement, but on a % basis it’s -9% vs -21%, so pretty significant.
  • Net Revenue Retention: 110% and 117% ex-SMB, a slight decline from last year, but given COVID, I’m not too surprised it dipped a little.

Sprout had a FANTASTIC quarter and I’m not surprised their stock is up ~7-10% today despite the market volatility. Mind you, these are just the numbers and I haven’t even dived into the qualitative considerations that we can get from the earnings report:

Justyn (CEO): We’re in a fortunate position to share amazing results today because of the many people that have contributed to our success. Our teams delivered an emphatic close to 2020, and we expect to deliver a fantastic 2021 as Social take center stage in the digital strategy for millions of businesses around the globe. I want to first briefly touch on our fourth quarter results, then discuss high level trends in our business and market that have occurred over the past year, which will build into our priorities for 2021. Our accelerating growth and strong results across the board give us confidence in our strategy and the investments we’re making in our future.

Clearly Justyn is very excited about his company’s performance, I am too.

Ryan (President): Justyn’s right, social is more important to more businesses than ever before, and we feel like we’re just warming up. 

How compelling is that?! Given their guidance, I definitely think further acceleration of revenue is possible in the future. What does that mean for shareholders? Two beautiful words: MULTIPLE EXPANSION!!!!!!!!

Joe (CFO): As we have talked about previously, we initially saw headwinds in our business from COVID-19 and they were relatively isolated within Q2. This impact was primarily elevated as a bechard and slower expansion activity in our agency and mid-market segments. However, these factors each reversed in the second half of 2020 and we are very pleased with the current trajectory of net retention. In Q4 of 2020, our overall dollar-based net retention exceeded 110%, and our ex SMB dollar-based net retention exceeded 120%. We believe that increasing platform stickiness, accelerating seed expansion, changing excitement mix and rising attach rates of our premium modules will each positively impact our expansion rates and drive multi-year acceleration in NDR from current levels.

Looks like their NRR is doing well given the stickiness of their product and platform and it seems COVID was an isolated event for Sprout, largely impacting Q2 only.

Joe (CFO): We expect organic growth rate to be low single-digit percentage points faster than our reported growth rate as we lap inorganic revenue from a year ago. This will be the last quarter in which we experienced a material difference in our organic and reported growth rates. We do not expect to discuss the difference beyond the first quarter. 

FINALLY, the organic vs. inorganic growth was driving me crazy since I could never get the revenue to tie due to the Simply Measured acquisition and them not providing actual numbers and only percentages.

Analyst: Great. Good evening, guys. Thank you for taking my questions. Justyn, one for you. You made a comment in your prepared remarks about being pulled into new use cases within the enterprise. And I know just for following you guys for a while, definitely, it’s always interesting to encounter different departments that are using your software, but that sounded like it might be a little bit more to that. So I just was wondering if you could maybe flush out that comment, and then I had a quick follow-up.

Justyn: Yes. Sure. Happy to do it here, Rob. So I think what we’re seeing really is more volume of adoption across customers, where our most progressive customers previously had been looking at new use cases and have been starting to operationalize social into things like their customer service, the product feedback loops, customer retention strategies, etc.

What we’re seeing right now is more than anything, there’s just more businesses that have reached that level of maturity. We’re certainly seeing some new use cases as well. I think the comps and Investor Relations is something that has come up more specifically and acutely over the last couple of quarters. We’re starting to do more of that. So the one that I would flag that I think is going to be more material throughout 2021 is likely on the commerce side.

The others are use cases that we’ve seen just in small batches in the past, but it’s starting to be something that we hear a lot more often and a lot more of the deals that we’re in are thinking more holistically across the organization about social than they were in prior quarters or a year ago.

So what’s interesting about this question is that it’s starting to show that Sprout Social as a product and platform can enable companies to do a lot more than the traditional usage of social: Customer Support and Marketing. I know personally, I have always seen value in Listening from an investing perspective and it seems there’s a ton of opportunity to do more with it in other departments that could have more material impacts to the business. Hopefully their Sales Enablement team is really building out any and every case study out there.

Analyst: All right. Very helpful. And then as you look at your international markets, has really been a good driver of growth so far this year. Where are you at? Or where do you feel like you are in terms of your longer-term plan in getting into specific markets, making kind of step function investments of opening local offices and hiring local people, I guess, how long should we think about that, that is kind of a bigger chunk of the investment pie versus getting to a level where you can really start seeing some tremendous efficiency there?

Ryan: Matt, this is Ryan. Yes, I would say that we’re still very early innings here. We opened up our first international office back in 2019 in EMEA and Dublin and have seen really good progress with that group from a productivity standpoint, getting people in the market has been very helpful for us locally, being on the right time zone and the right accent in the right language. We are continuing to invest there. I think it’s going to be a big opportunity for us over the next number of years.

Expanding beyond just EMEA into APAC and LATAM, we are going to be increasing our headcount there this year and the next few years. We also see just more localization opportunities getting more marketing efforts within those international locations and then also exploring channel opportunities internationally. So I’d say we’re early right now, but we do see it as a big lever in the future state for the company.

There’s just a huge TAM for this business and the fact that they’re in the early innings is very exciting to see.

Analyst: I’d love to hear a little bit more about sort of your view on the upgrade path. I mean, look, you had 1,200 new customer adds last quarter, almost 1,200 again this quarter. That’s just a tremendous number relative to what you’ve been historically doing. And so that flywheel seems like it can spin a little bit faster with respect to the upgrade path. But perhaps you could talk about that a little bit in the context of go to market, how you’re arming your reps with the tools they need to successfully upgrade at a faster clip?

Ryan: As you said, the customer adds have been awesome and that’s a combination of just great execution from the marketing team and driving awesome top of funnel as well as the sales team really getting after it. You add in there that, for us, obviously, we want to land as big as we can with our premium products. But the team also realizes that part of what’s made us so successful here is just the velocity of the sales motion.

And so when we get these customers in the product, we get their hands on not just publishing an engagement, but analytics and listening and if we can’t secure the full deal right away, that’s OK, we’ve got a sales team and a great customer success team on the other side that’s able to, as you said, kind of go in and increase the velocity of the flywheel.

So we’re trying to plan bigger. But even when we don’t, we’re setting up the team from a customer success and growth perspective to know what opportunities exist there that we’re going to be able to grow. And because we have those dedicated sales team on both the new business side and the growth side, we feel like we’re well covered as we continue to have these opportunities to grow.

And the last thing I’ll just say here, and Justyn touched on it earlier is, for us, it’s not just these premium add-on products, which add a tremendous amount of value. We’re just seeing the proliferation of use cases and users across the organization. So even if we land in marketing today, our growth teams, our customer success teams know there’s a customer care use case on the other side and many others.

Glad to hear that the marketing team continues to deliver ☺️ Just a lot of good news here and shows the tremendous opportunity.

Analyst: But as you’re looking at this new cohort, I’d be curious to see if you’re noticing any differences in how these customers are coming into your funnel, how they’re landing, the expansion cadence, anything else that you can point out with this cohort relative to what you’ve seen historically in new customers that come into the platform?

Ryan: So I think the major takeaways are, we’ve seen an evolution of the customers coming in. Justyn mentioned it a little bit before, there’s a different sophistication for these customers. There’s more use cases, which means typically more users and oftentimes more of the add ons. And I think that’s one of the big things.

The other thing and Joe mentioned a few minutes ago is just the opportunity to grow these customers into longer-term contracts as well. So generally, just feel really great about the cohort that we’ve been seeing this full year and especially in Q3 and Q4.

More use cases, more add-ons, increasing ACVs and longer-term contracts meaning less churn and higher NRR. All great things to hear!

Valuation & Wrapping Up

There’s just a lot to like in today’s results and it definitely helps when the CEO & President are both incredibly excited about the opportunity after such a huge report. The share price increase today definitely reflects investor sentiment of the earnings report. As of this writing, Sprout Social is trading at $74.78 (+10.54%) which is by my estimate a little over a 29 TTM EV/S (still unsure how many new shares they issued in the last quarter).

I believe before the market turmoil started happening, Sprout got as high as $82 or so which represented a 34 TTM EV/S. Given that they just announced a great Q4 and incredibly strong guidance, I think a 34+ TTM EV/S (21 FWD EV/S) is definitely possible, so I wouldn’t be surprised if the share price hit $90 before the next earnings report. Ultimately it depends on whether multiples can remain elevated and based on Powell’s commentary in the past 2 days, I do think we will continue to exist in a low interest environment which means multiple expansion and higher base revenue multiples.

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