Sprout Social, Inc. Q3 FY2023 earnings

Sprout Social reported third quarter revenue of $85.5 million, up 31% from the prior year quarter. Year to date revenue reached $240.1 million, up 30%. Annual recurring revenue was $359.5 million, up 33%. Remaining performance obligations came in at $228.8 million, up 67.1%, and deferred revenue rose to $122.49 million, up 44.5%. Both backlog measures are watched closely as indicators of future subscription revenue, and both grew faster than reported revenue in the period.

Profitability moved the other way. Gross profit was $65.3 million, up 30.7%, while gross margin slipped to 76.4%. GAAP operating loss widened to $24.2 million, and operating margin fell to negative 28.3%. Net loss was $23.0 million and diluted loss per share was $0.41. On a non-GAAP basis the picture looks very different. Non-GAAP operating loss was $0.6 million, narrower than the $1.4 million non-GAAP operating loss in the third quarter of 2022, and non-GAAP net loss was $0.6 million, narrower than $1.0 million. The gap between the two sets of numbers is mostly stock-based compensation and costs tied to the Tagger acquisition.

Cash generation was the weak spot. Operating cash flow was negative $5.5 million, down from positive $1.0 million in the prior year quarter, although year to date operating cash flow was $9.1 million, up from $7.7 million. Capital expenditures were $0.8 million. Free cash flow, a non-GAAP measure that subtracts property and equipment spending and acquisition-related costs from operating cash flow, was negative $3.4 million versus positive $0.5 million a year earlier. The Tagger Media acquisition carried total preliminary purchase consideration of $144 million, and the company borrowed $75 million under a new credit facility to help fund it.

Customer counts reflect a deliberate move upmarket. Customers contributing more than $10,000 in ARR grew 33% to 8,111, and those contributing more than $50,000 grew 49% to 1,252. Total customers dropped 5% to 32,383. Management ties the decline to the November 2022 price increase and to prioritizing larger accounts, and expects the trend to continue. Tagger, which closed on August 2, 2023, adds influencer marketing to the platform, while Repustate, acquired in January 2023 for about $8.4 million, brought sentiment analysis and natural language processing. Revenue from non-U.S. customers was approximately 28% of total revenue in the nine month period.

Guidance for the fourth quarter of 2023 calls for non-GAAP operating income between $0.6 million and $0.7 million and non-GAAP net income per share between $0.00 and $0.01. For the full year 2023 the company guided to non-GAAP operating income of $3.6 million to $3.7 million and non-GAAP net income per share of $0.12 to $0.13. It lifted the implied ARR growth rate exiting 2023 to about 30% from a prior view of 28% to 29%, and now points to full year non-GAAP operating margin improvement of roughly 270 basis points against an earlier range of roughly 200 basis points. Services revenue is expected to come in below 2022 levels. The company does not guide to GAAP operating loss, GAAP net loss per share or GAAP operating margin, saying it cannot reconcile those items without unreasonable effort.

Risks around the story are familiar but real. Sprout Social has to keep growing revenue and customers at a high rate, and management notes that price increases have hurt demand and retention. Platform outages, dependence on the major social networks and their APIs, and any failure to convert free trials into paid subscriptions could all slow growth. Integrating Tagger and Repustate is another execution test. Macroeconomic pressure, including inflation, higher interest rates, recession risk and geopolitical tension, could cut into customer budgets. The new credit facility adds covenants, including minimum liquidity of $30 million and trailing four quarter recurring revenue growth of at least 115% of the prior year period. Cybersecurity breaches and changing privacy rules remain ongoing exposures.