Sprout Social, Inc. (SPT) Earnings Call Transcript & Summary

Welcome to our next session. Really happy to have the team from Sprout here. I'm kind of all technology driven, but that slows me down sometimes. Actually I kind of wanted to get the hedge fund question first out of the way. And then we can talk about the [ business ].

So -- and I know the answer already, but I'm still asking. So what have you seen in terms of like obviously, you reported numbers and you talked about end demand then we saw like the off-cycle reporting season in the last week. People talked about October getting a little bit tougher. Maybe that's my own suspicious feeling, it's the last month of the quarter for them, so it's nothing to do with October, but like, okay, let's kind of pocket and what have you seen since -- or in Q3 and has it changed or anything new?

Yes, for sure. So what we talked about coming out of Q3, and we talked about this a couple of weeks ago is that we saw coming into Q4, probably the strongest pipeline that we've seen up in the mid-market enterprise part of business that we had ever seen and so felt really good and we talked about Q4 having -- guiding out towards a record net new ARR that was all based on what we were seeing top of funnel, what we were seeing from the strongest parts of our business. And so we haven't seen any major change to what we talked about 2, 3 weeks ago, and so we feel pretty good about the momentum coming into the quarter.

I think the other point there, Raimo, around like the record net new ARR in Q4, we also talked about getting -- in the month of October, getting off to the strongest start of any quarter of 2022. So we feel good already about a linearity perspective.

Yes, Okay. So October was good. Yes, yes. I mean on that note, a little bit like you always -- for as long as I cover you, we always had the discussion about like you guys having good visibility because you have that trial idea about like how to do things -- sorry, how to get a customer interested and they can try it out. Are those comments still valid? And what are you seeing there on the kind of early stage of the pipeline trial.

Yes. So we haven't seen a major change in the way that we win new business. It's so 90% of it comes inbound even up in the mid-market enterprise. And we didn't -- even in these larger deals, one of our major kind of plays on the go-to-market side, Raimo, was to get them into the trial. So we'll go to these large enterprise deals, and we'll go against our competitors, and they're doing PowerPoint, they're doing these demos. And we're just telling our customers and the users just go in the product and use it and just go in there and get into the trial, add your users, add your profiles. You can use advanced analytics, you can use social listening. And so that kind of play even up in the enterprise is still really powerful. And then also a couple of things it does it derisks the buying process for some of these larger enterprises, which is like, hey, normally, if they're using one of our competitors, not only do they have to buy the software, but then they have a 3- to 6-month implementation professional services so there's risk there, right? Like, hey, I bought the software? Does it do what it says it's supposed to do. With Sprout, we're like derisking that. And so we're also then shortening that buying cycle because they're in the product, and they don't have to think about whether or not it's going to work.

Yes. Okay. Perfect. I think we covered hedge for now. So the -- let's just change gear a little bit. Like the other big discussion and I have more with kind of the [indiscernible] investors as well or like bauxite is like that kind of evolving relationship with Salesforce. Can you just kind of to get everyone level set here, can you just talk a little bit about kind of the initial agreement and then we can go from there?

Yes. Yes. So there's a couple of things that have gone on with [indiscernible]. First, back in March of this year, Salesforce announced they were going to sunset their product in markets, Salesforce Social Studio, which has been in the market a long time. We competed against it. And they then, at that time, announced that we're going to recommend Sprout as their partner of choice for any of those customers to migrate over. Now we still have to go win those deals. We saw if that deploy our ease against them. But basically, we were the preferred partner to move all their customers out as they sunset that product through 2024. So there's a 2.5-year time horizon for those customers to migrate over. And so part of that was that we would be the preferred partner. The other part of that, that went along with that was this -- the product team reaching out and wanted to build this integration in the Salesforce Service Cloud. So you think one of the main value props of Salesforce Social Studio was the tight integration it had in the Service Cloud and this was their solution, for example, for their omnichannel service offering, right? They've got all the different channels covered, but they needed a social solution that was Salesforce Social Studio. So that was going away. And so they said, hey, not only is this necessary for us to migrate a lot of these Social Studio customers, but we also think this will open up a much larger opportunity for the other 100,000-plus Service Cloud customers that are out there. So as part of that relationship, we've built now, which just went live in November, a direct integration into Service Cloud in the native objects into their counsel, which were the only ones in the market that have that custom integration. And so we also think that's another opportunity for us to build upon the Salesforce relationship. We announced this morning or yesterday the integration into Tableau. And so that's another part of the relationship. So we're starting to build out relationships across the Salesforce product org as a broader kind of relationship that we're trying to build with that.

And what are you seeing -- like one thing is an agreement. And then the other thing is what's happening in real life. Like what are you seeing in terms of the kind of customer interest, early customer interest, et cetera.

Yes. So really strong interest. Salesforce does a really good job. If you think about one Salesforce's has huge value prop is the trust they have with their customers. And so when we're getting pulled into these deals with their AEs, their AEs have been really supportive. They're pulling us in advance they're really doing a good job kind of bringing us into those deals. And so what I can tell you is that a lot of these deals that we've talked about that we've won over the last couple of quarters have gone really well. And we've been really pleasantly surprised with the way that the relationship is going. We have a really tight -- we have a shared flag channel with their AEs. We have a joint customer landing page with a bunch of sales collateral. We've done multiple trainings not only on Sprout but on the Service Cloud integration with their teams. So we're running these training programs. And so we're doing a lot of kind of go-to-market stuff with them as well. And so I think from our perspective, it's going really well.

Yes. I think just to level set everybody, we announced the partnership in March. Q2, which was the full -- first full quarter of that relationship. We talked about converting 25 customers over from Social Studio to Sprout. We then talked about more than doubling those customer conversions in Q3 and having great momentum as we look into Q4 and eventually 2023 here. I think just to double-click on Joe's point on Service Cloud, the way that we built that integration is really compelling, right? When you talk about building an instance of Sprout into the Service Cloud console, what that means is that if you're an agent that lives in Service Cloud all day every day responding to customers, you now can respond to customers directly on social via Sprout without changing your workflow, without learning a new software, without retraining. And so it takes all friction out of not only that migration path from Social Studio to Sprout, but also the complementary nature of I'm a customer, I'm a Service Cloud customer today and I wake up tomorrow and I need to solve for social. Now I can implement Sprout really seamlessly into that workflow. And so that's Service Cloud integration, right? We announced it at Dreamforce in September. We talked in Q3 about having a couple of early beta customers. Bausch & Lomb was one of those biggest beta customers that we talked about having one in Q3. And we think there's a ton of momentum there as we look into 2023 as well, specifically with Service Cloud and then with Tableau, and the product relationship extends deeper as we think about the types of things that we're working on now with Salesforce, both on CDP and Genie and some other integrations that will hopefully build together here in the future as well.

The 2 questions on that one to follow up. Like the reference customer you mentioned now I kind of recognize the name, so it doesn't look like a small SMB that it used to be. Like what's the situation in terms of like getting pulled up like higher up in the market through that relationship?

Yes. So most of the customers we're seeing from them definitely fall in that mid-market enterprise in that $10,000, $50,000 bucket that we have for our customers. So they're definitely larger customers. They're definitely coming with more users, more use cases. And so definitely larger than our average ACVs.

Yes. And then does the Salesforce AE, does he retire a quota or like is that a referral to you? Or like how does it work? Because like sales guys are only kind of motivated as the incentive kind of stuck towards...

So on the Salesforce Social Studio, they don't retire direct quota on those deals. But on the Service Cloud, there's a relationship we have on any kind of Service Cloud integration and what that rev share might look like. So on one end, there is and then the other end, there is not.

Yes. I think the reality, and many of our sales leaders have come from Salesforce. Our President, Ryan Barretto, came from Salesforce. We have a good understanding of like the value system at Salesforce and how they actually sell, how they actually take care of their customers. So when you think about the Social Studio migrations, right, the Salesforce AE can retire quota if a customer had previously been spending $10,000 on Social Studio. If you're able to migrate that $10,000 of spend to Sales Cloud or Service Cloud or Slack or any of the other Salesforce portfolio of products, you would retire quota for that, which if you kept customer spend flat, you ordinarily would not retire quota for that, right? So there is incentive to get customers off of Social Studio and on to other Salesforce products. And then as part of that, and this was the reason why Salesforce selected us as their preferred partner, they're actively recommending the migration then from Social Studio to Sprout because Sprout reinforces the existing value of that investment in Salesforce, right? Sprout reinforces the investment in Service Cloud and Marketing Cloud and we integrate best, we partner best and we're able to set those customers up for the highest degree of success. On a go-forward basis.

And then just very briefly, I mean, I saw the Tableau announcement yesterday, but I have to say I'm struggling a little bit to see how that will work. Because like Tableau to me, was like defense, dashboards and spreadsheets to analyze my numbers. How does Sprout fit in there?

Yes. So what we're allowing those customers to do, it's this goal of Salesforce to have this 360 view of their customers. And in order to do that, the Social is a big aspect of that and so now what they'll be able to do is pull in social data via Sprout into Tableau that can sit alongside all their other customer information.

Yes, yes, yes. So it's basically -- but -- so your integration is more like -- sorry to be tech like, API based. And so then if you open up the AI, you can just bring it in.

Correct. Correct. But in order to get that access to the API, you actually have to purchase the Sprout Premium Analytics module. And so in order for them to have that access within Tableau, they have to buy the additional and a module of Sprout.

Okay. And it makes sense. Okay, yes, yes, yes.

So it's not like you can just turn on this integration and get all this data for free.

Yes, yes, yes. Okay. Perfect. And then last question is like the on that -- so you're the preferred partner, like how does it then work with other guys like there's kind of people below you and the [indiscernible] you're like, how do they fit in? I mean they can come up with their own stuff, but it's like not that much supported by Salesforce? Or how do you have to think about it.

Well, I think like any other -- this is very similar to a lot of the other folks in the space, like there's folks that are in the AppExchange, right, and they can build on top of Salesforce. They can work with other partners or they can build out custom solutions. We're the only ones that are in market. There's 2 things that are unique versus us and the other folks that are in the AppExchange. One is we're the only ones that have this integration directly into this Service Cloud counsel, into the native object. So the only place you can get that is through Sprout. And then we're the only, for example, preferred partner on the Social Studio migrations where they're recommending Sprout in these migrations. But the other customers like they've always had, they have -- if they're in the AppExchange, they can build on top of Salesforce.

Whatever you want.

Whatever you want. Yes.

Okay. Perfect. Makes sense. So the other big item that I wanted to leave a lot of time to discuss with you were the pricing changes that we announced last quarter. So maybe just kind of level set it for everyone, like -- so what were the actions you took and then we can dig deep from there.

Dig deeper, yes. So there's 2 things we did. So we announced pricing changes for existing customers as well as any new customers coming to our website, so there's 2 pieces. On existing customers, those increases will be high single digit, low double digits. And we hope that we should be able to touch every customer over the next 12 months, by the end of next year, depending on when the renewal is up or if they're month to month, when they hit a certain kind of threshold or tenure, so those increases will roll out over the next 12 to 14 months. And then on existing -- or on new customers on the website, so anyone that started a trial after 11/1, got the new pricing on the website, and that went from anywhere to 2.5x on our base plan to maybe 50% to 100% on our highest-level plan as far as the new pricing on our website. So those were the kind of 2 major pricing changes that we had.

And the -- like what then -- what motivated that? Because like look, as a [indiscernible] you would say like, look, tougher times, so we jack up prices. Welcome to Oracle to -- but that's -- I don't think that's what's going on here.

Correct. So what motivated us was we looked back the last time we increased pricing on our website, for example, is 2017. So if you think about it, it's been 5 years, and you think about the changes in social, you think about the number of networks that we've added, you think about the fact that we launched 100 new product features a year, like social has dramatically changed in the last 5 years and all the value we've added to the product, and we haven't changed the price at all. And so when we looked at that and then we looked at what our strongest our ideal customer, that 80% of our customers that drive a majority of our revenue, and we look at what they were paying, they're paying much more and the willingness to pay is much more than, for example, the bottom end of the customer. So what we realized was -- we were leaving way too much money on the table up in the mid-market enterprise because we were trying to put pricing on the website that captured all ends of the market. And so I think we -- what we were saying is, hey, we're okay, for example, for the unsophisticated low-end customer. We're okay not having as many of those because we're going to get twice as much value from what we can sort of the more sophisticated mature part of the market, and we were just missing out on too much of that revenue. It didn't make sense to try to have pricing that spanned so much of the market.

It's like sorry to -- it's more like I don't know how to raise the question. like it's funny because like you're not the only one that discovers, there's different customers. And what -- I have -- a few companies have discovered it, well, low end, because they don't spend anything with me. They can turn quickly, and I'm still spending money on them why like what drove that decision-making process?

Yes. So what it was when we -- over the summer, we started looking at like our strategic investments and strategic plan for 2023 and where we want to put like our go-to-market resources, where do we want to put our R&D resources. And we realize the amount of demand, not only on the go-to-market side, but on the features and the investment in R&D up in that mid-market enterprise was really starting to outweigh the needs of the lower end of the market. So we said, hey, we've got this huge opportunity upmarket in the mid-market enterprise. You got to remember, in the mid-market, we don't have a lot of competitors. We have the low-end competitors that we compete against in SMB and we definitely have the enterprise level. But like we have really no direct competitors everywhere in between, and that's where there's this huge market opportunity, and that's where we weren't capturing all the value. So when we looked at our existing customer base and when we looked at where the demand was coming from, that kind of drove this thing and, hey, by the way, we're seeing all this demand in this part of the market. So we got to make sure we're capturing that value. And our willingness to pay and the customer's willingness to pay in that part of the market was just so much higher. And so even in the high end of the market, if we look at the pricing changes against our enterprise competitors, we're still 40 -- even with these price changes, we're still 40% or 50% cheaper than the other enterprise solutions.

And that's on the new customers.

On the new customers.

Yes, that's not even the renewals. They are laughing.

So what we did on the existing customers, we actually had piloted this in the last 3 to 4 months with a cohort of customers to say, hey, would there be any big pushback, would they be pissed off, we got very little pushback. If you think about that we've never increased price, some of these folks 6, 7 years with the same price that they're paying, and we're saying high single digit, low double digits. Extremely little pushback.

And Raimo, to your question. Part of this is just an evolution of our business and also of the market, right? If you go back to the early days of Sprout, our first paid plan was $9 per user per month. And believe it or not, we still have customers paying us $9 a month. And you think about the low tier plan having increased now over the last 12 years from $9 to now $249, there's been this steady evolution as customers mature into needing a solution like Sprout. There's been this steady evolution of customer budgets and customer willingness to pay and the investment levels that are going into social. And our pricing strategy is just mapping to that maturity curve, right? And then when you think about the other evolution of our business, again, go back 10 years, a majority of our revenue would have been coming from SMB. And today, 70% of our revenue comes from mid-market and enterprise, they are our 2 fastest-growing segments. And so as we thought about the pricing strategy, let's make sure that we're pricing and we have a monetization strategy that aligns to both of those realities, right? And we don't have a monetization strategy that this one-size-fits-all approach. Because our business is not one size fits all anymore. It's very clearly pointed in one direction.

And then the -- I mean the -- but the existing customers like -- I mean, I know other vendors like a Workday would have an innovation index. So you don't want to kind of hit the guys with CPI, every year. But like your product is getting better every year. Like have you implemented something like that? Because like the price changes you do now is a one-off. But then like in a few years, you're going to have the same problem again. Like how did you think about that?

Yes. So we -- alongside this, we updated our contracts that allow us to increase price on a go-forward basis. So I think what we'll do every year is figure out what does that look like? I think a lot of it will have to depend on how much discount did you get on the first contract? How long you've been with us? Like so obviously, there's varying factors that go into that. But I definitely -- we definitely expect to have some kind of price increase for some of our customers every year. It won't be this significant. But I don't think we're going to wait another 10 years to increase price on existing customers, I think it will be a little bit more frequent.

And the other thing that goes hand in hand here is packaging, right? And we haven't really touched on this here. But one of the things that we've historically not done a great job of is packaging. And we've tended to introduce a new feature and just put it into all of our plans. But what we're being much more intentional about now is as we introduce new features and functionality, gating them to specific plans, right, whether we've got the good, better, best model, we've got the enterprise SKU, we have premium modules. And so you'll see us be much more intentional about where we introduce new features as a means of migrating customers up pricing tiers over time.

Yes. Like Tableau integration is a great example of that. Historically, we might have just given that to everybody and say, hey, integrate Tableau and now you have to have it -- like you have to have Premium Analytics to get it. That's like something that is new to the way we've been doing our packaging, which I think is long overdue.

It's like -- is that a benefit of having some more sales force guys in the organization as well because I think they are playing that pretty well. Over the last few years?

I think it goes along with the maturity of the market and the fact that some of these features that we're realizing how much value they add to these organizations and the fact that they're willing to -- they come -- they're willing to pay for these things. I think it's just -- it's more of the maturity of the market and maturity of our own team and bringing more senior folks in the organization saying, hey, by the way, why are we giving this away? I know -- like to your point, more senior sales folks saying, they'll pay for that. Like why would we just give it to them.

Yes. And then what -- I mean, obviously, it's very fairly recent. Have you seen any -- I'm sure you're tracking like what's my -- how is my attrition rate changing, et cetera? Like have you seen any early data points here?

Yes. So on the price increases?

Yes.

So we haven't seen -- like we said, we were testing this pre kind of these increases, and we just started rolling this out in December, and so it's early. Right now, but we haven't seen anything that material change in what we were expecting or in attrition so far now. Most of the -- a lot of the increases for existing customers just started to kick in, in December, so it's pretty early. But based on the test we had run and the larger cohorts we had done over the last 3 to 4 months, we don't anticipate any major changes.

The other thing that -- and it's more for the 2 of you because we give you the grief and the model numbers don't come in, like how much like in a way -- that should give you like a nice foundation for numbers next year. So like when the market is very nervous. Everyone is like, oh, my god, how low are the numbers going to come in. This should help in a way, get you sleep better at night.

It definitely -- I mean, it definitely helps. Any time you go from not increasing price on customers to like this, especially with the fact that we've never done it, so we have very little pushback. And then if a customer looks at -- if I'm an existing customer, and I'm saying, hey, high single-digit increase and then I go to the website and see what the current pricing is, they're still significantly paying less than the current pricing. We definitely think this is an upside for our business going forward.

Yes. Okay. And then do you think you will -- like it's more for communication with us? Do you think you will break that out a little bit? So it's like what's going to happen is you're going to have like less low-end customers coming in, so then your customer count is coming down, but the pricing is going to be better. And so now everyone is going then to scramble like is the business actually doing well? Or do you -- doing something? What's your thinking there of kind of helping us to understand that it's still doing all in the right direction?

Yes. So I think when we get into like next year, when we start talk about our results. I think you're definitely going to see us talk a little bit more about what's that trade-off between the number of customers we're adding, the increase in the ACVs. Where are those ACVs coming from? So I definitely think you'll see more color from us as we get further along in the next year on this stuff.

Yes. And from a metrics' perspective, we're not going to pull any metrics, right? I think that's something that we don't want to get in the habit of doing. I think you will, to Joe's point, you'll see us focus much more significantly on HCVs and ACV growth as one of the primary drivers of our growth. And then I think you also may see us introduce -- today, we have our overall customer count, the number of customers paying us more than $10,000 and more than $50,000. You may see us introduce a new tier of customer above that as we continue to grow into the enterprise as well.

Yes. Okay. Perfect. And last few minutes, I wanted to change a little bit on because we're -- there's growth and there's like profit and cash. Like obviously, the price increases should help you a little bit here as well. But like how do you think about this whole dynamic now, especially since we're in a more uncertain environment?

Yes. So what we've talked about, and we don't plan on getting off of this as we expect to drive 100 to 300 basis points of margin improvement every year through 2025, and we don't -- we don't see us slowing down. I think there's an opportunity with these pricing increases and some of the momentum we're seeing the business to be maybe on the higher end of that, but we'll see when we get into next year, and we see how the business is performing. It is something -- if you look back at Sprout's history, we have for, I don't know, 4, 5 years now, have continued to drive operating leverage in this business, while we're still growing it at 30-plus percent. So we always manage it in a very financially responsible way. I think the main reason for that is because we're an inbound-driven model, we have so much insight to where the demand is coming from, that we can always match that with the right level of investment. And so we don't ever get too ahead of ourselves on where is that -- we don't have to make large bets, on the go-to-market side, for example, and hope they pan out because of the way the go-to-market strategy works. And so I don't see us ever getting away from that kind of approach on the way we invest in the business. And so I feel pretty good about our ability to continue to drive leverage in this business. And still hit the growth targets we've talked about.

Yes. I mean, the thing is like software inherently is a fixed cost business. you have high gross margins, and you have your OpEx and your OpEx is fix and you plan your OpEx depending on where you think the revenue comes in and which profits you want to show. Like if you think about that kind of budgeting process and if you think about the answer in times like as a CFO or as a finance team, like how do you kind of plan this and how you kind of create flexibilities in case things pan out differently.

Yes. So the way we kind of look at flexibility is like, okay, what are we -- what are the areas that we know for sure, for example, that we need to add capacity to because we see demand. Like for example, right now, I can tell you the amount of demand we're seeing up in the enterprise business, we need to fill that capacity. So we need to invest in sales and marketing. And we -- and because of the tight sales cycle, 35 to 41 days, we get a pretty good understanding of how quickly those investments are working or not working. And so because of the fact that our sales team, for example, on the go-to-market side is on monthly quotas across the board, even our enterprise reps are not paid quarterly or annually. They're on monthly quotas, we can be pretty flexible and like, okay, do we need to push on the gas? Do we need a letup on the gas. We're not waiting 6 months to see if the sales rep panned out and whether or not we need to like, oh, we got to fire this person because they've been here 6 months and haven't sold the deal. And so I think because of that, we have pretty good indications on how to manage this in uncertain times and whether or not we need to pull back or not.

Yes. And I think, Joe, maybe is underselling this point a little bit, right? But his team, the finance team meets on a monthly basis with each of the sales leaders and each of the business unit leaders across the go-to-market organization. And that's really a refinement process to, on a real-time basis, understand what's working in the business, what's not working in the business, what needs more capacity and more investment. And that means that in real time, we're constantly making refinements to the right level or the optimal level of investment in the business. And so to Joe's point, that's what's allowed us to really consistently expand margins over time. I think that's what also puts us in a position today to still be hiring, right, when many companies are not because we've been making refinements for 5 straight years instead of trying to go get ahead of our skis and create demand and see whether that works or not. And so now as we look into next year, we're still in this position where we can't hire fast enough on enterprise, the growth sales role is kind of an evergreen role for us. There's constantly new rules available on the website, you just think about the amount of logos that we're bringing into the business on an ongoing basis, right? We need to continue to staff our growth sales teams to go back in and upsell those customers over time. So those are the 2 biggest areas of investment as we think about where we're hiring right now and as we think about next year.

Yes. I mean and also, if you talk about a sales cycle of like 30, 40 days, that's ridiculously -- I mean, that's almost like you kind of need to hire fast. Yes, yes. Okay. And then how do we think about cash and usage of cash now in these tougher times?

Yes. So we've been cash flow positive for 7 straight quarters, and we expect to continue to drive like leverage and free cash flow going forward. We've got $180 million, $200 million of cash. We don't burn money anymore. So I think for us, the only major use of cash would be on the M&A front if we saw something that made sense. We don't need that -- we don't need obviously that cash to run the business. Historically, we've done one deal in 12 years. So I don't think we're ever going to be super aggressive on the M&A side. But if we see something, technology that makes sense, we wouldn't shy away, but that's probably the only major use of cash we would see in 2023 would be on that front.

Yes, yes, yes. I mean do you have like -- sorry, that's more of CFO question, like do you have like a rule of thumb where you think like how much cash do I need in my business? It's like 3 months of -- how do you think about that?

I think that was pre-IPO when we were burning cash, and we were trying to figure out like, I think that's the way we would think about it, okay, how much money do we need before we need to raise the next round or before we need to do the next capital raise. For us, once we've been consistently positive, for me, it's more about how can we optimize that free cash flow? So it's actually the opposite how much more money do I need? It's like how much can we drive that up what can we be doing in the business, to move more customers to annual deals for month-to-month deals. And so I think for now, the focus is more on how do we increase the free cash flow versus how much cash do we actually need to run the business.

Yes, yes, yes. Okay. Perfect. Hey, that's just times up. I really enjoyed our conversations again. Hey, good to hear you again in person now.

Always a pleasure. Good to see you.

Thank you.