Sprout Social, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020; unaudited. Sprout Social sells cloud-based social media management software, primarily through subscriptions. Subscription revenue represented 99% of revenue. The company reported more than 25,000 customers across 100 countries and operates as one segment.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $33.7 million | $26.4 million | $95.6 million | $74.6 million |
| Gross profit / margin | $24.9 million / 74% | $19.2 million / 73% | $70.3 million / 74% | $55.3 million / 74% |
| Operating loss | $6.9 million | $5.1 million | $26.2 million | $21.4 million |
| Net loss | $7.0 million | $5.0 million | $25.8 million | $21.0 million |
| GAAP net loss per share | $0.13 | $0.30 | $0.51 | $1.25 |
| Free cash flow (non-GAAP) | $(4.0) million | $(3.4) million | $(13.4) million | $(10.3) million |
Cash, liquidity and obligations: At September 30, cash and cash equivalents were $117.8 million, marketable securities $49.5 million, and net receivables $14.4 million. Current assets were $193.7 million and current liabilities $51.7 million. Nine-month operating cash outflow was $11.2 million; investing cash outflow was $51.9 million, mainly reflecting $49.7 million of marketable-security purchases; financing provided $45.6 million. The company had no outstanding balance on its $40 million revolving credit facility and reported compliance with its covenants. Total liabilities included $25.6 million of operating lease liabilities. Non-cancellable operating lease and purchase commitments totaled approximately $99.7 million.
Changes versus the prior comparable period
- Q3 revenue increased 27% year over year; management reported organic growth of 34%. Nine-month revenue increased 28%, with reported organic growth of 37%.
- Customer count rose to 25,556 from 23,066. Total ARR increased to $141.9 million from $109.5 million; organic ARR was $140.6 million versus $103.9 million. Customers contributing more than $10,000 in ARR increased to 2,790 from 1,965.
- Q3 gross margin improved by one percentage point; nine-month gross margin was unchanged. Operating expenses grew faster than revenue in Q3, particularly general and administrative expense, contributing to a larger operating and net loss.
- Nine-month operating cash outflow increased to $11.2 million from $9.7 million. Deferred commissions and receivables were significant cash uses, partly offset by higher deferred revenue.
- The August follow-on offering raised $42.1 million net for the company from its issuance of 1,612,500 shares. Selling shareholders also sold shares but the company received no proceeds from those sales.
Outlook, commentary and risks
- Management expects continued investment, operating losses and negative operating cash flows for the foreseeable future. It believes existing cash and cash equivalents are sufficient for operating and capital needs for at least 12 months. No specific revenue or earnings guidance is provided in the filing.
- Management said COVID-19 had not materially affected operations or financial performance through the first nine months of 2020, but its future impact remains uncertain. Risks include customer budget cuts, slower sales cycles, nonpayment, churn and increased bad-debt expense; nine-month bad-debt expense increased $0.7 million year over year.
- Other principal risks include competition, customer acquisition and expansion, reliance on third-party social-network APIs and data, privacy and security regulation, international data transfers, and the ability to innovate and retain personnel. The filing highlights uncertainty following invalidation of the EU-U.S. Privacy Shield and compliance costs associated with privacy rules including GDPR and CCPA.
- Management expects cost of revenue to decline as a share of revenue over time, while planning continued spending on research and development, sales and marketing, and public-company support.
- A new Seattle office lease commenced in 2020, with stated future commitment of $7.9 million and expiration in 2031. No material legal proceedings or material indemnification obligations were reported.
- Disclosure controls were deemed ineffective because a previously identified material weakness in internal control over financial reporting had not been remediated as of September 30, 2020. Management reported additional review procedures and stated the financial statements fairly present the company’s results in all material respects.
- Subsequent event: the CEO became eligible in October 2020 for 120,916 additional RSUs after a $2 billion market-capitalization threshold was achieved; $0.2 million of compensation expense was recognized.
Investor verification priorities
- Track whether ARR and customer growth convert into durable revenue, renewals and expansion, particularly as customer budgets and payment behavior respond to COVID-19.
- Assess the trajectory of operating losses and cash burn, including deferred commission investment, receivables, bad debt and stock-based compensation.
- Review the use and liquidity of cash and marketable securities, and the company’s capacity to meet lease and data/service purchase commitments.
- Monitor remediation and testing of the material weakness in internal controls and the resulting effectiveness of disclosure controls.
- Evaluate exposure to privacy and data-transfer rules, third-party platform/API access, and any resulting compliance costs or service changes.