Sumo Logic, Inc. (NASDAQ:SUMO) Q3 2023 Earnings Call Transcript

Sumo Logic, Inc. beats earnings expectations. Reported EPS is $-0.04, expectations were $-0.15.

Operator: Greetings. Welcome to the Sumo Logic Third Quarter Fiscal 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I’ll now turn the conference over to your host, Bryan Liberator, Senior Director of Investor Relations. You may begin.

Bryan Liberator: Thank you, and good afternoon. Welcome to Sumo Logic’s third quarter fiscal 2023 earnings conference call. Joining me on the call today are Ramin Sayar, President and CEO; and Stewart Grierson, Chief Financial Officer. Our format today will include prepared remarks by Ramin and Stewart, followed by a question-and-answer session. Some of our discussions and responses to your questions will contain forward-looking statements, including statements relating to the expected performance for our business, expectations regarding our platform and solutions, expectations regarding our go-to-market efforts, our future financial results and guidance, our growth, expense and investment strategies, our market opportunities, the recent economic downturn, inflation and our overall future prospects.

These statements are subject to risks and uncertainties, actual results may differ materially from our forward-looking statements. A discussion of the risks and uncertainties related to our business is contained in our filings with the Securities and Exchange Commission, including our risk factors filed with our most recent quarterly report on Form 10-Q and the risk factors that will be included in our Form 10-Q that will be filed subsequent to this call. Sumo Logic assumes no obligation and does not intend to update or comment on forward-looking statements made on this call, except as required by law. Our discussion today will include non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results.

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Information regarding our non-GAAP financial results including a reconciliation of our historical GAAP to non-GAAP results could be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC on our Investor Relations website at investor.sumologic.com. For certain forward-looking guidance, a reconciliation of the non-GAAP financial guidance to the corresponding GAAP measure is now available, as discussed in detail in our earnings release posted on our Investor Relations website. With that, let me turn the call over to Ramin.

Ramin Sayar: Thanks, everyone for joining us today on our third quarter earnings call. We are pleased with the continued progress and strength in our business. We once again exceeded the high end of all of our guided metrics. In Q3, we delivered total revenue of $79 million, or 27% year-over-year revenue growth and ended the quarter with ARR of $298.9 million, or 22% year-over-year growth. We achieved these strong results, while also demonstrating outperformance across both gross margin and operating margin. Our improving operating efficiency is driven by a combination of continued cost optimization, improved sales productivity, and head count rationalization. We’ve driven sequential operating margin improvements throughout this year, as it remains a key area of focus.

Moreover, we remain optimistic about our opportunity and our ability to execute against our plans. We are committed to continuing to deliver more efficient growth, as we look to accelerate our plans to achieve cash flow breakeven and profitability. While in the near term, there is less certainty and more noise in the macroeconomic climate. We have control over how we manage the business and remain committed to delivering more durable growth and accelerating our path to profitability. Despite the macro uncertainty, we are still in the early innings of a multiyear growth cycle driven by digital transformation, cloud migration and security modernization. Companies are increasingly relying on digital services to help grow and operate their business.

And we play a critical role in ensuring that these experiences are both reliable as well secure. These long-term trends drive our business and are contributing to our strength, that we are seeing in our results. In Q3, we continue to see strong win rates with our customers increasing their adoption and usage of our platform. We ended the quarter with 501 customers with more than $100,000 in ARR, representing a year-over-year growth of 14%. Before I share some key customer wins, I would like to reiterate that our vision is to make the world’s digital experiences both reliable and secure. Our cloud native platform uniquely helps customers do three things. First, ensure application reliability. Second, secure and protect against modern security threats.

And third, gain insights into cloud infrastructure. This vision, and our strength was further validated by the fact that we are recently named a visionary in Gartner’s Magic Quadrant, for Security Information and Event Management for a second straight year. Additionally, we are the only cloud native vendor in the Gartner Magic Quadrant for both APM and observability as well as SIEM that offers a unified analytics platform for application reliability and security. As a reminder, at the core of our platform is best-in-class cloud scale log analytics. This is critical as logs are essential for detecting, diagnosing, troubleshooting and remitting both reliability and security issues. Rapid root cause analysis is essential to minimize end-user or business disruption and security and compliance risks to applications and cloud infrastructure.

Given the significant overlap in the logs required to ensure cloud application reliability and security, as well as the volume of data created by these cloud apps. The ability to effectively analyze these logs at scale from a unified platform will become increasingly important. We believe, we are uniquely positioned to help customers address the challenges of delivering reliable and secure digital services. With that, I’d like to share some examples of how our customers are using our platform and talk about key wins for the quarter. These wins were fueled by companies modernizing and migrating to the cloud, as well as cloud native companies expanding their footprint and platform usage. Many of the wins this quarter our with digitally disruptive companies, leveraging new technology and modern architectures to gain market share within traditional industries.

I’d like to first highlight some new logos that we landed in the quarter. The first was a six figure new logo deal with a large online retailer, who was newly spun-off from its brick-and-mortar parent company. The new entity needed a security solution that could be easily deployed by the existing team and work seamlessly with a modern cloud native technology stack. We proved our value during the POC process, we identified two ongoing threats that were quickly remediated. Ultimately, they selected our Cloud SIEM because of its ability to scale with their business and it’s easy out-of-the-box integrations providing immediate time to value. Next, we landed a six figure new logo deal with a Fortune 500 healthcare company that is moving to the cloud and expanding the use of Kubernetes for their microservices architecture.

Their existing solutions had difficulty scaling with the data generated by their microservices architecture, creating excessive personnel costs to configure and maintain it. They wanted their team to spend more time developing, and less time maintaining and manually troubleshooting issues. Therefore they select a Sumo Logic for our SaaS-based analytics offering and easy to use Kubernetes observability solution. These wins represent companies in different verticals that are digitally transforming their businesses, thereby requiring them to adopt new solutions to ensure the reliability and security of their cloud applications without having to run, configure and maintain those technologies themselves or needing specialize in-house skills. Besides new customers, we continue to see many of our existing and larger customers expand their use of our platform by adopting additional Sumo Logic products to solve additional reliability and security use cases, which is made easy with our flexible credit-based licensing model.

Additionally, data is growing faster than budgets and our cloud native platform can deliver significant economic benefits to our customers via the unified platform and data tears. I’d like to highlight a few of these exciting cross-sells. We landed a seven figure enterprise cross-sell with a tech focused telecommunications company, who is already spending over $1million with us. This cross-sell is a great example of how our platform seamlessly supports a variety of security and observability use cases. First, they have made three acquisitions in the last six months and wanted to standardize their logging on Sumo Logic because of their best-in-class log analytics for troubleshooting and remediating issues in real time. Additionally, they chose to standardize on Sumo because of our shared vision of open telemetry, standard across for observability.

According to our customer, their DevSecOps teams have experienced a 30% reduction in meantime to identify and reduction in the meantime to remediate versus competitive solutions. Second, they wanted a SIEM for their production and application environment and saw the benefit of using our single platform due to the similar or complementary log data for both application reliability and security. And they will also be using our FedRAMP Moderate Authorized SIEM in their FedRAMP environment. Another similar win came from our mid-market segment for a six figure cross-sell with media and technology company. They originally using Sumo for a classic monitoring and troubleshooting use case with logs, reducing time to identification and remediation when the payments or APIs failed.

They’re building out the security practices and adopted our cloud SIEM and SOAR as they saw the benefits of having a single vendor, providing a single platform for ensuring application reliability and security of their mission critical applications. While data consumption continues to grow more than 50% year-over-year, data volumes are continuing to outpace budgets. With increasing data volumes, there is a natural opportunity to drive further expansions. In the quarter, we had a couple of Fortune 500 companies, with seven figure upgrades due to continued data growth. They chose Sumo because of our data tiers, help lower their ingestion costs and are out of the box analytics helps increase their time to value. Lastly, I’d like to highlight that we continue to see strong traction with our channel partners for both observability and security deals.

More than two-thirds of our new business went through the channel in the quarter and we think we can continue to drive this number up, as we continue our focus shift to our partner first strategy. In addition, as we shift from channel fulfilled to channel sourced sales opportunities, it will free up sales cycles for our direct sellers, improving the reach and efficiency of our sales organization. This is an important lever for our future growth. These wins, highlight our continued traction, larger market opportunity as well as underscores the core differentiators of our unified cloud native platform for observability and security. Our platform is able to handle modern data volumes and unparalleled scale as our customers’ needs expand and contract.

An environment where customers are scrutinizing budgets, there’s an even bigger opportunity for customers to eliminate expenses by moving to our unified platform that has the breadth and scale required to meet their business needs. Additionally, our platform is highly audited and certified for a variety of industry, security and compliance regulations including PCI, HIPAA and FedRAMP. With that, I would like to share some quick product highlights. During Q3, we announced significant new capabilities and functionality to continue strengthening our full stack observability and security value by providing our practitioners with greater insights and usability. We announced reliability management, which is a better approach to measure and improve the reliability of distributed applications, shifting the focus on reliability towards the user experience.

Additionally, we’ve provided some exciting updates and enhancements to develop our strategy and user experience with our real user monitoring, a unified entity model, intelligent alert grouping and a new app to help practitioners manage their AWS performance and cost. For security, we continue to invest in developing security capabilities as well as enhancements to the platform in order to open up new routes to markets and levers for growth. This quarter, we announced that our Cloud SIEM is now available as part of the Sumo Logic FedRAMP Moderate offering. With this designation Sumo Logic became the first cloud native SIEM to deliver insights into on-premises and cloud environments for public sector organizations. Helping in our efforts to continue to expand our public sector presence.

Additionally, we continued our commitment and focus on our DevSecOps community and end-user practitioners. This quarter, we hosted our sixth annual user conference Illuminate a premier global education and community event that brought together customers with thought leaders in IT operations development and operations, security and more. Besides the free training, certifications and best practices content that we delivered a Illuminate. We also continue to support the broader open source community via contributions to open telemetry initiatives. I’m extremely proud of the highly differentiated solutions that we have to offer in a single platform that is recognized by customers and industry experts alike and I feel that our portfolio offerings have never been stronger.

Before, concluding, I’d like to welcome Timothy Youngblood to our Board of Directors as we further our efforts to help CISOs and organizations of all sizes address the increasing cyber security challenges with digital transformation and cloud migrations. Tim has extensive cyber experience and a deep understanding of challenges faced by his fellow CISOs and we’re super excited to have him join the Board. Now in summary, our industry leading cloud native platform has never been stronger and we continue to deliver improved results on both the top and bottom line as we drive towards the commitments we’ve made on the path to profitability and positive cash flow. I’m extremely proud of our continued progress and results, we have achieved so far throughout the first three quarters of our fiscal year.

I would like to thank all our employees for their continued dedication and passion to help us innovate, drive continued improvements in our go-to-market efforts and lastly commitment to increase our operational rigor. The impact of these collective efforts can be seen through the significant efficiency improvements from our initial guidance at the beginning of the fiscal year. With that, I’d now like to turn it over to Stewart Grierson, our Chief Financial Officer, who will provide more details on our strong financial results in Q3 and our outlook for Q4, as well as our fiscal year.

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Stewart Grierson: Thanks, Ramin. And thanks everyone for joining us on the call. I’d like to start with a brief summary of the financial highlights for the quarter and then go into more detail on each topic. First, as Ramin mentioned, we’ve continued to deliver strong top line results with Q3 year-over-year revenue growth of 27% and ARR growth of 22%. Second, we have continued to deliver our commitment to more efficient growth. In cost of sales, we executed some focused initiatives to drive efficiencies in our cloud infrastructure and operations, resulting in a reduction in cost of revenue from the prior quarter. These efforts, combined with the strong revenue in the quarter resulted in gross margins of 73%. In addition, as discussed in prior calls, we are executing on our revised go-to-market strategy and these actions are starting to pay off resulting in improved operating performance.

To recap, under Lynne Doherty’s leadership, we segmented our sales team into a hunter farmer model, implemented a channel first strategy, brought in sales leaders and up-leveled our talent to better fit this new model. The result has been a rationalization of the sales force, while driving productivity gains and maintaining growth. We have consciously reduced discretionary spend and overall hiring across all organizations in order to bring our cost structure more in line with our long-term operating plan. The result was Q3 operating margins of negative 7% of revenue, a significant improvement from the midpoint of our guidance of negative 23.5%. These results reflect our commitment to driving more efficient growth, as we execute on the path to profitability, we shared with you at our Investor Day on September 20.

As mentioned on our last call, we believe ARR is the best leading indicator of growth in the SaaS business. We ended the quarter with ARR of $298.9 million, representing 22% year-over-year growth. Our ARR is impacted by the reduced number of total sales reps and ramp sales reps from the changes we have driven in the sales organization. While these efforts are delivering better sales efficiency, it will take time for the sales organization to ramp and reach full productivity. As previously discussed, the benefit of these changes will not be linear in nature with greater impact as we progress into the second half of FY ’24 and beyond. Our $100,000 plus ARR customers are foundational to our ARR growth. In Q3, the number of $100,000 plus, ARR customers grew 14% year-over-year.

While the incremental count of these customers was not as significant as in prior quarters, their relative contribution to ARR was consistent as our larger customers contributed significantly to the growth this quarter. As expected, our dollar based net retention was consistent at 115% for the third quarter in a row. This remains a significant improvement from the prior year as we improved both our expansion and retention rates. We do expect Q4 net retention rates to be a few percentage points lower, given some known Q4 downsizing driven by budgetary pressures as some customers look to reduce spend in this uncertain macro environment. Turning to billings. Calculated billings for the trailing 12-month period was $311.7 million, up 18% year-over-year.

Recall that we look at calculated billings over a trailing 12-month period, as this metric can fluctuate from quarter-to-quarter due to the timing of our renewals and variances in billing schedules, which was particularly true this quarter for some of our larger customers. Remaining performance obligation or RPO remains healthy at $354.9 million, representing a year-over-year increase of 21%. Now, I’ll review the income statement in more detail. As a reminder, unless otherwise noted, all metrics are non-GAAP. As previously stated, total Q3 revenue increased to $79 million, up 27% year-over-year. We once again saw better than expected linearity in the quarter, a positive indicator of the improved rigor and discipline in the sales organization.

In addition, there were some upgrades in the quarter with associated contract revisions resulting in moderate revenue acceleration in the quarter. Q3 gross margin was 73%, which was a few percentage points better than the prior quarter. The improvement was largely driven by several focused initiatives to lower our cloud infrastructure costs. We expect Q4 gross margins to be in the 72% to 73% range as we sustain the savings from these initiatives. Longer term, we expect gross margins in the mid-70% plus range as we drive efficiencies in our cloud infrastructure and operations. With regards to operating expenses, we have continued to rigorously scrutinize hiring and discretionary expenses. By the end of this fiscal year, we will have eliminated roughly $27 million in expenses or approximately 9% from our original plan.

As previously mentioned, in Q3, we reduced operating expenses across all functions from the prior quarter. While we expect to modestly increase our operating expenses in Q4 as we add capacity and sales, we also remain cognizant of the greater uncertainty caused by the macro environment, and we’ll invest cautiously. As stated previously, our Q3 operating margin was negative 7% driven by revenue outperformance, improvements in gross margin and careful management of operating expenses. Net loss in the quarter was negative $4.4 million or negative $0.04 per diluted share based on approximately 119.1 million weighted average diluted shares outstanding. Turning to our balance sheet and cash flow. We remain well capitalized and ended the quarter with $342.1 million in cash and marketable securities and no debt.

Free cash flow in the quarter was negative $9.1 million or negative 12% of revenue. As we’ve shared previously, given the variability of free cash flow from quarter-to-quarter, we recommend looking at free cash flow and free cash flow margin on an annual basis. We expect to end the year with free cash flow margin of approximately negative 10%. We also expect to continue to deliver improvements in free cash flow margin in the future as we focus on driving more efficient growth. Turning to guidance. As a reminder, we believe that it is more relevant to measure the growth of our business on a full year basis given potential variability from quarter-to-quarter. The macroeconomic environment continues to create a higher degree of uncertainty. While we did not experience a material impact to our business in Q3, we are seeing increased scrutiny over budgets and buying decisions.

We also believe this environment and the associated uncertainty will progress through Q4 and into next fiscal year. Despite this backdrop, we believe that our offering is more resilient than most as we enable teams to work more efficiently, allowing them to accomplish more with fewer resources. The need to deliver reliable and secure digital experiences for mission-critical applications will continue to be a top priority for our customers and the broader market. For the full fiscal year 2023, we expect total revenue of $298 million to $299 million, representing 23% year-over-year growth. Non-GAAP operating margin of negative 16% to negative 15% and non-GAAP loss per share of negative $0.36 to negative $0.35 on approximately $117.5 million weighted average shares outstanding.

For the fourth quarter, we expect total revenue of $77 million to $78 million, representing 15% to 16% year-over-year growth. Non-GAAP operating margin of negative 14% to negative 13% and non-GAAP loss per share of negative $0.09 to negative $0.06 (ph) on approximately 120.5 million weighted average shares outstanding. In summary, we are pleased with our continued strong execution on both our top and bottom line priorities. We remain committed to delivering more efficient growth while accelerating our path to profitability as we navigate this uncertain macroeconomic environment. Our unified cloud-native platform for reliability and security continues to resonate with our customers as more customers are seeking to provide best-in-class digital experience to their end users.

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

Q&A Session

Operator: At this time, we will be conducting a question-and-answer session. And our first question comes from the line of Kamil Mielczarek with William Blair. Please proceed with your question.

Kamil Mielczarek: Thank you and then congrats on the strong quarter. Several of your peers have announced plans to slow down hiring. Can you provide more detail on how you’re thinking about headcount changes going forward? Are you playing more rationalization or given the initial of the Hunter-Farmer structure, would you be adding to the sales organization?

Ramin Sayar: Yeah, Kamil. We’re actually, as I said in the prepared remarks, we’ll be looking to add capacity to the sales organization, so we’re down year-over-year. Obviously, as we’ve made the changes, we want to make sure we have the right people in the organization. But we will always balance hiring with continued view to productivity gains. But our expectation is to add capacity in the sales work.

Kamil Mielczarek: Got it. That’s helpful. And I realize that ARR is the right metric to focus on, but there is a bit of a divergence between revenue, ARR and billings growth. Can you help us bridge the gap between these metrics and what’s driving the strong revenue acceleration?

Ramin Sayar: Yeah. So I think as we’ve shared, and I think you’re right, ARR is the best metric to look at in terms of kind of the leading indicator of growth. And so as we have made the changes in the sales org capacities down in particular ramp capacity is down, and that does have an impact in ARR, and that’s what you’re seeing in the numbers. And then revenue is a trailing indicator in a SaaS business. And so we’re getting the benefit of the strength in the prior quarters. As I mentioned, there was some very moderate sort of impact this quarter on some revenue acceleration, which helped with the beat, although, we were strong — we were glad of the strong beat regardless, but that’s the dynamic that you’re seeing. From a billings perspective, just to touch on that one.

We’ve talked about this in the past. We will have variability from quarter-to-quarter. And some of that’s got to do with billing schedules. And so one of the comments I made was we did see this quarter, a number of our larger deals had billing schedules that were — while they were one or multiyear contracts, some of the billing schedules were less than one year in duration. So they were either quarterly or semiannual and so that can impact billings the perspective of billings growth year-over-year.

Kamil Mielczarek: Got it. It’s very helpful. Thanks again.

Operator: Our next question comes from the line of Matt Hedberg with RBC Capital Markets. Please proceed with your question.

Matt Swanson: Yeah. Thank you. This is actually Matt Swanson on for Matt. I guess this would kind of be for both of you, but it’s really impressive to see the DBNRR hold consistent for three quarters given how challenging the macro has been. Could you just kind of expand, I guess, on what you think this means about how your customers are seeing your platform? And then given the challenging macro, one of the trends we’ve heard a lot this quarter is about consolidation to fewer vendors. Do you feel like you’re seeing that onto the platform as well?