Dropsuite Ltd

ASX:DSE

Earnings Call Transcript 2024-Q1

[Operator]

Before I introduce the gentleman who are going to be speaking, I just want to remind you [Operator Instructions]

But without further ado, let me introduce you to the CEO, Charif El-Ansari; and the CFO, Bill Kyriacou, who will be speaking in turn. And once they're completed, we'll come back and we'll get the Q&A session underway. But without any further, let me pass over to you, Charif.

[Charif Elansari, executive]

Thank you, and I want to thank everybody who is joining us today for our Q1, the March update. I know everybody is busy. I really appreciate strong showing today for our webinar. I'm going to open and give an overall update for the quarter as usual. And then what we'll do is that we'll have Bill, our CFO, cover the financials, then I do closing remarks, and then we open it up for about 20 minutes of Q&A.

Overall, we had a solid and well-balanced quarter in March. We grew top line by north of 30%, delivered cash flow positive and good gross margins, as you saw. We continue to see strong demand for data protection and equally strong validation for our scalable partner-first business model.

Hence, we continued investing in the business, namely in things that really matter, which is go-to-market and technology functions. This underlies a strong belief in our growth prospects, and that's underpinned with a lot of white space remaining as we've talked about before, which is about $400 million plus.

Just Office 365 and Google Workspace seats out there, and we still see 80% white space in the market. We continue to grow our partner base. We continue to see meaningful tailwinds all around cybersecurity regulation. And of course, we continue building a strong team and a strong culture that really helps us scale the business to the next level.

Now as we put in our presentation and our written document, we did see more churn in the MSC business, which was more than our typical 3%. It's still single digit, it's still sub 4%, and it is something that we're addressing, and we can talk about it in the subsequent slides. So when Bill talks about it, and of course, we can talk about it in the Q&A as well.

At the same time, we continue to build a strong funnel. We continue signing and adding distributors and MSP partners. We continue enhancing the value proposition for our MSP community, adding a respective number of new seats globally.

A couple of highlights on the product and go-to-market that I'd like to also talk about here. The first is we did a material enhancement in our seamless integration capabilities. This is something we talked about before, one way why which drops it differentiates itself in the market by having a very tight integration into the -- our partner's ERP systems.

In our channel, it's called PSA, Professional Service Automation. So the team has done a phenomenal job. We launched a very successful marketplace for this. So we expect to do more and more and further strengthen our seamless integration with our partners.

The second is we have introduced something called a point in timely store, think about as basically taking a snapshot and being able to store this snapshot as it was 3 months ago, 6 months ago, 1 year ago. Now that is combined with our continuous ability to back up nonstop, right, and restore nonstop and that is a very strong differentiator and a very unique way of restoring data. And remember, the storing data is why we exist, right, to be able to protect our MSPs and their end customers in case of deals.

Thirdly, we also continue streamlining and speeding up the partner serve, which is the service by which we introduced in beta in Q4 to help our MSP partners who don't have time and resources to migrate backup data from other vendors into JobStreet. We have more work to be done there, but we've made some very strong improvements in automating a good part of that process to make sure that we migrate the users, hence, we charge for this migration and also, of course, that will help us accelerate ARR and monthly repaying revenue in Q2 and beyond.

So we've done some in Q4, obviously. We've done some in Q1, but we see more opportunities for us to migrate more of the seats from competitors into Dropsuite in the second half of -- in Q2 and the second half of the year.

From a go-to-market standpoint, obviously, we continue expanding our partner service funnel. We had a strong addition of new MSP partners, both indirect and direct, including distribution partners, especially in EMEA.

One thing that we did, which is now public information is we launched an alliance with two of the best e-mail security companies in the world. And that is Proofpoint and SentinelOne. And that's in collaboration with one of our strategic distributors called Pax8, which is one of the largest cloud distributors in the world.

And this combination of product, which is Proofpoint and SentinelOne and Dropsuite, strengthens the value proposition for MSPs and the health clients in a big way when it comes to e-mail and production. So a lot of activities, a lot of good activities that are adding value, that are building the funnel as we go through the remainder of 2024.

With that, I'd like to ask our CFO, Bill, to provide the financial update before he passes it back to me. Thank you.

[Bill Kyriacou, executive]

Thanks, Adrian and Charif, and thank you to all attendees for your time today. In this financial overview will present our key business metrics and cash flow.

As we exit the March quarter, we continue our ARR momentum with solid quarter-on-quarter growth. We saw consistent constant currency ARR growth across our partner base, up 7% quarter-on-quarter and 31% PCP, with actual growth of 9% on prior quarter positively impacted by the FX movements in that quarter.

Our gross margin was in line with expectations in prior quarters at 59%. We continue to add capacity each quarter as we add new users and are focused on optimizing on our storage tiers.

Our ARPU increased circa 1% quarter-on-quarter on a constant currency basis, with continued product mix shift to our archiving and compliance products. Our operating cash flow was solid in Q1 with circa 400,000 positive cash flow generated, which has been normalized with the fluctuation in timing of cash receipts, which were strong in the quarter. And our payments to suppliers, which has seasonally increased on account of annual subscriptions, insurances and staff performance bonus payments.

Dropsuite has achieved consistent and material paid user growth year-on-year with a 22% increase PCP. We have increased our MST network by adding greater than 1,200 transacting MSP partners over the last 12 months, which we see as the leading indicator to future seat growth. We ended the quarter with 1.24 million paid users, where we added 73,000 new paid users in the March quarter. We noted as we pushed on just before, an increase in revenue churn to the sub 5%. Historically, we've been up 3%, and this was primarily due to pricing competition, especially in the EMEA region where we are -- with the company is introducing the necessary measures to address and mitigate that churn going forward.

Our key takeaways for our key metrics remain as consistent growth across each quarter on ARR, on ARPU, a user growth along with solid cash receipts growth with tracked to our ARR growth. And with OpEx to revenue ratio in Q1, in line with our reinvestment strategies that we executed in Q1 of last year.

We continue to scale OpEx across all functions with a focus on R&D and go-to-market whilst managing profitability and cash flow to 2023 levels.

Q1 delivered robust positive operating cash flow generation of circa $400,000 for the quarter. Cash receipts were strong in Q1, whilst noting, we've also normalized and cash receipts due to timing fluctuations from customers. There was also some positive impact on AUD cash receipts with the AUD-USD rate depreciating quarter-on-quarter with the majority of our tax receipts collected in USD.

Payments to suppliers increased 3% in Q1 factoring in seasonal annual payments that we mentioned earlier. Pleasingly, our cloud hosting costs have reduced in dollar terms against prior quarter with the benefit of higher gross margins. We will see fluctuations within each quarter for cash flow, but we manage on an annual basis rather than on a quarterly basis on that.

Dropsuite continues to reinvest into scaling the business for future profitable growth supported by the continued cash flow generation and profitability, and we remain well capitalized to invest per our 2024 capital allocation and growth framework.

[Charif Elansari, executive]

Thank you, Bill, for the overview. As you can see here, our focus is to continue investing in the business, specifically on technology, R&D on one side and also on go-to-market. We want to continue investing and to invest in scaling our platform for millions of users, continue enhancing the value proposition for our partners through continuous improvement of our products and services, and also introducing new capabilities and also new products, which we did announce earlier that we intend to launch one product in the second half of 2024.

We still have some work to be done to strengthen our go-to-market initiatives. Geo expansion comes to mind to markets like APAC, Germany, Canada, to name top geos that we -- because they were important and are completely underpenetrated.

We continue enhancing our tech support. This is the partner-facing support through a slew of continuous improvements, including self-service health center, which helps us become more efficient. And of course, we've been using quite a bit of AI to reduce the burden on the team, but more importantly, solve the MSP programs as quickly as humanly possible.

On the other hand, we're also enhancing our service by introducing weekend support and eventually 24/7 support for our partners. And of course, we have invested in -- invested in partner success, and that would play an important role in improving our partners' lifetime value and the longevity of the revenue and the seats that MSPs have with Dropsuite.

The bottom line here is that we will focus our investment on areas that will deliver a more scalable, a stronger and a larger company.

Going on to the next slide. We are doing this in an orderly manner, right? We are have -- we have developed and we have a very well-defined framework where we allocate capital based on quadrants around existing partners, existing products, which, again, we continue to see out of white space there, introducing new capabilities for new markets like, for example, government cloud in the United States, which started to see more and more traction in Q1, and we continue to be bullish on that. And of course, introducing new products, both organically and inorganically as the time pass by organic means to introduce new products built by our team. Inorganic, means M&A.

And finally, and in closing, before we open it up for Q&A. We continue wanting to affirm our optimism about our future, about our growth prospects, about the fact that we have a market-leading position, specifically when it comes to Microsoft 365 backup and archiving. And of course, while building a strong team and a strong culture.

With that, over to you, Adrian, so we can start the Q&A session.

[Operator]

[Operator Instructions] So we've got a number that have come in. So not surprisingly, was such a big group on the call. Let me start with the first one, and it's either yourself and perhaps Bill can follow on as well. So on ARR, specifically. So with Q1 now out of the way, could you frame how we should think about growth over the rest of the year?

[Charif Elansari, executive]

Yes. Yes. Thank you for asking the question this way because we don't give specific outlooks to the market, but we do give some high-level indication.

So if you look at our ARR growth, the incremental quarter-on-quarter ARR growth that we see. And this is a big measure of how we measure success internally in the company, and I encourage shareholders and investors to look at it the same way.

We average about $1.45 million of quarterly incremental ARR in 2023, right? The average -- the first quarter in Q1, we don't have an average in Q1 in 2024. The first quarter in 2024, this ARR -- net ARR growth quarter-on-quarter was $1.6 million, right? So obviously, as we continue investing in the business, our expectation is that we continue improving that number on a year-on-year basis. And that's how I would frame the ARR growth expectations and intentions going forward.

[Operator]

Next one. This could be one for you, Bill. Can you please quantify the amount of seasonal costs? I think you may have mentioned this already, but the amount of seasonal costs that were in the quarter.

[Bill Kyriacou, executive]

Yes. We did note, Adrian, that cash costs included annual subscriptions, annual insurances and annual performance, staff performance, bonus payout. We don't give the specifics around that. But if you look at the trend for the last Q1 in the last few years, you can see that there was a specific increase around both key areas for each of those quarters.

[Operator]

Next one, one probably for you, Charif. So seat adds for Q1 FY '24 were below my expectations. And you mentioned momentum through the year. Can you please talk through your thoughts on seat add momentum by quarter through the year?

[Charif Elansari, executive]

Yes. I would say that my commentary would be very similar to what I just covered when it comes to annualized recurring revenue. At the end of the day, any recurring revenue is the name of the game, right? And the recurring revenue is simply average revenue per user times, number of users times 12, and that's how you get to ARR.

Our position is that we have high expectations of what we and the team can deliver, right? And our expectation is that -- and we're holding ourselves accountable to delivering better growth in dollar terms versus 2023.

[Operator]

There's a couple of questions on churn. So let me kind try to group them. So you mentioned churn was higher in the first quarter due to pricing. But can you elaborate on some more on what strategies you might put in place to combat the churn?

[Charif Elansari, executive]

Yes. One big takeaway from the churn that we saw is that the majority of it is coming from partners who are buying our products and services through wholesalers or distributors. And then for folks who are familiar with our business model, we either sell directly to the managed service provider or we sell to the MSP, the MSPs provider via a wholesaler or a distributor, right? And what we saw is when we don't do enough touches or we don't work with these MSP partners, we see higher churn.

So one thing that we're doing is that we're extending the responsibility of our product success team to not only dealing with direct partners, but also dealing with indirect partners so they can be completely apprised of our product enhancements, feature enhancement with partner served, with improving support, health center, 24/7 week and support et cetera, et cetera to bolster the value proposition.

And that's what we've started doing in Q1. We expect to continue doing it in the subsequent quarter. Again, the key takeaway is that the majority of this churn happened through these indirect partners. And remember, we are a team of small to moderate size, and we have now about 4,500 partners.

So ensuring we have the right number of partner success managers and representatives to do that is that what we've been doing, which is reinvesting in the business, to ensure that we can cover and support all these users. When I say support, I don't mean just technical support. I mean support for growth for churn reduction and for additional seats and also upsell to our higher end SKUs like our [indiscernible].

That is the most important thing that we are -- we have set to do, and we continue to improve on -- we will continue to improve on this regard. At the same time, I mean, I don't want to give a specific outlook on churn. And I can tell you what we're doing, what's within our control, so we can address the churn, while keeping in mind that churn is still below -- annual churn is still below 5%, which is how you do expect it.

[Operator]

Good answer. So you've made reference to MSPs. So just -- and some of this has already been in your answer, but you might want to expand a bit further. So you've added a large number of MSPs over the last year. So what is your approach to making these partners larger in value? And what is the strategy to make these partnerships and drive the business?

[Charif Elansari, executive]

Yes. The answer is twofold. One is what we just covered, which is really strengthening partner success and partner support across the board, right, from education to training to touching base and communicating about our product enhancements to having more and more coordinated check-ins with all our partners or as much as possible all partners. That is going to be important.

The other one that really has a scale this, so we can go from 4,000, 5,000 MSPs to 10,000 MSPs is what we call automating the customer journey, which is how do you have touch points throughout the lifetime of the customer or the MSP, right? From the day they get onboarded, all the way to when they add the first 100 seats and then the next 500 seats and the next 1,000 seats.

And then as they evolve from a customer journey standpoint, we have a nuance way of communicating and reaching to these partners at scale. So we need to do the automated piece, and we need to do also the high touch piece, depending, of course, on the value of the MSP and the lifetime value of the MSP.

This lifetime journey, which will automate quite a bit in terms of how we do things is expected to be launched in Q3, which will also be of help and support and add value to the overall experience when working with Dropsuite.

[Operator]

Next question is probably for you, Bill. So DSC exited FY '23 with a record gross margin of 70%. How should we think about the balance of the year post this first quarter?

[Bill Kyriacou, executive]

Yes. Thanks, Adrian. So we did exit in December of last year at 70%. For the full year 2023, we're at high 80s -- high 68%, apologies. And we do expect the growth in percentage for 2024 on an annual basis to be in line with 2023 margins. As we say that, we continue to work on these avenues to improve our gross margin in the mid- to long term as well.

[Operator]

Next question, probably still with you, Bill. So you've previously stated an expectation to maintain cash flow and profitability in line with FY '23. Can you talk about how you see operating costs for the balance of the year post this first quarter?

[Bill Kyriacou, executive]

Yes. Like you mentioned, the intention that we have is for our profitability and our cash flow to remain positive, and within dollar terms in line with 2023. We do still see a need to continue to invest in the business itself, core products, new products, new markets that we have there.

As for our road map, we will continue to invest for the rest of 2024 on that basis and on the basis of our capital allocation framework that we've got set up.

[Operator]

Couple of questions for you on EMEA. So can you provide more color on the type of competitors competing on price, featural functions in EMEA? SaaS companies or large ERP software companies?

[Charif Elansari, executive]

Yes. First of all, I mean, we've seen -- and I think we mentioned a couple of months ago that we saw some softness in EMEA overall. We see the impact between what's happening in Russia-Ukraine and in the Middle East as well as having economical softness in EMEA, and that's affecting the overall market. We did mention that a couple of months ago.

The competition we saw is coming from the largest -- the larger players, the players that have a combination of backup, security and other solutions. And then because of the weakness of the economy and the weakness of demand, we're seeing MSPs occasionally, of course, not all the time, as you see the churn is still within respectable percentages, deciding to go for the cheapest solution or the cheapest offer because of that economic pressure that they are facing.

Now as I said, we need to do a better job in presenting the value and interacting directly with MSPs that are -- that have a "indirect relationship". Indirect relationship means that they go through distributors imports and meaning that we don't build them on a monthly basis. We have one total bill from the wholesaler that covers all the MSPs under [indiscernible].

Now that we continue having a premium positioning in the market. And we continue to sell a 25%, 30% higher than the competition. And we intend to keep it this way because what we offer in terms of capability features and utility for the MSP and end the client continues to be in the SME space specifically, continues to be unparalleled.

[Operator]

Next question, there's a couple on M&A, and there was one particular sarcastic one, which the questioner kind of admitted to. But I think probably it's a broad kind of conversation on M&A. So can you please elaborate on progress on M&A? General activity on your side with respect to strategic work stream?

[Charif Elansari, executive]

Yes, absolutely. And I do appreciate the sarcasm and as I told you earlier, Adrian, I'm happy to take any questions. So the M&A is something that we continue working on. At the same time, you have to keep in mind a couple of things. We are not desperate to do M&A. We still have a lot of good things happening on the organic business.

So we're being picky and choosy, and we're looking for high conviction M&As. And as a case in point, I just don't want to stay genetic. I'm going to give a couple of examples. We did shift through many companies in the March quarter. And I can highlight two examples of where we went further than just sifting through and having earlier conversations.

We had two companies that we looked at very seriously and multiple conversations. We call it [indiscernible]. One was a security company that really fits really well with our offering around Office 365 backup archiving. But the valuation expectation mismatch was so huge that we decided to walk away, okay? So you're talking about smaller ARR and very, very high expected valuation.

The other one is as a company in the backup space where while the valuation was a bit more predictable. Once we dug deep into two, three conversations with the CTO and the team, we realized that the product caveat are quite shallow and the skillset and the team they have, specifically on the engineering and product side was also quite weak. So we passed and decided to move on.

The other thing I want everybody on the call to know is there are oscillations in the market. So today, private company valuations is richer than public company valuations. A few years back, it was the other way around. And that is one of our headwinds today is that there is a mismatch between expectations of public companies like ourselves versus companies who are in the data protection space, and private who are being funded by VCs or other investors at higher valuation.

Eventually, with all the good and hard work the team is doing, something will pan out. But it has to be logical across multiple dimensions. Logical, in terms of the fit and the quality of the product and the team and the go-to-market and the ARR and has to be logical from a valuation stand.

So we're going to stand our ground. We're going to continue being logical and guarded on how we do M&A because it has to be high conviction. The organic business is good and M&A is a disruptive type of activity. We have to integrate the products. We have to integrate the team to better be high competition.

[Operator]

Very, very clear. Next question. Is there any time line on a shift to private cloud?

[Charif Elansari, executive]

Yes. We -- I mean the name of the game is to continue finding ways to maintain and over the mid and long term, improve our gross margins. Without giving any time frame, we believe that the answer is not cloud-only, not on-premise only, the future is hybrid.

So we already have some of our customers already are on an on-premise solution in Europe and Germany. We also continue to use predominantly Amazon services, Google Cloud to a much lesser extent so far. And then this is the position that we're going to have. We're going to have a hybrid type of arrangement with the name of the game being sustaining and improving gross margins over the mid and long term.

[Operator]

Quite a cheeky question to ask, but I'll ask it anyway. So why not aim to demonstrate at least some profit growth in order to ensure the company is building its reputation as a profitable company?

[Charif Elansari, executive]

Yes. I want to remind the attendees that Dropsuite was profitable before profitable was in fashion. We are profitable in the end of 2021 when everything is SaaS company, almost without exception, was burning a lot of cash. So I would ask the shareholders and the investors to keep that in mind, like we have been, I think, really good custodians of shareholder money, and we've been very careful of how we make our investments. And we see the opportunity cost of holding back on the investing while we have a lot of tailwinds behind our backs, will do us and our shareholders the disservice in the medium and long term.

So for example, adding a little bit of profitability just to make a point, which we can do any time, any day when we decide to is not going to be for the best interest of our company and our shareholders in the medium and long term. Hence, our decision to stick to being in an acceptable range that will demonstrate profitability but doesn't show that we need to grow it now while knowing full well that when you look at larger companies, SaaS companies, software companies selling to the MSP space, and the attendees can look at companies like Enable, which is on the New York Stock Exchange or Datto, which was on the New York Stock Exchange before it was acquired, you can look at very healthy EBITDA margins of north of 20% at scale.

[Operator]

But to answer, you got two thumbs up. So well done. So final question for the session, and we can wrap up now. So how are your new products such as archive and QuickBooks going in gaining market share?

[Charif Elansari, executive]

Yes. So archiving has been around for a while, and I'm pleased to say that archiving, which -- so let me expand a little bit. So backup is a product like insurance policy, right? So when you lose data, you can use backup to recover your data and that's what the backup is.

Archiving and compliance is a product that not only helps you protect your data and get a wider loss, but it also helps you in case you have a lawsuit or you have a problem with one of your employees and you need a lawyer or a compliance officer to investigate and sift through a lot of data and e-mails and files to determine what happened in the past.

Dropsuite's unique proposition is that we combine these two products into one, and that has continued to resonate. And I'm pleased to say that archiving product, which combines back up and archiving now far exceeds from a revenue standpoint that of backup only. And that's one of the reasons why you see ARPU growing over time.

So that's going well. It's been there for a while, and we're very happy with where we are, and we see more areas for improvement and more product introductions or future introductions for a good, better, best type of strategy.

Now our newer products are, I would say, Google Workspace is still new-ish, not new but new-ish. And that is tracking really well and growing at a faster pace than our core business. So we're satisfied, and we still see more areas to grow the Google Workspace business.

The second one that we launched was QuickBook Online backup, which is accounting software backup where we did fall on our stores in January and say, unfortunately, the owner of that company called Intuit, which is one of the big SaaS companies listed on NASDAQ, they decided to walk away from the MSP market after they announced that MSP market is going to be one of the five big bets.

We still have a few hundreds -- we have, and we've seen some growth of hundreds of licenses on QuickBooks, but not material enough to expect anything major to come from that. It's profitable. It's growing, but the numbers will not be material for us in the medium quarter. But we're going to keep the product and there are some -- several MSPs, we're extremely happy and continue to add licenses as we speak.

Then lastly, GovCloud, Government Cloud. GovCloud is a product that's built in the United States can only be managed in the United States that caters to the U.S. government and all its agencies and the state and local government. That is starting to see some traction. We're not going to split the products by revenue for each one, but I can tell you that we've seen a very strong, albeit from a small base, a strong uptick in demand and in ARR in Q1, and we expect this to continue throughout the year.

These are the products that we have. We did mention that we expect a new product to be launched in the second half of 2024 as well.

[Operator]

Thank you, Charif, for the exhaust of the group. So let me hand back to you now for any closing remarks.

[Charif Elansari, executive]

Well, thank you, Adrian, and I want to thank everyone here joining us, our shareholders, our employees. I think we still have a lot of things to accomplish in the foreseeable future. And I do look forward to updating you in the coming quarters. Thank you, everyone.