Dropsuite Ltd

ASX:DSE

Earnings Call Transcript 2022-Q2

[Craig Sainsbury]

Good afternoon, everybody, and welcome to Dropsuite's 2Q 2022 quarterly results update. Today, we have Charif El Ansari; Bill Kyriacou; and Manoj K, who are going to be presenting the presentation.

Just a little bit of housekeeping. At the end, there will be a question-and-answer session. [Operator Instructions]

So with that, Charif, I'll hand over to you.

[Charif Elansari, executive]

Thank you, Craig. Thank you, everyone, for joining our Q2 update. I'm extremely pleased to be reporting some record results across top line as well as the bottom line as well as the cash flow generation.

We continue to play a mission critical role in cybersecurity for companies large and small. We continue leading with our products, and we continue growing globally across more than 100 countries. We continue building a very solid team across multiple locations, and we continue to grow our recurring revenue at a very, very healthy pace.

I'm not going to spend so much time on challenges and opportunities. I think the audience totally understands the opportunity coming from the ever-growing growth of cybersecurity concerns and risks and challenges, the growing regulation and also the continuous movement from on-premise environments into the cloud, which is mostly demonstrated by the growth in very, very high growth of SaaS services across multiple applications from CRM to e-mail to communications productivity to accounting software, et cetera. And then we see a continuous lack of complete security and cybersecurity hygiene by not backing up many of these applications.

I'm going to spend another minute on the opportunity here by describing the type of partner that we work with, they are called managed service providers. Those are the companies that mostly SMBs outsource their IT requirements and services to, those MSPs drive about $200 billion of IT spend every year. Those number in about 152,000 worldwide. Keep in mind, though, that they are mostly in OECD countries, which is where we tend to focus. Those MSPs are growing at a very healthy pace, double-digit between 11% to 20%.

And interestingly, the #1 source of growth for those MSPs is the going up the value chain and offering the services to enterprises -- specifically with enterprises between 500 to 5,000 seats per company. And as no surprise here, the #1 tailwind is offering cyber defense, software, selling bundles of services that contain backup as well as many different variations of cybersecurity software in a bundle that is sold to SMBs and increasingly to the enterprise.

And this is both really well for us, given our business model that we've talked about before, we continue growing our partner base. Now keep in mind, when we talk about our numbers here, we're talking about the partners that we signed directly, but there are hundreds and now we're in the thousands of smaller MSPs that are buying Dropsuite through our IT distribution partners, think of them as wholesalers. And this culminates in us exceeding 800,000 paid users for the June quarter.

And just a quick reminder, this model allows us to really be investing and continue investing in product innovation, R&D while we do better scaling across sales, support and marketing and give us some meaningful operational leverage.

We continue driving the advantage and the growth here by being really focusing on the partner experience, right, by integrating our software into their workflows into their ERPs, which makes provisioning of the software, the billing, the supporting extremely seamless and not so time consuming, which is very important for our partners, specifically the MSPs that I mentioned earlier.

We combine that with an exceptional user experience. And this meant that we are still the #1 Office 365 backup provider by software reviews for the third year in a row. And this also mean that we continue delivering very strong results, strong momentum across the business. Keep in mind that all the PCP or year-on-year and quarter-on-quarter numbers are on constant currency to be very conservative on how we present our numbers.

So our annual recurring revenue is now at $20 million, a very nice milestone. Our gross margins, as we have committed, continue picking up, and we'll have -- my colleague, Manoj, covering it a little bit more in terms of what we're doing.

Users is growing, as I mentioned, and we have reached the 800,000 mark. ARPU continues to grow, thanks to the continuous growth of the higher end SKUs that we have specifically around Office 365 and Google Workspace Backup plus archiving. And the churn, the revenue churn continues to be at world-class at sub-3%.

For those of you who saw the AGM presentation, we also talked about how strong our net revenue retention is, which is more -- or greater than 125%, which is absolutely world class. Combined revenue churn sub-3% with net revenue retention above 125%, and you have a very solid story for continuous growth across our partners.

I will pass this to Bill now, who's going to cover the cash flow for the quarter.

[Bill Kyriacou, executive]

Thank you, Charif. We are pleased to report a return to positive cash flow quarter in June with normalized operating cash of $400,000, increasing 266% on the prior quarter's cash burn.

Cash receipts increased 17% quarter-on-quarter and 81% on the prior corresponding period on a normalized basis with strong collections in the quarter, assisted by the AUD depreciating against the USD in June quarter, which positively affected our AUD cash receipts with the majority of receipts collected in USD. Our DSO KPI was steady against prior quarter.

Cash payments in line -- cash payments by line item on the 4C include payments for storage costs, which grew 14% on prior quarter and 112% on the prior corresponding period. Our focus remains on gross margin improvement initiatives as a priority.

Payments to start in the quarter were flat compared to prior quarter, with the March quarter inflated by annual staff bonus payments made. Payments for admin and corporate costs declined 63% on the prior quarter. We began the March quarter inflated by annual one-off payments, including insurance renewals and subscriptions. Payments on marketing increased 24% on the prior quarter with increases relating to conferences and online initiatives.

The June quarter was our largest positive cash flow quarter, and we expect this to continue in future quarters. Normalized operating cash flow for the first half of 2022 was circa $160,000 positive, and we reaffirm our outlook for positive operating cash flow for 2022.

[Manoj Kalyanaraman, executive]

Thank you, Bill. Hope I'm audible to everybody. My name is Manoj, and I joined as the CTO of Dropsuite in February this year. Prior to that, I essentially was working as a leader of a product and engineering team managing a SaaS product in the Microsoft data management space. I am very happy to speak with you all on the occasion of our quarter 2 results.

Next slide, please. What I want to do today is essentially walk you through the various technology initiatives and technology key focus areas, in order for us to be able to drive the continued growth in business at a pace faster than the market.

So first off, we continue to focus on hiring and growing our team. In this, we essentially are focused on organizing our team around key priorities. And to ensure that our retention continues to be high, we're investing in training and development. This, we believe, will build the right engineering team for our future growth.

We continue our focus on innovation both in terms of product features and technology. On the technology aspect, we are focused on things like data pipeline, automation of workflows and to invest more in our technology stack. These investments will pay off by allowing us to deliver more product features and new products to the market at a very fast pace.

We are custodians of data, of large volumes of data. We want to continue to derive insights from this both internally and for our customers. This will allow us essentially to derive right insights of how our cutomers used the product and prioritize the right features for our customers.

Lastly, scaling the cloud. This business that is born in the cloud, and we continue to scale our business in the cloud. I want to share more about this initiative in the next slide.

[Charif Elansari, executive]

Manoj, if you don't mind, you can continue using this slide to explain how you are scaling the cloud. Thank you.

[Manoj Kalyanaraman, executive]

Scaling the cloud essentially is the ability to use multiple cloud technologies and bring them together to operate more effectively on the cloud.

What we are exploring is the use of multi-cloud. Multi-cloud essentially is our ability to bring both public and private cloud services like Amazon and combine them to pick the right offering for our -- to pick the right service for our offering. This will allow us to bring in best of the -- best-of-breed services for our use.

Next is, our focus continues on compression, storage and security of data. We are essentially starting to store our data in different storage tiers in Amazon, and this has led to a reduction in the storage cost on the cloud, which is allowing us to improve our gross margins, contributing to the increase in gross margins.

We are a company that want to focus a lot more on the road map. And so we are opting to bring more enterprise-grade third-party out-of-the-box products. This will allow us essentially to accelerate our road map and also manage our own infrastructure more effectively.

So we don't have to build every piece of software that actually can be bought out of the box. These initiatives, I think, will help us continue to grow our business and also allow us to drive profitable growth overall.

I'll hand this back to Charif. And I look forward to handling any questions that you may have at the end. Thank you.

[Charif Elansari, executive]

Thank you, Manoj. As you have seen, when you heard Bill talk and Manoj talk about how we're looking into the business, how the kind of results we are delivering, the kind of profit and cash that we are generating. We are really well positioned to have an investment flywheel where we're growing top line, we are ensuring that we're scaling really well from a gross margin standpoint, we are making investments along the way by generating this profit and then investing prudently for future growth. This is something that we've covered in multiple quarterly presentations before.

The significant tailwinds that we have, our product leadership, that growth in the partner network. And again, we still have a massive headroom to go forward, the underserved [indiscernible] market in the SMB space mostly, but even in the mid-enterprise. And the fact that we're building an amazing team across multiple locations makes me really optimistic and makes us believe that this is absolutely the right investment framework for us as a company.

So if you look -- if you think about it, we have 3 main pillars of our growth strategy. One is continue growing our existing business, which as I just mentioned, still has a long way to go. So maintaining and sustaining our product leadership, introducing new features and capabilities, expanding our partner base. I mean I mentioned earlier that there are 130,000 MSPs globally. We barely have 2% in terms of share. So plenty of room to grow just with our existing organic business.

And then we continue growing our sales footprint. In our most recent announcement, we onboarded a phenomenal sales leader to have the channel for us in Australia and New Zealand, which makes me really excited about growing in our home base in Australia.

The second pillar is organically introducing new products, and this is something that we have committed to. We've committed to delivering a new data protection product by the end of calendar 2022. And the rationale for introducing new products is that, as we mentioned earlier, there's a crazy amount of data moving into SaaS software products and solutions, and those also need protection.

We're picking products for better protection that resonate with our existing channel partners, and we also look forward to increasing our users, our revenue per user and our gross margin by introducing new products.

And then thirdly, we continue exploring accretive acquisitions that are of high conviction. And here, the concept here is not to acquire companies to just buy their users, basically doing the same thing that we do.

We are more interested in broadening the scope of our data protection solutions and then cross-selling to the existing channel, we are making sure that we're taking our time on accretive acquisitions because we want to make sure we have the right company to acquire, and we want to make sure we don't be focused on the first 2 pillars if we acquire their own company.

Hence, we're taking our time to choose the right high conviction acquisition. What we're looking to do is to continue leading the pack in terms of the quality of our products and then to continue growing at a much faster rate than the market. The backup and the global cloud backup and recovery market is growing between 20% to 24% per year, and we hope to be growing at a much faster pace than the market in the foreseeable future.

With this, I want to quickly reaffirm our strong outlook for 2022 and beyond. We continue to be aided by strong tailwinds. We continue to be leading with our products. We continue building a phenomenal team, and we continue to expect to have profitability and cash flow generation while growing ARR and the top line overall at a very healthy pace.

With this, I conclude the presentation, and we'll be all happy to receive any of your questions and answer them on this call. Thank you.

[Craig Sainsbury]

Thank you, Charif. [Operator Instructions].

First one for Charif is on churn. Positive to see that the churn is below 3%. Can you just provide a little bit more detail, please, on what that means? Is that quarterly churn, 12-month rolling average annual churn? A little bit more detail on that, please.

[Charif Elansari, executive]

Yes. My apologies, this is written in the fine print at the bottom of the slide. When we talk about churn in this presentation and typically in all our announcement, we're looking at the partners' revenue churn year-on-year. So what we compare, for example, June 2021 revenue versus June '22 revenue, and that's how we calculate the churn.

We believe that looking at the MSP churn is the right way of doing this. Same thing with net revenue retention because the MSP partner that we covered earlier is our customer. So it is the right measure for us as a company.

[Craig Sainsbury]

Right. Thank you. Next question is around acquisitions. You mentioned looking at accretive acquisitions. Interested in your thoughts between using the cash balance that you've got, but also given that there's been a large degree of devaluation in terms of the value, a lot of tech companies that are out there and Dropsuite share prices has held up remarkably well. What's the balance between scrip versus cash in your acquisition, thoughts?

[Charif Elansari, executive]

We still believe that no matter how the market behaves, you can look at the total value of an acquisition and say, "okay, the valuation has to drop in light with what's happening to overall valuations in the industry."

We are still big believers that scrip and earn-outs should be a critical component of any acquisition.

Given the size of our company, when we acquire a smaller company, it will still be a significant addition to our staff. It will be still a significance to our ARR. So ensuring that we are sort of fighting in the same tranches for at least 2 to 3 years is absolutely fundamental. So we continue to think of earn-outs and script as a critical component of any future acquisition deal.

[Craig Sainsbury]

Thank you. Next question is, ARR is over 20 million, over 800,000 customers. Are you finding the Dropsuite brand is becoming more recognized globally with your customer base, and are you finding it easier to establish a presence in some of those new markets?

[Charif Elansari, executive]

Absolutely, it is happening every day. Our brand is getting better recognized. And keep in mind, when we talk about brand recognition, we're talking about dealing with our MSP community, just to be clear. We're not talking about end clients.

I was at a partner event yesterday in the U.K. and I mean the feedback that I personally heard from partners was, I would say, really humbling about how much they like working for us, how much they -- the most common thing that they say is it just works. It makes us look good with our end clients, and I've heard it repeatedly yesterday so many times.

And this kind of feedback is absolutely critical in the type of channel that we service, which is the MSP channel. Keep in mind that the MSP stand to service a certain region or even like a very specific small part of a region, let's say, a small part of London as opposed to overall metropolis. What this means is that MSPs don't tend to compete aggressively against each other.

So word-of-mouth collaboration comparing notes is absolutely typical in the industry. And hearing this feedback repeatedly yesterday plus, of course, you've got the software reviews, plus you see all kind of good feedback we hear on Reddit, on Facebook and also directly like I did yesterday from our partners, makes me strongly believe that our brand and recognition is growing by the day.

[Craig Sainsbury]

Right. And a follow-up question from that. Are there any insights or comments that you can share on how your competitors are in the market and what you're seeing from that competitive landscape at the moment?

[Charif Elansari, executive]

Yes, we've seen, like we mentioned, I think, in the previous webinar about an acquisition that happened in the industry, the [indiscernible] rock the MSP industry, that was an acquisition by our largest competitor, it's called Datto. They were publicly listed on the New York Stock Exchange. They were acquired by a private equity-backed company and went back to private.

And that is sending a bit of tremors in the MSP community. They're worried about cost cutting, worried about reduced support. They're also worried about increasing prices from that competitor. So we're seeing actually MSPs seriously considering, and I would say some of them are flocking away from this -- from Datto because of that acquisition by a private equity backed company called Kaseya. So this bodes well for a company like Dropsuite.

Aside from that change, we don't see any further changes in the competitive landscape. We continue to see a much bigger win ratio on our side. That has not changed even though, and I've mentioned this earlier, we do tend to charge a premium of about 25% versus our largest competitor, which is Datto.

[Craig Sainsbury]

Thanks, Charif. Another question, I guess, on the competitive landscape that's come in. It says Azure and AWS have reported slower sales growth through the past quarter as businesses have been reopening. Is Dropsuite seeing any slowing in its sales pipeline?

[Charif Elansari, executive]

We have not seen any slow down so far. We also haven't seen any meaningful slowdown even in the worst days of COVID in the last couple of years, right? Now at the same time, we are at, I would say, unprecedented times in terms of inflation, recession.

Now keep in mind that backup and cybersecurity overall is becoming a table stakes item for businesses. And it's almost becoming an existential question to have the right security posture.

So while we are moving into uncharted territory in terms of the macroeconomics, I strongly believe that we are in a good position given the tailwinds that we discussed earlier about cybersecurity, the threat of losing your data and possibly losing your business, plus the regulation that we continue to hear more about across multiple countries around the world.

[Craig Sainsbury]

Next question is on product gross margin, being performing well and picking up over the past couple of quarters at 64% now. Where do you think you can see that going to?

[Charif Elansari, executive]

Yes. We are -- even though we're not giving a specific number, the great work that Manoj and team have been doing makes me optimistic about continuous growth of gross margin in the coming few quarters.

Like Manoj mentioned, we are rationalizing some of the type of storage services we're using with Amazon. We are also improving our search capabilities at a lower cost. We are also taking a multi-cloud approach, which also Manoj mentioned.

With all these initiatives, some of them are being implemented, some of them will be implemented, we continue to be bullish about our gross margin in the coming few quarters.

[Craig Sainsbury]

And that might just segue into a question for you, Manoj, that's come in. You've talked about that multi-cloud architecture as a way of looking at reducing costs. Can you quantify, loosely, what do you think that multi-cloud program can deliver?

[Manoj Kalyanaraman, executive]

Yes. I think the multi-cloud offers us more services to pick from, not necessarily just cost alone, but also enabling us to choose the right service.

As an example, Google uses something called Bigtable and BigQuery, which actually could help us to data management much efficiently. And there are many such services because we play a lot with Microsoft 365. Azure sometimes offers us very good storage capabilities as well.

So in my slide, I spoke about multi-cloud both from a point of view of enabling product differentiation and then choosing the right service for our product, not being just a signal [indiscernible] a lock-in.

However, all of these initiatives, all of these decisions are driven not only towards investing in the right technology but also to ensure that our gross margin remains healthy. I wouldn't want to go down the path of estimating a number because many other factors contribute to it, but we are committed to maintaining the right cost efficiency as we go into multi-cloud.

[Craig Sainsbury]

Thanks, Manoj. Back to you, Charif. Can you provide a little bit more regional breakdown of where you're seeing the growth in the market, Europe, America. We noticed you've recently hired a sales and channel executive for the Australia and New Zealand market. Just a bit of color on that regional growth, please.

[Charif Elansari, executive]

Yes. Our largest market -- and we probably need to start maybe showing our investors the regional breakdown in subsequent presentations. Our largest market is North America.

But for the last few quarters, the largest -- the fastest-growing market for us has been the EU, which has continued to show some tremendous growth. The growth really started with GDPR induction in [ 2018, '19 ] and the growth continued at a very healthy clip. Now albeit from a smaller base, but that's doing really well.

APAC is also showing promise. But when I talk about APAC, I'm mostly thinking about the OECD portion of APAC. So we're focused on Japan. We're focused on Singapore, Hong Kong, and we're focusing on Australia and New Zealand.

We've reached a certain amount of ARR in Australia and New Zealand without having a full-time sales executive there. And we reached a point where like this is absolutely the right time to start investing there, and then we onboarded, I would say, a world-class sales executive to lead the effort there to build the team around him as we grow -- as we further grow there.

[Craig Sainsbury]

[Operator Instructions] Next one for you, Charif. You've mentioned an ambition to grow at 2x the growth of the backup market. Can you provide a little bit more color around some of your broad assumptions underneath that? Are you looking at sort of a number of products, number of partners, number of end users? What would you think for that?

[Charif Elansari, executive]

Yes. That's a great question. I mean the first thing to keep in mind is when we talk about the total industry, the cloud backup market, you're talking about enterprise, you're talking about server cloud backup, you're talking about desktop cloud backup, it's a big market. And then there's a SaaS component to it, which I believe is still at its nascency, right?

So we are focusing on the most, I would say, promising and possibly the fastest-growing portion of the market. So that's on the macro side, right? That's point #1.

Point #2, we did mention that we barely have 2% of the MSP community working with us. right? So you've got some massive upside there, right? That's #2. #3, with new product induction, we expect to add more users, more ARPU and more gross margin.

And lastly, our existing organic business, not just from an MSP standpoint, but from an end user standpoint, continues to have a lot of white space. So a lot of these SMBs are still not in the mindset of backing up their SaaS applications.

So if you combine all those and do some math, growing at approximately 2x the market, plus or minus, is something that we believe is achievable, and we absolutely need to be building the team and expanding our sales and marketing footprint to deliver these targets in the next 2 to 3 years.

[Craig Sainsbury]

And you mentioned ARPU has been growing very strongly over the past sort of 6, 7, 8 quarters. What has been driving that? Is it the number of products per customer that you're selling, if it's that, can you give a bit of an update in terms of roughly how many products per customer?

And are we starting to see any price increases potentially coming through in this inflationary environment that we're seeing at the moment?

[Charif Elansari, executive]

Yes. When you think about our ARPU increase over the last few quarters, it has been driven by a couple of reasons. One, we've been seeing a shift from our -- in mix from the lower cost products like a simple e-mail backup or worksite backup into the higher featured, higher-priced Office 365 and Google Workspace Backup.

Now on top of that, we have introduced some time back an archiving and compliant SKU for Office 365 and Google Workspace that complements backup. So typically, in the industry, some of the regulated, or many of the regulated companies, they have to buy a backup product and then aiding product to comply with the regulator.

In our case, specifically in the SMB space, we are offering an upsell path where you can have backup and archiving under 1 umbrella, under 1 product, and that tends to be priced higher. So these 2 reasons are driving the ARPU upwards.

Now as we introduce new products, and as we plan to increase the users with these new products, we look forward for ARPU to continue to improve, but that's definitely subject to us delivering and executing well on new products that will be most definitely at a higher ARPU than what we have today.

[Craig Sainsbury]

Great. Thank you. And last question coming in, Charif, and I know you're going to be limited on what you can say on this, but it has been asked a few times, so I'll pose it to you. Top line, we've seen them creeping up on the register over the last little while. Have you've been in conversations with them and any idea of what their intentions are?

[Charif Elansari, executive]

Yes. Actually, my most recent conversation was 2 days ago with top line. Top line continues to be extremely supportive, extremely happy with our results. Given the type of company or fund they are, I haven't seen any indications of anything atypical of a typical fund, right? They're accumulating, they like the management, they like the Board, they like the business. They do their homework really, really well. And they see an opportunity of our stock that they feel is -- still has a lot of room to grow, frankly, speaking.

[Craig Sainsbury]

Excellent. Well, Charif, Bill and Manoj, thank you very much for your time. The investors out there, if there's any other follow-up questions, please e-mail to myself or to Charif, and we'll answer that. And Charif, I'll just hand back to you to close.

[Charif Elansari, executive]

Thank you, Craig. I want to thank everyone for attending today. As you saw with the presentation. And with the new faces today, I mean, we're growing the team, we're growing the business. We continue to be really optimistic about the next few years. And I want to thank you for your continued support.