Dropsuite Ltd

ASX:DSE

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Craig Sainsbury]

[Audio Gap]

we have CEO Charif Elansari and CFO Bill Kyriacou. [Operator Instructions]

So with Charif, I will hand that over to you.

[Charif Elansari, executive]

Thank you, Craig. And thank you, everyone, for joining us today. We really appreciate it.

We had a strong June quarter, growing ARR by more than 30% year-on-year, with strong user adds well north of 100,000 and as well as high partner adds; with of course, positive cash flows, good gross margins; and churn, very importantly, returning to normal historical levels. We see, as we always say, continuous demand for data protection is evergreen. We continue to see a lot of white space. We continue to see our growing stature and great reputation in the MSP community. Our team's solid execution also helped underpin these strong results.

In this quarter, and I'm going to talk a little bit about various operational areas here that we delivered on in the June quarter, first, we introduced a new product called Entra ID backup. And this is really interesting here, especially with what we hear about people, because of their settings and configurations, are losing data or not being able to access data. So this is a new product that allows MSPs and, of course, their end customers to back up all of these settings and all these identities to make sure that, in case anything happens, the MSP or the end user can restore these settings and configurations so -- to go back into business very quickly. I want you to keep in mind that we expect monetization to happen towards the late of Q4, not earlier than that.

We also introduced a non-for-profit SKU. Again this is the same product packaged for non-for-profit. And because Microsoft sell [ that non-for-profit SKU ], we have very tight control on who is buying this specific SKU. It's off to a very good start. This is also -- I want you to note that this is a slightly lower ARPU as all software companies do when they sell to non-for-profit. I also want you to note that this has been delivered with a partnership with one of our largest distribution partners, Pax8. And this is a 2-way exclusive arrangement for a year, where we are the only non-for-profit backup partner for Pax8, and vice versa. We would only do it for 1 year with Pax8.

Importantly, we also strengthened our seamless integration into the partner's workflows. And we always talk about how we're not competing against backup vendors who are selling [indiscernible] to enterprise, for example. We continue to perfect that integration into our MSPs workflows, into the ERPs. And we did introduce a new integration with HaloPSA, a small but fast-growing and becoming more popular ERP system for our MSP partners. And that is a big [ leap ] for us in terms of our ability to introduce more and more of these integration capabilities. This will save time and efforts for MSPs to manage our product and support their end customers.

Also, we have started to hit our strides with a service we introduced and we did mention at the end of the fourth quarter called [ partner serve. Partner serve ] is a paid server -- service. That means we charge the MSP for migrating their backup data from other vendors, from competition, into Dropsuite. Now the reason why we love this product is because this cuts the sales cycle for our MSP partners who are keen to use Dropsuite but are stuck with another backup vendor. We started to now hit migrations in the thousands of seats. And this is something I continue and we continue to be bullish about in the foreseeable future.

While we continue and remain vigilant on churn, we did see this important metric to return to its historic lows of sub-3% revenue churn, with our sales team and support team increasing their focus and rigor on partner success and partner check-ins. And perhaps most importantly, we delivered a record quarter in terms of user and partner growth in June, in the June quarter.

I will let Bill, our CFO, cover the results in detail.

[Bill Kyriacou, executive]

Thanks, Charif and Craig. And thank you to our attendees today.

In this financial overview, we will present our key business metrics and cash flow for the June quarter.

We exited the June quarter with solid ARR momentum against prior quarters. We added a record number of paid seats in the quarter alongside strong partner acquisition for both direct and indirect transacting partners. This led to constant currency ARR growth of 8% across the quarter and 30% pcp, with AUD growth of 6% on prior quarter negatively impacted by FX movements within that quarter. In U.S. dollar terms, we added a record $1.9 million of incremental ARR for the quarter, which is a step change from the historical average growth of $1.6 million.

Our gross margin was in line with expectations and prior quarters at 69%. We continue with our initiatives to optimize our storage tiers and add capacity each quarter as we add users.

Our ARPU was up 4% on pcp on a constant currency basis that yielded 1% on prior quarter given the combination of seat adds and user-product mix during that quarter. As Charif mentioned, our churn returned to the standard 3% levels in the quarter. And we continue to monitor and build our relationships with both direct and indirect partners who buy through our distributed channels.

Our operating cash flow generated in the quarter grew to AUD 540,000, which has been normalized for fluctuations from prior quarter receipts. And our payments to suppliers were in line with expectations, with cloud hosting payments benefiting from our gross margin initiatives.

On our Positive growth momentum slide. Our takeaways here continue to focus on the key metrics remaining as consistent growth across each quarter on ARR, paid user growth and cash receipts [ attached to ] ARR growth. Our OpEx-to-revenue ratio for the quarter remains in line with our capital allocation and reinvestment strategy. We're strategically increasing OpEx across all departments, prioritizing the investments in R&D and go-to-market initiatives. This strategic growth is balanced by maintaining profitability and cash flow broadly in line with prior year levels on a -- in dollar terms.

Our Q2 operating cash flow generated was up 37% on prior quarter and in line with expectations. Cash receipts were solid in the quarter, whilst noting we have normalized cash receipts due to prior quarter fluctuations. Also, with the volatility of the AU-U.S. currency [ clearing ], there was some impact on AU receipts, with the rate appreciating 2% quarter-on-quarter, which impacts receipts collected in USD. We have seen these fluctuations in FX over the last quarter, so this is a known variance for us.

Supplier payments moderately rose 3% compared to prior quarter, highlighted by spending on cloud hosting; seasonal marketing campaigns; and continued investments in nonproduction IT, such as software, testing and consultants, as part of our reinvestment strategy.

The company remains committed to reinvesting profits into scaling operations for long-term profitable growth. This strategy is supported by a consistent positive cash flow generation. We do focus on annual financial management, acknowledging there might be quarterly fluctuations and maintaining strong capital position, allowing us to invest in accordance with our capital allocation and growth framework.

Thank you, Charif.

[Charif Elansari, executive]

Thank you, Bill.

With the results that you saw with the, I would say, evergreen tailwinds that we see in terms of data protection needs when it comes -- cybersecurity challenges, regulatory challenges we've talked about before, cyber insurance requiring more and more rigor in terms of security portion, including backup, we continue in our reinvestment mode that we've been consistent in -- since the end of 2021, beginning of 2022.

At the same time, we do it in a way that is structured and rigorous. And our capital allocation framework continues to, first and foremost, looking at ways to expand our existing business. We still see a lot of white space in our core business of Office 365 backup and archiving. How do we grow the business? How do you invest in customer success and support? How do you strengthen the integrations, as we gave an example earlier with HaloPSA? These are examples of things we will do in terms of defending and, very importantly, growing the core.

We'll also continue expanding with the same products into new markets. Examples will be Google Workspace, which continues to grow at a very healthy pace. WE -- a good example would be non-for-profit that we talked about earlier today.

We expect and we should expect a more and further increase and also expanding into new products, like the one we talked about today also with Entra ID. And this is again we continue to see strong tailwinds. We continue strengthening our position, our reputation, our stature in the MSP market, which is the market that is really the core and the engine of growth for our business. We continue focusing on building not only a great product but also a great team, so the people element continues to be very important for us.

We continue to be highly selective, looking for high-conviction, accretive M&A opportunities; and of course, continue growing our ARR responsibly and profitably. And as I said before, internal investments will continue to be expected in the next couple of quarters at least, if not more.

With that, I'd be delighted to answer any of your questions for the next 20 minutes or so.

[Craig Sainsbury]

Thanks, Charif. Thanks, Bill. [Operator Instructions]

[Craig Sainsbury]

Charif, a few questions have come in around the net adds quarter-on-quarter with the users. Can you break that down a little bit more? Was that added pretty evenly through the quarter? Was there a bit more momentum coming in at the end of the quarter in terms of an exit rate? And where are you seeing the momentum, so far, through July?

[Charif Elansari, executive]

Yes. The -- we had a very strong quarter. Some of it started in April and it ended in June, so I would say we had a consistent quarter in terms of growth. We won a new MSP business in North America, which is our largest market. We also saw notable wins in Asia Pacific, specifically in Australia and New Zealand, which made me very proud given that we're an ASX-listed company. And of course, EMEA also delivered as well -- but in that order in terms of the impact. We also were pleased to see quick traction on non-for-profit. So that was there was some pent-up demand that was released in the market. And again we're still early days. I want the attendees to keep in mind that there are thousands of MSPs who sell to this big sector, especially in OECD countries. And this goes from any sort of NGO, including business institutions [ here ]. I'm sure the [ F&Ds ] know that, for example, [ churches ] is a massive vertical in the United States, as one example. With that, we also have said that, as we do our and execute on our reinvestment strategy, growth in ARR, specifically quarter-on-quarter ARR, and also in user adds is going to be how we determine whether we're being successful in our reinvestment strategy.

[Craig Sainsbury]

Just a quick one. You did mention NFPs there in terms of part of the potential growth that is coming through. On product discount, is there much of a discount from NFPs? And can you commentate on how much that discount potentially could be?

[Charif Elansari, executive]

Yes. I mean it's not massive. It's profitable. Again this is a bit of an NDA with our partners. Specifically, we mentioned this was an exclusive deal for 12 months but, again, nothing that is nonprofitable, but it's something, I would say, that is very, very common. Google, Microsoft, Salesforce, they all have non-for-profit SKUs. And when we announced this SKU or this offering, I cannot tell you how much appreciation we received from our MSP partners, to the point there was clapping in the room when we announced it in June, a couple of months ago, 1.5 months ago.

[Craig Sainsbury]

Just back on the seat adds. There's been a few follow-up questions just around the sustainability of that seat adds. Obviously it was a record quarter. Are we anticipating similar levels going forward? And some of those drivers that you mentioned around MSP, both direct and indirect adds, is that a bit of a portent of potential seat adds to come?

[Charif Elansari, executive]

Yes, I mean, Craig, as you know, we don't give a specific outlook, but at the same time, we also have had a record new partner adds in the June quarter. We have also been very clear that it's really important that we show incremental ARR growth quarter-on-quarter. And also it's very important to show that, if we grew our users by X in 2023, we absolutely should and will be able to deliver a higher number in 2024. And we're showing that, but allow me not to go into the details on exactly how many seats adds we expect in Q3 and Q4.

[Craig Sainsbury]

Now you said you're not giving any form of guidance going forward, and we know that, but I'll still pose this question...

[Charif Elansari, executive]

Indeed...

[Craig Sainsbury]

Previously we've said that, the second half, we'd anticipate to be stronger than the first half of the year. Second quarter is obviously [ rebased things ]. Are we still expecting a very strong second half? And is sort of the 2Q the new baseline for business?

[Charif Elansari, executive]

Well, I mean, again, we focus on the year. And yes, you're right. Historically we've seen stronger second half than the first half. We cannot guarantee that. All I can say, that we continue to be being focused on delivering strong results, which is as part of our reinvestment strategy, with all the tailwinds that we see in the industry.

[Craig Sainsbury]

Just moving on to ARPU. It was broadly flat period-on-period. Can you just talk a little bit more about the product mix in there that drove that ARPU and where you see that product mix potentially shifting over the remainder of the year?

[Bill Kyriacou, executive]

I can take this one, Craig. We note that the ARPU increased 4% on pcp on constant currency basis. Though, as you highlight, it was flat to a small decline in the quarter. We attribute this to the combination of seat adds and user-product mix, with some of the deployments placed on our backup SKU only and also some growth in the not-for-profit SKU that was recently launched as well. Our growth strategy emphasizes securing new partners and seats and increasing sustainable and profitable ARR rather than that solely maximizing ARPU on that front.

[Charif Elansari, executive]

Maybe I can add also that I think we had mentioned earlier that we're looking into different flavors of our offering, something I mentioned earlier, I think, on more than one call as something called bring your own storage. Bring your own storage means that we sell the backup, the software and the [ completion ] capabilities and the search capabilities, but the cost and the responsibility of storing the data would reside either with the partner or with [ an end client ]. That would be another good example where ARPU might not be as high naturally, because we're not paying for storage, but at the same time, it will be profitable ARPU because we will still be expecting to get good gross margins. So these are the kind of things that we're looking at and possibly will be starting to show in the second half of the year. Our focus will be profitable ARR, as opposed to ARPU, because of these mix fluctuations that we expect.

[Craig Sainsbury]

Next question. I'll just read this one out for you. Receipts grew faster than revenue in the quarter. Guidance for FY '24 expects profitability and cash flow to be roughly in line with FY '23 levels but year-to-date delivering better than that. Are we expecting cost growth into the second half of the year or just a better performance that we've previously been forecasting?

[Bill Kyriacou, executive]

Yes, from our perspective, we're quite comfortable with the way revenue and costs are growing on that. It's part of our reinvestment strategy on that side, so we won't give explicit numbers or guidance on that front, other than to say that we tend to take somewhat of a conservative approach on that side once we get some traction there. Charif, you wanted to add?

[Charif Elansari, executive]

The other thing -- I wanted to add a couple. Another thing here is the reason why we don't get very specific is we want to make sure that we are opportunistic when we see some high-conviction reinvestment areas. We want to jump into them without painting ourselves in a corner. That's the reason why we say that. I mean we could be -- and as we always say, we are in range, as opposed to a specific number that we give for the year.

[Craig Sainsbury]

Just staying on costs. There was an increase in marketing expenses during the quarter, but was this aimed at reducing churn? Or was it caused by new product launches or some other form of increased marketing spend?

[Charif Elansari, executive]

Yes. We -- there was -- it was mostly about our fluctuation in marketing, depending on the trade shows that we invest in; the marketing -- the other marketing activities like lead generations, working with consultants on branding and lead generation, et cetera. In the June quarter, we had the biggest event of the year, which was quite expensive. We were one of the main sponsors of that event; and of course, we flew a delegation, including myself, for the event. And that's what -- one of the reasons why we see the June marketing expenses a bit higher than usual.

[Craig Sainsbury]

All right. [ And then, to that degree ], I ask the next question on costs. Is there any seasonality in that marketing [ expense ]? It does seem so with the conference cycle that you're attending.

[Charif Elansari, executive]

Yes, absolutely. June tends to be on the higher side.

[Craig Sainsbury]

Next question, just around the level of cash flow normalization that we saw for the quarter, please. Bill, if you can elaborate on that.

[Bill Kyriacou, executive]

Yes. Thanks, Craig. So normalization was really the offset from Q1. So in Q1, we did receive some early receipts from partners on that end. And we normalized those out of the Q1 receipts and brought them back into Q2 on that end.

[Craig Sainsbury]

As you'd expect, a few questions have been coming in around that CrowdStrike global outage. What are the positives from that for Dropsuite? Are we anticipating more people to be looking for backup as a result of the impact that potentially could come from software updates?

[Charif Elansari, executive]

Yes, it's really important to note that what happened was a bit of a sad day for the IT industry overall, with massive disruptions to millions of people. It's estimated that 8.5 million devices globally were affected by this, right? This is -- to be clear: This is not Microsoft's fault, all right? This is CrowdStrike issue affecting Microsoft's servers and endpoints but not affecting Mac and Linux. And we operate, by the way, mostly on Linux and Mac, so we were not affected at all. And we use Amazon Web Services, for the most part, so we're really not affected with this, but this has really affected operating systems. This has [ affected ] access to Teams, e-mail, Office 365. It was a painful 3 days here.

Now backup becomes more of top of mind in this case, but again remember that our MSP partners are already working on adding in more and more backup to cover the white space that we have, but it's also a stark reminder about the need of having this independent backup that's completely divorced from where -- your production data that you use every day. We've been very steadfast in this position, I will say, since 2018. And I think, once every few months, we continue to be validated or justified in our positioning there. And again, because we deal with our MSP partners, they know fully well the [ end points ] of this independence.

[Craig Sainsbury]

[Operator Instructions] Next one in -- for you, Charif. Currently there's around 4,500 indirect partners, which is growing at a record rate. Can you please discuss the penetration of users within these indirect [ partners ]?

[Charif Elansari, executive]

Yes. I mean, when we talk about white space, we're not just talking about theory about white space, like -- we think that there is white space. When we look at the amount of Office 365 users that's being sold by these wholesaler distribution partners that we have and then we compare that to the number of users or seats who are backing up their Office 365 -- and this is not only counting Dropsuite, to be clear. It is counting us and the competition there. The white space continues to be very formidable and very interesting for us. And again I want to tie it back to our internal reinvestment strategy. That is a major driver of the reason why we believe in reinvestment. We talked earlier about 80%-plus white space and continue to stand by that number.

[Craig Sainsbury]

Right. Thank you. Charif, that's it for the questions. I'll just hand over to you for any final remarks.

[Charif Elansari, executive]

I want to thank everyone for joining us. I want to thank also Craig and Bill always.

As we said, we continue to be very optimistic about our future. We continue to invest responsibly. And I do look forward to giving you our next update in the next few months. Thank you.