Dropsuite Ltd

ASX:DSE

Earnings Call Transcript 2024-Q3

[Craig Sainsbury]

Good morning, everybody, and welcome to Dropsuite's Q3 2024 Investor Presentation. With me today, we have Charif El-Ansari and Bill Kyriacou. Charif and Bill will do a short presentation on hitting the key highlights, and then we'll open up for question and answers. [Operator Instructions] I'll read that question out to both Charif and Bill.

Charif, with that, I will now turn it over to you.

[Charif Elansari, executive]

Thank you, Craig. Thank you, everyone, for joining us today. We had another strong quarter, strong numbers across the board with no exception. We continue to see demand and tailwinds around data protection, cybersecurity, regulation. We continue to bolster a growing and a great reputation in the MSP community, coupled that with strong execution by our team, and we delivered some really strong results.

It's really important to note here that we have several things that we have executed on quite well and something that have continued over the past several years, but it has a compounding effect, namely the fact that we have very solid partner net revenue retention. That means when you onboard partners over time, they continue to grow. And that's happening for a couple of reasons. Reason number one, we are very fortunate to be operating in a large and growing channel, namely the managed service provider channel. And that bodes really well for a company like ourselves.

The second one, which again is not unknown to the audience, is that we continue to onboard new partners. We're growing the partner base. And then as they get onboarded, we then derive a solid net revenue retention with low churn. That combination is really potent when it comes to strong growth and, of course, profitable ARR growth as well.

The third motion is something that we talked about before, but it has really delivered material results for us in the third quarter of this year, namely something that internally and with our partners, we call PartnerServe. PartnerServe is a paid service that we give a completely white glove service, that's paid, to migrate data from competitor solutions into Dropsuite. Now the reason why we like the service is not because of the few dollars that we make per seat when we do the migration. The important thing is that we bring the ARR forward by solving this issue for many prospective partners who want to do business with us, but they're stuck with their vendors. So this is something that, as I said, has contributed in a very strong way in the third quarter.

Last but not least is another thing that we talked about before, something called bring your own storage. Bring your own storage means that we still deliver the same quality software, we still deliver the computational capability behind the software. But when it comes to storing the data, the e-mails, the files, the contacts, et cetera, that's being taken care by a partner and that's also being paid by a partner. What we've been doing is that we've been expanding these relationships, specifically around something called OEM. OEM means that we do very deep integration into another vendor in the space. Maybe they might have other type of data protection capabilities, and then we combine them into a seamless user experience. That has contributed to a certain extent in Q3, but we expect more upside in the coming few quarters on this front.

With that, I mean, the most important thing to note is that we've really delivered another record quarter. And when I talk about record, obviously, we're a SaaS company. So almost every quarter, absent of any very weird events, every quarter is a record. But here, it's very important to talk about the incremental ARR growth is a record and the incremental record seat growth is a record as well.

With that, I'll let my colleague, Bill, our CFO, talk about the results in details. Thank you.

[Bill Kyriacou, executive]

Thanks, Charif, and to our attendees today. In this financial overview, we will present our key business metrics and cash flow for the September quarter. As we've touched on, September quarter metrics that we achieved were very strong during the quarter with continued ARR growth and paid seat growth momentum against prior quarters. For the second consecutive quarter, we have added a record number of paid seats alongside strong partner additions for direct and indirect transacting partners, which has led to constant currency ARR growth of 9% across the quarter and 34% PCP, though with actual AUD growth slightly impacted by the FX fluctuations in the quarter. In U.S. dollar terms, we added record USD 2.3 million of incremental ARR for the quarter. This was up from a very solid Q2 of $1.9 million incremental ARR. And we do prefer to use USD as a metric here as majority of our revenue is derived in USD. It also removes some of the FX fluctuations by quarter.

Our gross margins remain healthy and in line with our expectations and the previous quarters. We do continue our efforts in optimizing the storage tiers and increasing capacity for each quarter as we add new users, and then we're also adding the new data for those users. Our ARPU was up 1% on a constant currency basis on PCP, though it reduced 1% on the prior quarter on a constant currency basis. This is attributed to the combination of seat adds and user product mix with peer displacement seats added on our backup SKU or backup-only SKU and at not-for-profit SKU. Our North Star metric remains to add profitable ARR with healthy margins.

Our churn remained steady at sub 3% for the quarter, and we continue our focus on relationship touch points with direct and indirect partners that are purchasing via our distributor channels. And pleasingly, our operating cash flow generated in the quarter grew to $780,000, which is normalized for any fluctuations that occur for prior receipts and payments to suppliers, though with marketing payments coming back against the higher prior quarter seasonal events, and cloud hosting payments were higher, though in line with our paid user growth and our expectations also.

Our key metrics here show that we have steady growth each quarter, including ARR growth, paid user expansion and cash receipts aligning with that ARR growth. The OpEx to revenue ratio for the quarter remains in line with our capital allocation and a reinvestment strategy. We continue to strategically invest and increase OpEx spend across all departments with continued focus on R&D and the go-to-market initiatives that we have. This strategic growth is balanced by maintaining positive profitability and cash flow for the year.

Our Q3 operating cash flow generated was up 46% on prior quarter and also in line with our expectations. The cash receipts growth was solid this quarter and had similar growth to prior quarter. The volatility in the AUD USD currency pair has had some impact on AU cash receipts with the exchange rate appreciating 2% on prior quarter, impacting the collected receipts from USD. Now these foreign currency fluctuations have been observed throughout the year. Overall, payments to our suppliers moderately increased 2% against prior quarter, and this was primarily driven by higher spending on cloud hosting, upfront payments for new investments in software security with modest growth in employee payments.

The company remains dedicated to reinvesting profits to scale operations for sustainable long-term growth. This approach is reinforced by a consistent generation of cash flow -- positive cash flow. While we focus on annual performance, we acknowledge there's potential fluctuations by quarter, though we maintain robust capital position that enables us to invest in line with our capital allocation and our growth strategy framework.

I'll hand over to Charif to discuss future growth and outlook.

[Charif Elansari, executive]

Thank you, Bill. As you saw, we delivered very, very strong results. And this is in no small part a result of the fact that we continue reinvesting in the business. We -- I mean, the things that we talked about previously, right, ensuring high net revenue retention, adding new partners. Well, guess what? This also requires investments in making sure our products continue to be premium and best-of-breed in the market. We also need to ensure that we continue integrating seamlessly into the workflow of our partners. Of course, that also means that we need to deliver phenomenal sales execution and also support our customers throughout their journey. That is all about investing in our existing products and also in our existing channel. The same thing could be told about PartnerServe. PartnerServe, this migration service, obviously, this required a lot of engineering effort, a lot of technical effort to deliver it. And of course, it has to be coupled with a sales motion to execute this.

We also have been expanding into new markets. We talked about non-for-profit SKU, which we launched, and that's quad 2 on the slide that you look at. This is the same product that we have, but we are now making it appeal to new channels or verticals. It could be GovCloud, which we launched, and now we are doing quite well on that product, and now we also have non-for-profit. These are 2 good examples of what we're talking about here.

Third is we're also introducing new products, right? We talked about Entra ID Backup. Entra ID is basically Microsoft's way to manage identity of users and identity in the age of the cloud is really the most -- one of the most critical ways by which companies got hacked these days. So being able to back up the identity of the user. Identity means: what you have access to, whom you share trials with would be a good example of what we mean by identity is another area of reinvestment for us. When it comes to our views on which one is organic, means we build and reinvest in internally versus inorganic means M&A, we think of delivering on existing products internally. But when it comes to external products or new products, it could either be built organically like in the case of Entra ID or it could be through M&A.

Can you go to the next slide, Bill? Thank you. In closing, we continue to be very fortunate to be operating in an environment with strong structural and macro tailwinds from cybersecurity to regulation, to the move to the cloud, to a very strong channel that we operate in. The managed service provider channel continues to be a fast-growing channel north of 10% per year expected until 2030 and maybe beyond as well. We continue to command a market-leading position in Office 365 Backup. And remember, Office 365 Backup is the biggest SaaS product in the world. Still a lot of white room to grow, continue to growing the team. We continue to pursue accretive M&A opportunities if the price is right. These days, we're seeing a lot of companies, but the price is really not right. I'm happy to cover more on the M&A -- on the Q&A front as well. We continue to expect solid growth, continue to invest in the business, and we continue to guide for positive EBITDA and cash flow for FY '24, which is also a calendar year for us.

With that, I'll pass back to Craig, and I'm happy to answer any of your questions along with Bill. Thank you.

[Craig Sainsbury]

[Operator Instructions] First one is coming. There's a few questions around this one. Charif, this PartnerServe, can you elaborate a little bit more on that, please, in terms of the amount of seats that drove in the quarter and what you think the potential of that is going forward?

[Charif Elansari, executive]

So typically, when we -- on the ASX or on public listed companies, when we talk about material, we're talking about north of 10%. So that's -- I mean, we're not going to elaborate beyond that, but definitely above 10% contribution to the numbers. Let me double-click on this. I think it's important for our attendees to understand it. So let's say we talk to a new partner and they say, we're stuck with vendor A. The data is there. It's very hard to remove the data and extract it out of their systems. We love you guys, but we cannot do business with you because we're stuck. And we heard this repeatedly to the point where the team here at Dropsuite said, why don't we create a migration service? We charge for it. And then we migrate the data white glove solution from that partner into -- from that partner's vendor A, we call vendor A, into Dropsuite. We started this in the end of 2023. Q1 was the beginning, Q2 improved and then Q3 is when we really got the technical breakthrough, to be able to extract data at scale from a select number of vendors. Unfortunately, some of the vendors in this space continue to hold data hostage, completely hostage, right? You cannot even leave them. If you have to leave them, you have to lose the data. That still remains, but there's still several important competitors who make it possible -- difficult but possible to migrate data out of their systems. And that's what the team has cracked in the last few months, and we're able to extract data at scale, hence, the contribution that we saw from PartnerServe in Q3. We expect to continue to see good traction on this PartnerServe motion in the coming few quarters.

[Craig Sainsbury]

There was just a follow-up question on that around PartnerServe. Can you talk through the economics of PartnerServe? Is that something that will be able to sustain the margins that you've been able to see the rest of the business?

[Charif Elansari, executive]

Yes. I mean, keep in mind a couple of things. One is that we are charging for the service. But again, the service revenue is small, and that's not what we're -- that's not the game here for us. The game for us is to bring monthly recurring revenue and annual recurring revenue as early as possible.

In terms of margins, I mean, you saw the margins, the margins are still flat. Now sometimes on these deals, remember, most of the competitors are below our price. And these partners are typically using the cheaper product, which is the backup product, not the backup plus archiving product. So there is a little bit of ARPU headwinds, as you saw in Bill's presentation. But again, the focus for us is all about profitable ARR, and you saw the gross margin actually slightly, slightly improving quarter-on-quarter.

[Craig Sainsbury]

I'll skip ahead to a couple of questions that were around that ARPU and being slightly down quarter-on-quarter, which you've just mentioned. Can you elaborate a little bit more on that? Is that some of the new partners that have come in just using one module only? Just a little bit of those implications on ARPU.

[Charif Elansari, executive]

ARPU is really about the product mix and what we're selling. We introduced something called non-for-profit SKU, which is almost the same product, but it's a lower ARPU. It's part of being part of the community, but also it really does generate more demand, right? And that also contributed, by the way, in the third quarter. So that is slightly ARPU dilutive, right? And you've got partners, there is a higher probability that the partners that we're deploying partners with are going to opt for the cheaper, lower priced and lower feature product, which is backup. That's going to be slightly dilutive as well. The third element, which we might talk about in detail is that when we partner with a company and we're offering -- bring your own storage solution, well, guess what? Dropsuite is not paying for storage. Storage being paid by the partner or the customer. So in that case, obviously, the ARPU is going to be lower. But again, in all these cases, we continue to ensure that we have solid gross margin. Now on the flip side, we continue to see solid growth of the archiving SKU, which is the premium SKU. And as we introduce capabilities like Entra ID, we expect also the combination of Office 365 Backup, let's say, and archiving with Entra ID to actually increase the ARPU on these SKUs. It's a bit of a yin and yang, right? You've got the certain products or flavors that we're going to bring ARPU down. We're going to get some flavors going to bring ARPU up. To be honest with you, it's very difficult to predict exactly where ARPU is going to go because now we're offering more and more products and more and more flavors, and it's very hard to control demand to exactly where we want it to be. As long as we're delivering solid profitable ARR, we are very happy.

[Craig Sainsbury]

That would agree addressed a couple of questions that were there around the BYOS module, but I'll just still pose them. Can you just elaborate a little bit more on BYOS? How you see that going out? And as you mentioned, you're not paying for storage. So it will be a lower ARPU module but potentially have a higher margin than some of your other products. Is that correct?

[Charif Elansari, executive]

Yes. I mean we're not going to talk about margin because it depends on the volumes and it depends on the deals, et cetera. It's just that we see opportunity, and we've seen an opportunity, and I think we've talked about it in previous webinars, where there is a set of partners who really want to control their storage, right? They want to have their own key. They want -- they're focused about privacy, maybe they're focused about cost and they want to use a lower cost storage solution, right? This is typically for larger partners. We're not going to do it for any partner who comes and says, I want to bring your own storage. That's one part of the equation to explain why the ARPU is inherently going to be lower while the margin is going to be fine, right?

The other thing is, in some situations, what we're doing is, we're doing what is typically called an OEM partnership. OEM partnership that -- it means that the partner will take our product, will use our APIs. We always talk about seamless integration as one of our way we differentiate against competition. We have a very, very strong integration capabilities. They will take our product and the APIs. They will integrate it into their product as if it's their own, right? That's called OEM. And then they also point storage to their own storage facilities, not to ours. And these kind of deals are popping up on our radar.

And if you recall for some of the attendees who've been with us for the last many years, we really cut our teeth with these kinds of relationships with -- on the hosting space. Now we're doing the same in different flavors with different vendors as we go forward.

[Craig Sainsbury]

Just working down the product suite, TD SYNNEX, you've mentioned before there's -- you've been working through a few [indiscernible] problems. Can you just update us on how that's progressing, please?

[Charif Elansari, executive]

So on TD SYNNEX, there has been a lot of leadership changes there. And this is public information because TD SYNNEX is a public company. We are working through a lot of change taking place on their end. We continue looking forward to strengthen the numbers. Of course, the numbers are growing, but I think there still remains a lot of potential with this massive distribution partner.

[Craig Sainsbury]

Next one, GovCloud. You mentioned it's looking positive. Can you elaborate a little bit more on what positive would be? And how do you see the outlook for this product going forward?

[Charif Elansari, executive]

Yes. Again, as we continue working with more of the mid-enterprise partners, example would be TD SYNNEX and others, we continue to push forward with more seat growth there on GovCloud. We've been very clear about this. We're working on GovCloud as part of our typical segments, meaning SMB and mid-enterprise. So I don't want the attendees here to think that we're going to expand beyond state and local government and go into the federal government, which is really not our expertise. We're not an enterprise company, and we've been very clear about this. So the focus is going to be still about how do we use our partnerships and work with our partners to continue to grow the GovCloud business in predominantly the state and local part of the American government.

[Craig Sainsbury]

Thank you. As always, there's a few questions around this one. Microsoft Syntex, any update, any visibility that you're seeing on their product rollout?

[Charif Elansari, executive]

No. I mean we continue to see what we've seen before. It is going to be an additional backup product that some enterprise customers are going to have. We don't expect it to be the backup solution for enterprise. Again, remember, the backup in this case, is still residing in the same cloud where the primary data is, in this case, Microsoft 365. So we still have the same position that we had more than 1 year ago on Microsoft Syntex. No change.

[Craig Sainsbury]

Thank you. A few specific questions just on Q3 now. Can you discuss whether the Q3 growth was consistent through the quarter? Or was there some acceleration towards the end of the period in September?

[Charif Elansari, executive]

Yes, we don't usually disclose these things, but I can say that there wasn't anything extraordinary in the last 10 days of the quarter where we had to -- like some companies do, they might like push certain deals to make the numbers look good. No, we didn't do any of that. And that's what the attendees has in mind.

[Craig Sainsbury]

Next question. Q3 grew about 34% and some of the forward indicators are looking pretty strong. Prior indications on ARR had the growth around 30%. Are you expecting a strong finish through the year and good momentum into 2025? And any change in terms of some of your outlooks around [ '25 ]?

[Charif Elansari, executive]

So typically, like, for example, when we -- in January, when we're covering the fourth quarter of 2023, outside of -- we had a churn event with a legacy partner -- outside of that, it was a record quarter. So typically, Q4 tends to be a good quarter, right? But in terms of specifics, we really don't give outlooks on a quarterly basis. And I really also want the attendees to remember that we're really managing the company on an annual basis, and we really don't try to do out of maneuvering on a quarterly basis. So for us, it's really important that we deliver strong, meaningful incremental growth in annual recurring revenue and in paid users on an annual basis because we are reinvesting in the business. We feel we have a great responsibility with our shareholders to deliver that incremental growth because we're being allowed to invest the money back into the business.

[Craig Sainsbury]

Now apologies, having said that, how you look at a year-on-year and another quarter-on-quarter question for you as they come through. Staff costs only increased modestly over the quarter. Are there any plans for hiring into the fourth quarter or next year? Or do you anticipate to potentially start to see a bit of an improvement in that spread of cash flow generations of this more stable cost base?

[Charif Elansari, executive]

So we haven't really finalized our 2025 budget, I mean, and we were still in October, but we have an idea. We have -- back in 2022, we said to expect that 2022 to 2025 are reinvestment years for us. While we don't have firm numbers, we would expect 2025 to be another reinvestment year for us. Now why are we doing this? We're doing this because we have these -- we're very fortunate to have these market tailwinds in the industry, like we talk about cybersecurity and cyber threats, regulation, move to cloud, we have about 5,000-plus MSP partners. The industry has 130,000 or 150,000 MSPs in the markets that we serve. So lots of white space. Lastly, on white space, very important, when we talk even to analysts at Gartner that covers the big enterprise space, they still see a lot of white space in Microsoft 365 Backup. So if Gartner sees that in the enterprise space, you can only imagine how much bigger the white space is in the SMB space and the mid-enterprise. So net-net, we are making all these reinvestments because we -- as shareholders, we sincerely believe this is the right thing for us as shareholders to do at this point of time.

[Craig Sainsbury]

I'll segue that into a few questions that came in around when the company would think about slowing down that investment or when that investment spend starts to slow and when the company will start to look at growing net profit and growing the cash flow? Is there an inflection point that you see within the business? And how do you and the Board think about that?

[Charif Elansari, executive]

Yes. I mean we -- of course, we have these discussions internally. We also don't disclose these things externally at least at this point. I mean the point that I've raised before on these kinds of forums is we're not even at $50 million ARR, okay? We have line of sight. You can see the numbers are inching there or moving there. But again, we're still a very small company. And we strongly believe that focusing on healthy profitable ARR is the right thing to do. Now of course, we continue to look at this in a very objective way, in a critical way, and we have a very strong and independent Board. I mean I'm 1 of the 4 Board members, the other 3 are independent. So we're being held accountable to delivering strong, meaningful growth. Otherwise, we really don't earn the right to reinvest in the business.

[Craig Sainsbury]

I'll take another question on to that that's popped up. Given the growth and the focus from the Board and you on growing, has there been any thought to providing more guidance to the market in terms of 2025, but where you think the growth of the business can get to?

[Charif Elansari, executive]

We don't -- again, given the size of the business, we don't plan to provide detailed guidance. My observation, specifically in companies of our size, once you start giving guidance, you start acting in certain times in a very irrational way to just deliver the numbers and taking shortcuts, creating long-term issues that we really don't need to expose ourselves to at this juncture. By the way, this is very similar to our approach to M&A, right? The minute you start saying, okay, we have this big deal that we are doing the due diligence on and we announced to the market, well, guess what? Deep inside, we're going to feel that the urge to get the deal across the line, even though we might be skimping on some critical issues and concerns from a DD standpoint. So I think at this juncture, given the size of the company, we are -- and you are, as a shareholder, much better served without giving any detailed guidance. The guidance that we've been very clear on is that we have a very strong mandate from our shareholders, the majority of them at least, to deliver healthy profitable ARR growth, healthy means good gross margins and cash flow positive. That's what we're seeking to most likely for 2025 as well.

[Craig Sainsbury]

Very good answer. You did just mention M&A. And as you'd expect, there's a few questions on M&A from the audience. Can you just provide an update on the M&A progress and opportunities...

[Charif Elansari, executive]

Yes. We continue to keep warm several interesting opportunities. The unfortunate thing is in the last 1-plus years, 1.5 years, the private market valuations have been much higher than the public company valuations. And that has been a challenge for us because we also want to make sure that we don't take any actions that will dilute our shareholders or make us have a bad deal where the numbers don't make sense to us as executives and also as shareholders. So what we've done is we continue learning a lot. We continue building trust and relationships with these targets and biding our time -- when the right time comes, we'll definitely execute on a strong acquisition, but we have to be patient to make sure that we're taking care of shareholder value as well.

[Craig Sainsbury]

Thank you. Bill, just to bring you into the Q&A here. Are you able to give a breakdown of the currencies of your cash holdings at the end of -- sorry at the end of the quarter?

[Bill Kyriacou, executive]

Yes. Thanks, Craig. So with our current cash holdings, we have the majority of our cash sitting in AUD. We did raise a $20 million in 2021, and that has yet to be deployed. So the majority of our funds are in there. As the U.S. revenue grows and the seats are added from the U.S., we are seeing a buildup of USD as well as we move forward.

[Craig Sainsbury]

Just a few more questions here, Charif and Bill to move through. We're seeing some of your competitors are locking up data and making it difficult for their customers to leave. Could you see a situation where more competition start locking up data to defend against a model like PartnerServe?

[Charif Elansari, executive]

I mean we cannot rule it out completely. The good news is we're dealing with partners, right? We're not dealing with small and medium businesses who don't know the limitations and the challenges. So the MSPs, obviously, they are IT professionals. They are becoming more gated and more careful of whom they want to entrust and partner with, which I think this really bodes for us. So even in the worst case of, again, companies locking up data, which I don't think is going to happen because it has some serious reputational issues in the industry, in the channel. This also will bode for us in another way, which is like here is Dropsuite, they allow you to leave -- to download the data anytime and leave them anytime, but they still have very low churn, great reputation, et cetera, et cetera. So either way, I think it's good for us to be very honest with you.

[Craig Sainsbury]

And finally, you've mentioned net revenue retention a few times through the presentation. Are you able to elaborate where NRR is sitting at the moment and how you've seen that...

[Charif Elansari, executive]

Yes. We do lodge the number every AGM because there's always some small fluctuations every quarter. But if you look at the AGM presentation, you can see it's north of 120%, very solid. And I'll explain why it's solid. First of all, we talked about the MSP channel continues to be in good health, growing in double digits, right? So the MSPs themselves are growing. But also MSPs when they start working with Dropsuite, they start -- let's say, they have 20 clients, right? They start with 1 or 2 clients. And then over the year and years, they start adding more and more of these additional clients, which really bodes well for us from a net revenue retention standpoint.

[Craig Sainsbury]

Thanks, Charif and Bill. That's the end of the Q&A. Charif, I'll just hand back to you for any final comments.

[Charif Elansari, executive]

Thank you, Craig. Thank you, everyone, for joining. As you saw, we had a very, very solid quarter. We thank you for your continued support, and we look forward to presenting to you again in January. Thank you so much.