Datto Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
November 9, 2021

There are 5 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Datto Third Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer It is now my pleasure to turn today's call over to Mr.

Operator

Ryan Burkhard, Director of Investor Relations. Please go ahead.

Speaker 1

Thank you, operator. Good afternoon, everyone, and thank you for joining us today to review Datto's Q3 2021 financial results. With me on the call today are Tim Weller, Chief Executive Officer and Jon Abbott, Chief Financial Officer. During this call, we may make statements related to our business and would be considered forward looking statements under federal securities laws, including projections of future operating results for our Q4 and full year ending December 31, 2021. As a result of a number of factors, actual results may differ materially from those projected in such statements.

Speaker 1

These factors are set forth in the earnings release that we issued today under the section captioned Forward Looking Statements, And these and other important risk factors are described more fully in our reports filed with the Securities and Exchange Commission. We encourage all investors to read our SEC filings. The following statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. In addition, Datto undertakes no obligation to publicly update or revise any forward looking statements made here. Additionally, non GAAP financial measures will be discussed on this conference call.

Speaker 1

A reconciliation of these non GAAP financial measures To the most directly comparable GAAP financial measures is available in our Q3 2021 earnings press release, which can be found on our Investor Relations website. The financial supplement and webcast of today's call are also available on our Investor Relations website. I would also like to inform you that we will be participating in 2 for conferences in the coming weeks, including the RBC Capital Markets Global Technology Conference and the Barclays TMT conference. Please reach out to me if you're interested in joining our schedule. With that, I'll turn the call over to our Chief Executive Officer, Tim Weller.

Speaker 1

Tim?

Speaker 2

Thank you, Ryan, and many thanks to everyone for joining us on the call this afternoon. We are excited to report strong Q3 results and to raise guidance again for 2021. I'll begin with a few highlights from the quarter, followed by an update on 2 significant product launches that we made In security and cloud, we solidify our leading position in providing cybersecurity solutions for our MSP partners. And finally, I'll turn the call over to John to discuss our financial results and guidance in more detail. The 3rd quarter was another record quarter for Datto.

Speaker 2

Subscription revenue growth was 20% year over year, reflecting another quarter of sequential acceleration. Our growth continues to be paced in percentage terms by Datto SaaS Protection and Datto RMM, both of which also have strong new security add ons. Our business continuity and disaster recovery product, BCDR for short, continues to reaccelerate With another sequential increase in new ARR, overall, all major products and geographies saw healthy growth. We ended the quarter with $627,000,000 of ARR, up almost $29,000,000 from Q2, And we added 400 net new MSPs in the quarter, bringing the total number of MSP partners we serve to 18,200. ARR per MSP also continued to increase, demonstrating the ongoing strength of our MSP cohorts.

Speaker 2

Overall, I'm delighted with the way our partner facing teams executed in delivering another great quarter. On the product side in Q3, we launched 2 new significant offerings, SaaS Defense as a security add on for our SaaS Protection Continuity product And Datto Continuity for Microsoft Azure, extending our flagship BCDR product into the public cloud, where Azure is far and away the most popular with MSPs. I'll give some additional details on each now. Let me start with SaaS Defense, our newest security product. This product addresses the number one cybersecurity attack vector, which is email and related attachments.

Speaker 2

In fact, MSPs report that 64% of ransomware attacks on their clients originate in Microsoft 365 inboxes. Our SaaS defense solution has its foundations In our acquisition earlier this year of Bitdam, an Israel based company, we have run independent third party testing of our proprietary technology against 5 of the most widely used email security solutions available today And we come out in the top 1 or 2 on effectiveness and had the lowest false positive rate. SAS Defense even finds 0 today threats. Following the acquisition, we worked diligently with our new team members to tailor the product for MSP delivery. According to data from the FBI, phishing has exploded as the number one cybercrime and it is aimed at theft of login and password credentials.

Speaker 2

These stolen credentials are used by other cyber criminals to launch large coordinated ransomware attacks. SaaS Defense It's based on a novel set of intellectual property that independent testing has shown to be best in class against sophisticated phishing and malware The target Microsoft 365 inboxes, OneDrive, SharePoint and Teams. It is a robust yet simple to use Security solution that eliminates the need for additional MSP headcount or in-depth security training. In addition, it is bundled with our SaaS Protection product, creating a strong margin opportunity for our MSP partners In a low friction purchasing motion, the initial response to SaaS Defense has been outstanding as partners recognize the critical need for email security today and love that SaaS Defense is highly effective, easy to use and fits seamlessly with SaaS Protection. SaaS defense is a first line of security defense like AV or firewalls, preventing malware from running.

Speaker 2

In the second line of defense is Datto ransomware detection for RMM, which is now deployed on over 1,400,000 endpoints, up from over 1,000,000 on our last call. Our solution addresses escalated situations where the attacker has actively bypassed the in place antivirus or EDR solution And malware is running on servers or PCs under direct control of the attacker. Without our ransomware detection, each of these events Would likely end in ransomware or worse. So we are incredibly proud of each save over the past year and there have been many. We intend to continue to expand our product offerings on the front lines of defense going forward.

Speaker 2

Now let's talk about the last line of security defense, which is recovery. Our market leading continuity products have been the last line of defense and security for MSPs and their clients since day 1. And the importance of bulletproof flexible recovery is only increasing as cyber attacks become more common. As a leader in continuity, we're now doing about 75,000 restores per month and growing. With our cloud deletion defense, We have also performed over 400 complete saves for partners and their clients on the brink of total data loss These are scenarios where a cyber attacker locks a client's primary servers with ransomware, Then actively erases all backup images, local and cloud, using stolen credentials.

Speaker 2

In each case, The immutable copies in Datto's cloud saved the day and prevented what could have been a business ending event for the end client. That brings me to the newest member of the Datto Continuity family, Datto Continuity for Microsoft Azure. We've brought MSPs and community on the development journey all year. So we were thrilled to officially launch it in September. Much like SaaS Defense, the early response from partners has been incredibly energizing.

Speaker 2

Datto Continuity for Microsoft Azure or DCMA for short is comprehensive business continuity and disaster recovery solution that protects MSPs and their clients' Azure Public Cloud Workloads, providing protection against malicious ransomware attacks, security breaches, Server software problems and cloud outages. We recently announced our strategic partnership with Microsoft, which was key in our development efforts and features a strong co marketing relationship on DCMA. We believe Datto Continuity for Microsoft Azure is the most secure highest performing continuity solution in the Azure ecosystem. On top of all this, DCMA is fully integrated into the Datto platform, so MSPs can manage and protect their clients' Live applications and data in Azure right alongside workloads in private clouds, on virtual machines or on premises, all from a single unified platform. Importantly, our DCMA product restores Azure virtual machine images in the Datto cloud, which allows MSPs to get their clients' environments running quickly, even if Azure itself is experiencing a cloud outage.

Speaker 2

While it's early in the public cloud move for SMBs, worldwide end user spending on public cloud services is forecasted to grow more than 23 This year to greater than $330,000,000,000 according to Gartner. This should prove to be a key growth area For MSPs and Datto for years to come, as MSPs support their clients in the migration to infrastructure as a service or IS. We are now in position with a leading and differentiated solution to help our MSP partners on this journey. Lastly, I will note that applications and data are growing everywhere in the public cloud led by Azure, but also in private clouds, virtual machines and on prem. We're seeing solid continuity growth in all arenas.

Speaker 2

MSPs are also managing and protecting an increasing share of these SMB digital assets as they continue as an industry to eat into the $1,300,000,000,000 of global SMB IT MSPs are even pushing into co managed services partnering with IT departments and enterprise government and EDU clients. Datto's market leading comprehensive portfolio of continuity solutions allows MSPs to protect digital assets wherever they live. So those were the 2 major new product announcements in Q3, but we continue to have releases every quarter and sometimes every month across our product portfolio, Continuity, RMM, SaaS, PSA and networking, with a particular focus on security features in each. Security continues to be at the core of everything we do at Datto. We highlighted this recently for MSP partners at our DattoCon event in early October.

Speaker 2

It was the largest event in our history attracting more than 4,700 virtual attendees from 50 countries. Our primary message to the MSP community was that they are now on the frontline in the global cybersecurity battle. Cybercrime is now a $1,000,000,000,000 annual drag on the global economy and the attackers are increasingly finding SMBs to be attractive targets. As the primary provider of IT services for their clients, MSPs are now squarely in the security business. There are 2 strong implications that follow.

Speaker 2

1st, MSPs will increasingly choose their vendors based on security as the number one Going forward, trust in the security of their vendors will matter more than bells and whistles or costs. 2nd, MSPs have a massive opportunity in providing security solutions to protect their clients and to profit and grow from doing so. For each of these 2, we believe we are strongly positioned to be a partner of Choice with the best technology solutions in the cybersecurity battle. As a vendor, we anticipate a large return on the years long investment We have made and will continue to make an internal security. In fact, we announced at Datocon that we are the only RMM vendor to have passed a stringent security audit called BSIM used by a consortium of leading technology and financial companies.

Speaker 2

We also pointed to a strong development pipeline on security products, which we will bring to market as sell through offerings that MSPs can use to protect their SMB clients while also finding good margin for themselves. My call to action for MSPs at Datocon Was to define their security stack immediately and improve it over time. That will help our partners secure themselves and their clients, both as a trusted advisor and with our innovative products. We will benefit from differentiated reliable products, Our scale and our persistent focus on security at our core. My Datocon keynote address, Including demos with our engineers of some key security and cloud products is posted in the Investor Relations section of our website.

Speaker 2

Datukhan also featured a keynote from our Chief Information Security Officer, MSP interviews and over 100 vendor sponsors, consistent with our open ecosystem approach. Building on the security themes from DattoCon, we will offer investors a deeper look into Datto in a few weeks at our first ever Investor Day on Thursday, December 9. We have an exciting agenda planned that will give you a better understanding of our Products and technology, our unique go to market approach with our MSP channel partners, our financial model and the incredible opportunities we see ahead in securing digital assets. We hope that you can join us. Look for registration information coming soon on our IR website.

Speaker 2

In summary, we are pleased to have delivered another record quarter and 2 significant new product launches that align with the MSP industry shift We see great momentum across our business today and we're excited about our strong product cycle that will contribute to growth in 2022 and beyond. We remain well positioned to capitalize on the large and growing opportunity With our current product portfolio and roadmap and the deep trusted MSP relationships that we have built. Finally, I want to thank everyone on the global Datto team for all of your hard work and our MSP partners for their continued support. With that, I'll turn the call over to John.

Speaker 3

Thank you, Tim, and good afternoon, everyone. We're pleased to report terrific Q3 results today, where we outperformed across the board. As I review our numbers, please note that I'll be referring to non GAAP metrics unless otherwise specified. You can find a reconciliation of non GAAP measures The GAAP measures in the press release that we issued this afternoon and in the supplemental financials posted on our website. Our Q3 results reflect great momentum across our suite of products and continued acceleration of our business.

Speaker 3

3rd quarter recurring subscription revenue of $146,800,000 grew 20% from Q3 last year. Subscription revenue growth is now accelerated every quarter this year. Subscription revenue comprised 93% of our total revenue, which came in at $157,900,000 in the quarter, representing 21% year over year growth, well above the high end of our previous guidance. Our revenue results reflect a benefit from foreign exchange rates of approximately 1.5%. Strong operating results drove the upside to our guidance, with currency providing less of a tailwind than we had forecasted.

Speaker 3

ARR at September 30 was $626,700,000 up 20% From $522,800,000 a year ago and nearly a $29,000,000 increase sequentially. We ended the quarter with more than 18,200 MSP partners, a net increase of 400 in the quarter, And we grew the number of MSPs contributing over $100,000 in ARR to more than 1300, A 24% increase from a year ago. Our sell through model continues to drive strong growth within our installed base of partners As they roll out data solutions to more SMBs, those SMBs consume more data in seats and they both adopt more data products. Our 3rd quarter gross margin of 73% was in line with the strong margin we saw in Q3 2020. 3rd quarter operating expenses were $80,100,000 a 40% increase from Q3 last year, as we continue to invest with a focus on security and cloud to drive revenue growth.

Speaker 3

As a reminder, expenses Reached a low point last year in Q3 when we saw the full quarter impact of the expense reductions we had implemented in response to the COVID crisis. The vast majority of the increase in operating expenses this year was driven by personnel costs. Within OpEx, Sales and marketing expenses were $32,800,000 an increase of $8,600,000 from Q3 2020 as a result of expanded sales staffing levels as well as higher marketing and sales commission expenses. R and D expenses were $21,500,000 an increase of $6,800,000 from Q3 2020, which underscores our continued investment in technology development and security. G and A expenses were $23,600,000 An increase of $8,000,000 over Q3 last year, primarily driven by expenses associated with being a public company And recruiting costs related to increased hiring this year.

Speaker 3

And finally, depreciation expense within operating expenses was $2,100,000 compared to $2,400,000 in Q3 2020. Operating income for the Q2 was $35,800,000 compared to $39,000,000 in Q3 2020. Adjusted EBITDA for the quarter, which excludes stock based compensation, restructuring costs and transaction related and other expenses, was $43,800,000 compared to $45,800,000 in Q3 2020. Our adjusted EBITDA margins were 28%, reflecting continued hiring in the areas of security and cloud, some normalization of travel and return to office And costs associated with being a public company. CapEx in the quarter was $11,700,000 and free cash flow was strong again at $20,300,000 Our balance sheet remains very strong with no debt and approximately $207,000,000 in cash at the end of the quarter.

Speaker 3

Turning to guidance for the Q4 and full year. The increase in our 2021 guidance reflects our positive outlook for the continued acceleration of the business. For the Q4 of 2021, revenue is expected to be in the range of $161,000,000 to $163,000,000 Adjusted EBITDA is expected to be in the range of $38,000,000 to $40,000,000 Our Q4 total revenue guidance represents year over year growth of 16.5 percent at the midpoint, including 0.5 percentage point of FX tailwind. And we expect subscription revenue growth to be 17.5% at the midpoint. For the full year 2021, We're raising our revenue guidance to a range of $615,000,000 to $617,000,000 And we're also raising our adjusted EBITDA guidance to a range of $174,000,000 to $176,000,000 Our full year revenue guidance represents year over year growth of 18.5 percent at the midpoint, including a 2 percentage point FX tailwind.

Speaker 3

This is up meaningfully from our prior guidance for full year growth of 17.5%, which included a 2.5% FX tailwind. We expect subscription revenue to account for over 93% of total revenue in 2021. Capital expenditures for the year are expected to be in the As a reminder, for non GAAP income taxes, we use an effective tax rate of 25%. For calculating EPS, we estimate approximately 168,000,000 fully diluted shares for Q4 and 167,000,000 fully diluted shares for the full year. In closing, we believe our Q3 results and 2021 guidance Reflects the ongoing strength of the business.

Speaker 3

We're very excited about our momentum going into Q4 and look forward to talking more about our business and outlook at our upcoming Investor Day on December 9. With that, we'll open up the call for questions. Operator?

Operator

Your first Question comes from the line of Sanket Singh with Morgan Stanley. Your line is open.

Speaker 4

Thank you for taking the questions. And I guess right off the top, congrats to the team for getting back to 20% AR growth. Yes, we're a 20% grower before the pandemic and to hit that this level is quite the achievement. But sort of leads to my next question, which is Kind of bluntly, do you think you can sort of keep it up at these levels with the sort of major product cycle that you have That's sort of set to be launched. And then with that, Tim, if there wasn't If it was another sort of enterprise company that doesn't have the channel model that you guys have, sometimes security slows down the sales cycle.

Speaker 4

And with this big push into security, I'm just trying to see what the impact on the sales cycle at data would be relative to a traditional sort of company selling to the enterprise.

Speaker 2

Great. Thanks, Sanjit. John is going to take a shot at the numbers, and I'll add something on security.

Speaker 3

Yes. No, we were really happy to see ARR growth continue to accelerate. That certainly has been the plan and See, it hit the 20% mark this quarter was great. Look, we won't draw a line in the sand here today, but you can see a clear trend in the

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Datto Q3 2021
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