Backblaze Q3 2024 Earnings Call Transcript

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Provided by Quartr
November 7, 2024

There are 8 speakers on the call.

Operator

Good day, and welcome to the Backblaze Third Quarter 20 24 Earnings Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Ms.

Operator

Mimi Kong, Head of Investor Relations. Please go ahead, ma'am.

Speaker 1

Thank you. Good afternoon, and welcome to Backblaze's Q3 2024 Earnings Call. On the call with me today are Glenn Budman, Co Founder, CEO and Chairperson of the Board and Mark Swedan, Chief Financial Officer. Today, Backlaze will discuss the financial results that were distributed earlier this afternoon. Statements on this call include forward looking statements about our future financial results, the impact of our go to market transformation and cost saving initiatives, use of our IPO proceeds, results from new features, the impact of price changes, partnerships and sales and marketing initiatives, our ability to compete effectively and manage our growth and our strategy to acquire new customers and retain and expand our business with existing customers.

Speaker 1

These statements are subject to risks and uncertainties that could cause actual results to differ materially, including those described in our risk factors that are included in our quarterly report on Form 10 Q and our other financial filings. You should not rely on our forward looking statements as predictions of future events. All forward looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them except as required by law. Our discussion today will include non GAAP financial measures. These non GAAP measures should be considered in addition to and not as a substitute for our GAAP results.

Speaker 1

Reconciliation of GAAP to non GAAP results may be found in our earnings release, which was furnished with our Form 8 ks filed today with the SEC. You can also find a slide presentation related to our comments in the webcast, which will also be posted to our Investor Relations page after the call. Please also see our press release or presentation for definitions of additional metrics such as NRR, gross customer retention rate and adjusted free cash flows. Thank you for joining us. I would now like to turn the call over to Gleb.

Speaker 2

Thank you, Mimi, and welcome everyone to the call. We had strong third quarter results. Revenue grew 29% with B2 Cloud Storage growing 39% and adjusted EBITDA margin came in at 12%, our record since going public. Over the past few quarters, I've shared product innovations that we have delivered and I feel very good about the unique value proposition we provide and the product roadmap we have in place. But today, I want to focus on 2 new major initiatives.

Speaker 2

The first to drive revenue growth, particularly around B2 Cloud Storage and the second to drive cost efficiencies. In our prior call, I introduced 2 new executives that we brought on, Jason Wakim as Chief Revenue Officer and Mark Swedehan as Chief Financial Officer. They joined us with a clear mandate, grow revenue faster and accelerate our path to being free cash flow positive. I'll share details about the new go to market transformation that Jason is spearheading and Mark will speak about aggressively tightening our cost structure. On the go to market front, Jason has hit the ground running and has brought a new sense of energy to the team.

Speaker 2

He's focused on 3 critical areas to drive greater growth, upskilling, partnerships and sales plays. 1st, upskilling. We identified that the team lacked a structured approach to qualify leads and execute larger deals. In response, Jason set up a repeatable process that gave the team clear objectives and focus. While still early, we've seen an immediate impact.

Speaker 2

The team booked a record amount of annual contract value wins in over a year. We also signed 2 multi year deals, each totaling approximately $1,000,000 and built a record pipeline, including the most 7 figure opportunities in our history. 2nd, partnerships. We previously did a good job signing up resellers, but we realized that we spread ourselves too thin across unproductive partners. Jason prioritized the resellers with the most value and we are focusing on those relationships.

Speaker 2

As a result, pipeline opportunities coming from our reseller partners have more than doubled quarter over quarter. 3rd, sales plays. Jason, along with our marketing team are aligning on a core set of sales plays to streamline the activities and drive repeatability. The go to market transformation includes restructuring our marketing team. We appointed a new internal leader and are focusing the team on driving more large opportunities into the pipeline, while returning to our roots of driving efficient brand awareness via our content and community flywheel.

Speaker 2

The combination of the changes we're making are focused on driving higher sales productivity, which enables us to deliver more rapid yet efficient growth. We're moving fast in transforming our go to market approach. We expect this transformation to be substantially completed by the end of Q1 with revenue growth accelerating out of Q2. I'll plan to share more of our progress and new initiatives in our next earnings call. In addition to driving revenue growth, we are aggressively driving efficiency with Mark leading a robust expense management process to maximize ROI and improve our operating leverage.

Speaker 2

As a result, we have accelerated our path to profitability and intend to be free cash flow positive in Q4 of 2025. Through a combination of this focus on accelerating revenue growth and driving free cash flow, we aim to become a Rule of 40 company over time. Now turning to business highlights. First, we've announced the opening of a new data center region for Canada, which complements our existing regions in the U. S.

Speaker 2

And Europe. This is an exciting next step in Backblaze's growth story as it opens Backblaze services to customers wanting to keep their data in Canada and to serve Canadian customers' data sovereignty requirements. We expect this new data region will be live and available for customers in Q1. In concert with the opening of this data region, I'm excited to announce that we have joined forces with Opti9, the largest Veeam managed service provider in Canada. Opti9 helps customers with managed cloud services that include security, backup and disaster recovery and Backwoods will support the cloud storage needs for those use cases.

Speaker 2

Another highlight I want to mention is around AI. At the end of the quarter, the amount of data stored with us by AI customers has more than doubled year over year. 3 AI customers recently migrated to BackWise and are paying us a total annual revenue run rate of over $500,000 These customers came to Backblaze because we provide a cost effective solution to store their data and simultaneously allow them to use that data with any specialized GPU cloud they wish. We believe we're providing the best underlying platform for the Gen AI industry. 1 of these large AI customers said, and I quote, Backblaze is an amazing solution for AI training data.

Speaker 2

We looked at a number of options and Backblaze is seriously the best. In closing, I'm incredibly excited for our future. The changes underway are driving us to better capture the $55,000,000,000 cloud storage opportunity in front of us. Now, I will turn it over to Mark Sweden, our new CFO.

Speaker 3

Mark? Thank you, Gleb, and good afternoon, everybody. It's hard to believe that it's been 3 months since I joined. But as Gleb noted, we've been pretty busy planning the future. When I first joined, I had 3 major hypotheses about Backblaze.

Speaker 3

1st, Backblaze offered an incredible product with a unique competitive advantage priced at 80% below the traditional cloud service providers. 2nd, a go to market model that needed reinvigoration. And 3rd, a cost structure that can be right sized to increase operating leverage. So 3 months into the job, I would say that my original hypothesis still stand and have been further reaffirmed. As Glenn noted, Jason has been leading a transformational change in our go to market activities supported by a product that customers love.

Speaker 3

On the cost structure side, we did kick off a comprehensive zero based budgeting exercise. Most companies expect to have automatic year over year increases from inflation, vendor price increases and salary raises. Despite those expected cost increases, I'm happy to announce that our year over year run rate costs are expected to go down by over $8,000,000 This is coming from a variety of actions including a 12% reduction in force that took place this month, an aggressive process of putting all our external spend out to bid and stopping activities that do not align with our future strategy. This allows us to invest some of those savings into revenue generating sales capacity, which would offset some of the above savings. Let me now turn to the results of the quarter.

Speaker 3

Q3 revenue was $32,600,000 representing 29% year over year growth and in line with the midpoint of our guidance. B2 cloud storage revenue was $16,200,000 reflecting a 39% increase over the same period last year. P2 growth was strong, but lower than we would have liked and this was primarily due to churn happening early in the quarter and large deals closing later in the quarter. Computer backup revenue totaled $16,400,000 reflecting 20% growth exceeding our expectations due to better than expected retention. Net revenue retention or NRR for the total company was 118% compared to 108% last year.

Speaker 3

The year over year improvement mainly benefited from the price increase that we put in place in Q4 2023. The total gross customer retention was 90% in the quarter compared to 91% in the prior year. The high NRR and customer retention demonstrates the strategic importance of our product offerings to our customers. Continuing on to the income statement. Adjusted gross margin was 78%, maintaining the all time high seen in the last quarter.

Speaker 3

This is a meaningful increase from the 74% in the same period last year as we continue to build scale. Adjusted EBITDA continues to improve at $3,700,000 or 12% of revenue driven by revenue growth and cost management. This is a very meaningful improvement from minus 3% in the prior year representing a 1500 basis points increase. As a broader picture of our P and L and our operating leverage, our variable costs are about 25% of revenue. This includes key components tied to scaling such as hardware spend, data center operating costs and other smaller variable costs.

Speaker 3

So as our revenue increases about 75% should be flowing to the bottom line. This represents great operating leverage. Turning to the balance sheet. Cash investments and restricted cash totaled $25,600,000 at the end of the quarter. I'll take this opportunity to reiterate that we are on track to end the year with at least $20,000,000 Our cash flow from operations for the past 9 months are $10,300,000 a dramatic improvement from cash use of $10,600,000 for the same period last year.

Speaker 3

This represents a $20,900,000 improvement over the prior year. As for free cash flows, we are starting to disclose our adjusted free cash flows in our earnings release and we define it as our operating cash flows less purchases of PP and E, capitalized software costs, principal payments on capital financing leases and non recurring charges. We are disclosing and emphasizing our adjusted free cash flows because we are laser focused on being a growth company that is free cash flow positive. Our adjusted free cash flows year to date were negative $16,000,000 compared to negative $38,000,000 in the same period last year, showing a dramatic improvement of $22,000,000 As it relates to cash, we have sufficient liquidity to run the business as we transition to be free cash flow positive. However, of course, we'll always look at opportunities to improve our capital structure.

Speaker 3

Moving to our guidance. We expect Q4 total revenue to be within the range of $33,500,000 to $33,900,000 As a reminder, we lap our price increase in Q4, which helped drive the revenue increases of the past year. For the full year, total revenue is on track to be $127,000,000 to $128,000,000 We expect Q4 adjusted EBITDA margin to be in the range of 12% to 14%, which excludes the one time restructuring costs. For the full year, we expect adjusted EBITDA margin to be 9% to 11%. While we'll provide full 2025 guidance in Q1 as usual, I'd like to share some thoughts about 2025.

Speaker 3

We plan to exit Q4 of 2025 with an adjusted EBITDA margin of approximately 20%, which is about double where we plan to finish this year. And in Q4 of 2025, we expect to be adjusted free cash flow positive. From thereon, we expect the operating leverage will kick in to help us grow free cash flows in a healthy way given our low variable cost. Our long term objective is to be a rule of 40 company based on revenue growth and adjusted free cash flow margin. In summary, we're excited about the path ahead and the momentum that is already in place.

Speaker 3

And with that, let's take your questions. Operator?

Operator

Thank you. We will now begin the question and answer session. And the first question will come from Jeff Van Rhee with Craig Hallum Capital Group. Please go ahead.

Speaker 4

Great. Thanks for taking my questions. A couple for me guys. First, Glenn, on the B2 side, talk for a second about the you said some churn late in the quarter. Just expand on that because you had pretty good you had some expansion in the net retention number from 114 to 118.

Speaker 4

So it sounds like you thought it was going to be even better, but just talk a bit about that. And then secondarily, you're getting some big deals here in on the B2 side and clearly moving up market in terms of realizing how far up market you can stretch. Maybe just talk about how far up market B2 goes? Who do you see as the ideal addressable market for that product capability?

Speaker 2

Hey, Jeff. Thanks for the questions. Appreciate it. On the churn side, the churn that we saw what happened early in the quarter, we expected it, but it happened earlier in the quarter. So the we still had like you said, we still had very strong NRR and we had a strong gross customer retention.

Speaker 2

It's just a handful of customers that churned out earlier than later in the quarter. In terms of the upmarket side of things, we don't really see a specific limit to how far it can go. We've got multiple exabytes worth of storage under management already that's large enough to handle any workload. We've signed those couple roughly $1,000,000 multiyear deals that we talked about. So those are quite significant size opportunities.

Speaker 2

We think we have the opportunity to go above and beyond that as well. We do want to build repeatability into more of that go to market motion. So but if you think about the path where we came from in 2021 when we went public, the average customer was paying us $124 So moving up to 115 customers paying us over $50,000 that we announced last quarter and these two customers paying us about $1,000,000 each is quite the trajectory already.

Speaker 4

Yes, yes, for sure. And maybe just last for me, you commented obviously you're making some substantial changes in the go to market while managing for free cash flow. An interesting comment coming out of Q2 2025, you're looking for accelerated revenue growth. Just talk about, just to be clear, are we talking overall revenue growth or are you just speaking specifically there to be 2?

Speaker 3

Hey, Jeff, this is Mark Soultin. Great to be on. I know it's my first earnings call, so hi to you and everybody on. Jeff, what I would say is, in the short term, I mean, obviously, as we lapse the price increase, RB2 year over year revenue for the full year will probably mid to high 30s. I think what's important here is where we're headed to and as Gleb made in his comment is once we come out of Q2 of next year is when the leading indicators would start translating to the lagging indicators, right?

Speaker 3

Leading indicators now, obviously, we entered Q4 with record sales pipeline, close these 7 figure type of deals and got more of those. So we're very excited about the momentum, but these are leading indicators that then will translate into revenue.

Speaker 4

Okay. I'll leave it there. Thank you.

Speaker 2

Thanks, Jeff.

Operator

Your next question will come from Ittai Kidron with Oppenheimer and Company. Please go ahead.

Speaker 5

Hey, guys. A lot to unpack here. Maybe just Mark following on your answer here. I mean, look, Gleb was very clear on 2Q acceleration. And if you're lapping the price increases on the computer backup, it will have to be B2 to accelerate, no, just pure math?

Speaker 3

Yes. Listen, that's fair, right Ittai. I mean that's B2 is definitely the long term growth play for us and we continue to see that happening. I mean, it's a market that grows at about 19%. We're already growing above market.

Speaker 3

But to be honest, it's not good enough for us, right? We got to be growing at a faster rate. And I'm talking about post price increase coming out of that phase, right, because that's not a permanent benefit. So coming out of price increase, we want to see that B2 number year over year be a lot healthier, be higher. I think that go to market transformation we said is it takes about 3 quarters to do.

Speaker 3

We're a quarter into it. And that's why Gleb said coming out of Q1, you'll see the benefit in kind of Q2 in the second half of next year. We have all the right indicators coming into it. In fact, we're lacking so much the early indicators of our sales efficiency that part of our savings of the $8,000,000 we're injecting it into more sales capacity to further accelerate that growth.

Speaker 5

Got it. With regards to the 12% workforce reduction, can you be a little bit more specific in what areas you were cutting?

Speaker 3

So it's a comprehensive zero based budgeting exercise. Headcount payroll is our biggest cost, but we have other cost drivers too. So we went and we just took a fresh look at everything. So I would say in general, it's kind of across the board, so that we could create capacity of where we want to invest, which would be sales capacity. One area where we probably did more than others is our marketing.

Speaker 3

We found our marketing over index on payroll and as we are seeing our sales velocity increase, we need to feed it more demand generation. So we want to shift frankly from headcount to demand generation budget there. So that's where you're seeing a big part of that 12%. But I'd say it's pretty much across the board because we took a fresh look at everything. And as you can imagine, some things you could be locked into for a while will take longer to realize, but the 12% is effective immediately.

Speaker 5

I appreciate that. And then it's great to see the positive free cash flow target for the Q4 of 2025, but can you give us a rough estimate and what would you think your exit cash balance would be at that point?

Speaker 3

Well, you're asking me for numbers we haven't given. What I'll tell you is this much. I mean, we would aim to not have any change in cash, meaning Q1 and Q2 will likely continue a bit of negative free cash flows. And then at some point, getting to Q4 will be free cash flow positive. But when you add other things like option exercises and other sources of cash, chances are there wouldn't be much change next year in cash balance.

Speaker 3

But then we come out of it in a free cash flow positive way. So when we're headed into 2026, you're talking about higher hopefully higher revenue growth for V2, right? And then operating leverage where $0.75 of every extra dollar coming then would flow to the bottom line.

Speaker 2

Right. Okay. And then

Operator

I'll let you

Speaker 2

And then one thing I'll say is and for the for behalf too, one of the things that I've been excited about with having Mark join on board is he's taking a very thorough look across our spend broadly. So the 0 based budgeting approach, I mean, putting all the existing vendors out to bid and negotiating on the contracts on the subscriptions, etcetera. So it's a pretty comprehensive process and I think it's going to drive good efficiency for us going forward.

Speaker 5

Got it. And then I guess, Gillette for you then on the sales evolution that Jason is implementing. All the points that you mentioned on how he's changing things make a lot of sense. I guess my question is more of time to productivity, number 1. And second, when you look at the talent that you have, clearly, I'm sure in the workforce reduction, perhaps there are some changes over there as well.

Speaker 5

But do you believe that the talent that you have can adjust appropriately adjust to the changes that Jason is implementing or you'll need to continue to kind of weave in and weave out as you go in order to kind of get this right. I mean, all the steps are seem very logical. I'm just to call already that you think in 2Q there will be acceleration, meaning giving yourself 6 to 9 months to see that transformation, it's kind of get tight, I guess. So help me get my hands around your confidence level here and what else we'll need to change there?

Speaker 2

Yes. So Jason has been on for a few months now, right? So we've seen the steps that he's taken. And I guess the reason that I have a good level of confidence and I think we have just internal enthusiasm is the early indicators of that engagement. So Jason brought on a VP of Sales and Head of Partnerships that we announced recently.

Speaker 2

They've hit the ground running. The team that he has, he's evaluated who's on his team and has made some changes on that front, but also been excited about many of the people that he has on there. So I think he's got a good team. We're planning to invest, like Mark said, in some additional capacity for the sales team based on your those good early indicators. And just the fact that we even with the short time he's been on and even with the short time he's had to make changes, we've already seen both the early indicators of success things like pipeline growth, but also actual early successes like the Closed Won deals.

Speaker 2

So that gives me some confidence that he and we together are going to be able to achieve some good results.

Speaker 5

Got it. Appreciate it. Thanks, guys.

Operator

Our next question will come from Eric Martinuzzi with Lake Street Capital Markets. Please go ahead.

Speaker 6

Yes. I wanted to ask about the gross margin. We had a good quarter here with the 78% gross margin. Given the investment in the new data center in Canada, should we be looking for that gross margin to maybe take a step down in Q4? Or what are we thinking about for gross margin trajectory given the investment?

Speaker 3

Hi, Eric. I don't see that much impact to the gross margin in those expansion because they're co locations and then we lease out the hardware. So it kind of blends in over a few years as we wrap it up. So I would say the adjusted gross margin going from 74% to 78% benefited well from the price increase, which is a permanent shift. So I don't see that changing in any meaningful way in the short term.

Speaker 6

Okay. And then back to the top line, you talked about pipeline, Bill. Are we changing those large deals, obviously, is where we're trying to get increased build. Is the build that you're seeing reflective of changes that have taken place, since Jason came aboard? Or is this kind of these deals were in the hopper prior to his arrival?

Speaker 2

Yes. Eric, one of the things that actually Jason did when he came in was he scrubbed the pipeline that we had and instituted some more rigorous controls around what qualifies this pipeline. So I actually would say that the quality of the pipeline in addition to the size of the pipeline, the size of the pipeline has increased, but I think the quality of the pipeline that is in that has actually increased because he's put more rigor around that.

Speaker 6

Got it. Thanks for taking my questions.

Operator

The next question will come from Zach Cummins with B. Riley Securities. Please go ahead.

Speaker 7

Hi, this is Ethan Wiedell calling in for Zach Cummins. Thanks for taking my questions. To start with the Optanine partnership, can you maybe elaborate a little bit on how that might facilitate your move up market or allow some SAM expansion for the new data region?

Speaker 2

Sure. So Opti9 is the largest Veeam MSP in Canada and they have customers globally. So they service they're an MSP, they service customers with a variety of IT needs including backup and security and disaster recovery. And they use Veeam and other products to provide those services. The back end of those products need storage, right?

Speaker 2

So when you're using a product for backup or product for disaster recovery, a product for ransomware protection, you need those products need data somewhere. And they're going to be using us for the data storage for their customers going forward. And so it's an opportunity that one is not specifically about upmarket movement, although they have customers medium and large customers as well. But that is more about a regional and partnership focused expansion with them.

Speaker 7

Got it. Makes sense. Thank you. And it sounds like you have some good early traction with your expanded sales team. Are you still looking to build out your sales team at this juncture, balancing out your cost efficiency initiatives?

Speaker 3

Yeah, Jason, this is Mark. Like I said, we have $8,000,000 over $8,000,000 of year over year savings in our fixed costs. We will reinvest some of that to expand sales capacity. The good thing about our sales team now is whatever is said in there in terms of channel management, account management, the kind of stuff I'd say that should be revenue generating, but it's not as much as let's say sales rep. The reinvestment is all going into sales rep expansion and that kind of skill set.

Speaker 3

So really yes, so it's really about as Jason is pretty much well on the way of fixing up the productivity of that team, now adding it to it along those models is what we're doing. Got it. Thank you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Mr. Gleb Budman for any closing remarks. Please go ahead, sir.

Speaker 2

Thank you everybody for the questions. I also want to take a moment to say that while we believe that the reduction in force was the right decision to align our spending with where Backwoods is going in the future, it was a difficult decision as we care about all of our employees. I want to thank our whole team for all the work and the dedication to both our customers and to our company. And I'm excited to have the opportunity to work together in our next chapter. Thank you everybody for joining the call and we'll talk to you next time.

Speaker 2

Bye bye.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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