Backblaze, Inc. Q3 FY2024 Earnings Call

Good day, and welcome to the Backblaze Third Quarter 2024 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. Mimi Kong, Head of Investor Relations. Please go ahead, ma'am.

Thank you. Good afternoon, and welcome to Backblaze's third quarter 2024 earnings call. On the call with me today are Gleb Budman, Co-Founder, CEO and Chairperson of the Board; and Marc Suidan, Chief Financial Officer. Today, Backblaze 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. 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. Reconciliation of GAAP to the non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K 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.

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 two new major initiatives. The first is to drive revenue growth, particularly around B2 Cloud Storage, and the second, to drive cost efficiencies. In our prior call, I introduced two new executives that we brought on; Jason Wakeam as Chief Revenue Officer; and Marc Suidan 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 Marc 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. He's focused on three critical areas to drive greater growth: upskilling, partnerships, and sales plays. First, 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 have seen an immediate impact. The team booked a record amount of annual contract value wins in over a year. We also signed two multiyear deals, each totaling approximately $1 million and built a record pipeline, including the most seven-figure opportunities in our history. Second, 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. As a result, pipeline opportunities coming from our reseller partners have more than doubled quarter-over-quarter. Third, 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. The combination of the changes we are 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 Marc leading a robust expense management process to maximize ROI and improve our operating leverage. 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. 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 Backblaze will support the cloud storage needs for those use cases. 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. Three AI customers recently migrated to Backblaze and are paying us a total annual revenue run rate of over $0.5 million. 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 GenAI industry. One of these large AI customers said, and I quote, "Backblaze is an amazing solution for AI training data. 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 billion cloud storage opportunity in front of us. Now, I will turn it over to Marc Suidan, our new CFO. Marc?

Thank you, Gleb, and good afternoon, everybody. It's hard to believe that it's been three months since I joined. But as Gleb noted, we've been pretty busy planning the future. When I first joined, I had three major hypotheses about Backblaze. First, Backblaze offered an incredible product with a unique competitive advantage priced at 80% below the traditional cloud service providers. Second, a go-to-market model that needed reinvigoration. And third, a cost structure that can be rightsized to increase operating leverage. So, three months into the job, I would say that my original hypothesis still stands and has been further reaffirmed. As Gleb noted, Jason has been leading a transformational change in our go-to-market activities, supported by a product that customers love. 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 million. 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. Q3 revenue was $32.6 million, representing 29% year-over-year growth and in line with the midpoint of our guidance. B2 Cloud Storage revenue was $16.2 million, reflecting a 39% increase over the same period last year. B2 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 $16.4 million, 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. 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 demonstrate 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. 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 $3.7 million 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 1,500 basis points increase. As a broader picture of our P&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. 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 $25.6 million 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 million. Our cash flow from operations for the past nine months are $10.3 million, a dramatic improvement from cash use of $10.6 million for the same period last year. This represents a $20.9 million 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&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 million compared to negative $38 million in the same period last year, showing a dramatic improvement of $22 million. 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. Moving to our guidance. We expect Q4 total revenue to be within the range of $33.5 million to $33.9 million. 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 million to $128 million. 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. 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 there on, 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 are excited about the path ahead and the momentum that is already in place. And with that, let's take your questions.

I have a couple of questions. First, Gleb, regarding the B2 side, can you elaborate on the churn you mentioned late in the quarter? You saw some improvement in the net retention rate, increasing from 114% to 118%. It seems like you anticipated an even better result, so I’d like to hear more about that. Secondly, you’re securing significant deals on the B2 side and clearly exploring how far you can advance into the market. Could you discuss how far upmarket B2 can go and who you consider to be the ideal target market for that product capability?

Jeff, thank you for the questions. I appreciate it. Regarding churn, we experienced it early in the quarter, which was something we anticipated, but it came sooner than expected. Despite this, we still achieved strong net revenue retention and impressive gross customer retention. Only a few customers churned earlier in the quarter instead of later. On the upmarket side, we don’t see any specific limits to our potential. We already manage multiple exabytes of storage, allowing us to handle any workload. We've also signed a few multiyear deals worth around $1 million, which represent significant opportunities. We believe there's even more potential for growth beyond that. Our goal is to create repeatability in our go-to-market strategy. To give you some perspective, when we went public in 2021, the average customer paid us $124. Now, we've moved up to 115 customers paying over $50,000, as we announced last quarter, plus these two customers paying about $1 million each, which shows substantial progress.

Yes, for sure. Can you clarify your comment about making substantial changes in the go-to-market approach while focusing on free cash flow? You mentioned looking for accelerated revenue growth coming out of Q2 '25. Are you referring to overall revenue growth or specifically to B2?

Jeff, this is Marc Suidan. 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, obviously, as we lapse the price increase, our B2 year-over-year revenue for the full year will probably be mid- to high-30s. I think what's important here is where we're headed to, and as Gleb pointed out, once we come out of Q2 of next year is when the leading indicators would start translating to the lagging indicators, right? Leading indicators now, obviously, we entered Q4 with record sales pipeline, closed these seven-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.

A lot to unpack here. Maybe just, Marc, 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, just pure math.

Yes, that's fair. B2 is definitely our long-term growth focus, and we continue to see positive trends in that area. The market is growing at about 19%, and we are already exceeding that growth rate. However, we still feel it’s not enough. We need to grow at a faster pace, particularly after the price increase, as that boost isn’t a permanent benefit. After the price increase, we aim for the B2 year-over-year growth to be significantly healthier and higher. The go-to-market transformation we're implementing is expected to take about three quarters, and we are currently one quarter in. That's why Gleb mentioned that the benefits will start to materialize in Q2 and increase in the latter half of next year. We have positive indicators leading into this, and we are so pleased with the early signs of our sales efficiency that we are reallocating part of our $8 million savings into expanding our sales capacity to further accelerate growth. We conducted a comprehensive zero-based budgeting exercise, examining all aspects of our costs. Payroll, which is our largest expense, is a significant factor, but there are other cost drivers as well. We looked at everything from scratch to identify areas where we could create capacity for our desired investments, particularly in sales. One area that received more attention than others was marketing, where we found that payroll spending was disproportionately high. As our sales velocity increases, we need to enhance our demand generation efforts, which means reallocating budget from headcount to demand generation. This shift contributes to the 12% reduction that you see. Overall, this review was widespread, and while some commitments may take longer to adjust, the 12% reduction is effective immediately. You're asking for numbers we haven't provided. What I can say is that we aim to maintain our cash levels, which means Q1 and Q2 will likely see some negative free cash flow. At some point, after getting through Q4, we expect to be free cash flow positive. However, when you factor in other elements like option exercises and additional cash sources, there will likely not be much change in our cash balance for next year. Ultimately, we anticipate coming out of this situation with positive free cash flow. Looking ahead to 2026, we expect to see increased revenue growth for B2 and improved operating leverage, where a significant portion of new revenue will contribute to the bottom line.

One thing I want to emphasize is that I'm excited about having Marc on board as he is conducting a thorough review of our overall spending. The zero-based budgeting approach involves putting all current vendors out to bid and negotiating contracts for subscriptions and other services. This is a comprehensive process, and I believe it will lead to improved efficiency for us in the future.

This is Ethan Widell calling in for Zach Cummins. To start with the Opti9 partnership, can you maybe elaborate a little bit on how that might facilitate your move upmarket or allow some SAM expansion for the new data region?

Opti9 is the largest Veeam managed service provider in Canada, serving customers around the world. They address various IT requirements, including backup, security, and disaster recovery, using Veeam products along with others. These products require data storage, and as they offer backup, disaster recovery, and ransomware protection services, they will rely on us for their customers' data storage needs moving forward. This presents an opportunity that is less about attracting larger clients, although they do have some medium and large customers, and more focused on regional and partnership-driven expansion.

Yes, Ethan, this is Marc. As I mentioned, we have achieved over $8 million in savings year-over-year in our fixed costs. We plan to reinvest a portion of that to enhance our sales capacity. The positive aspect of our sales team is that the elements related to channel management and account management, which should ideally generate revenue, are not performing as strongly as sales representatives. Therefore, our reinvestment will focus primarily on expanding our sales representative team and improving those skill sets. It's really about enhancing the productivity of that team, as Jason has been working on, and integrating these strategies into our approach.

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 Backblaze 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. Bye-bye.

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