Backblaze, Inc. (NASDAQ:BLZE) Q3 2023 Earnings Call Transcript

Backblaze, Inc. (NASDAQ:BLZE) Q3 2023 Earnings Call Transcript November 8, 2023

Backblaze, Inc. misses on earnings expectations. Reported EPS is $-0.44 EPS, expectations were $-0.22.

Operator: Good day and welcome to the Backblaze Third Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mimi Kong, Director of Investor Relations. Please go ahead.

Mimi Kong: Thank you. Good afternoon and welcome to Backblaze’s third quarter fiscal year 2023 earnings call. On the call with me today are Gleb Budman, Co-Founder, CEO and Chairperson of the Board and Frank Patchel, 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, use of our IPO proceeds, results from new features and offerings and 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 risk and uncertainties that could cause actual results to differ materially, including those described in our risk factors that are included in our Annual Report on Form 10-K 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, not as a substitute for our GAAP results. Reconciliation of GAAP to 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 and gross customer retention. Before I turn the call over to Gleb, I’d also like to mention that in the latter portion of our call, as in prior calls, we will be addressing questions from investors that we gathered through the Say Technologies platform. Thank you for joining us and I would now like to turn the call over to Gleb. Gleb?

Gleb Budman: Thank you Mimi, and welcome everyone to the call. We delivered a strong Q3. First, we believe that we’re at an inflection point with higher revenue growth expected in Q4 and 2024. Second, we’ve made great progress on our financial performance, particularly adjusted EBITDA and cash, as Frank will detail later. And third, our team continues to innovate on our storage cloud, delivering a dramatic increase in upload performance and making our B2 cloud storage up to 30% faster than Amazon Web Services storage offering, while continuing to be just one-fifth the price. Before Frank talks about the financials, I’d like to share some observations on the industry’s continued shift toward the open cloud. We hosted our third annual Tech Day a few weeks ago.

Thousands of IT administrators, developers, and other cloud architects attended Tech Day, which we co-presented with Coreweave, Fastly, and Snowflakes. The event demonstrated how B2 Cloud Storage works with other specialized providers to power a successful open cloud strategy. This strategy gives customers the power to break free from the constraints and high costs of traditional cloud providers. For AI use cases, we presented a session with Coreweave, a specialized cloud provider of large-scale GPU-accelerated workloads, to show how pairing our services supports AI workflows, which consume and generate data at an exponential rate. B2 cloud storage is an ideal cost-effective storage solution for AI workflows and processes, including the AI model, training, and inference data.

With Fastly, the presentation showcased how to secure edge workflows and serve up data from B2 cloud storage. And with Snowflake, we shared how their analytics platform efficiently works on data stored within B2, demonstrating how Backblaze’s interoperability allows users to put industry-leading platforms like Snowflake to work on data within our storage cloud. The thousands of technical decision-makers participating in Tech Day further confirms that customers are more and more interested in moving toward the open cloud, where they have the freedom to build the best solutions for their needs at a fraction of the cost. Turning to our growth strategy, we focus on making it easier for customers to adopt and grow on B2 cloud storage while continuing to expand the ecosystem of partners and resellers.

As we’ve discussed before, this strategy includes self-serve, sales-assisted, and partnership efforts, along with focusing on cultivating application storage use cases. I’ll touch on some highlights for each of these. For self-serve, we have completed overhauling our website infrastructure and have seen encouraging results with increased year-over-year growth in new customers. Our sales-assisted motion continues to add and grow larger customers. For example, one such large customer started with 400 terabytes of data earlier in the year and has since fully leaned in, increasing their data stored by 5x, which translates to over $100,000 in AR. This is a trend we see often, where customers start small and move more data to B2 once they realize the full extent of B2 cloud storage’s cost savings and ease of use.

Moving on to our partnership initiatives, we announced new and expanded partnerships with HYCU and Qencode. The HYCU partnership helps extend our reach within the multi-billion-dollar data protection as a service market. And the Qencode partnership adds an additional B2 cloud storage distribution point for media production customers. We also continue to make progress with our channel partner program. In Q3, we signed our largest multi-year B2 reserve deal with an upfront $1 million commitment. And finally, I’d like to share a developer story which highlights our ability to serve innovators in the AI space and illustrates how we continue to make headway within our application storage initiative. One of our joint customers with Coreweave is an application developer using AI to reinvent how 3D motion capture works.

With this customer’s SaaS offering, there’s no need for special environments, clothing or sensors. Creators can simply capture human movement and their AI translates it into usable 3D animation. But they needed a cloud storage provider that could scale with their ambitious growth plans while also providing free egress for them to easily migrate their data into Coreweave to run AI workloads and archive those results. After considering other traditional providers, they found that Backblaze could best serve their needs. This is a great example of how AI use cases require both powerful servers for processing large volumes of data as well as affordable, accessible object storage. Next, I’m excited to share a recent important innovation in our storage platform, which we call “shard stash” that led to a significant performance improvements for B2 cloud storage.

Small file uploads, which we define as upload smaller than one megabyte, make up the majority of upload activity for B2. For this type of upload, Backblaze is now up to 30% faster than Amazon S3. This breakthrough increases efficiency for customers and helps free up resources for other tasks. B2 cloud storage continues to be one fifth the cost of the traditional cloud providers while delivering more value to customers across our platform. Additionally, for computer backup, we launched version 9.0, which features improvements to performance and usability as well as a highly requested new local restore experience. As we announced in August, we’re looking forward to continued improvements with our advanced groups administration, which delivers features to free enterprise IT managers from the burden of complex and expensive endpoint workstation backup solutions.

Now, I’d like to share some of the feedback we received from the price changes and product upgrades we announced in August, which became effective in October. While it is still early, Churn was generally in line with our expectations. Our customers appreciate our continued investments in the platform and valued our recent upgrades and improvements to popular features, such as complimentary one year extended version history for our computer backup service, and three times free egress for B2 Cloud Storage. As we have shared previously, we believe an open cloud will serve customers best, and our free egress helps make that a reality. Following our announcement, we saw new customers engage with us directly because high egress fees charged by other providers are a major pain point for them.

Offering free egress cut through the noise and spoke to what customers really cared about, the freedom to choose best of breed solutions for how they want to store and use their data. And before I hand the call over to Frank, I’m excited to welcome Chris Opat, our new Senior Vice President of Cloud Operations to Backblaze. Chris is a customer-centric leader with over 25 years of industry experience in edge computing, data center management, and multi-cloud enablement. At companies like StackPass and CloudReach, Chris oversees the strategy and operations of our global cloud storage platform. Having already seen Chris’s impact on accelerating the deployment of the performance improvements I mentioned earlier, we’re all very excited to have him aboard.

Now, I’d like to turn the call over to Frank. Frank?

Frank Patchel: Thank you, Gleb, and thanks everyone for joining us today. Q3 was highlighted by surpassing the $100 million in ARR milestone. As Gleb mentioned, we also believe it is an important inflection point for the company. Next quarter, we expect to accelerate revenue growth, reduce cash usage by about half sequentially, and reach positive adjusted EBITDA, all of which I will discuss in further detail. Turning to our third quarter financial results, unless otherwise noted, I will be referring to non-GAAP metrics and the growth rates mentioned are year-on-year. We remain focused on two key metrics, revenue growth and adjusted EBITDA, which is defined in our earnings release. I will provide some initial thoughts on 2024 later in this call, and full year 2024 guidance on our Q4 earnings call in February.

Our quarter three revenue totaled $25.3 million, an increase of 15%. B2 cloud storage revenue was $11.6 million, reflecting 31% growth. Computer backup revenue totaled $13.7 million, reflecting 4% growth. In Q3, B2 cloud storage represented 46% of total revenue. Turning to retention metrics, we track net revenue retention or NRR, and gross customer retention. Total company NRR was 108%, with B2 cloud storage at 120%, and computer backup at 100%. Gross customer retention was 91% overall, consistent with the prior year, with 90% for B2 cloud storage and 91% for computer backup. Working down the P&L, adjusted gross margin was 74%, down from 76% last year. Similar to prior quarters, the primary driver of the decrease in gross margin year-on-year is due to the costs associated with our new and expanded data centers.

This quarter, adjusted EBITDA loss of 841,000, or negative 3% of revenue, compared to a loss of $1.9 million, or negative 8% in quarter three of 2022. The beat was due to gains in operating efficiencies and to a lesser extent, some one-time gains. Turning to the balance sheet, cash, and short-term investments, including restricted cash, totaled $36 million at the end of Q3, 2023, versus $45 million at the end of Q2, 2023. Now I’d like to provide our outlook for Q4. Regarding our recent price increase, while still early, churn has generally been in line with our expectations, and we see the price change as a net positive for revenue, adjusted EBITDA, gross margin, and cash usage. For the fourth quarter, we expect revenue to be in the range of $27.9 million to $28.7 million.

This is a wider range than typical for our fourth quarter guidance, due to the price increase that just started and is rolling through quarter four. We expect Q4 adjusted EBITDA margin between a positive 1% and a positive 3%. Q4 is expected to be our first quarter of positive adjusted EBITDA as a public company. As an additional highlight, we also expect gross margin to trend up and cash usage to decrease by half sequentially due to revenue growth and the impact of the price increase, as well as further operational efficiencies. For the full year of 2023, we are raising the bottom end of our full year revenue guidance by $1.2 million to $101.2 million to $102 million. We are also improving our full year adjusted EBITDA guidance to a range of negative 6% to negative 4%.

We are still in the process of finalizing our 2024 budget, and we will provide our full 2024 guidance in February. However, we expect Q3 2023 to be the inflection point with revenue growth trending up in Q4 and in 2024. Additionally, we anticipate adjusted EBITDA will be positive for the full year next year as we continue to drive top and bottom line growth. I will now pass the call back to Gleb. Gleb?

Gleb Budman: Thanks, Frank. We had a strong Q3, expect to see higher revenue growth in Q4 and 2024, and are on track to be adjusted EBITDA positive in quarter four with dramatically lower cash usage. I want to extend a huge thank you to our team, both for delivering these financial results and for developing the storage performance innovation that is now enabling us to offer upload speeds up to 30% faster than AWS. These are major accomplishments to be proud of. Operator, we’re now ready to take questions on our call.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Simon Leopold with Raymond James. Please go ahead.

Simon Leopold: Thank you for taking the question. I wanted to see if maybe you could help us think about how the price increases could play out in 2024. And I appreciate you’re not ready to guide to 2024, but what might be helpful is if you could walk us through the timeline and impact when you’ve done price increases in the past. Thank you.

Gleb Budman: Sure. We’ve had two price increases in the past in our computer backup business. And the way that computer backup, the price increase rolls through, is that 75% of those customers are on one and two year contracts. So as they renew, the price increase phases in. And the same will be this time on that computer backup. There’ll be a continued phase in of the price increase. It started in October this year and will phase in across that period. On the computer backup side, on the B2 cloud storage side, this is the first time that we’re having a price increase. It’s for our pay-as-you-go customers. And all of those customers had their price increase become effective immediately in October. So that’s really how it will go. The B2 is already engaged, and the computer backup will phase in.

Simon Leopold: Great. And then the other thing I’m trying to get a better handle on is, if you’re providing the free egress, and I understand why that would be attractive to your customers, is there some way to help us understand the cost to you?

Gleb Budman: As Frank said, they have seen the price increase take effect. We do have customers that are using B2 Reserve and customers that aren’t committed contracts, and they do not have the price increase affect them.

Simon Leopold: Great. And then just as a quick follow-up, just trying to understand, if you’re allowing free egress, I assume that means you’re absorbing those costs, can you give us some sense of how to estimate the magnitude of the cost to you?

Gleb Budman: Well, yes. Remember, as far as egress, for all of our partner accounts, they had free egress already. So an egress is not immaterial. It’s certainly a cost of the business. But we think that going forward, the customers now get three times their storage amount in free egress. We think this is very important to the open cloud concept, and it’s really going to boost the business overall for that reason. So the upsides are much more positive than any limited downside in the cost. So it’s not immaterial, but it’s very absorbable.

Simon Leopold: Thank you very much.

Operator: Our next question comes from Ittai Kidron with Oppenheimer. Please go ahead.

Ittai Kidron: Thanks, guys. Nice results. Let me follow up on Simon’s call. A question, I guess. Why do you feel free egress is even needed given the significant cost advantage you already deliver relative to AWS? Wouldn’t that by itself cover very quickly any egress cost that a customer would incur in transferring over?

Gleb Budman: Hey, Ittai, this is Gleb. Thank you for the question. So we believe that we provide, obviously, a tremendous amount of value to the customer simply because we provide a very easy-to-use storage platform, and that storage platform is one-fifth the price point of AWS for the storage. So that’s certainly strong material value to the customer. One of the things that we have found with egress is that customers can be confused at times about what egress is going to cost for them because they don’t necessarily know. It’s a little bit hard for them to sometimes predict. And because they are — because they’ve been burned by the egress fees on the traditional cloud providers, they just worry. So it’s a point of mental friction for them.

And so with our goal of making it easy for customers and our goal of really driving the open cloud movement where customers get to choose where they want to keep their data, how they want to use it, we wanted to make that easy. Like Frank said, it’s not the egress, the revenue that we collected was not immaterial, but was certainly not very significant because one, we already offered completely free egress through our partners, companies like Fastly and Cloudflare and Vulture [Ph] and others. And we’re providing up to 3x on any egress today. So it’s not a huge financial impact for us, but it is, we believe, a huge benefit to customers in kind of how they think about the open cloud.

Ittai Kidron: When you make that available, you require them to sign multi-year tractual obligations or one can be month to month and have you pay for egress?

Gleb Budman: So this doesn’t change the requirement for how we work with the customers. The customers can still sign up for pay as you go. They can still purchase B2 Reserve and they can still sign a committed contract with us for a longer period of time. So the free egress doesn’t change with that. Now, what we do offer is a universal data migration, which is where we cover the cost of egress to get the data out from the traditional cloud providers, to get the data out from Amazon or Azure or Google Cloud. And if we’re providing the customer the ability to do that, then we do ask for a one-year commitment on their data to us. But in terms of free egress from Backblaze up to 3x, there’s no requirement for them to sign a contract for that.

Ittai Kidron: Okay, and regarding the price of B2, what percent of your B2 revenue is pay as you go versus contracted ahead of time?

Gleb Budman: It’s about majority currently.

Ittai Kidron: Majority, okay. And when you talk about being the fifth, the cost of AWS, is that before the price increase or after? Am I assuming you’re becoming a quarter rather than the fifth, the price of AWS after this price increase?

Gleb Budman: No we believe that we’re still approximately one-fifth the price point today. AWS has a variety of different costs with transaction fees and everything else as well, all of which are added costs and added complexity. So we believe that we’re still approximately one-fifth of the price point.

Ittai Kidron: Okay, and then last one for me, Gleb, just from a big picture standpoint, macro-wise, can you talk about how your pipeline is looking like, backlog looking like, average deal size looking like, and also closing rates, help me understand from an execution standpoint, where you stand on that front, appreciate it.

Gleb Budman: Sure, absolutely. So we talked in the prior quarters about how the pipelines, the close rates were good, the timelines were good, that we weren’t seeing those get longer or worse, whereas others had seen that. What we’re seeing now is in line with our prior quarters, so I think quite strong. And the pipeline itself is the largest pipeline that we’ve ever had at the company. So feeling pretty good about where things stand from a macro for us.

Ittai Kidron: Can you just clarify that, bill from? It’s naturally as the company grows from quarter to quarter, you’re going to have the biggest backlog, but maybe you can talk about the growth of the backlog, number one, and number two, the quality, how mature is it for you?