Good day, and welcome to the Backblaze Q3 2024 earnings call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch tone phone, and to withdraw your question, please press star then two. 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 Q3 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 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, and I would now like to turn the call over to Gleb.
Thank you, Mimi, and welcome everyone to the call. We had strong Q3 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 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've seen an immediate impact. The team booked a record amount of annual contract value wins in over a year. We also signed two multi-year 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'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 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 $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. 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 in the way 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 right-sized to increase operating leverage. So, three months into the job, I would say that my original hypotheses still stand and have 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 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.
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 in 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 is $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-$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-$128 million. We expect Q4 adjusted EBITDA margin to be in the range of 12%-14%, which excludes the one-time restructuring costs.
For the full year, we expect Adjusted EBITDA margin to be 9%-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're excited about the path ahead and the momentum that is already in place. And with that, let's take your questions. Operator.
Thank you. We will now begin the question and answer session. To ask a question, you may press star or then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Jeff Van Rhee with Craig-Hallum Capital Group. Please go ahead.
Great. Thanks for taking my questions. A couple for you guys. First, Gleb, on the B2 side, talk for a second about you said some churn late in the quarter. Just expand on that because you had pretty good some expansion in the net retention number from 114 to 118. 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 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?
Hey, Jeff. Thanks for the questions. Appreciate it. On the churn side, the churn that we saw happened early in the quarter. We expected it, but it happened earlier in the quarter, so we still had, like you said, we still had very strong NRR, and we had a strong gross customer retention. It's just a handful of customers that churned out earlier than later in the quarter. In terms of the up market 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 million multi-year deals that we talked about, so those are quite significant size opportunities. We think we have the opportunity to go above and beyond that as well.
We do want to build rapid ability into more of that go-to-market motion. 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 million each is quite the trajectory already.
Yeah. Yeah, 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 B2?
Hey, 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, I mean, obviously, as we lap 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 mentioned in his comments, 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 enter 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.
Okay. I'll leave it there. Thank you.
Thanks, Jeff.
The next question will come from Ittai Kidron with Oppenheimer & Co. Inc. Please go ahead.
Hey, guys. 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, not just pure math.
Yeah. Listen, that's fair, right, Ittai? I mean, 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, 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 three quarters to do. 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 and the second half of next year. We have all the right indicators coming into it.
In fact, we're liking so much the early indicators of our sales efficiency that part of our savings of the $8 million, we're injecting it into more sales capacity to further accelerate that growth.
Got it. We forgot today, 12% workforce reduction. Can you be a little bit more specific in what areas you were cutting?
It's a comprehensive zero-based budgeting exercise. Headcount payroll is our biggest cost, but we have other cost drivers too. We went. I mean, we just took a fresh look at everything, you guys. 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. We found our marketing over-indexed on payroll, and as we are seeing our sales velocity increase, we need to feed it more demand generation. We want to shift, frankly, from headcount to demand generation budget there. 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.
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.
I appreciate that. And then it's great to see the positive free cash flow target for the fourth quarter of 2025. But can you give us a rough estimate, and what would you think your exit cash balance would be at that point?
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. 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 hopefully higher revenue growth for B2, right? And then operating leverage where $0.75 of every extra $1 coming then would flow to the bottom line.
Right. Okay.
Then one thing I'll say is, and for the rest too, one of the things that I've been excited about with having Marc join on board is he's taking a very thorough look across our spend broadly. So the zero-based budgeting approach, I mean, putting all the existing vendors out to bid, negotiating on the contracts, on the subscriptions, etc. So it's a pretty comprehensive process, and I think it's going to drive good efficiency for us going forward.
Got it. And then I guess, Gleb, 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 a time to productivity, number one. 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. 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 seem very logical. I'm just to call already that you're thinking 2Q, there'll be acceleration, meaning giving yourself six-to-nine months to see that transformation.
It's kind of getting tight, I guess. So help me get my hands around your confidence level here and what else we'll need to change there.
Yeah. So Jason's 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. 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 Marc said, in some additional capacity for the sales team based on those good early indicators.
And just the fact that 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. So that gives me some confidence that he and we together are going to be able to achieve some good results.
Got it. Appreciate it. Thanks, guys.
Again, if you have a question, please press star, then one. Our next question will come from Eric Martinuzzi with Lake Street Capital Markets. Please go ahead.
Yeah. 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?
Hi, Eric. I don't see that much impact to the gross margin in those expansions because they're colocations 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%-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.
Okay. And then back to the top line, you talked about a record pipeline build. Are we chasing those large deals? Obviously, as we're trying to get increased build, is the build that you're seeing reflective of changes that have taken place since Jason came on board, or is this kind of, "Hey, these deals were in the hopper prior to his arrival"?
Yeah. You know, 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 as 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.
Got it. Thanks for taking my questions.
The next question will come from Zach Cummins with B. Riley Securities. Please go ahead.
Hi, this is Ethan Widell calling in for Zach Cummins. Thanks for taking my questions. To start with the Opti9 partnership, can you maybe elaborate a little bit on how they might facilitate your move-up market or allow some SAM expansion for the new data region?
Sure. So Opti9 is the largest Veeam MSP in Canada, and they have customers globally. So they service their 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? So when you're using a product for backup, a product for disaster recovery, a product for ransomware protection, 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 up-market movement, although they have customers, medium and large customers as well. But that is more about a regional and partnership-focused expansion with them.
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 with your cost-efficiency initiatives?
Yeah, Jason, this is Marc. Like I said, we have over $8 million of year-over-year savings in our fixed cost. We will reinvest some of that to expand sales capacity. The good thing about our sales team now is whatever is set in there in terms of channel management, account management, the kind of stuff I'd say that should be revenue-generating, but is not as much as, let's say, sales rep. The reinvestment is all going into sales rep expansion and that kind of skill set. So really, yeah. 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.
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.
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 is now concluded. Thank you for attending today's presentation. You may now disconnect.