Good afternoon and welcome to the Backblaze Second 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 James Kisner, Vice President of Investor Relations and Financial Planning. Please go ahead.

Thank you. Good afternoon and welcome to Backblaze's second 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 offerings, partnerships and sales and marketing initiatives, our ability to compete effectively and manage our growth, our strategy to acquire new customers and retain and expand our business with existing customers, and our efforts to hire and retain key personnel. 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, and this will be moderated by our new Director of Investor Relations, Mimi Kong. I would now like to turn the call over to Gleb. Gleb?

Thank you, James, and thanks to all of you for joining us. We continue to execute on our growth strategy this quarter. Total company revenue grew 19% year-on-year with strong 39% year-on-year growth for B2 cloud storage and 7% growth for Computer Backup. I want to start with two business highlights. First, our increasing success in moving upmarket. I'm proud of our team for executing on larger customer deals for both Computer Backup and B2 cost storage. I'll go into the numbers in more detail later, but we're seeing success in moving up market both among paying customers and in our sales pipeline. Second, I'm happy to report that we are well on our way to our previously announced goal of approaching adjusted EBITDA breakeven in the fourth quarter. Frank will provide some insight on why we believe the company is well-positioned to return to being cash flow positive without needing to access equity capital markets. I'm excited by the cloud storage opportunity ahead by supporting customers in the direction they want to head with the cloud as leading advocates for the value of an open cloud ecosystem where customers can use the combination of clouds best suited to their needs. We believe customers need to be able to store and use their data any way they see fit. Additional cloud service providers are walled gardens that charge customers egregious fees to move data out of their clouds. And yet customers desire for best-of-breed solutions and the high prices of traditional cloud providers are driving customers toward an open cloud ecosystem being enabled by providers like Backblaze. And as these customers discover our ease of use, our openness to other technical platforms and our low priced leadership, they tend to grow their usage and adoption of open cloud solutions as…

Thank you Gleb and thanks everyone for joining us today. Turning to our Q2 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. Our Q2 revenue totaled $24.6 million an increase of 19%. Backblaze B2 contributed sales of $10.8 million reflecting 39% growth. Computer backup revenue totaled $13.8 million representing 7% growth. Please note that included in this number is a onetime catch-up payment of approximately $200000 from one customer that was received ahead of our estimates which will not reoccur in quarter three. In Q2, B2 cloud storage represented 44% of total revenue, continuing its upward trend. We're pleased by the continued strong growth as this highlights the resiliency and predictability of our business model and the appeal of our cost-effective solutions for customers. Turning to retention metrics. We track growth customer retention and net revenue retention or NRR. Gross customer retention was 91% overall with 90% for B2 cloud storage and 91% for central computer backup. Total company NRR was 110% with B2 cloud storage at 121% and computer backup at 103%. Working down the P&L. Adjusted gross margin was 75% down from 77% last year but an improvement from 72% in quarter one 2023. 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 which we mentioned in Q1. Adjusted EBITDA was a loss of $1.8 million or negative 7% of revenue compared to a loss of $1.9 million or a negative 9% in Q2 of 2022. Turning to the balance sheet. Cash and short-term investments, including restricted cash totaled $45 million at the end…

Thanks, Frank. Finally, I would like to recognize the commitment and hard work of the entire Backblaze team for delivering another strong quarter. Operator, we're now ready to take questions from the sell-side analysts on our call.

We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Chad Bennett of Craig-Hallum. Please go ahead.

Great. Thanks for taking my question. Congrats on the quarter. So just Gleb maybe just talk about on the B2 Cloud side a little -- I didn't hear much on the macro commentary, if there was any. And I think the past few quarters or a couple at least we've talked about sales cycle shrinking and win rates improving. Just kind of how that business performed relative to your expectations from a bookings or ARR standpoint would be great.

Yeah. Thanks, Chad for the question. Good to hear from you. So maybe I'll start and then if Frank has anything to add to it. I think from the macro perspective one of the things that we talked about in prior quarters is that the traditional cloud providers have been talking about the headwinds and challenges of customers looking to optimize their spend with them. The customer is basically looking at it and saying how can I provide the same value to my customers, while decreasing my cost of infrastructure. And obviously, a great way to do that is to switch to a lower-cost provider like Backblaze. And so they've been seeing significant optimization challenges to their environment. And we have been on the one hand some of the headwinds in the past of customers just generally doing less industry-wide. But on the other hand, we get to be the beneficiaries of customers looking to optimize away from some of the traditional clouds. I think we're still seeing customers coming to us for those same reasons, right? Customers are continuing to try to optimize off of the traditional cloud providers and continuing to look for high-value choices and we're the beneficiaries of that. So we talked about close rates and close cycles in the past. We're not going to report on those quarter-on-quarter-on-quarter. But what I'll say is that they've been relatively consistent with what we've said in prior quarters even improving slightly. So I think we're enthusiastic about kind of how that's looking overall.

Okay. And then maybe a follow-up on B2 Cloud. Just any commentary on B2 reserve bookings and in particular kind of performance through the channel there. And then I believe from a guidance standpoint, you guys have talked about B2Cloud ARR growing 40% this year. Are you still comfortable with that growth rate?

So let me touch on the B2 reserve and then I'll hand to Frank for the growth rate for B2. On B2 Reserve, one of the things just for people who may not remember from prior calls, the reason we are excited about B2 Reserve is that we see it as something that is good for customers for the channel and for Backblaze. B2 Reserve is the packaged version. It's the fixed price version of our B2 offering. So it's good for the customers because they have predictability. It's good for the channel because it's easier for them to sell that. And so we launched that in roughly the middle of last year. So B2 Reserve has continued to grow strongly sequentially quarter-on-quarter. So we're seeing good traction with it. As we talked about last quarter, it was $1 million in ARR. So it's not a dominant portion of the business. It's not super material yet. But we are enthusiastic about the growth. And maybe Frank you can talk to the B2 growth numbers.

Yeah. Thank you, Gleb. Hi, Chad. So recall that B2 grew around 40% in quarter one and in quarter two and we expect a similar growth rate in quarter four. But specifically in quarter three, we do see a one quarter dip in that B2 grow to around 30%. And this is due to certain headwinds including softer data growth recently, some seasonality and really a tough comparison to the quarter three 2022 due to that prior initial ramp of our largest account ever. But as I said, we expect that Q3 dip to be temporary and we believe B2 will accelerate back to its Q4 40% or above.

Got it. And then maybe last one if I may for you Frank probably just -- so what -- it appears to be -- you took out $12 million plus in annual costs out of the business. I guess a couple of questions. Does that annualized rate -- run rate start in Q3 here? And then secondly can you provide us any color into how that segmentation looks on the P&L from a cost standpoint and where those costs came out of?

Yes, it's actually -- what's going on is that we've got costs that are moderating in many areas because remember that in 2022 we stood up all of our new departments right? And that was -- we really pursued that enormous potential for B2 in front of us and to be a public company. So, what's happening right now is we're really moderating that growth quite a bit. The -- from a P&L standpoint, we do have savings across all the line items. So in the gross margin, for example, we have -- because we have lower lease costs, we're buying less equipment for the reasons I stated the depreciation does go down. We do have headcount that either reductions or much slower growth in really all the areas. So, it's really pretty widespread.

And evenly spread would you say? I mean is there a way to think about magnitude of each line rough magnitude of the line items?

Well, the facilities goes into the G&A, but we have other moderating expenses there. And in our restructurings we reported that it was in sales and marketing areas that were not performing as well as we had hoped. So, we did some moderation there.

Okay, good. I appreciate it. Nice job on the quarter. Good to see the reiteration of the guide also.

Thank you.

The next question comes from Elle Niebuhr of Lake Street Capital Markets. Please go ahead.

Hey, this is Elle on for Eric Martinuzzi. I'm hoping you could talk a bit more about your expectations on IT spending going into 2024. And what sort of feedback you've received from your channel partners?

Hi, Elle. Thanks for the question. So, by IT spending, do you mean just general kind of customer spend on IT infrastructure? I'd say we're certainly not guiding 2024 yet. And I don't know that we have a tremendous amount of visibility into what customers are expecting to spend in 2024. I think we've seen some of the traditional cloud providers and some of our peers talking about that they expect customers to continue to be focused on optimization for the near term and possibly slightly longer-term future. So, just from kind of the industry data that we're seeing it seems like this trend of customers continuing to look for where to find value so that they can provide the services that they want to provide to their customers, while continuing to look for spend optimization doesn't seem to have quite stopped yet. And I think in the -- AWS announced that their growth still slowed to 12% year-on-year. And I think that was still driven in large part by customers continuing to look to optimize their infrastructure. And so it seems like that has not yet stopped. And so as they continue to look to optimize we'll continue to look to help them.

Great. Thank you. And then last question. Could you just touch on gross margin a bit more and go into detail on Q2 and what you're expecting for the rest of 2023?

Yes. We always are expect -- I'll do non-GAAP. We're always expecting the non-GAAP gross margin to be in the mid-70% range. what happened was we were lower than that in quarter one we were at 72%. And the reason that we bounced back up in quarter two is that we had the cessation of a lot of duplicate expenses as we were moving into our larger data centers. And then we opened up new data centers as well. And there's a lot of one-time costs and setting them up kind of across the board. And once we had all of that behind us which was in quarter two, we had that nice bounce up again. So, as we look at the gross margins going forward, we do feel that they're going to be quite -- they're going to be in that range continuing, because we do invest all the time in the data centers, but we don't have this large increase in either the number of data centers or expansions.

Great. Thank you.

The next question comes from Erik Suppiger of JMP Securities. Please go ahead.

Yeah. Thanks for taking my questions. First off, just curious, any update on what your hiring plans are for the rest of the year and where you expect headcount to be over the -- at least where did you end with headcount in Q2? And then, you had talked about your growth -- year-over-year growth going down to 30% in Q3 and then back to 40% in Q4. What is the biggest factor for Q3, the tough comp? Or what gives you the confidence that we will see the growth rate recover?

On headcount we haven't provided quarterly headcount. But what we did provide was this. Last year we grew headcount by 45% for the reasons that I stated earlier. It was our first public year and we needed to standup groups to go after this enormous opportunity that we have. Now, what we said also is that, it's really moderating where we're filling in here and there for programs. And our headcount is -- and then, we did have a reduction in staff. So our headcount remains low. It has a very modest up-tick for the rest of the year. And that's one of the reasons that we're so quickly heading to EBITDA breakeven. As far as our …

Okay.

Okay. As far as our confidence on, what is causing that one-time dip, it is for the reasons that we said. They're pretty equal, I would say the -- when you have your fastest and largest -- when you have your largest account start as fast as they did in quarter two they grew the entire quarter and were at their peak within one quarter. That does make a difficult comp, because they're so large. We had said before, the $1 million account annualized. And the other factors are there as well. But when we look at quarter four we have much more optimism of the 40%, but it's really returning back to where we've been.

Okay. And then lastly, have you seen any change from AWS from a pricing perspective?

We haven't. I mean, I think that from a competitive landscape perspective with them we continue to see somewhere that has been fairly consistent. So we still see a number of customers moving over to us from AWS. We shared another one on the call. This time, we -- I think in the last quarter we shared one coming from Amazon, one coming from Google, one coming from Azure. And we continue to see customers moving from those both for the pricing reasons. I think that we're about one-fifth of their price point. But also because of our open ecosystem the free egress that we provide to our technology partners is something that a lot of our customers appreciate as well as the ease of use of the service.

All right. Very good. Thank you.

Thanks Erik.

The next question comes from Simon Leopold of Raymond James. Please go ahead.

Great. Thanks for taking my question. I wanted to see, if maybe you could help us understand the sensitivity of your cost of goods sold to essentially the cost in data centers. And really the question sort of rooted in the view that data center space is scarce and therefore there's, a lot of people competing for the capacity. And then also, just relative to a year or two years ago cost of electricity has gone way up. And your gross margins have been pretty stable. So I'm trying to get an understanding of sort of how that's affected you and how you think about that within the cost of goods sold. Thanks.

Yeah. You're right, Erik [ph]. The data centers have been -- and their expenses have been stable in the sense that we haven't been as affected by what you're doing -- by what you're saying. The data centers when we actually -- remember they're colo sites and we only contract for what we believe we will use. And if we need more we can do that. So we're in contracted rates with the major providers, and we so therefore can anticipate, what our costs will be in the future. As to the power, we did anticipate or electricity we did anticipate large increases, not as large as what we saw in Europe, but Europe is a smaller data center. And so we've been comfortable in being able to forecast it and absorb those costs.

And just as a quick follow-up sort of rough math suggests that your operating expenses should be maybe just south of $19 million in the next quarter. So you're just putting a number to it would be helpful. I think everybody sort of asked that question in a couple of different fashions. Maybe just south of $19 million make sense to you to what you're expecting?

What we've said before is that we really expect quarter-on-quarter expenses to be relatively flat. They're not exactly flat because we have programs that are in some quarters out of others but I think you can continue to see that. What you saw on quarter one to quarter two was only a 1% increase in OpEx expense. So that's been our trend.

Great. Thanks for taking questions.

The next question comes from Zach Cummins of B. Riley Securities. Please go ahead.

Hi, good afternoon. Thanks for taking my questions. Gleb I just wanted to ask you about the prospects of moving upmarket. As you're thinking about getting involved with larger customers I mean what's the primary channel that you believe is going to be getting you towards those larger customers? Is it really the outbound channel or through strategic partners?

Thanks for the question Zach. So one of the things we said at the IPO was that while we're focused on the mid-market, our platform can support any size of customer. And so the first part of that is I'm excited that we're seeing larger customers wanting to use the platform and we're successfully winning those deals and having them be happy satisfied customers on our platform. In terms of where do we find them from our outbound sales team that we stood up with some of the proceeds from the IPO has started generating pipeline and bringing in some of those deals. So we're seeing a healthy pipeline of which larger deals are an important part of that pipeline. But we're also seeing deals that come to us inbound. And this is I think a function of the blog and the content marketing that we have invested into over the years. And some of those customers they read about us they learn about us and then they come to us proactively directly. So we see it from both. I would say that we expect that we will be getting some from channel. We mentioned one that came through our technology partner Fastly. We think that our partners benefit from working with us. So the Fastly example is any customer that works with one of the edge compute providers they need to have data and that data needs to be stored somewhere. If that data is locked up inside of one of the traditional cloud providers that it makes it expensive and difficult for the customer to use those other best-of-breed edge cloud providers. And so it's in the customer's best interest. It's in our partner's best interest to have them move their data to us. And so we had that win from Fastly that they brought to us and we expect to see more deals coming from technology partners as part of the ecosystem bring deals to us. Some from the channel we're already seeing pipeline from outbound and we're already seeing inbound deals as well.

This concludes our question-and-answer session. I would like to turn the conference over to Mimi Kong Director of Investor Relations.

Thank you, Andrea. I want to thank all the analysts for joining the call today and thank you for all your questions. Next we will answer questions submitted by retail investors on the Say Technologies platform. The first question I have is for both Gleb and Frank. What is management's plan to become a more profitable company? A – Gleb Budman: So in terms of becoming a more profitable company, there's two obvious pieces to that. We're going to grow revenue and we're going to moderate expenses. On the growing revenue side of it, we talked about the four pillars that we're focused on with our growth initiatives, which is optimizing our self-serve motion, which makes it very efficient for customers to sign up; scaling our sales assisted with deals like the ones that we talked about over $50,000 that we're seeing traction with and the $1 million deal that we signed last year and the largest computer backup deal that we just announced this quarter. So that's on the sales assisted side. On the partnership side in expanding both with technology partners and channel, and then, the last one being the application storage use case where we help customers as a strategic part of their structure. So investing behind the growth of the company so that we grow revenue and then moderating on the expense side. And maybe Frank, you can touch on the moderating on the expense side.

Yes. We're continuing to drive efficiency and it's through the disciplined headcount additions. And as Gleb said, we're really investing in projects with solid returns. We measure everything. So we can see which ones are doing the best where more investment should be and which ones we should pull back on, because we're not as happy with those returns. And the other important thing is that we're on track to approaching adjusted EBITDA breakeven in that fourth quarter.

Now, next question is for you Gleb. What are some future projects for the company?

So future projects, I assume also includes future products. So we have a long history of improving our services, adding value to customers. We don't disclose our product road map for competitive reasons. But you can look back at some of the things that we have done. So for example, we opened the East Coast data region for customers to be able to choose that. We added cloud application which enabled customers to store their data in multiple regions by turning on that functionality. We launched B2 Reserve, which we talked about a little bit earlier during the Q&A, a partner API, which helps our partners make it easier for them to integrate our service into their product offerings extended version history for our computer backup customers. So we've done a lot of things to help customers store their data, protect their data and also use their data and that's where we continue to invest in. We're also working with our partners on enabling solution sets. So, the solution set that we talked about with our continuity centers for disaster recovery is an example of that as well as some of the other services that moved on with our edge compute partners. So overall, I think you can look back at some of the road map items that we have shipped as examples of things that are on our roadmap to ship.

And Gleb, what do you view as Backblaze's competitive advantage over other companies offering similar services? What is distinct or unique about Backblaze compared to competitors?

So in terms of distinct and unique, so first of all we are dramatically easier to use. And I know a lot of people say that. I know a lot of technology companies in particular say that. And one of the things that we've seen is customers that sign up with us and then later come back and say, oh my God, it was so easy to use your services. And the conversations I had with some of them was like well, yes, we've said that it was easy. But the response I often get is, I know you said it was easy. Everybody says their technology is easy but yours actually was. And I think a lot of times ease of use is an underrated benefit. And analysts found that our customers save 92% of their time by being -- because we're so much easy to use. Apple has built a $1 trillion company by focusing on making products easy to use. So I think ease of use is one very key differentiator for us. We're also dramatically less expensive than other providers and we are supporting the open cloud ecosystem and we do that by making it easy and inexpensive for customers to use their data in the way they see fit to use it with other edge compute providers, with other AI services, with other compute providers, et cetera. So by enabling them to have that open ecosystem of data, we make it so that it's easier for them to build their business the way they want to build it. So much easier to use, much less expensive and supporting the open ecosystem.

And this next investor would like to know where do you see growth opportunities in the coming year?

So growth opportunities in the coming year. I mean, we're pursuing this $50 billion market by 2027. So there are many opportunities. I think that we've talked about the growth initiatives that we're pursuing. We also highlighted that we're seeing momentum and investing behind going after the larger customers in the mid-market. And so I see that as an interesting opportunity for us. B2 Reserve, which we talked a little bit about it earlier on this call it's not a very large part of B2, but it is a rapidly growing part of B2. And on the computer backup side, we have helped both individuals and businesses for a long time. We're continuing to see more businesses specifically come to us looking for us to help them protect all of their employees in all their employee data with our computer backup service.

Now this next shareholder asks, how will I benefit with the other shareholders putting my faith and money with your company? I have been optimistically happy and supportive to date, why should I continue down this path?

So first of all I appreciate all investors and shareholders investing and having faith in us and giving us the runway to execute on our growth initiatives. Certainly I also hope that as shareholders some of you may choose to become customers, which will both help the growth of the company and also hopefully help you as well. From the investor side specifically, since the time we went public we entered into a market, which we're facing inflation, recession fears, interest rate hikes. And despite that we executed as we said we have been building the company in a stable and predictable fashion. We executed on our growth initiatives. We grew revenue double digits year-on-year in every quarter since we went public. We're approaching adjusted EBITDA breakeven, which is a key milestone on our path to profitability. And as Frank talked about we have taken action on improving our cash flow trajectory as well. Recently, we also eliminated the dual class share structure that we had, which now gives all shareholders equal voting rights. And we saw that as a good step for corporate governance and also just being a shareholder-friendly company. So I think we've executed well and we're taking actions to be supportive to shareholders overall.

The next question is a little bit more technical, what strategies are in place to ensure privacy store data?

So privacy and security of data are actually both critically important for us. We have a Chief Information Security Officer with a staff in place. That team works every day to ensure privacy. And that team also has throughout the organization other partners that work with them across the company to ensure the security and privacy of data. We encrypt data in transit. We offer various levels of encryption at rest. We use third parties to attempt to find vulnerabilities in our systems. Overall, we have a robust security and privacy program with physical, digital and policy safeguards. We recently completed our SOC 2 audit. So overall we're seeing a host of actions and have the teams in place to protect customer data privacy and security.

And Gleb, this next investor asks your competitors have raised prices. Are you considering the same? Should you?

So we certainly believe that we're in excellent value. As we talked about we're seeing many customers leaving the traditional clouds to continue providing high value to their customers, while reducing their infrastructure costs. We believe we're a great value in the current market and we are always considering ways to both optimize our product offering and ways to grow our business.

Now this next question is very topical. Is Backblaze going to use AI for future growth?

So AI is certainly something that's top of mind. It's a very exciting time to run a business that benefits from data growth when there are new applications constantly that are generating data. Certainly generative AI, is growing explosively. We are starting to use and looking at additional ways to improve productivity inside of the company using AI. And on the AI front our customers are using AI. We have dozens of AI customers that are through our sales-assisted motion alone. And you may remember, our sales customers are about 20 times larger than our self-serve customers. So, there's certainly, a lot of growth being generated by -- in data by AI use cases and we're excited about the opportunities to leverage that for the growth of Backblaze.

The next question, how are you encouraging employees to seek more responsibilities and leadership roles? Now, this investor also notes, I believe this promotes staff to self-promote the company and in part create positive culture and increase ROI.

So, I love the question in part, because we all agree with the -- we agree with the sentiment, right, which is that at the end of the day, the people make the company and the happy and successful people in the company, lead to happy and successful outcomes for everybody including for investor ROI. So, our culture is very important to us. We certainly, believe from promoting from within. I think we have some data points that show that we've been supportive on this front. We were recognized by Great Places to Work. We recognized for a 2023 diversity award. We were recognized by Fortune's Best Workplaces, in the Bay Area. Our turnover continues to be low and we continue to regularly reevaluate, how we can help and ensure that our employees are happy and successful as part of the company. And hopefully, they also are excited about promoting Backblaze to their customers, their friends or other partners, et cetera.

Let me give you a rest, Gleb. You did a marathon of questions. Next question, will be for Frank. So how has the management managed or limited possible exchange rate fluctuations?

No, it's a good question, because we do have customers in 175 countries. But, we don't have large foreign currency risk. And the reason for that, is that our customers pay us in US dollars. And then when we look at our expense side, we just don't have a lot of international expenses. We have some for our international data centers. We have international taxes. But overall, the foreign currency risk for us is very low.

And that concludes the portion of questions from a Safe Technologies. Andrea?

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