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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
All right. Good morning, everybody, and welcome to Dropsuite's third quarter investor call. I'm Craig Sainsbury, help the company with their Investor Relations.
With me today, we have Charif El-Ansari, who is the CEO; and Bill Kyriacou, CFO. Just as a quick matter of housekeeping, there will be the presentation, and then there'll be an opportunity for Q&A at the end of the session. [Operator Instructions] So with that little introduction, Charif, I will now hand over to you. Thank you.
Thank you, Craig. Very grateful for everybody joining our third quarter call today. We have delivered yet another record quarter on every single topline metric from ARR to user number to average revenue per user. This has been a journey that we've been embarking upon in part driven by some significant tailwinds that we'll cover briefly, but also in big part to solid execution and strategy on behalf of the Dropsuite team. We are not going to take you through all the statistics here. I think most of you, if not all of you, are really familiar about the challenges around cybersecurity, and ransomware and data privacy regulation. A stark reminder is what happened in Optus in Australia very recently, which reminds everyone, whether it's a small business or an enterprise business or a government, in fact, about the importance of having meaningful and strong security hygiene, whether it is deploying cybersecurity software, backup, training and awareness for employees as well as doing some of the fundamentals like multi-factor authentication, software batching, et cetera.
So when you look at our industry, which is specifically the cloud backup and recovery market, it continues to be bought by strong tailwinds around cybersecurity regulation and cloud migration. The one thing I would add, and probably, you will see in the next version of this presentation is that we're seeing some very [ strict posturing ] by cyber insurance companies where they're starting to refuse to even cover companies who don't have proper security posture, and that's yet another tailwind that I think will be significant in the near and distant future.
We continue to punch above our weight. We have been getting some really lovely accolades from market research companies. We got the #1 SoftwareReviews for the third time in a row, which makes us confident and also give us high conviction that honing our competitive advantage, which revolves around delivering the best partner experience that means weaving ourselves into their workflow and into the software that they use to run their business.
In addition to delivering an exceptional, highly intuitive user experience, and of course, we've developed engineering and cloud engineering specifically as a competency for our company being deployed across 14 data centers. We currently are backing up and provide the ability to search across more than 50 billion objects globally. And of course, the foundation is always building a strong, responsive, passionate and a caring team. And this is something that we've delivered really well, and we can see that in engagement scores. We can see that in very, very low levels of attrition.
Let me hand over to my colleague, Bill, here, so he can cover the results, and then he'll hand it back to me, talking more about strategy. Over to you, Bill. Thank you.
Thank you, Charif, and thank you to everybody for joining today. I'll run us through our third quarter results, where we delivered strong operational metrics across the third quarter, including annual recurring revenue of AUD 23.3 million at the end of September, which was up on an actual basis, 16% on prior quarter and 78% on PCP. On a constant currency basis, we're up 11% on prior quarter. And when we look at constant currency, we are calculating movement using a static USD/AUD rate during the quarter. We also note some very immaterial negative movements by the USD appreciation against some of the other various currencies that we're dealing.
When we look at paid users for the -- exiting the month of September, we're up to 886,000, which is 10% on prior quarter. In the last 3 quarters, we have added an average of 80,000 new paid users per quarter, and we continue -- we see this continuing going forward. Our monthly ARPU has increased to AUD 2.20, and on a constant currency basis, this is up 1% on prior quarter. Now this is also due to us having a product mix shift from a lower-priced backup-only product to a higher-priced archiving product. And there's also the USD/AUD upside that we've got in the quarter itself.
Very pleasingly, for gross margin, we have improved our gross margin to 66% as we exit September quarter. This is up 2 percentage points on the June exit of 64% and 4 percentage points up on the December '21 and March '22 exit of 62%. And this is really due to the good work of our CTO, Manoj, and his DevOps team in looking how we can implement new initiatives on storage costs and search and retrievable costs, and that's coming to a fruition now. Our direct transacting partners were up 4% to 473 at the end of September, and we have more than 3,000 indirect transacting partners at the same time. Our partner revenue churn remained very stable at sub-3%.
Thanks, Charif. When we look at our operating cash flow and a continuing trend from the prior quarters, we had, for the September quarter, positive operating cash flow of $590,000, which was up 45% on the June quarter of $400,000. This is also due to cash receipts up 19% to $5.15 million on prior quarter. We had a very strong conviction on cash collections in the month of September, and this is also aided by the USD/AUD tailwind, where we are earning the majority of our revenue in USD, and we're collecting that cash in USD also, which is providing us with a natural cash hedge when we're paying our USD hosting fees, our USD salaries and our USD suppliers and marketing costs from there. We exit the September quarter with cash at hand at $2.25 million (sic) [ $22.25 million ].
Now as we look at reinvesting for future growth, we look at our quarterly normalized operating cash flow, and you can see, we're continuing the positive cash flow quarters for June and September. And at the end of September on a year-to-date basis, we have $750,000 operating cash flow positive when we exclude the due diligence costs that we paid in Q1. Now this is opposed to the full year 2021 operating cash flow where we exited the year at plus $260,000. And we reaffirmed our guidance to remain cash flow positive for the remainder of 2022.
In 2022, we have also managed to increase our operating leverage. Whilst we continue to invest in adding capacity and capabilities within FTEs and improve our gross margin improvement initiatives, we are increasing our cost base at a lower level than our ARR and revenue increases at the same time, which is also improving our operating leverage and allowing us to reinvest in new product innovation and improvements to our current processes. When we apply the rule of 40, Dropsuite sits above 80 for the first half of 2022, and this is up from mid-60s for the full year 2021, which is in the top tier when we compare that to our fees in the market. Thank you, Charif.
Thank you, Bill, for the updates. Let's talk about our future before we conclude and open it up for Q&A. We have to remember that we have delivered results at scale with very prudent and limited working capital deployment in the last 9 years of the company, thanks to our partner-led model, which scales really well. Whereby our partners, many service providers and distributors and hosting providers are doing the selling, the marketing, the billing, the support on behalf of Dropsuite while we focus on delivering a great partner experience and a great user experience, as I explained earlier. And then when you look at the pie chart on the right-hand side of the slide, you can see that we have barely started in terms of our penetration in the core partner segment, which is the MSP segment, having about 3,000 transacting, i.e., revenue generating MSPs out of a universe for a minimum of 132,000 globally, predominantly in our [ ACV ] countries. When you combine the scale, we're able to achieve with the partner model, along with what Bill outlined in terms of the reinvestment, we have really created [ fly region ], where we're growing our ARR, our revenue and of course, our cash receipts. And then our profit and then we're reinvesting it back into the company in the form of sales expansion, product expansion, improving bench strength overall, further automation, further deployment of enterprise-grade tools to make us more productive and to grow faster.
This framework, we believe, will help us continue growing at a much faster rate of an already growing market, which is the cloud, backup and recovery market. And this growth will come in three forms: One is doubling down and tripling down on our existing business, which has still a lot of room to grow. The second is introducing new products, and I'm very pleased to mention that we have launched our new product earlier this week. It's currently enclosed data with a limited number of partners, and we'll be making the announcement either in November or in January of 2023. And finally, and importantly, we continue to progress multiple conversations around accretive acquisitions, but they need to -- they have to be high conviction because the traction we're getting from existing business plus the fact that we're really pleased that we'll be introducing new products fairly soon to our revenue streams and to our channel partners, makes us very careful on ensuring that we don't lose focus -- not just money, but also focus, time and energy on acquiring companies that don't fit us either from a quality standpoint or from a cultural standpoint. Before I conclude and talk about our outlook, I want to spend a couple of minutes to explain what kind of companies are we pursuing when it comes to acquisitions. First, the rationale is fairly straightforward. There are two main things here. One, we want to leverage all the tailwinds that we talked about earlier from cybersecurity threats to regulation to the continuous movement to the cloud. The second, and probably, I would say, equally important, we've been growing our channel really fast. So expanding our -- the share of work with our partners, that means adding new products and revenue streams to existing and new partners is, relatively speaking, a low hanging fruit because the extent of investment and support, sales and marketing is going to be limited because of the existing channel.
Now in terms of flavors of what kind of companies we're looking for, first and foremost, we are staying true to our mission of safeguarding business information, helping businesses stay in business. So this is the data protection theme. Now around it, there are multiple flavors or multiple pillars. One is doing exactly what we do, which is backup, but adding new data sources -- additional sources to back up and to protect.
The second is compliance. Bill mentioned that one main reason why our average revenue per user is increasing is because we're selling more of the higher price that have some compliant elements SKU, and we believe that we can introduce organically and also through acquisitions, potentially additional SKUs that would improve our ARPU and our gross margin.
Third, when you think about the 50 billion objects and growing that we are ingesting and backing up and searching, finding companies who have the layer of insight analytics to uncover is to businesses and our partners would be the third lever. And lastly, and also importantly, data governance, which means how do you ensure when a business has 20 SaaS applications to run their business. How do you ensure that the data is staying in the right place and is only accessible and available for the right people in the organization as well as outside the organization. I hope this gives you a better understanding of what we're looking for. We are not looking for companies that help us just increase our user count by doing exactly what we're doing. We believe strongly that we have a market-leading product today. So the focus is to introduce complementary -- logically complementary products to expand our share of work with existing and growing partner base.
And finally, I just want to reiterate a sunny outlook for the company. We all know the talk about inflation and recession. From our experience, but also from experience of people who have been in the MSP and the channel industry for 1 or 2 or even 3 decades, the channel industry -- the MSP channel industry specifically is highly resilient. So even in the worst of times, there remain a certain amount of growth, and the channel continues to be healthy, growing at a CAGR of -- north of 12% for the coming 7 years until 2030. And with the type of products we have with the tailwinds, with the quality of team that we built and we continue building, we sincerely have strong confidence in our ability to continue growing the business for the foreseeable future.
With this, we conclude our short presentation, and I'd be happy to answer any questions you would like me to answer today. Thank you.
[Operator Instructions] First one in for you, Charif. Can you please elaborate further on your future sales pipeline?
Yes. The best answer to reflect on that is the limited market share that we have in the MSP industry. So when you look at the industry, you're looking at a 2% penetration. When you look at the total addressable market of Office 365, you're talking about a sub-1% market penetration. So this is the overall landscape of where we are. So we continue to build a very strong sales pipeline, both through existing partners who are onboarding larger and larger clients, right? So historically, we were firmly in the SB, small business place. Then we devote to SMB, and now we're playing strongly in the mid-enterprise space, which is in the high hundreds or low thousands of users per customer. So in short, we have a strong funnel, and we believe we'll continue expanding that funnel by expanding our sales team and our marketing footprint globally in the foreseeable future.
Next question is, you've been adding approximately 70,000 to 80,000 users per quarter. Is there a limitation on how many you can add? And if you were to add 160,000, let's say, in a quarter, would there be needing to be extra staff on board to be able to do that level of additions?
Yes. First of all, I highly encourage the listeners today to look at our growth over the last 3 years. So historically, we used to had 20,000, 30,000 users, then we added 50,000, 60,000, and now we're adding 70,000 to 80,000 right? So that number continues to grow. The beauty of being in the cloud is that -- and having the competency is that we built a highly scalable engine to ingest data globally, as I mentioned, 50 billion and growing in [indiscernible] data center. So the incremental staff to add more users is much limited. And yesterday, we had a very well-attended Investor Roadshow or an Investor Day, and we showed how -- for example, we doubled our sales team -- sorry, our engineering team, why we tripled our revenue in the last 3 years. That is the theme that we'll continue following in the foreseeable future.
Next question is -- actually, two on geography. One, can you please give a bit of a breakdown in terms of revenue by geographies for the quarter? And then second question is, is there any form of geographic focus for your acquisitions? Are you looking at North America, Europe, for instance?
Yes. Happy to do that. If you refer to the midyear results, the detailed report, we have broken down the revenue there. If you want to get into more details, I'll give you the high level here. So the Americas contributes roughly 65% of the revenue, followed by EMEA, about 22% of the revenue and then the rest remains with APAC, which is predominantly Singapore, Hong Kong, Australia as well as Japan. We, as a company, have continued to focus on OECD countries where you have a high level of IT maturity and a much higher propensity to pay and invest in technology and that's something to continue in the future.
Now taking a page of what I just mentioned, when you think about M&A, I would say, North America is by far the most interesting market when it comes to M&A. And that will be followed with -- by certain geographies in Europe like the U.K. and Holland and then followed by Australia. So we're looking ideally for companies that are more of a Anglo-Saxons, kind of presence where you have low regulation, much higher cultural affinity, and we speak all the same language, which is English. That would be the ideal geography and profile of the companies we're looking at as we speak.
Next question is, do you have any government clients to date? And is this a sector of focus for you?
Yes. The answer is, we do have some state and local customers. State and local -- in the U.S., they have 3 levels of government. There's a federal, the state and then there is local. We do not have any government -- federal government customers because those -- are you talking about like the deep end of enterprise, which we don't cover today, but we do have a state and local, like for example, schools would be -- public school will be an example of our government business. Now the reason why we are looking forward to onboarding more customers in the gov, gov space. So we recently launched the government sanction -- U.S. government sanction data center with Amazon Web Services is that the regulation in the U.S. is such that it's not just that the government users have to be on the government data center, every single vendor in the U.S., and we're talking about thousands -- and I would say, tens of thousands of vendors that are dealing with any form of government in the U.S. have to use the government sanction data center for their business. And that's what makes us excited about doing more business in that space.
Two questions on pricing. First one is, ARPU has been going up over previous quarters. Is that from a baseline price increase? Or is that more being adding on extra services to your clients?
Yes. So to draw the longer-term picture, historically, we were selling more basic products like basic website backup, basic e-mail backup, and those had lower ARPUs. As we started shifting the mix to higher priced and, of course, higher featured products like Office 365 backup and Google Workspace backup, the ARPU started moving up at a very healthy pace. And recently, we've been seeing more customers buying the -- even the highest SKU, which combines back up with archiving, and we're seeing some very healthy mix shift to those products. That means our MSPs are seeing value in positioning that product to their end clients. Now as we look further to the future, as we look at introducing new SKUs in new products, we talked about the government data center, which -- where the ARPU will be higher naturally because it needs more handholding and more level of security clearances to do that, we expect the ARPU to continue ticking up in 2023.
Great. The next question on pricing was, you've explained how ARPU has been going up through those extra higher-level products that you've been adding. Is there the ability or have you been able to so far put through price rises on the baseline product?
Yes. So far and historically, with few exceptions, we have rather than focusing on increasing the price of the base SKU, what we have been doing is introducing higher price and, of course, higher feature SKUs and then gently pushing our partners to take upon those SKUs. And I believe that this kind of approach will save us a lot better. I mean just to give you an example, by July this year, the highest price SKU has eclipsed any other SKU in terms of revenue contribution to the company. So that's the strategy that we're focusing on, introducing new SKUs and shifting the [ ARPU operates this way. ]
How that all flows down into margins? There's obviously a very good improvement in the margin quarter-on-quarter. Do you see much more to be able to come through in terms of that improving margin either from growing ARPU or from continuing to reduce costs?
Yes, we do look at multiple ways to improve our ARPU, our gross margin, in fact, everything in metric in our business. So what -- the one thing I want to draw your attention to before we talk details about margin is that what we do as a company is, what -- we are basically giving gross margin away by giving the discounts and the rebates to our partners. In exchange, we're getting some really strong operational leverage, and you can see it in our OpEx, right? So that's something I want to make sure I draw your attention to first. Now when it comes to the gross margin, we will continue looking at areas to improve the gross margin without giving any specific outlook on how it would look like.
A couple more questions have popped up around that enterprise space and the size of your customers. So one is, you're engaging with university or tertiary, secondary education facilities at all?
We have. Now we have approached that sector with caution. While we -- as I mentioned earlier, we do have universities, we have schools that are part of our customer base working through our partners. At the same time, we haven't built an education vertical specific strategy because that vertical is the most sensitive vertical of all verticals. That, of course -- and the NGO vertical. So frankly, we've a project where we would deliver the product and deploy it, but without doing any significant discounting and price sales.
The next one might be -- maybe a little bit more detail, and we can follow up with this one offline. But the question was, is able to give a little bit of a breakdown on revenue by size of user enterprise. So let's say, break it up between enterprises of more than 500 and less than 500, let's say.
Yes. Perhaps, we should -- I mean as we continue growing and expanding in multiple segments, we should look forward to doing this maybe in 2024, where we present that to our investors and shareholders. I can tell you a couple of things. One, as I mentioned earlier, we still have a significant amount of users in the micro business space. We have also seen in the last 3 years, significant and the fastest-growing segment has been between 10 to 200. And that's been the core focus for us working with our MSP partners. And most recently, the fastest-growing segment has been between 200 to 2,000 customers in [indiscernible], remind you that starting from a smaller base. So I would say that the focus going forward will be less and much less on the micro business, which is per [ try ] employees, a lot more on the proper SMB, which has been -- which has grown significantly in the last few years and of course, on the higher segment, about 200 or 500 users.
The growth in customers that have come on board to Dropsuite over the past year or 2, have they come from other providers and you've been able to provide better service? Or are they first-time users of backup technology?
This is what makes our segment really exciting. I would say, about 80% to 85% is white space. It's coming from white space. So our competitor was nothing. And everybody now over time -- remember, this is a massive industry and massive amount of users. Overtime, there has been more and more requirements to back up, whether they had like a bad incident, whether they're getting more regulated, whether it's cyber insurance, like I mentioned earlier.
So about 80% to 85% is white space so far and then 15% to 20% is the displacement of the competition. And what's really interesting, we do talk to the Gartner analyst, one of the well known IT research company, probably the biggest in the world, and they're firmly focused on the big enterprises. And they're saying, even in the big enterprises, they're still seeing 40% to 45% penetration of Office 365 backup, and they're seeing continuous interest by enterprises to back up cloud applications like Office 365. In summary, we still have quite a bit of white space to conquer.
Two more questions in the queue at the moment for Charif. One of those is for Bill. The latest quarter-on-quarter growth is a little bit lower in constant currency terms in the past 3 quarters. Any explanation as to why growth has moderated?
Yes. Thanks, Craig. I think if you look at the quarter-on-quarter and then the PCP growth over the last year, we can see that we've been growing at 60-plus percent year-on-year as well. So the growth that we've had in Q3 of that 11% on constant currency is within our expectations. The last 3 quarters have been within our expectations as well. So we don't see any requirement there to shift anything that we're moving on at the moment. I think that this will come back to us, and as I mentioned, just within our expectations.
Thanks, Bill. Last question I've got at the moment for you, Charif, is around the momentum of the business, and I'll paraphrase the question a little bit. There's been a lot of high-level talks about data breaches with Optus, hiding data breaches which happened with Uber. Are you starting to see a lot more momentum come to you from people that looked at back up and the risk of cyber security?
Yes, for sure. Now keep in mind that Optus sounds huge because it's happening in our base, which is Australia. But I mean, as late as -- I think in December 2019, the U.S. government was hacked and that was a huge [ deal ] through a company called SolarWinds and even Microsoft was affected. So this is a continuous trend. And what I find really interesting, but at the same time alarming is, we continue seeing fiber and backup budget increase. While we also, at the same time, continue to see increase in cybersecurity incidents and data breaches, which lead me to conclude -- and this is a personal conclusion here that I wouldn't be surprised to start seeing more government regulation to dictate the security posture of companies, right? And of course, it doesn't start with the small business, it starts with the massive companies, the enterprise. For example, in Australia, the government has designated about 1,500 institutions, organizations, governmental and private systems of national security, and they are almost starting to dictate the security portion of those companies. So in summary, this is a long-term tailwind, and every now and then, you're going to hear a high-profile story. What you're not hearing about is the hundreds and thousands of other stories that are happening to people like you and I, where we don't -- they are not reported and nobody knows who they are because they're small and medium businesses.
Right. Charif, Bill, thank you for that. That's all the questions that were in queue. Charif, I'll hand back to you for any closing remarks.
Thank you so much, Craig, Bill, and most importantly, those who have attended. I think we have a record number of attendees today. So I'm really grateful for that. I mean what I hope you come out from this webinar and from reading our announcements overall is that this is a company at the right time at the right place with the right products and the right team. And I cannot tell you how much I'm looking forward to continue updating you on our traction in the next few quarters.
With that, I conclude and thank you again for attending.