Datto Holding Corp.

Good day, and thank you for standing by. Welcome to the DATO first quarter 2021 earnings results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1 on your telephone. In the interest of time, please limit yourself to one question and one follow-up question. and please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Mr. Ryan Burkhart, Director of Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for joining us today to review Gatto's first quarter 2021 financial results. With me on the call today are Tim Weller, Chief Executive Officer, and John Abbott, Chief Financial Officer. During this call, we may make statements related to our business that would be considered forward-looking statements under federal securities laws, including projections of future operating results for our second quarter ending June 30th, 2021 and full year ending December 31st, 2021. As a result of a number of factors, actual results may differ materially from those projected in such statements. These factors are set forth in the earnings release that we issued today under the section captioned forward-looking statements. And these and other important risk factors are described more fully in our reports filed with the Securities and Exchange Commission. We encourage all investors to read our SEC filings. The following statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. In addition, data undertakes no obligation to publicly update or revise any forward-looking statements made here. Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures is available in our first quarter 2021 earnings press release, which can be found on our investor relations website. A financial supplement and webcast of today's call are also available on our investor relations website. I would also like to inform you that we will be participating in several investor conferences coming up in June, including the William Blair Growth Stock Conference, the Evercore ISI T&T Conference, and the Bank of America Global Technology Conference. Please reach out to me if you're interested in joining our schedule. With that, I'd like to turn the call over to our Chief Executive Officer, Tim Weller. Tim? Thank you, Ryan, and many thanks to everyone for joining us on the call this afternoon. We are excited to report strong Q1 results and an improved outlook for 2021. I'll begin with a few highlights from the quarter, followed by comments on Datto Commerce, our latest product launch, and then I'll update you on two key themes for 2021, cloud and security. Finally, I'll turn the call over to John to discuss our financial results and guidance in more detail. This year started on a strong note as momentum from Q4 carried into Q1 with total revenue growth of 16% and subscription revenue growth of 17% year over year. We saw strength across our entire product suite, led by continued rebounding of our BCDR products and strong growth in our SaaS protection and RMM products, driven by the powerful trends of digital transformation and cyber resilience. We ended the quarter with $573 million of ARR, which represents a higher sequential increase than in the previous quarter. We view this as a key leading indicator of revenue reacceleration. In Q1, adjusted EBITDA was $47 million, and we generated more than $24 million of free cash flow, representing our fourth consecutive quarter of positive free cash flow. In addition, the number of MSP partners we served grew to 17,300, up 300 from the end of 2020. As you know, we are the largest pure-play IT solutions provider to the MSP community, and we are dedicated to serving this channel every day in our sales and support motions and in creating technology which is purpose-built for the managed service provider channel. We provide MSPs with mission-critical, sell-through solutions for their SMB customers, software tools to run their own businesses efficiently, and a wealth of resources to grow their businesses and expand their margins. We never go around in MSP to sell directly to their SMB customers, and that has established unique, highly aligned relationships that we have spent years building one by one. We are more than just another vendor to MSPs. We are their trusted partner. No other company of our scale can deliver on that promise to MSPs, and it creates a major barrier to entry for potential competitors. Let me now briefly touch on our most recent product launch, Datto Commerce, into the North American market. Datto Commerce is a real-time quoting and procurement platform for MSPs that increases their efficiency and profitability. It simplifies how MSPs quote, sell, and procure. With Datto Commerce, we followed our well-established playbook of how we entered networking, RMM, SaaS protection, and security with small acquisitions of great teams and differentiated technology that we tailored for MSPs. We purchased the commerce technology in the middle of 2020, and we operated it in Australia and New Zealand last year while adapting it to the unique demands of the North American market before commercially launching in April. Consistent with our open ecosystem philosophy, Datto Commerce will work on virtually any PSA or RMM platforms partners are using. And of course, it integrates seamlessly with Datto's PSA and RMM software. I should also give a shout out to the Datto PSA and RMM teams for landing in the upper right quadrant of the Canalys Research point of view grid. Meanwhile, Forrester Research recently concluded that the average payback period for data partners on an investment in our integrated solutions of unified continuity, PSA, and RMM is less than six months with a very high ROI. Before I turn the call over to John to run through our financial results and outlook, I wanted to leave you with some thoughts on two key themes for 2021, cloud and security. Datto helps MSPs and their SMB clients in securing digital assets, both applications and data. We protect those assets, help manage those assets and validate that protection, and help users to connect to those assets. Protect, manage, connect. All our products work together in that common goal of securing digital assets. Let's talk about cloud. Our software services are cloud managed and delivered as SaaS applications. We operate our own exabyte scale data cloud that gives us the advantages of cost, flexibility, and control. Our partners and the SMB clients they serve are at various stages of their own cloud journeys, but will operate for the most part in hybrid cloud environments for the foreseeable future. What we offer our partners is the ability to secure digital assets in a hybrid cloud world, no matter where data and applications live. We believe our ability to offer a unified, predictable experience across disparate environments is important to our partners, who in many cases manage digital assets that run on-premises for high performance, in private clouds, in M365 and Google workspaces, and sometimes in the public cloud. The next step for us in hybrid cloud protection is our Azure continuity product, which will give our partners with public cloud workloads the same highly reliable Datto continuity performance and robust security that they have come to trust from Datto. Our Azure product is on track for beta and Q2, and partner demand is very encouraging. We expect Azure to broaden our market opportunity for unified continuity and contribute to our ongoing reacceleration. I look forward to sharing more in coming quarters. Finally, let's talk about security. Continuity, as we deliver it, fits squarely into any security framework because we're involved in application and data recoveries every week, many of which are a result of ransomware or other cyber attacks. Continuity used to be primarily providing protection against server crashes, internet outages, or the occasional natural disaster. Now it's defense against active cyber threats. I have always described continuity as the last line of defense of security. With our launch of ransomware for RMM in Q4 and the acquisition of Bitdam in Q1, we are accelerating our path into other areas of security beyond just recovery. With each new offering, we plan to bring MSPs strong margin opportunities as they protect their SMB clients and monetize security. The early evidence is good. Partner demand for our new ransomware detection and isolation feature for Datto RMM continues to grow, with just under 500,000 endpoints now protected, almost double from 250,000 less than a quarter ago. We're also helping our partners shape their cyber resilience roadmaps with thought leadership for MSPs in the form of content, webinars, and events, like our recent MSP Tech Day on cyber resilience. The event delivered a deep dive into cybersecurity, business continuity, and incident response to help MSPs and their SMB clients protect against growing cyber threats. Our leadership in security expands beyond our sponsored events to the international arena, where Datto serves as a founding member of the Ransomware Task Force, a broad coalition of experts in industry, government, law enforcement, and international organizations coming together in the fight against ransomware. The Task Force recently released its report and an event where the U.S. Secretary of Homeland Security addressed an audience of U.S. policymakers and others with recommendations on how to confront this urgent national security risk for countries around the world. Our own CISOs participation shaped the Task Force guidance for MSPs and SMBs to recommend financial funding and support to help MSPs develop cyber resilience capabilities, among other critical measures. Closer to home, we continue to make ever increasing investments to ensure that our own infrastructure practices and products are secured to the highest standards. In summary, I couldn't be more pleased with our Q1 results and see good momentum across the business. We remain as committed as ever to our MSP partners and see many opportunities to help them grow their businesses with margin-enhancing sell-through products and to operate more efficiently with our PSA, Commerce, and RMM products. Cloud and security have always been fundamental to Datto, and we'll continue to invest in these areas to abstract away their inherent complexity and turn them into growth and margin opportunities for our MSP partners. Thank you for your interest in Datto and the MSP story. With that, I'll turn the call over to John to take you through our financial results and outlook. John?

Thank you, Tim, and good afternoon, everyone. We're pleased to report strong first quarter results. And as I review our numbers today, please note that I'll be referring to non-GAAP metrics unless otherwise specified. You can find a reconciliation of non-GAAP measures to GAAP measures in the press release that we issued this afternoon and in the supplemental financials posted on our website. Our first quarter results reflect strong execution from our team and continued momentum across our whole suite of products. First quarter recurring subscription revenue was $135.6 million, up 17% year over year, which includes a benefit from favorable foreign exchange rates of approximately 3%. Subscription revenue comprised 94% of our total revenue of $144.9 million in the quarter, exceeding the high end of our previous guidance. ARR at March 31st was $572.5 million, up 15% from $498.4 million a year ago, and importantly, increased $30 million sequentially. This included a benefit of approximately $4 million from our annual ARR currency exchange rate recalibration. Excluding this FX impact, ARR increased $26 million sequentially, up from $20 million in Q4 of 2020 and $16 million in Q3, providing continued evidence of the reacceleration of the business. We ended the first quarter with more than 17,300 MSP partners, a net increase of 600 year-over-year and an increase of 300 sequentially. We're encouraged by the return to growth in MSP partners in the first quarter and believe the increased churn associated with the pandemic is now largely behind us. We also grew the number of MSPs contributing over $100,000 in ARR to more than 1,150, up from 1,000 a year ago. Our sell-through model continues to drive strong growth within our installed base of partners. As they roll out Datto solutions to more SMBs, those SMBs consume more data or seeds, and they both adopt more Datto products. Our first quarter gross margins of 75% were up from 71% in Q1 2020, driven by the operating leverage we're realizing in our 24 by 7 support function and increased efficiencies in the infrastructure supporting our software solutions. First quarter operating expenses were $69.6 million, a slight reduction from Q1 last year, reflecting a lower cost structure during the pandemic. Within OPEX, sales and marketing expenses were $29.6 million, a slight decline from $31.3 million in Q1 2020. R&D expenses were $17.6 million, an increase from $16.4 million in Q1 2020. G&A expenses were $20.2 million, an increase from $19.5 million in Q1 2020, and now include public company costs. And finally, depreciation expense within operating expenses was $2.1 million compared to $2.5 million in Q1 2020. operating income for the first quarter was $39.4 million, or 27% of revenue, compared to $18.6 million, or 15% of revenue, in Q1 2020. Adjusted EBITDA for the quarter, which excludes stock-based compensation, restructuring costs, and transaction expenses, was $46.9 million, compared to $25 million in Q1 2020. In recalibrating our cost structure during COVID and as a result of ongoing efficiency initiatives, we expanded our adjusted EBITDA margins to 32%, a significant increase from 20% in Q1 2020. As we discussed on our last earnings call, we're investing in cloud and security to drive revenue growth, and as commercial activity returns to pre-pandemic levels, we expect adjusted EBITDA margins will revert to levels in the low to mid-20% range. Free cash flow in the quarter was positive $24.5 million compared to negative $15.2 million in Q1 2020. and we ended the quarter with just over $149 million in cash. Turning to guidance for the second quarter in full year 2021, the solid profitability and structural operating leverage in our business provides ample capacity for us to continue investing in technology innovation, go-to-market resources, and scaling infrastructure to support and sustain our long-term growth and expand our leadership position in the market. Our 2021 guidance continues to include the impact of incremental investments in the important areas of cloud and security. For the second quarter of 2021, revenue is expected to be in the range of $146 to $148 million. Adjusted EBITDA is expected to be in the range of $34 to $35 million. For the full year 2021, we're raising our revenue guidance to a range of $594 to $600 million, and we're also raising our adjusted EBITDA guidance to a range of $134 to $138 million. Our Q2 revenue guidance represents year-over-year growth of 18% at the midpoint, inclusive of a 3% FX tailwind, and our full-year revenue guidance represents year-over-year growth of 15% at the midpoint, inclusive of a 2% FX tailwind. It's important to remember that Q2 2020 was our lowest revenue quarter last year as a result of COVID impacts, making that an easier comparison this year. We expect subscription revenue to account for over 90% of total revenue in 2021 and capital expenses to be in the high single-digit percentage range of revenue. As a reminder, for non-GAAP income taxes, we use an effective tax rate of 25%. For calculating EPS, we estimate approximately 170 million fully diluted shares for Q2 and 175 million fully diluted shares for the full year. In closing, we believe our Q1 results and 2021 guidance reflect the ongoing reacceleration of the business. We're very excited about our momentum going into the rest of the year and look forward to reporting on our progress in the quarters to come. With that, we'll open up the call for questions. Operator?