$DSE provided a qualterly business update, first out of the blocks in my RL and SM portfolios, ahead of an investor webinar tomorrow morning.

Quarterly Update

Their Highlights

 Annual Recurring Revenue (ARR1) of $34.3m, up 35% on the Previous Corresponding Period (PCP)

 ARR was up 3% on prior quarter (QoQ), with momentum impacted by the stronger AUD:USD exchange rate. ARR was up 7% QoQ on a constant currency basis

 Q4 FY23 operating cashflow of $0.27m and unaudited FY23 cashflow of $2.3m

 Monthly ARPU of $2.46 down 2% QoQ due to AUD appreciating and up 9% on PCP

 Product gross margin of 70%, up 2% QoQ and inline with PCP

 Onboarded 26 new direct and 231 indirect transacting partners

 Total users now exceed 1.16 million

 Appointment of Eric Martorano as an independent non-executive director

 DSE remains well-funded with $24.3m cash as at 31 December 2023. 

My Analysis

$DSE is making good progress when viewed on a PCP basis; however, this was a softer Q-o-Q result which appears in part due to FX impacts. However, at the Q-o-Q cash level payments (+12%) expanded while receipts (-4%) contracted reflecting a significant reduction in cashflow from operations, tipping $DSE back into consuming a small amount of overall cash. (It is unclear that this is strictly a seasonal pattern, so I do need to go back to last year and have a look.)

We are of course always going to see q-on-q variability, however, the reason to hold these smaller cap companies at the inflection point is to see them blast through and generate stronger margins and operating leverage. So today's result does little to address this question over $DSE.

In summary, for me, there is no basis in today's result to take any action. Ideally, I'd like to be adding to my small RL and SM position. I'll attend tomorrow's webinar but for now, $DSE is a hold for me - albeit one towards the lower end of my conviction list.

Disc: Held in RL and SM

Just noticed that Topline Capital Partners LP (a west coast US based boutique investment management firm) has increased its stake in $DSE from 27.4% to 28.5%. They seem to be easily able to do this whenever there's a queue of sellers significantly exceeding the buy orderswithout moving the price.

18 months ago they were just at 20%, so clearly are following a determined path to gobble up stock that's available. Despite this holding, they don't have anyone on the Board.

One to watch, I think.

Disc: Held

Following my Straw this morning, I thought I'd add some further detail from the investor call:

Cash Flow

CFO highlighted that the very strong receipts will not be repeated in the next Q ("next Q receipts will be lower"). The strong result was due to a focus in the last Q on collections. Charif, however, reiterated that $DSE will be both cashflow positive and EBITDA positive for the full year.

Churn Event

The large churn event was due to a Latin American hosting service de-platforming $DSE as part of going out of business due to competitive pressures. This was in part due to strength of $US in which $DSE products are priced (and presumably high inflation/decline of the national currency). Charif emphasised that this legagy customer was from 2018, has delivered a profitable contribution, but that $DSE focus is on developed countries, so that have no customer support in that country. A futher 40,000 customers will come off the next Q from this same event.

I asked about the definition of Partner Revenue Churn, and Charif confirmed that this is revenue from partners at the start of the year that is still in place at year end. He stated this is the appropriate metric because the MSPs are $DSE's customers, not the end customers. He further said that the underlying end customer churn rate is in the range 5-7% which is good.

Competition from MS Syntex

Charif said they are not seeing any change in customer behaviour. Material on the MS Syntex threat was included in the appendix. He reiterated the "single point of failure" key message and asserted that this is an important consideration for CIOs ("large and small"). While it is early days, Charif remains very bullish on this. He drew the comparison that Microsoft is active in cyber security offerings, but that there are a lot of very successful cyber security firms, continuing to grow strongly. "This is not our Netscape moment".

M&A

Charify highlighted that this is sbout identifying complementary product capability for cross-sell and not acquiring customers. He is adopting a disciplined approach.

My Key Takeaways

Overall, a good result with nothing of concern in the presentation or Q&A.

Just one thing to note, as I wondered in my initial straw, the quarter's receipts are unusually strong, and so we will see a softer result in the next Q more in line with the recent trend.

Disc: Held in RL and SM. Will be increasing my position in line with my investment strategy to build a position over time.

ASX Announcement

$DSE issued their quarterly report this morning, with an investor call later this morning.

Their Highlights

• Annual Recurring Revenue (ARR1 ) of $33.4m, up 10% on prior quarter (QoQ) and 44% on the previous corresponding period (PCP)
• Q3 FY23 operating cashflow of $1.39m
• Monthly ARPU of $2.57 up 9% QoQ and 17% on PCP
• Product gross margin of 68%, stable with prior quarters
• Onboarded 35 new direct and 209 indirect transacting partners
• Gross paid user additions of 86k, offset by deactivation of 53k from a low ARPU, legacy partner, resulting in a net increase of 33k users
• Total paid users now exceeds 1.1 million
• DSE remains well-funded with $24.6m cash at 30 September 2023.  

My Analysis

$DSE continues to advance steadily.

Pleasing to see is very decent cash generation, with closing cash up $1.6m on the previous Q, indicating good cost control meaning more of the strong receipts for the quarter staying put in the bank account. This is now the 6th consecutive quarter that the closing cash balance has increased,...we're up to $24.56m from the low point of $21.344m in 1QFY22, but this is the first time the cash balance has increased by more than a few hundred 000s.

The churn event is something to keep an eye on, although the report highlights that this is a legacy low ARPU customer. Certainly the strongly growing ARPU is consistent and an indication of the contribution of some of the higher value products launched over the last year or so.

On churn, Charif's preferred metric is Partner Revenue Churn, which is reported as <3%. I'm not sure what I think about this metric and keen to hear other StrawPeople views. Did we discuss it with Charif last meeting?

The strength of the result can be seen in the cash flow trend chart below, with the combined effect of strong receipts and control of costs driving a step up in cash flow.

So I'm left wondering, is this just a good quarter given that there is noise in receipts and payments from Q to Q, or are we really now starting to see the business scale and the contribution of higer value products coming through? The next quarter or two are needed to confirm the trend, but this is looking positive.

Disc: Held in RL and SM

This afternoon I had an interesting conversation with someone in my network who is co-owner/co-founder of a boutique cyber-security services firm. More generally, it was an eye-opening/jaw-dropping discussion. But my point here is to share key points regaring $DSE and the Microsoft back-up announcement.

My contact was not knowledgeable about $DSE (and is not an investor in it) as his focus is on larger enterprise clients and goverment agencies. However,he is very well-credentialled, sitting on the advisory board as a cyber-security expert to a highly respected Australian IT institution, so I attach some weight to his insights, as I would not normally write up opinions of non-expert acquaintances.

When I shared what was going on with MS-365 backups and the speculation about the impact on $DSE's value proposition, he did not hestiate and was unequivocal. He stated that the principal of "defence in depth" would mean that a completely independent back-up service would always be valuable from a business continuity/resilience perspective, for some of the reasons we have speculated about here. He believeds there would continue to be a large and growing market for such a service.

He went on to say that cyber attackers usually follow a dual strategy of seeking to defeat firewalls and go first of all for the back-up service. A back-up hosted in a completely separate environment, governed and controlled by a separate entity would be a more robust proposition. This would particurly the case if the service maintained compliance with the various global cyber-security standards. Such a service would also likely have advantages in terms of cyersecurity insurance premiums - a rapidly emerging area. He is also involved in this as a service line, as part of what his company does is assess cyber-risk of comapnies seeking insurance.

While he admitted that many clients might settle for a back-up service provided by the SaaS provider, he would always recommend his clients to view an appropriately-credentialled, completely indepedent service as superior, and this would be reflected in an actuarial assessment.

He fully agreed that $DSE may have a job of work to do to educate their MSP customers, as there is a high degree of variability in capability on security awareness across the MSP industry. This is in large part because of the limited availability of security talent. He cited that there is a shortage today of 30,000 IT securiy professionals across Australia, and one of his biggest areas of focus at the moment is defending his existing staff from poaching attacks my competitors.

Ironically, I have reduced by $DSE position in the last few days, simply because I wanted to increase some other positions, and it is lowest on my merit order for allocating capital (There being no cash in my SM position, and in RL I am "at weight" in my microcap / risky portfolio, so am unwilling to add more cash.) I'm not sure that today's conversation would have changed my decision, had it occurred a few days earlier, but it does strengthen my conviction somewhat regarding my remaining $DSE holding.

I regret I cannot give referenes to back this all up, as it was a private conversation. But this is someone with impeccable credentials whose opinion I trust.

So, when we meet with Charif, one question to ask in addition to understanding the MSP response to $MSFT Back-up, is to probe how security-savvy his MSP customers are, and what EXTRA effort he believes is required to educate them?

Just off the $DSE call.

CEO Charif El-Ansari stated up front that they'd received a lot of investor questions following the $MSFT Inspire Partner Conference and that he'd address those questions at the end of the presentation before moving to Q&A.

The main body of the presentation tracked per the slides with nothing exceptional,other than a remark about continued churn of about 15,000 seats of a low ARPU legacy customer/partner, who still has an undefined number of users to "offboard". It doesn't sound material, although there was a reference to it slightly flattening the receipts growth curve. (Every little helps!)

To $MSFT

Charif made clear that this has been in the public domain for around 18 months, although it is being given profile at this year's partner conference because Syntex is being showcased. Syntex facilitates extraction of data from $MSFT products for use by AI, and 365 Backup is linked to that.

He stated that he does not consider that 365 Backup impacts the core proposition of $DSE. This is because 365 Backup still uses $MSFT Azure infrastructure, and the distinctive point of $DSE is that it is completely independent of $MSFT, being hosted on AWS.

He made some secondary points including that $DSE is advantaged at a price point of $3/seat versus $5-8/seat for Syntex.

Regarding the ability of partners to also access 365 Backup for their non $MSFT aps and data that connect via $MSFT APIs, this would only be the case if this was done on the Azure platform, so he reiterated the importance of the indepedence of $DSE.

Overall, it was a confident and articulate response dealing with the matter head-on.

Other Items

• Sales and marketing for balance of FY23 to focus on 365, Gov Cloud and QBO products
• Highlight that these new products have been thoroughly developed with partners and are high ARPU products
• Expects staff costs in H2FY23 to be below H1FY23
• Expects solids positive EBITDA and FCF for the Full Year, highlighting the reinvestment of cash into sales and marketing
• Expect FY margins to be ahead of FY22, and to sustain and improve these over the medium to long term
• Continues to look at M&A, however, the opportunities to date have been too highly priced and they've not been willing to pay.

The Usual Cash Flow Trends

Herewith my usual CF trends for Quaterly and Trailing Twelve Month (TTM) views.

Update on My Key Takeaways from this morning

It will be interesting to see how the new products drive ARPU, particularly Gov Cloud in the US and QBO backup.

Regarding $MSFT, only time will tell how much stock customers place on having a true independent back up. If the risk you are seeking to avoid is a cyber attack, then as a layman (and not an IT security expert), true independence has some value. I have no way of assessing this further, and ultimately the voice of the customer will decide. I'd imagine some customers might be comfortable with the $MSFT solution on its own, in which case it will be interesting to see if Charif's assertion about the advantaged $DSE price point holds up as a second line of defence in partner marketing and, indeep, if it matters enough to partners. The partner impact is an area that wasn't really explored.

I did - after all that has transpired in the day - increase my RL position to a total of 1%. I'll leave my SM holding where it is, as its already 5.8%, and I usually run at between 3-5 to 1 ratio between SM and RL weightings for most holdings.

Ahead of this afternoon's call, $DSE have issued their 2Q report.

ASX Announcement

Their highlights

 Annual Recurring Revenue (ARR1 ) of $30.4m, up 8% on prior quarter (QoQ) and 51% on the Previous Corresponding Period (PCP)

 Q2 FY23 operating cashflow of $0.34m

 Monthly ARPU of $2.35 up 2% QoQ and 13% on PCP

 Product gross margin of 69%, stable with prior quarter

 Investment in expanded global sales staff in 1H FY23 anticipated to accelerate growth

 Well-funded with $23.0m cash at 30 June 2023 

My KeyTakeaways

Solid results across the board with an increased closing cash balance.

$DSE is now in a position where it can reinvest operating cash to drive growth. It will be interesting to see if the "anticipated" acceleration pans out.

$DSE SP has run hard over recent months. Should there be a significant pull back, I'd like to increase my small position, but I'm in no hurry.

Disc: Held in RL (0.75%) and SM