BLZE - NASDAQ

Thank you for standing by. My name is Danika, and I will be your conference operator today. At this time, I would like to welcome everyone to the Backblaze Second Quarter 2025 Earnings Call. [Operator instructions] Thank you. I would now like to turn the call over to Mimi Kong, Head of IR. Please go ahead.

Thank you. Good morning, and welcome to Backblaze's second quarter of 2025 earnings call. On the call with me today are Gleb Budman, Co-Founder, CEO and Chairperson of the Board; and Marc Suidan, Chief Financial Officer. Today, Backblaze will discuss the financial results that were distributed earlier. Statements on this call include forward-looking statements about our future financial results, the impact of our go-to-market transformation, sales and marketing initiatives, cost- saving initiatives, results from new features, the impact of price changes, our ability to compete effectively and manage our growth and our strategy to acquire new customers, retain and expand our business with existing customers. These statements are subject to risks and uncertainties that could cause actual results to differ materially, including those described in our Risk Factors that are included in our quarterly report on Form 10-Q and our other financial filings. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them, except as required by law. Our discussion today will include non-GAAP financial measures. These non-GAAP measures should be considered in addition to and not as a substitute for our GAAP results. Reconciliation of GAAP to non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC. You can also find a slide presentation related to our comments in the webcast, which will be posted to our Investor Relations page after the call. Please also see our press release or presentation for definitions of additional metrics such as NRR, gross customer retention rate, and adjusted free cash flows. Finally, we will be participating in the Oppenheimer Technology, Internet and Communications Conference on August 11. Thank you for joining us, and I would now like to turn the call over to Gleb.

Thank you, Mimi. Good morning, and thank you, everyone, for joining us today. Backblaze delivered a strong Q2, exceeding both the revenue and adjusted EBITDA guidance for the second quarter in a row. Total revenue was $36.3 million, up 16% year-over-year. B2 revenue was $19.8 million, up 29% year-over-year. Adjusted EBITDA margin doubled year-over-year to 18%. As we outlined last year, our focus has been to accelerate B2 growth and become adjusted free cash flow positive. We've accelerated year-over-year B2 growth from 22% at the end of last year to 29% this past quarter, and we remain on course to be adjusted free cash flow positive in Q4. This marks an important step as we continue our progress towards becoming a profitable Rule of 40 company. Now what's behind these numbers is the value we provide to customers: our increased pace of innovation, our go-to-market transformation, and our incredible opportunity with AI. Regarding the customer value we provide, a recently published report we commissioned from independent analyst firm Enterprise Strategy Group found that Backblaze B2 is up to 3x more cost efficient and takes up to 92% less time to manage data compared with competitors, up to 3x more cost efficient and up to 92% less time to manage. That is significant customer value. We also continue to hear from customers frustrated with other cloud providers for their surprise fees. In fact, over 80% of organizations using competitors report unexpected storage charges. In today's cost-conscious environment, can you imagine having to explain to your CEO, CFO or Board that you had significant cost overruns because your cloud provider has surprise storage charges? At Backblaze, our predictable pricing and ease of use consistently set us apart. It's a key reason customers switch to us and stay with us. Now let's talk about our increased pace of innovation. On our last earnings call, we introduced B2 Overdrive, which delivers the highest throughput performance per dollar in the market. In early Q3, just 2 months after launch, we've already signed our first six- figure B2 Overdrive customer, a clear indicator of its strong product market fit, and we're thrilled to help customers with their high throughput performance needs. We also announced a suite of new tools to help customers protect and manage their data. Anomaly Alerts uses AI to detect suspicious data transfers, helping customers spot potential data exfiltration or ransomware early. Enterprise Web Console with role-based access controls makes it easier for larger companies to manage access and stay aligned with

Thank you, Gleb, and good morning, everyone. We are excited by our second quarter results with both revenue and adjusted EBITDA beating the high end of our guidance. This is the second consecutive quarter of beating guidance on both revenue and adjusted EBITDA. The combination of our zero-based budgeting exercise, our go-to-market transformation and the AI revolution, including a significant AI customer, is driving these strong results. It's hard to believe, but next week marks my 1-year anniversary with the company. Looking back, I'm incredibly proud about the results that we have achieved. When I started, I conducted a thorough assessment of the situation, consulted with our leading analysts and with investors, and worked with Gleb and the Board to lay the groundwork for: one, solidifying our balance sheet; two, making Backblaze a sustainably profitable company; three, accelerating revenue growth. The good news is we've addressed all three of these objectives at an incredible pace. Here is a quick summary of our achievement. First, on solidifying our balance sheet, we aggressively reduced the cash usage and recapitalized the balance sheet with a secondary offering in November of 2024. We also established a new line of credit this quarter, giving us further financial flexibility. Second, on being a sustainably profitable company, we shifted our focus from adjusted EBITDA to adjusted free cash flow, which incorporates our capital expenditures. We conducted a zero-based budgeting exercise, freeing up $8 million in expenses for 2025 and strategically redeploying nearly half of those funds to drive more productive growth. We remain on track to achieve our guidance of becoming free cash flow positive in Q4 of this year. Our subsequent aim will be to achieve GAAP net income positivity as operating leverage kicks in. Third, on accelerating revenue growth, we launched a go-to-market transformation. This has resulted in 2 consecutive quarters of increased B2 revenue growth, including a significant 600 basis points acceleration in Q2 over Q1. While these are phenomenal results, I consider this just the first phase of our transformation with plenty more to come. We're continuing to focus on growing B2 in the future and are incredibly proud of the team's success in moving the needle so quickly. These pillars of our transformation set the foundation for Backblaze to become a Rule of 40 company. Now turning to our results for the quarter. Revenue finished strong at $36.3 million, a 16% year-over-year increase. B2 revenue growth climbed to 29% as we continue our momentum with another quarter of increased growth. This outperformance was driven by solid direct sales bookings bolstered by strong AI tailwinds, including a significant AI customer. Our Q2 investor presentation, available on the IR website, outlines the four drivers behind the B2 revenue growth, which comes from: net organic data growth; direct sales, cross and upselling; new logos from self-serve; and new logos from direct sales. This chart provides clarity on what drives our revenue growth. Computer Backup revenue grew 4% year-over-year, driven by the October 2023 price increase, of which the benefit has largely ended. In the second half of 2025, we see Computer Backup declining in the low to mid-single digits on a quarterly basis. We continue to see areas for growth and are exploring options to improve the business. But at this point, we feel it is prudent to provide this outlook. Moving on to net revenue retention, or NRR. For the quarter, overall NRR was 109% versus 114% the same period last year. For B2 Cloud Storage, NRR was 112% compared to 126% in the prior year and 117% in the prior quarter. As a reminder, the decline is mainly due to the price increase lapping and it will continue to roll off the next quarter as we calculate NRR with a trailing 4-quarter average. Computer Backup NRR is 106% compared to 105% in the prior year. Gross customer retention continues to be strong at about 90% across B2 and Computer Backup. Gross margin improved to 63% from 55% in the prior year. As we disclosed last quarter, we evaluated the estimated useful life of our fixed assets based on more recent operational data and found that our hardware lasts an estimated 6 years instead of the 3 to 5 years estimate that we previously were using. This change better reflects our business operations and accounts for most of the gross margin improvements this quarter. The remainder of the margin expansion was from our technical operations team driving more benefits of scale across our infrastructure. As a result, adjusted gross margin improved to 79% from 78% last year. Our operating expenses continue to decrease as a percentage of revenue as operating leverage kicks in. Operating expenses improved to 82% as a percent of revenue from 86% in the prior year. We expect continued improvement as we scale further. Q2 adjusted EBITDA margin doubled over the prior year to 18% and beat the high end of guidance of 16% by 200 basis points. Adjusted free cash flow for the quarter came in at negative 11%, a 1,000 basis point improvement from negative 21% a year ago. We are on track to be adjusted free cash flow positive in the fourth quarter. Both adjusted EBITDA and adjusted free cash flow margins benefited from stronger revenue performance and robust cost controls. Looking at the balance sheet, we ended the quarter with $50.5 million in cash and marketable securities. In June, we announced a new $20 million line of credit with Citizens Bank. This new facility comes with industry standard covenants related to EBITDA attainment and maximum debt leverage ratios. We plan to use this facility for equipment capital expenditures outside the U.S., where leasing rates are comparatively much higher, resulting in interest expense savings. Last quarter, we outlined steps to reduce our rate of equity dilution through RSU net cash settlement. This quarter, we are announcing an additional initiative. Our Board has approved a stock repurchase program of up to $10 million over the next 12 months. The proceeds for this buyback will come from exercise stock options and the employee stock purchase plan. This cash-neutral move will help us improve our dilution trajectory. Our combined actions are expected to reduce our projected path of stock-based compensation dilution by approximately 15% to 25%. Until our cash flows permit, this is a cost-effective way to manage equity dilution. Over the long term, our goal is to reduce dilution from stock-based compensation down to 0. Before discussing our guidance, I'd like to provide some color around B2 revenue growth for the back half of the year. As mentioned, our Q2 beat was helped by a large AI customer who ramped up data storage in a short period of time. But we want to be mindful of the potential variability. Regardless, I'd like to reiterate that we continue to expect B2 revenue growth to exit the year with at least 30%. Looking ahead, we are guiding Q3 2025 revenues to be in the range of $36.7 million to $37.1 million, with B2 revenue growing in the range of 28% to 30%. For adjusted EBITDA margins, we are guiding Q3 to be in the range of 17% to 19%. For the year, we are raising our revenue guidance to be in the range of $145 million to $147 million from the previous range of $144 million to $146 million. This is due to better-than-expected B2 performance. As for adjusted EBITDA guidance, we reiterate the 17% to 19% range. To wrap up, in Q2, we continue to accelerate revenue growth while also delivering operating efficiency gains. Looking forward, we believe that we are well positioned to continue delivering durable and efficient B2 revenue growth as we set the course to being a Rule of 40 company. Now I would like to turn it over to the operator so we can open it up for questions.

[Operator Instructions] Your first question comes from the line of Jeff Van Rhee with Craig-Hallum.

Just two or three from me, if I could. Gleb, maybe on the seven-figure customer that you talked about in the quarter, just curious a little more background on that deal. Was that a displacement? And if it was, who was it? Maybe just a little more color there. And then secondarily, on the B2 Overdrive, maybe you could just expand a little bit. Obviously, quick out of the gate to get a six-figure customer. Can you put a little finer point on kind of how that pipeline is building? Any quantitative measures?

Yes. Thanks, Jeff. Appreciate the questions. So on the seven-figure customer, they were an existing customer that was smaller before. They've been with us for a handful of quarters at this point. And effectively, their data has been just growing very significantly. And it's an AI company. It's greenfield data. It's data that didn't exist before. And we're seeing this with more AI companies that the data is actually getting created for them. So we're absolutely doing displacements. The B2 Overdrive is an example of a displacement where we took the data away from a hyperscaler. But in the case of a lot of the AI companies, they're actually creating new data, whether it's for model building or because of the generative nature of AI. In terms of the Overdrive customer, so this was a customer that we actually connected with before we announced Overdrive. They had been with a hyperscaler. They were getting killed by egress fees, and they started looking for an alternative where they could save costs on their data storage for their usage, especially because they were doing model building and they needed to move the data from where it was being stored to one of the neo cloud providers in order to build their models. When we announced Overdrive just shortly after we started engaging with them, they got very excited and said they actually need more performance if it's available. And they decided to test it and do a proof of concept. Their eyes lit up and they just -- they started testing and got very, very excited very quickly and moved forward because with the AI companies, the GPUs are very expensive and time is money. And so, being able to use B2 Overdrive for that performance is very impactful for them.

Yes. That's great. Great coming out of the test front.

Jeff, sorry, you also asked about the pipeline. So what I would say is -- it's a new product, right? So it's still quite early, but we've got about a dozen companies who we're in pretty good discussions with at this point around Overdrive use cases. And what I would say is, obviously, we have about 0.5 million customers. So on the one hand, a dozen doesn't sound like a lot. On the other hand, every one of these has to be a multi-petabyte size customer and at a more premium pricing.

Last one for me then maybe on the channel front. Just any update on channel efforts? I know you were leaning in there, making some moves to get a little deeper, get a little tighter. Just where are you there? And how is that mapping to your expected progress?

Yes. On the channel side of things, we're seeing a consistently increasing number and value of both leads and then closed ARR business. We've we focused in, as we talked about before, on a smaller number of channel partners to drive more meaningful business with, and that's been working as a good strategy. I will say that because the AI companies tend to buy direct, a lot of the bigger opportunities have actually been through the direct side of things, but the channel has been an important component for us.

Our next question comes from the line of Ittai Kidron with Oppenheimer.

Nice quarter as well. Maybe we're running too far ahead here, Gleb, but what percent of your B2 customers do you think can be Overdrive customers?

Yes, it's a good question, Ittai. I think that one of the things that we see, obviously, is that AI use cases, we think, are going to continue to increase and become a bigger and bigger part of the overall. And I mean, there's no reason why the AI alone at some point isn't a $1 billion opportunity for storage, right? And a lot of those AI companies need the performance because the GPUs are so expensive that the faster they can get the data to the GPUs when they're actually ready, it makes sense, right? So I think that any of the companies who are building models, Overdrive is a good value for them. We also see other use cases where they're doing high-performance computing and some of the media workflows where moving lots of data is also important. So I think at this point, Overdrive is only being offered for multi-petabyte customers. So that's going to be on the larger set. But it's -- in general, we think that Overdrive is potentially available for anybody who's doing significant AI workload. And as you can imagine, AI is potentially a huge opportunity for us.

That makes a lot of sense. I guess I'm just kind of eyeballing your website, for example, right now. And the pricing is more than double for Overdrive. So clearly, this is a huge opportunity for you. But I guess it also begs the question on whether you should have another price tier somewhere in the middle for hybrid, just in a way to touch on a broader set of your customers faster. Does that make any sense? Is there a way to better -- not maybe better, but add tiers to your current pricing plans to kind of better peel out more value out of your customers?

Yes. I mean I think that as we go forward, we're going to try to keep that good balance of providing a lot of value to the customers but also keeping things simple. And so, one of the areas that we've won historically with customers is that some of our competitors have 8 different pricing tiers and 13-page pricing documents in 6-point font and you need a PhD to understand what you're going to get charged, which is part of why they also get these -- why we said 80% of customers get these surprise storage fees. So we want to make sure that we keep things simple for companies. At the same time, we are listening to customers to hear what needs do they have. And so, Overdrive came because we heard from customers saying, I love the performance. I love the durability, I love the availability. By the way, the GPUs are so expensive. If we could get the data there even faster, we pay more for that. So we'll listen to the customers and see what it is that we can do to provide value. But I think that there's certainly opportunities for us to introduce other things for them to subdivide and support their workloads.

That's great. Last one for me, Marc, on the Computer Backup, solid quarter actually. And so -- and you have very good retention rates. I hear your guidance on -- now that we're lapping the price increase. I guess the question is, with good gross retention here, how do you think about the puts and takes in your -- in the decision whether to raise price again or just keep things as is and let this slightly decline over time. Help me think about your thought process here. What are the triggers to think about over the next 12 months in this business?

Yes. So what I would say is we really focused on B2 growth. I mean we doubled down on that, and we said we're going to get it up to 30% by the end of the [Technical Difficulty]

Looks like we've lost the speaker audio lines. Just give us one second.

Can you hear me Ittai?

Now I can, yes.

All right. So what I was saying, Ittai, is our first phase was really to grow B2. And now that we got B2 well on track to get to 30% by the end of the year, we feel that's the new baseline for B2. Now we're able to work on two things, which is both see where do we take B2 from there, but also put more attention and focus on backup. But until we materialize more our actions on the backup side, and Gleb could elaborate what can we do on that front, we thought it would be prudent to say there's nothing net new, right? Two quarters ago, we said the customer count is declining by low single digits. And what you're seeing is we lap the price increase that coming through. But Gleb will elaborate on potential actions. Once those actions materialize, we'll start changing our views on the guidance for backup.

Yes. Ittai, I think Marc is correct on all that. And I think what I would say is in terms of things that we're doing, we spent a good chunk of time and focus on the go-to-market transformation for B2. We're taking some of those learnings and then applying them to the Computer Backup side to drive the business opportunity there. The other thing is in early in the year, we launched Enterprise Control, which was an upgraded functionality for Computer Backup. And then we just launched a feature that was the single most requested feature by larger companies for Computer Backup, which is Legal Hold. And so, with those two components, combined with the learnings from our go-to-market transformation, we've put a tiger team internally on Computer Backup. And so, there's focus on getting that business to be a kind of steady business. There's no current plan to do a price increase with that. But as you know, we've done a few in the past. So it's not out of the question, but we want to make sure we provide a lot of value to customers as with all of our offerings.

Our next question comes from the line of Simon Leopold with Raymond James.

First one, really to follow up on the backup trending. I guess there was a messaging that the outlook is trying to be conservative. But what is your understanding of why the customer count is going lower on the backup portion of the business? In other words, is it that customers are price sensitive or are you losing to competitors? Could you help us understand the rationale for why you've lost or expect to lose customers?

Simon, this is Gleb. So I mean, first of all, the gross customer retention rate on Computer Backup is 90%, right, which is -- and has been pretty consistent for a long time. So 90% gross customer retention is actually a pretty industry-leading metric for -- especially for consumer and small to medium business metrics. And so, we continue to see that. So it follows that trend line. I think in the consumer side of the business, it's a secular declining business, just slow secular decline, right? And that's in part because people aren't doing backups of their laptops and desktops as much as they used to because there's a lot more streaming and mobile devices and the like. On the business side of that, I think we actually have more opportunity. And that's, as I mentioned, with the new functionality that we launched with Enterprise Control and with Legal Hold and with the learnings from our go-to-market transformation, that's where we get to put some weight behind the business side of the Computer Backup offering.

Then pivoting to the B2 opportunities. In the past, you've talked about some of your alliance partners and how they've played into, I'd say, the value offered to your business-oriented customers. In light of some of the trends you have, particularly around AI, can you update us on how you see the featured alliance partners? I'm thinking about sort of the companies like Veeam and Fastly and how that plays into the strategy?

Yes, it's a good question. And I would say that alliance has continued to be a really important part of our strategy. Some of the types of companies that are becoming alliance partners are shifting. Some of the providers of GPUs are leaning in with us more because the customers need a lot of storage. They need the storage to go hand-in-hand with the GPUs, and they go -- they're a natural fit together. So some of the area that we're seeing more engagement in is around that part. But overall, the great thing about storage is it's a key part of almost everything that everyone does. At the same time, a lot of what we're trying to do is help people with a -- solve an entire solution. So we're looking to help them -- if we're looking to help them solve their virtual machine backup needs, then partnering with virtual machine backup companies like Veeam, where they're the software and where the cloud storage is good. If we're looking to solve an AI data pipeline, then partnering with the various neo clouds that they do that with in the modeling and the inferencing is a good space. So we try to work with partners in order to solve the actual full-end solution for customers.

Then just one last one is maybe if you could shed some light on your priorities in terms of internal investment, basically, how to divvy up your spending growth between sales and marketing versus R&D?

Simon, this is Marc. So R&D, if you -- our R&D as a percent of revenue, when you take the R&D expense line and the R&D that's capitalized is consistently going down as a percentage of revenue because we're benefiting from our scale, right? Not because we want to invest that in innovation because if anything, you just saw this past quarter, we had several major releases. On the sales and marketing side, what we're focused on is productivity of our investments there. And what you saw is B2 net new ARR went up by $6.9 million, which is a record for us in quarterly net new ARR. Additionally, if you look at B2 growth, if you factor out the price increase, this was the record growth at 29% in 7 quarters. So sales and marketing is all about productivity. I mean there's different ratios of what you aim for there. And R&D at this point, I would say, for us is really absolute dollars kind of keep -- not let it grow more than mid-single digits in absolute dollars, but as a percentage of revenue, we'll continue to benefit from our scales and will come down every year.

Our next question comes from the line of Eric Martinuzzi with Lake Street Capital Markets.

The enterprise security suite, I was just hoping to get a sense of the potential uplift for a typical enterprise account if someone is using you for a storage situation, whether it's Computer Backup or B2, what does the uplift -- what is the uplift potential if they decide to sign up for the security suite?

Yes, Eric, thanks for asking. So I'll break it down in a couple of little pieces. So first of all, Enterprise Web Console with the role- based access control helps them manage larger numbers of people interacting with it, and it's really targeted at ease of use. So there's not an extra charge for that. It's part of the offering. But as it's been rolled out in private preview with customers, the sales team has talked about how they've absolutely loved the functionality. And so, I see that as a customer adoption and customer retention and customer satisfaction functionality. On the Bucket Access Logs, it's functionality that enables them to keep and track all of their data that they use, and all the ways and operations and everything. So it depends on the size of the data they pay for the amount of data that gets stored. The Anomaly Alerts is a fee for the amount of data that's being analyzed as part of that. And so, it's not a large dollar amount per terabyte. But if they're protecting a lot of data, then that can be an interesting and material uplift. So we're in the early stages of testing some of the pricing pieces of that one as we want to really show that there's a lot of value to customers. And I think that there really is going to be data infiltration, ransomware, these are issues that organizations are dealing with all the time. And some of these organizations are ending up paying $10 million, $20 million, $30 million to deal with some of these implications for them. So there's a lot of value if we can help detect that early before they've had a major breach.

My second question is on the kind of a macro-related question. Obviously, you had a good quarter and a good outlook, but it's in part driven by the better-than-expected traction on the AI front. As far as your SMB oriented SMB sized customer, what's the health there? Typically, you've seen in times where SMB is softer, you've seen the amount of data being stored start to tail off of a trend line. Have you seen anything there on the SMB side?

I think that the core business continues to be strong and the AI is an accelerant. So as I was looking through the deals that we won last quarter, just kind of eyeballing through them, right? I mean there's MSPs, there's K-12 schools and colleges and universities. There's cities, there's counties. There are software companies, media companies, ad agencies. There are companies across the board adopting Backblaze. If you look at the gross customer retention metrics, they continue to be strong. The net revenue retention metrics continue to be strong. And so, the core business, it's not like backups are no longer important or media content is not getting generated or application storage use cases like surveillance and streaming are shrinking. So all of those still continue to be growing areas. But AI is big. And so we're leaning into that opportunity for us. I think just looking at it, I mean, going from 0 to 3 of our top 10 customers being AI companies and the 40x growth rate in data, it's where we're putting an increasing amount of focus because of the size of that opportunity, but the core business continues to be strong.

Yes. And another way to evidence that, Eric, it's Marc. Slide 13, we posted a new slide into our quarterly earnings deck that breaks up what's driving our growth. And you could see that all four categories of our revenue driver growth are improving. That includes: net organic growth, so existing customer base organically growing; it includes cross-selling and upselling by our direct sales team; it includes new self-serve, thousands that show up every quarter and sign up; and new direct sales bookings. So it's pretty well diversified that really sets us up to get to that 30% quarterly growth rate and really makes that our new baseline from thereafter, right? That's the momentum we carry forward from there.

Our next question comes from the line of Jason Ader with William Blair.

I wanted to ask on the B2 NRR. Can you just talk about some of the puts and takes there? And just maybe an outlook for the back half of the year for just B2 NRR?

Jason, it's Marc. The 112% coming down 500 basis points from the previous quarter, that's all the price increase lapping and the trailing 4-quarter impact. Our actual NRR, if you look at that Slide 13, those first two categories at the bottom pretty much represent NRR and actually improved in Q2 over Q1. The improvement was driven by -- Gleb referenced a large customer. I referenced a large customer. They were with us before. So that big ramp-up fed into Q2, but you could also see all variables of that growth rate improve. As for the rest of the year, I would say, on a reported basis, is the trailing 4-quarter average, you'll probably have another quarter of that lapping price increase impact us. But then it should stabilize. And then as we improve our customer success, I think that will be more into 2026, you'll start seeing improvements from there.

Yes. And Jason, I would just say one example for me of that improvement in customer success. So we talked about earlier this year that we brought on a leader for the customer success organization. She's been doing a fabulous job of revamping how we engage with our customers, really focused on both getting significant value to them and making sure that they're getting full value of the platform and also looking at what opportunities we have to expand with them. One thing that happened this quarter was we had a customer that had been a roughly $15,000 a year customer. And when our customer success team engaged with them and really showed them kind of the value that they could get, that customer grew from $15,000 for a 1-year deal to becoming a $500,000 TTV over a 3-year deal. So I think that there's a lot of that type of opportunity in a customer base of 500,000 customers.

So if we take out the impact of price and we take out the impact of the single big AI customer that was in the numbers a year ago, was there -- I guess, was there expansion on the existing base? So did the NRR actually improve if you adjust for those two items?

If you adjust for those two items, I would say it's more in the stable range. Because if you remember in Q1, we talked about a customer -- a large customer that went away. In Q2, we talked about this new customer coming in. So when you put all these, it all nets out to a very stable number. And then like we said, once this customer success motion kicks in, that's when you'll start seeing it go up in a healthy way.

Great. And then, Gleb, just one for you, and I'm hung up on this question. I think I've asked it on a number of different earnings calls. But can you just explain and help people understand why you guys are not at a disadvantage on the AI storage side by not having compute and GPUs in your offering?

Yes. It's actually -- I think we're at an advantage. So one of the things is that the GPUs and storage -- there are two pieces of it, but GPUs service two concrete parts of the overall AI workflow, the model building and the inferencing. The overall data pipeline for AI is actually five stages. It's data collection, it's data processing where you do all the labeling. It's the model training, it's the inference and it's the monitoring, right? And so, we get to [Technical Difficulty]

Looks like we've lost the speaker audio once again. Just give us one moment, please.

Can you hear us again?

Yes, I can hear you now.

I think you're on maybe Stage 4 or something.

Stage 4... So just kind of the five stages of the pipeline, right? So Stage 1 is where you collect all the data, you ingest it and you get it ready. Stage 2 is where you label the data. Stage 3 is you build the models. Stage 4 is you run inferencing on it and Stage 5 is you monitor it. And so, the GPUs are great for the model training and the inference. But back ways, we get to participate at all five of these stages and help customers in each one. So for the data collection part of it and the ingest, that is all about having a really affordable, highly durable place to store a lot of data that scales. GPUs have no role in that, but we play a key role in that. Stage 2, where you have the data and you label all of it, again, GPUs aren't really a significant portion of that, but the data needs to be stored in a place where you can do that with. Stage 3 for the model training, the GPUs play a big role in it, but it's really important to have high performance, high throughput data storage where you can get it to the GPUs because a lot of times, the customers will sign, for example, a 90-day contract for access to their GPUs. Once they have all the data collected and labeled, they want to get it to those GPUs as fast as possible so that they're not wasting any of that time. That B2 Overdrive offering that we introduced is perfect for that. Once it's done with the model training, you have the inference. This is our more classic application storage type use case where you're running the models on top of it. Again, it's really important to have durable, available, high performance, and affordable data storage for that. And then the last part of it is the monitoring of it, where you -- again, you don't need much in the way of GPUs for that, but you absolutely want to keep the data. So one of the things I think that's also interesting is that GPU usage is spiky, but storage is sticky. So even though you may ramp up your GPUs and shut them down, you're not going to get rid of that data. And so, we get to participate in all parts of the AI workflow. We get to keep the data, even though the GPUs go up and down. And because there are more and more places where you can get GPU availability, right? There are all these neo clouds popping up. We're increasingly seeing customers who want to make sure that their data is outside of the traditional hyperscalers who try to lock you in because they want access to have their data go to whichever neo cloud provider they want to use. So we're really building this storage platform for the next era of the way that technology is built when it's not just locked inside of the hyperscalers.

Our next question comes from the line of

Marc, I know you've really focused on this go-to-market transformation here over the last several quarters of bringing in new leadership and building out additional teams there. Can you kind of give us a sense maybe in a baseball analogy, kind of what inning we're in, in terms of building out the actual teams and functionalities versus actually having everyone in place and really just executing against the plan now?

Just my one follow-up question is maybe just around the updated adjusted EBITDA guidance. Nice to see the continued outperformance here in the first half. Are there any incremental investments that are contemplated in the current guide in the second half? Just curious on the puts and takes of how we should think about the ongoing margin progression.

Yes,

Our next question comes from the line of Mike Cikos with Needham.

This is Jeff Hopson on for Mike Cikos. Are you guys seeing the length of sales cycles for AI companies coming in shorter as I would kind of expect them to see the large cost and performance advantages much quicker than others? Or do they still tend to be a little bit longer as you kind of move up market?

Jeff, thanks for the question. You're absolutely right. We're actually seeing some of the companies moving really fast. I mean you saw that with our B2 Overdrive note, right? So they came in and within 2 months of B2 Overdrive launching, they signed a six-figure deal. So a lot of these companies, they're newer companies, and they are just accustomed to themselves moving very quickly and the needs that they have are significant. So some of them, I will say, are more hesitant to sign long-term contracts, in which case, our ability to have our consumption-based model actually works great for them, and we're thrilled to have them on our consumption-based model. But they definitely seem to be moving faster than some of the other more traditional organizations.

Makes sense. I know you guys are lapping price increases now, but what is the kind of the methodology for if or when you implement future price increases on B2, considering you guys are still substantially cheaper than your competition?

We don't have any plans to do additional price increases on B2. We obviously always evaluate what we should be charging for the different services in the market. But we want to provide a lot of value to the customers. That's kind of rule #1. So we'll continue to evaluate, but there's no intention or no plan to at this point. What we did was we launched B2 Overdrive, which solves a different need for them. And that starts at $15 per terabyte and it goes up from there depending on the performance that they want because that service, we can offer up to a terabit per second of performance for that, which is just -- I mean, it's hard to wrap your head around how fast that is and how much data that can move. And so, with that type of performance, we price it still for providing a lot of value, but it's certainly a significantly higher price point.

Yes. And the starting price for that is 250% above our current standard price. So that's how we monetize more, right, giving more value to our customers. And everything we're launching, we're aiming to make it either gross margin neutral or accretive to our current model. So we'll slowly see ongoing, hopefully, improvements in our gross margin.

Our final call comes from Rustam Kanga with Citizens.

Congrats on the outperformance of B2 relative to the prior expectations. Just one for me. It looks like there's a solid drumbeat of innovation with several announcements for your security features. I understand some of these are in private preview. It looks like Legal Hold has a complementary trial phase. Gleb, I know you touched on the monetization there. I just wanted to ask, big picture, to what extent do you think these enhancements sort of naturally help bolster the shift upmarket?

Yes. Thanks for the question, Russ. So we've focused on functionality for performance, functionality for security, functionality for AI. These are definitely supporting that upmarket momentum. So event notifications, which we launched in the past few quarters, that was to enable organizations to actually build their applications and integrate us better into all their workflows, Legal Hold supports organizations. It was literally the #1 most requested feature from the larger companies for Computer Backup. Bucket Access Log was something that customers were asking for because they wanted -- we became an increasingly strategic part of their fundamental infrastructure. And so, they wanted to plug that into the insights they were getting around how their -- the security was -- of the overall environment. So these are both natural and helping us close those bigger opportunities. Like I said, Enterprise Web Console with role-based access control, when that was previewed to customers, what I heard from the sales team was basically, wow, like customers loved it. So I think the go-to-market transformation that we're doing is -- helps us make sure that our teams and processing structure are better able to sell to large organizations, and these tools and functionalities give them the features and products to make that easier.

All right. I will pass it back to Gleb Budman for closing remarks.