Barracuda Networks, Inc. (NYSE:CUDA)
Q1 2017 Earnings Conference Call
July 7, 2016 4:30 PM ET
Maria Riley - IR
BJ Jenkins - President, Chief Executive Officer
David Faugno - Chief Financial Officer
Rob Owens - Pacific Crest
Joel Fishbein - BTIG
Gur Talpaz - Stifel
Jonathan Ho - William Blair
Andrew Nowinski - Piper Jaffray
Melissa Gorham - Morgan Stanley
Michael Kim - Imperial Capital
Good afternoon, and welcome to the Barracuda Networks First Quarter 2017 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please also note that today's event is being recorded. At this time I would like to turn the conference call over to Maria Riley with Investor Relations. Ma'am, please go ahead.
Good afternoon and welcome to Barracuda's first quarter fiscal 2017 earnings conference call. On today's call, BJ Jenkins, President and CEO, will provide an overview of our first quarter fiscal 2017 performance. Then David Faugno, Barracuda's CFO, will review the financial results in more detail and provide guidance for fiscal 2017 second quarter. We will then open the call for your questions.
This afternoon, Barracuda issued a press release announcing the company's financial results for the first quarter ended May 31, 2016. A copy of this release and supporting financial materials are available in the Investor Relations section of the company's Web site at www.barracuda.com.
During the call, we will make forward-looking statements such as those containing the words may, expects, believes or similar phrases that provide information which is not historical in nature. These statements involve risks, assumptions and uncertainties. For a more detailed description of these risks, assumptions and uncertainties, please refer to the company's filings with the Securities and Exchange Commission, including the risk factors contained in our most recent annual report on Form 10-K for the information on risks and uncertainties that may cause actual results to materially differ from those described in the forward-looking statements.
And with that, I’ll now turn the call over to BJ Jenkins, President and CEO of Barracuda.
Thank you, Maria. Good afternoon and thank you for joining us today to discuss our first quarter fiscal year 2017 results and recent events at the company, including our CFO transition.
In the first quarter, we exceeded guidance on revenue, billings, and non-GAAP EPS. Our Q1 revenue grew 11% year-over-year to $86.7 million and gross billings came in at $98.2 million, up 4% year-over-year. Billings for our core products grew 21% year-over-year and the corresponding subscription ARR grew 55% to reach $140 million.
Our core products include all of our cloud and MSP delivered security and data protection solutions in addition to our next generation firewall and backup appliances. On the bottom line, we achieved non-GAAP EPS of $0.20 per share, which on a comparative basis is more than double our EPS in the first quarter of last year. Our results this quarter were driven by focused execution of our strategy to align our product portfolio with the growth trends we see in the market, optimize our avenues to market, and drive profitability as we have for all of our business.
As we discussed in April, to capitalize on the growth trends we see in the market, we are increasing our focus on security and our cloud delivered products and services. We are targeting three specific key product areas, email security and management, particularly as it relates to Office 365. Network and applications security and data protection, which includes backup and cloud archiving. Businesses need to secure and protect their users, applications, data, and business assets. Company email, web applications, the network itself, remote access, mobility, and users, are all under attack.
While these threat factors remain constant, attack surfaces are always changing and security is paramount as threats become more sophisticated. No matter how customers want to purchase or deploy, whether using a traditional bar MSP or large public cloud provider like Microsoft Azure or AWS, Barracuda delivers solutions to make IT simple, secure, and affordable for our customers.
As we have seen for a long time in on-premise deployments, email security and management is critical, particularly with the increase in targeted phishing attacks and ransomware. These same threats exist in cloud deployments. Utilizing the IP in our award-winning email security platform, we launched Barracuda Essentials for Office 365 in February. Barracuda Essentials for Office 365 enables organizations to operate more safely and efficiently in Office 365 by protecting customers against advanced email based attacks that lead to security breaches, data loss, and business disruptions.
It includes enterprise class technologies that leverage Barracuda's advanced global threat intelligence framework to provide security protection in real time and granular policy management. While our Barracuda Essentials for Office 365 suite has only been in market for a short time, we are building solid momentum and are pleased with the initial customer adoption among both new and existing customers that are migrating their email to the cloud.
Let me share with you a couple of customers that recently adopted Barracuda Essentials for Office 365. An IT services and consulting firm on the East Coast that runs three data centers was using a competitor’s solution and was experiencing outages. This customer had an extensive requirement list that included multi-tenancy, white listing by domain, attachment blocking, and other advanced security features. After evaluating Barracuda Essentials, they selected Barracuda to replace their existing solution. As a result, we quickly secured a five figure order for more than 3000 users.
The second customer is Spanx, a well known apparel company. Spanx has been a Barracuda email security and message archiving customer for some time and recently moved its email to Office 365. As part of this move, the company adopted Barracuda Essentials for Office 365. Spanx was easily able to replicate the rules and enforcement policies on its Barracuda on-prem email security device over to our cloud security service, resulting in a five figure deal for our email security and compliance addition.
These two companies represent just a sample of the many new and existing customers choosing Barracuda to help them migrate and protect their Office 365 deployments. Moving to network and applications security, we also continued to build momentum among our customers. In fact in the first quarter we achieved record billings for our next generation firewall solutions and we are seeing an uptick in demand for our web application firewall solutions.
In a six-figure deal, we recently won a new customer that was looking to add web applications security to its existing load balancers. After evaluating capabilities of several vendors, this online tax preparation service selected the Barracuda web application firewall. This customer expects to move to Azure within a few years and selected Barracuda in part because of the deployment flexibility we offer, including our ability to easily replicate policies and move to Azure with them as well as the ability to massively scale virtual appliances in order to meet current and growing performance needs.
Next week, we expect to launch the Barracuda next generation firewall version 7.0, a cloud-ready firewall designed for customers adopting cloud-based applications, operating dispersed network environments, and leveraging public cloud and infrastructure as a service platforms. The Barracuda next-generation firewall improves connectivity and performance and safely enables cloud adoption.
Moving beyond products, we also continued to expand our routes to market. In the MSP channel, we continued to add new partners and products and we are pleased with the growth we are generating through this route to market. In the first quarter, we added 160 new partners to our Intronis platform and we now have nearly 2,700 MSP partners.
We also continued to add new products to our MSP platform, including a backup appliance as a service subscription and the Barracuda Essentials for Office 365 security offering. Additionally, just last week, we announced the availability of our Barracuda next generation firewall via the Intronis platform. Now customers have the choice to purchase solutions in all three of our key focus areas; email security and management, network and applications security, and data protection on a monthly subscription basis. (Auidt End)
In the public cloud, we also continued to build momentum. We grew the number of public cloud opportunities in our pipeline 48% over Q1 of last year. While still off a small base, we more than doubled new public cloud billings year-over-year and we are seeing new opportunities with very large enterprises as they look to migrate to the public cloud. To date, we have added 29 new Fortune 1000 customers with our public cloud solutions.
A couple recent notable wins in the public cloud include, the China online store of a large U.S. based technology company chose Barracuda's next generation firewall and web application firewall to protect its online store deployed in Azure. And secondly, a multinational web property was looking to replace its existing web application firewall to protect internal and public facing apps on AWS, including several ecommerce apps with PCI requirements. This customer selected the Barracuda web application firewall based on the ease of deployment on AWS with ability to buy directly from the AWS marketplace as well as the auto-scaling functionality, simple administration and overall performance and cost.
These two customer examples demonstrate how Barracuda is helping safely enable public cloud adoption for customers critical applications. We believe that our success in public cloud is driven by our continued focus, strong product differentiation and partnerships with leading public cloud providers. Highlighting the value or solutions bring to our public cloud partners, in May we were recognized as the 2016 Microsoft Azure certified ISV solution partner of the year. This achievement speaks to the growing momentum Barracuda has in public cloud and the value Microsoft sees in the relationship.
In summary, we are executing on our strategy and are pleased with our progress and first quarter performance. We continue to develop new products and services that empower customers to maintain security and control of their users, applications and data regardless of where they reside. We believe we are building strong momentum in the market and achieving growth in our core product focus area while at the same time improving our profitability.
Before I turn the call over to Dave to review our Q1 financial performance, I would like to highlight some recent management team changes. In early June, we appointed Hatem Naguib as SVP and GM of our security business. Hatem joins Barracuda from VMware, where he was the VP of networking and security and helps NSX become one of the industry's fastest growing infrastructure software products, growing to $600 million run rate over three years.
Additionally, Ezra Hookano will join the Barracuda team as VP of channels. Many of you may remember Ezra from when he served as our original VP of sales, helping grow the company from inception to $100 million in revenue. Our new leaders will help guide Barracuda's overall strategy to support customers looking to simplify their IT security and data protection infrastructure on-premise, in the cloud and in hybrid deployments. In addition, as we announced in our press release, David Faugno will be transitioning out of the CFO role after ten successful years leading our finance organization. Dave was instrumental in building the company from its earliest days through the successful execution of our IPO and our transition to a public company and in helping us reposition for our future. He has been a real champion of our customers, employees and shareholders and has built a solid financial, operational and strategic foundation.
Dustin Driggs will replace Dave as Barracuda's Chief Financial Officer in August. Dustin has worked with Dave since 2007, most recently serving as our worldwide controller and Chief Accounting Officer, and we are excited to have Dustin step into this role as part of our succession planning. He knows our business well, has a tremendous team and I am very confident of his ability to lead our finance organization moving forward. We will also continue to benefit from Dave's experience and leadership as he serves in an advisory capacity, helping us transition the CFO responsibilities to Dustin as well as helping us with several other strategic initiatives. I want to personally thank Dave for all his contributions to Barracuda and for the friendship and support he has given to me.
With that, I will now turn the call over to Dave for a more detailed review of our first quarter financial performance and second quarter guidance.
Thanks for the kind words BJ. Before running through the details of a strong first quarter, wanted to follow up on BJ's comment about the CFO transition here at Barracuda.
I have worked side by side with Dustin for a long time and I could not be happier for him or more confident with him in this seat moving forward. Turning to the results. Revenue in the quarter was $86.7 million, an increase of 11% year-over-year and 3% sequentially. Our total subscription revenue was $65.3 million, which accounted for 75% of total revenue.
On a geographic basis, the Americas were 76% of total first quarter revenue. Revenue from EMEA was 18% of total revenue and APAC 6% of total revenue. Our number of active subscribers in the first quarter exceeded 286,000, which was an increase of 14% year-over-year. Renewal rates, which we calculate on a dollar basis, were 93% in Q1 and our average contract length were consistent with Q4 of FY '16.
As we discussed last quarter, we believe the gross billings metric is becoming less of an indicator of our business momentum as our billings composition changes. In order to improve visibility into the composition of our business, we are providing subscription ARR, or annualized recurring revenue, and breaking out billings into three categories. First, our core product billings, which include all of our cloud and MSP delivered security and data protection solutions in addition to our next generation firewall and backup appliances.
First quarter billings for our core products grew 21% to $55.9 million and the related subscription ARR grew 55% year-over-year to $140 million. Next our legacy on-premise billings which consist of appliance based on-premise solutions outside of the next generation firewall and backup areas. First quarter billings for this category were $37.8 million which was in line with our expectations and represents a slight sequential decline. The related subscription ARR was $116 million or 1% growth over the prior year.
And last, our non-core billings which includes areas that are not tightly aligned with our go-forward strategy and where we expect to see some consolidation. First quarter non-core billings were $4.4 million, reflecting the discontinuation of CUDA Drive. Total gross billings for the quarter were $98.2 million and total subscription ARR was $263 million, an increase of 24% over the first quarter of last year. As a reminder, a supplemental presentation posted on our Web site includes a breakout of our billings and ARR and a reconciliation of billings to revenue.
Returning to the P&L, non-GAAP gross margin in the first quarter was 80.3%, which represents 130 basis point decline from the first quarter of last year and was flat sequentially. Non-GAAP operating expenses in the first quarter were $51.9 million or 60% of revenue compared with 70% in the first quarter of last year and 64% in the prior quarter. Consistent with our strategy to balance our investments with growth and realign our resources with our strategic focus areas, we ended the first quarter with headcount of 1487, compared with 1520 at the end of last quarter.
Research and development expenses in the first quarter were $16.4 million or 19% of revenue compared with 19% of revenue in Q1 of last year and 18% in the prior quarter. Sales and marketing expenses for the first quarter were $28.8 million or 33% of revenue compared with 42% of revenue in Q1 of last year and 38% in the prior quarter. General and administrative expenses for the first quarter were $6.7 million or 8% of revenue compared to 9% of revenue in Q1 of last year and 8% in the prior quarter. Non-GAAP operating income more than doubled year-over-year to reach $15.3 million in the first quarter which demonstrates the flexibility of our business model.
Non-GAAP operating income was well ahead of our guidance of $8 million to $9 million as sales and marketing expenses were lower than we expected due to the timing and reassessment of select marketing programs. In Q2 we expect sales and marketing expenses to increase sequentially as we build momentum in our core focus areas and move forward with our marketing campaigns as well as add sales resources in selected areas such as public cloud and MSP. Consistent with the strategic plan we outlined last year, we will continue to focus on driving profitability and cost efficiency while at the same time investing in our key focus areas to grow our business over the long-term.
Returning to Q1 results. The non-GAAP tax provision was $4.6 million in Q1. Our non-GAAP net income in the first quarter was $11 million or $0.20 of earnings per share on a diluted share count of $52.9 million. Turning to GAAP results, we reported first quarter GAAP net earnings per share of $0.05. this compares to a GAAP net earnings of $0.06 per share in the last quarter and $0.07 per share loss in the same quarter last year.
Now let's turn to adjusted EBITDA, a non-GAAP measure that adjusts for the changes in deferred revenues and costs. In the first quarter we generated $17.9 million of adjusted EBITDA or 21% of revenue, up from $15.8 million in the same quarter of last year. Cash flow from operations for the first quarter was $12.1 million which compares to $6.3 million generated in the first quarter of last year, an increase of 92% year-over-year. Capital expenditures in the first quarter were $1.9 million. Adjusted free cash flow in the first quarter was $10.9 million, which compares to $5.3 million in the first quarter of last year.
We closed the quarter with cash, cash equivalents and marketable securities of $167 million. During the quarter, pursuant to our stock repurchase plan, we repurchased a total of 17,631 shares in the open market at an average weighted cost of $15.91 per share for a total of $280,000 in consideration. As of the end of the quarter, under our current $50 million share buyback authorization, we repurchased a total of 1.5 million shares at an average weighted cost of $12.82 per share for a total consideration of $19.5 million.
And finally, deferred revenue at the end of the quarter was $393.1 million compared with $381.1 million at the end of the first quarter last year. Now turning to guidance. For Q2 FY '17, we expect billings to be in the range of $96 million to $99 million. We expect revenue to be in the range of $84 million to $86 million. Guidance for non-GAAP operating income for the second quarter is between $9 million and $10 million and non-GAAP EPS for the second quarter is expected to be approximately $0.12 to $0.13 of earnings per share given an assumed share count range of 53.5 million to 54.5 million shares.
While it is not our general practice to update our full year outlook, given our strong performance in the first quarter and current outlook for the second quarter, we are updating our guidance for the 2017 fiscal year. Additionally, our fiscal year guidance reflects the narrowed product focus including the discontinuation of CUDA Drive. For fiscal year 2017, we expect revenue to be in the range of $340 million to $345 million. Guidance for non-GAAP operating income for the year is between $42 million and $46 million. Non-GAAP EPS for the fiscal year is expected to be approximately $0.54 to $0.59 of earnings per share, given an assumed share count range of $53.5 million to $54.5 million shares.
That concludes our prepared remarks today. But before we open it up to Q&A, I wanted to make a couple of brief personal comments. My decision to make this change now is a reflection of how good I feel about where we are as a company moving forward. We have a greater clarity of vision and an outstanding team that is executing on our plan. We have momentum in our core focus area and as we continue to advance our strategic plan. I would really like to thank the employees, board of directors, customers and partners of Barracuda for their support and opportunities I have been afforded over the last ten years.
I would like to specifically thank, Michael, Zach and Dean for entrusting me to help them build out their vision and to BJ for his outstanding leadership, mentorship and friendship. Now BJ, Dustin and I are happy to take your questions.
[Operator Instructions] Our first question comes from Rob Owens from Pacific Crest Securities. Please go ahead with your question.
If I look at the receivable balance this quarter, either expressed in days billings or days sales, and days billings is probably more appropriate given the shift to subscription. It's one of the lower numbers that we have seen in a while. So does that give us any indication relative to either the linearity of the quarter, were there any big deals in the quarter? Just any color would be appreciated. Thanks.
Rob, it's BJ. I will start off and Dave can jump in off of it, but the linearity for this quarter was very smooth and better than we had seen in the previous year. If you look at the three months and the progression that was more in line with what we had seen, you know the first couple of years of becoming public, we were very happy with the order flow and the linearity that happened in the quarter, much better than it had been in the previous year.
Yes. And as our business transforms to more ratable purchases and a very strong renewal business and more monthly, you tend to see very short cycles between, kind of order and cash on those parts of the business as well, and so I think combined with the linearity that BJ mentioned, you see a better performance on the deal flow base.
Great. And then second, walk us through this kind of your general thinking in around guidance with the sequential downtick, given 75% plus of your business is moving towards more of a subscription basis, is this indicative of some of the volatility you might see on the appliance side of the business?
No. You know, Rob, it's a few things. If you look at Q1, we have got a very very strong renewals performance at the end of Q4 and in Q1, and very often that leads to some revenue recognition as the linearity plays out there. And maybe it's a little bit above the norm. So that also drops to the bottom line and gives you a little bit better performance on the EPS basis as well. So as we roll forward and looking at Q2, we have just projected a little bit more conservatism in the linearity and the amount of revenue that comes in around the renewals activity. And we also, similarly on the bottom line, we did a really good job in the first quarter kind of optimizing the cost structure, particularly around sales and marketing initiatives.
As we see some real strong momentum in some of our core growth areas, particularly around things like public cloud, Office 365, and MSP, we have some opportunities to kind of start to invest behind some of the momentum there, really sort of catalyze growth a few quarters out. And so, the combination of those things put us in kind of $0.12 to $0.13 range in Q2.
Rob, it's BJ again. If I maybe add a little more color on both the expense and investment side. In Q1, there were some specific expense savings that we were able to get out. We didn’t run a large centralized kick off this year. The management team, a smaller group flew into each of the geos to do the training this year, so there was some substantial savings there. And so, we were able to get that in Q1. In Q2, there are investment areas such as Microsoft has their worldwide partner conference. They had their kick-off since the start of their year, and so in the areas like public cloud we will be making some investments there that will offset it in the coming quarters.
Yes. And just, I am sorry, it's Dave. One last point, to speak to the annual guidance. Certainly, the latter part of the year is where you are going to see more of the impact of the non-core products for which we are seeking strategic alternatives, and so that factors into our thinking as we get later on in the year as well.
Our next question comes from Joel Fishbein from BTIG. Please go ahead with your question.
David, congrats and good luck going forward. I just want to follow up on one of Rob's questions and I think you already answered it, but I want to make sure and then I have a follow-up. The first is on the margins side. You obviously outperformed very significantly on the margins side in Q1 and then the guidance going forward assumes that you are not going to be able to walk that margin through. And I think BJ, you just answered it in terms of some of these investments that you will be making. But was there -- did the outperformance in Q1 sort of surprise you? Is that part of the reason why you weren't -- didn’t spend more in Q1?
Well, I think, I told we did a very good job on the expense side in Q1 even better than we had expected. We have been very focused on the expense side, and if you look at some of the savings that I did describe, that was there for us, so we knew we could get at it. But then I think we have done a good job of optimizing our marketing expenses, our overall headcount has come down, and we have reallocated resources into the focus areas where we are getting a better return. And that all helped us outperform in Q1. If you look at our core billings, the areas we are focused on Joel, we were up in Q1 21% year-over-year, and that’s the area where we are aligning resources and investing going forward, and that areas like Office 365 where we are very excited, have over 1000 customers and are out of the gate well. Our public cloud, our Intronis business, and so you are going to naturally see some of that come in Q2 and through the rest of the year.
Okay. Last one, follow up from me is on the renewal rates. They have been jumping around a little bit. 93% dollar base renewal rates this quarter. And Dave you said that towards the back half of the year, we might see that move around some more. Is that what I am hearing or do you expect that to trough out?
Yes. So a couple of quarters ago we had a lower renewal rate performance on the dollars basis and a lot of that, we said at that time was timing based. And so, we did see a lot of that swing back, particularly in Q4. And we had a very strong Q1 renewals performance as well. And the other thing is contract lengths tend to constrict a little bit or contract a little bit. You actually have a much better annualized renewal rate than even your natural dollars based renewals rate. In this particular quarter, we are about 4 percentage points better on an annualized basis. So, about 97% renewal rate on an annualized basis versus the natural 93%. So we are very happy with the renewals performance. You will see volatility from period to period as timing sometimes plays into it. Things like, even like where the holidays fall, things like that. But we feel good about the momentum of the business really in all the categories we are focused on.
Our next question comes from Gur Talpaz from Stifel. Please go ahead with your question.
I was hoping you could elaborate a bit on some of the efforts of Microsoft. Obviously a lot of talk about Microsoft on the call itself. Doing a lot of Azure, a lot with Office 365. How do you seize the opportunity? What do you see going forward and ultimately how do you balance the opportunity with Microsoft's own efforts in security? They have obviously done a bit more with purchasing Adallom, Secure Islands. How do you sort of balance the opportunity with the potential risks associated with kind of pushing deeper into Microsoft?
Yes. Thanks, Gur. It's BJ and I will start off on this one. I think the predominant sales for us in Azure and in AWS are in the areas of web application firewalls and next generation firewalls. And this is an area where Microsoft has been, I think, very clear that they want to partner and that they want to be able to provide a very secure, application oriented framework for the customers and they are doing that with partners and I think it's why our work here is, quite frankly, why we won the partner of the year award from Microsoft. What we are seeing today is, and we have talked about this in previous quarters, is they are actively bringing us into accounts as things like secure connectivity, traffic management, management between public cloud and on-prem. So the hybrid managed framework are important for their customers as they move in. And it's also important that these security solutions work with Azure active directory and are integrated into that and into their security competency which we have done.
So the results of that today is we see ourselves being brought into accounts by Microsoft. We are getting into customers that we wouldn’t get into previously. We have, as we said on the call, 29 Fortune 1000 customers now that have come via this work with Microsoft and AWS. And it's because of the offerings we have and how it's integrated with them. So we view it as an incremental opportunity, I know a lot of people have been talking about the public cloud is a headwind for us. We view public cloud as an opportunity area for us going forward. When you think about the areas we are investing in in sales and marketing, we are putting more sales people on our -- MSPs on our public cloud team. If you see our advertising and branding, it's very centric around public cloud firewall, public cloud security, secure connectivity. Bringing your applications into the public cloud. And we view this as a real, big opportunity for us going forward.
That’s helpful. If you look at the legacy on-premise business on the billing side. It looks like it's flattening out in the high 30s. Is that the right way to think about the business going forward in terms of just the overall contribution. And then on the ARR side at around kind of the one teens, 116 or so, is that the right way to think about the business going forward or should we think about that being a bit more volatile as we kind of push through the year.
Yes. Hey, Gur, it's Dave. So I think several quarters ago we were getting the question about, is there going to be continuous deceleration on the legacy on-prem and I think we said at the time that we thought that it kind of would be stable and kind of flat, it wasn’t. The next couple of quarters had proven that out. And so we see growth on an ARR basis and on a natural billings basis. Pretty good stability in that legacy on-prem. While the public cloud deployments and SaaS deployments of our customers contend to be -- continue to be where the action is, we see a lot of hybrid environments as well. And a lot of what we provide in that legacy on-prem environment really supports legacy hybrid environments of our customers which we think this year are quite well. So arguably there is some reasonable stability at that kind of level.
In the meantime we have accelerated growth in the core side. So the billings growth went from 15% last quarter in the core area up to 21% this quarter. And so the combination of acceleration of the core where we are focused and so it fits stabilization around that legacy category, I think provides us a pretty good basis to kind of move forward. And second part of your question, I am sorry, could you ask that again?
Just on the subscription ARR side. If you look at the legacy on-premise business, it's stabilizing in kind of the 116-117 range, kind of 21% year on year.
Yes. Yes. I think we see pretty good stability both on an ARR and the natural billings basis in that category.
Yes. It's BJ. Maybe to add a little bit to that. Even on some of the legacy on-prem business in the future we will be adding security capabilities like advanced threat detection to those on-reimbursement devices. And so I think it gives us a basis to keep that legacy stream more stable than it may have been in the previous years.
Our next question comes from Jonathan Ho with William Blair. Please go ahead with your question.
Dave, I just wanted to start off by saying that it’s being great to work with you and Dustin, just wanted to congratulate you on the new opportunity as well. So just to start out, I just wanted to get a sense from you about maybe what inning we are in relative to the three-pronged strategic plan that you outlined in the past? And how far we are -- along we are in each of those initiatives?
Yes. Jonathan, I still think it's early. We are really four months in into having the Office 365 offering out and again the early signs there are good. To give you a feel of what we see, we have over 1000 customers using that offering now. 38% of those are net new customers to Barracuda. It's been about a 20 day sales cycle on average and it's been around our traditional ASPs. So the early signs of that are good but we are four months in. If we look at public cloud, again and I think we have said this, it's a small amount of billings today but it's growing rapidly and we see things like getting 29 Fortune 1000 customers that are very promising to us in terms of incremental opportunity. And so when we looked at that focus and the core areas and the resources we are putting down into it, we are two quarters in. So I think it's early. We feel very good about what are seeing in those early returns but we got to keep growing that part of the business and we are very focused in getting the right amount of investment into it to capitalize on the opportunity we see out of the gate here.
Got it. And then just to understand this Office 365 transition a little bit better. Can you give us a sense of what the buyer behavior is like? Are they selecting a security solution before they go to Office 365 or are they sort of trying out what Microsoft is giving them and they maybe deciding they want something afterwards.
Yes. It's a mix. But I would say as we have gotten into this there are more customers asking security questions out of the gate than had previously. So I think many of the first movers into this space just use Microsoft ELP for protection and then start thinking more about what else they may need on top of it. So we certainly see a decent amount of customers who have already Office 365 and then are asking security questions. One of the examples we gave you though was a competitive replace. And we do see our fair share of that also. And again I think the thing that’s been promising for us here is 38% of our customers who have signed up for the Office 365 Essentials are net new to Barracuda. So I think we are doing a better job of helping or own base transition in the Office 365 while at the same time really increasing our ability to attract new customers who are considering it.
Yes. The other thing I would add to that, Jonathan is what we have seen is a lot of customers lined of, kind of purchasing Office 365 and get hung up on migration. And a lot of times the managed service provider community are kind of passed with that migration activity, and when that happens it gives them a great opportunity to wrap that new service around a management layer and an incremental protection layer that makes the customer more comfortable and also provides the managed service provider a little bit more relevance. And so that’s a real, I think, enabler of more of a proactive approach to adding appropriate capabilities around the migration through the MSP channel.
Our next question comes from Andrew Nowinski from Piper Jaffray. Please go ahead with your question.
Some of the other enterprise focused security vendors have started to see some large deals pushing out and taking longer to close. I know you had smooth linearity in the quarter. So I am wondering if the SMB market might be a bit more resilient to a slowdown in spending than the enterprise space?
Well, you know I think each of these spaces, in my view, act differently at different times. While the enterprise space seemed to do very well last year, again we saw some reduction in contracts, some elongated sales cycles and so I don’t think they always act in congruence. And again in our space I think our offerings are much more aligned where that SMB buying trend has gone to, which is there has definitely been a move to SaaS and public cloud, and there's been a move towards monthly. And as we have gotten our offerings I think more in line with where that customer demand is going and we have seen better linearity. I can't speak really to what's happening on the enterprise side because we don’t play there on a daily basis. In public cloud when we do do enterprise deals, they are longer sales cycles but we have seen them closing with regularity and we do see these enterprise customers evaluating and moving applications into the public cloud.
Okay. And then on the -- let's go to EMEA, it's down 5% this quarter yet and your quarter closed well before the Brexit vote. So I am wondering if you can give us any color on the decline in Europe. And then any assumptions regarding its impact for the August quarter.
So that was revenue -- and certainly I think some of the things we talked about last fiscal year, we didn’t perform well in Europe and that’s reflected in the revenue now. On the billings side of the business, Europe has stabilized and improved for us and specifically in network security they had a very good Q1. So we are happy with the Europe performance there. With regards to Brexit, may personal feeling is that this is going to take a long time to play out and there is -- we have to see how it plays out. But when we look at our business, we have more employees in mainland Europe and we do development there than we do in the U.K. and so I don’t think it will impact our business substantially going forward.
Our next question comes from Erik Suppiger from JMP Securities. Please go ahead with your question.
This is John on for Erik. The difference in gross billings and net billings has trended up significantly over the last year. It was up again this quarter, I think which implies the returns reserve has trended up. Can you just help me understand why that has trended up over the last year or so and then how should we forecast that going forward?
Yes. Hi, this is Dave. It's within the range that we had historically experienced and certainly in the range of expectations. A little bit at the high end over the last quarter or two as we have kind of rotated out of distribution a little bit. And so distribution still plays a role moving forward but as the world becomes less reliant on kind of hardware, a more kind of flat channel model than a heavily distribution oriented one I think makes more sense for us. And so that distribution rotation kind of changes a little bit of the appliance side of the business. But going forward I think that traditional kind of range in and around 10% is where we should typically expect it.
Yes. And then maybe, it's BJ, just to make one more comment in general about the channel. In our view, we are completely dedicated to the channel and the channel is changing rapidly. Faster than I had seen before. I know a lot of people talk to the traditional channel partners. We just had our Americas partner conference last week and we had our Europe one in May. And almost all of those partners are looking at more of an MSP or service oriented offering going forward. All of these partners are trying to figure out how to play in public cloud. There are now new partners who are born in public cloud that we are working with. So there is a real evolution in the channel and how transactions are happening with our SMB customer base that I feel we have really got our offers aligned to now and there is a lot of excitement in our partner summits about how they can bring these to market.
Okay. Thank you. And then one more question. I think over the last year the number of active subscribers has growth significantly faster than gross billings. Can you just talk about what's driving that? Is that having any implications for ASPs or just kind of help me understand that a bit?
Yes, I think there is a couple of dynamics going on. Obviously, ASPs will come down if you look at it but we are also, if you look at our firewall offering, for example, where now we have much smaller firewalls that are deployed at endpoints and branch offices. You can get more one customer buying hundreds of devices and the ASPs is going to come down while the overall transaction is still very good. So there is some of that dynamic. Same thing in backup. When you think about a customer may have a large centralized unit and then smaller units in the remote offices, that’s going to drive that dynamic.
One other thing I would just say about that active subscriber number. It doesn’t reflect any of the customers that we have one the -- the end user customer that we have on the MSP platform. And so the number of people actively using Barracuda subscriptions is even higher than reflected in that number. If you think about the number of partners which is now over 2,700 with Intronis and then the number of customers they serve beyond that. So I think that number is becoming a little less relevant as we go forward. But you can think of the ASP going down because of the number of small units we have out there.
Our next question comes from Melissa Gorham from Morgan Stanley. Please go ahead with your question.
Dave, sorry to see you go but best of luck. I just want to ask a question on data protection business. So you have noted some new functionality that you have released in terms of like backup as a service but in previous quarters you have talked about the storage business being relatively weaker. Is there any change that you are seeing from a demand perspective and are you seeing improving growth in data protection?
Yes. Hey, Melissa, it's BJ. We had a steady, good quarter in data protection. I think the trends that we see, again, I think I feel like we have our offerings more aligned with these trends now. The first has been more at the lower end, the use of service provider and buying on a monthly basis. So our traditional 100 and 200, kind of lower price standalone solutions has gone more to monthly subscription via the Intronis platform. So that’s been one trend and it's been the movement to lower end to really pay by the month in type of cloud service.
The second trend has certainly been the rise of software only solutions and the fact that we have released the backup virtual edition, now puts us in a better position to capitalize on those opportunities. Places were companies like [Beam] [ph] have performed very well. We set ourselves in more of those opportunities going forward. And we continue, if you look at our releases and the releases we have coming out, we really continue to increase the performance of our solution, our standalone solution. And so we have seen good stability in growth at the high-end of the product line as we have improved the performance and capacity of the systems we have put out. So that business, I think for us versus the second half of last year has stabilized. We had good growth in Q1 and we feel good positioning of the offers going forward and where the products stands.
Okay. That’s helpful. And then just a follow-up for Dave. Dave, in terms of the billings growth through the full year, I know that you are not guiding to billings necessarily but we have seen a lot of fluctuation in growth and we have seen improving growth this quarter. As we are facing easier comps in the second half of the year, is there any reason why billings growth shouldn’t continue to improve.
You know we are not giving annual billings guidance for sure. I think we have seen a trend now for sequential billings growth as business has gotten a little more, on an apples to apples. And so certainly as you indicated, the compares get better in back half of the year. We are focused right now, on our next quarter right now and the billings guidance there and this trend that we see particularly in the core area, are really encouraging for us and we are just going to continue to try execute to that.
Melissa, just the other thing I would just say, reiterate Dave's point, but we are doing it quarterly. We certainly have this non-core area that we have to think about in the second half and the kind of strategic options we are evaluating for those products and those will, can and will impact the second half. And so we are not trying to get ahead of ourselves, we really want to focus on what we know about the quarter in hand to put that out.
Our next question comes from Michael Kim with Imperial Capital. Please go ahead with your question.
Just to follow-up on the EMEA region. Could you talk a little bit about some the investments you're making to drive billings growth now it's more stable, may be aligning that closer to what you're seeing in North America? And secondarily behind that, are you seeing a lot more activity around the security side or more on the data protection side?
Hey, Michael, you want that for Europe specifically?
So I think I had mentioned previously last year we didn’t perform as well in EMEA as we had hoped and really in the Q3 and Q4 timeframe we brought in new leadership with Chris Ross running sales for us in Europe. And then Chris has implemented really a change in the model that is more, looks like what we are doing in the Americas. So we have really built out the inside sales team. We have aligned that to the focus areas. And so I think we have just seen better efficiency starting to happen and better productivity in Europe out of that sales model change. We are actively working on top of that to build out and increase the channel. Secondly, we have brought Intronis. So Intronis has now expanded overseas so we do have our MSP offering available in the U.K. and have intention over time of building that out in Europe which I think gives us access to an incremental market. We have always been strong in network security and security overall in Europe and I think we have a very good core competency in our sales force towards security in Europe and we continue to execute well in those security offerings in Europe. Our goal is really to improve our data protection business in Europe in the coming year and I think we have that opportunity. So we are definitely selling more security than we are data protection and we hope to improve on that in the coming year.
Great. And then just on the MSP channel. Are you starting to see any opportunities to drive the security part of the business into that channel more efficiently globally or is it still primarily focused on data protection? How is the MSP channel starting to develop?
We are very excited about that. Over the last three months we have added the Office 365 package to the Intronis platform and just last week we rolled out the next generation firewall product and we have already got an order for the next generation firewall product. So we think when we have surveyed the MSP partners, when you look at the features or offerings they are looking for, email and network security, we are very high in the list. And they like to work with few vendors and consolidate those offerings where they can. So we think there is a great opportunity for us to drive security offerings through Intronis. So it's early but we had a good start with Office 365 and out of the gate selling that well and I was happy we have gotten our order in the first week. We had the next generation firewalls out too. So we feel good about the security offerings via MSP.
And with that ladies and gentlemen, we have reached the end of the allotted time for today's question-and-answer session. I would like to turn the conference call back over to BJ Jenkins, President and CEO, for any closing remarks.
Thank you and thanks everyone for joining the call today. I just wanted to thank our customers and partners for their continued support of Barracuda and I want to thank all of the Barracuda employees worldwide for all of your great work and all you do every day. We look forward to updating everyone very soon. Thanks for joining.
Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.
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