Barracuda Networks' (CUDA) CEO BJ Jenkins on Q3 2017 Results - Earnings Call Transcript

| About: Barracuda Networks, (CUDA)

Barracuda Networks, Inc (NYSE:CUDA)

Q3 2017 Earnings Conference Call

January 09, 2017, 04:30 PM ET

Executives

Maria Riley - IR

BJ Jenkins - President and CEO

Dustin Driggs - CFO

Analysts

Jayson Noland - Baird.

Ugam Kamat - J.P. Morgan

Rob Owens - Pacific Crest Securities

Erik Suppiger - JMP Securities

Andrew Nowinski - Piper Jaffray

Gur Talpaz - Stifel

Hamed Khorsand - BWS Financial

Michael Kim - Imperial Capital

Srini Nandury - Summit Redstone Partners

Good afternoon, and welcome to the Barracuda Networks Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note that today’s event is being recorded.

At this time, I would like to turn the conference over to Maria Riley from Investor Relations. Ma’am, you may begin.

Maria Riley

Good afternoon and welcome to Barracuda’s third quarter fiscal 2017 earnings conference call. On today’s call, BJ Jenkins, President and CEO, will provide an overview of our third quarter fiscal 2017 performance. Then Dustin Driggs, Barracuda’s CFO, will review our financial results in more detail and provide guidance for the fiscal 2017 fourth 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 third quarter ended November 30, 2016. A copy of this release and supporting financial materials are available in the Investor Relations section of the Company’s website 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 to provide information which is not historical in nature. These statements involve risks and 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 information on risks and uncertainties that may cause actual results to materially differ from those described in the forward-looking statements.

Also, please note that unless specifically noted otherwise all financial numbers discussed today are on a non-GAAP basis. Non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP.

A full reconciliation of the non-GAAP measures as well as a discussion of why we present non-GAAP financial measures are included in our earnings press release that is available on our website.

Additionally, on this call we will give guidance for the fourth quarter of fiscal 2017 on a non-GAAP basis. We do not provide reconciliations of our forward-looking non-GAAP financial measures to the corresponding GAAP measures due to the high variability of and difficulty in making accurate forecast and projections regarding the items excluded from these non-GAAP measures and accordingly such reconciliations are not available without unreasonable effort.

For additional information, please see our earnings press release that is available on the website.

And with that, I will now turn the call over to BJ Jenkins, President and CEO of Barracuda.

BJ Jenkins

Thank you, Maria. Good afternoon everyone and thank you for joining us to discuss our third quarter fiscal year 2017 results. Our Barracuda team delivered strong results in the third quarter. We continued to execute our strategy to capitalize on the evolving trends in the market and drive growth as more businesses look to secure and protect our users, applications, and data as they move to cloud environments.

Our focus is to position Barracuda as a leading provider of security and data protection solutions across cloud, MSP, and on-premise deployments. We continued to gain traction with our customers and partners and our financial results in the third quarter reflect the progress we are making in our target areas.

Our Q3 revenue grew 11% year-over-year to $88.8 million, and on the bottom line we generated $0.22 in non-GAAP EPS. We achieved over $100 million in gross billings for the second consecutive quarter.

Third quarter total gross billings grew 13% year-over-year with core product billings coming in ahead of our expectations and growing 30% year-over-year. Third quarter performance for our three core product focus areas; email security and management, network and application security, and data protection each performed well.

First, in email security and management, growth was driven by our cloud based solutions including strong adoption of Barracuda Essentials for Office 365 from both new and existing customers.

New Billings for On-Premise and Cloud delivered solutions combined grew sequentially for the third consecutive quarter. In Q3, we added over 1000 new customers to Barracuda essentials for Office 365 bringing the total number of customers to over 2000.

Additionally, 50% of these customers are net new to Barracuda, up from 30% last quarter. We believe the expanding number of net new customers using Barracuda Essentials to help protect their Office 365 assets demonstrates our ability and opportunity to gain share as more customers look to leverage cloud hosted environments.

Email was the most exploited threat factor and traditional approaches to email security are not sufficient to combat advance threats. One recent product innovation that I briefly mentioned last quarter is our email threat scan tool, which helps customers gain visibility into the threats hiding in their email and improve their security posture.

Email Threat Scan is driving some of the momentum we are seeing in Office 365 by quickly demonstrating the benefits of our solution. A great example of this is with the 9000-user University that recently migrated its email to Office 365 but did not initially have the budget to enhance their email security posture. After scanning their email with our Email Threat scan, they identified several latent threats existing in their email environment and quickly realized they needed to add advanced protection and purchased Barracuda essentials for Office 365.

Second, in network and application security, we’ve generated record billings for both our next generation firewall and web application firewall solutions within both on-premise and cloud deployments. We recently announced several updates through our web application firewall product line that help to simplify the way application security is deployed and managed, including API integration with our next-generation firewall solutions.

The Barracuda next generation firewall was designed for the cloud era with features that enabled direct access to cloud applications and disperse networks where quality of service, network reliability, and secure connectivity are required at every location. We continue to garner industry accolades for leadership in this area.

In a recent study by MRG Effitas and AV-Comparatives, Barracuda’s next generation firewall was recognized as a top performer and was the only product to achieve 100% coverage for all malware samples.

This result demonstrates our ongoing commitment and innovation around securing and protecting our customers from attacks. And third, in data protection, we delivered solid organic billings growth driven by increased demand, new product enhancements, and the improved price performance offerings introduced last quarter.

Data protection is a critical component of a company’s security fabric. Many companies do not have a solid up-to-date backup solution in place which leaves them vulnerable when faced with a ransomware attack or other advanced threats.

Let’s consider the latest attack that temporarily disrupted a large public agency which could have resulted in a more damaging outcome. This financially motivated attack hit on Black Friday, the busiest shopping day of the year and impacted a large number of systems responsible for daily operations. While there was some disruptions and inconvenience for the agency, they never considered paying the ransom and were able to get back up and fully recovered with Barracuda Backup.

Once they located and eliminated the malware, they simply erased the encrypted data and restored their original data from their backup. Having a comprehensive and integrated backup email archiving and recovery strategy is critical to the ability to recover quickly from ransomware attacks with minimal impact.

Moving beyond our core product focus areas during the quarter, we also continued to expand our routes to market. We are building on our strong momentum in public cloud including growing our pipeline of new public cloud opportunities and expanding our market reach. Some of our recent activities in the public cloud include announcing the availability of the Barracuda next generation firewall on the Google Cloud platform.

The Barracuda next generation firewall is the first next generation firewall available on the three leading cloud platforms. In addition, we had a strong showing at AWS re:Invent where we announced several feature enhancements aimed at simplifying web application security for AWS customers, including a new metered billing option for our web application firewall on AWS.

Barracuda is the first third party web application security solution on the AWS marketplace where customer usage can be aggregated and charged as part of an existing AWS invoice. Using the metered service, customers can take advantage of a consumption based pricing model to match capacity to their needs providing greater flexibility and control over how they deploy security in their AWS environments.

Lastly, we recently announced that 2nd Watch, one of the largest consulting partners for AWS selected the Barracuda web application firewall to help customers reduce complexity, increase visibility and migrate to their cloud securely and affordably.

Barracuda products allow customers to maximise their AWS investments with secure, tailored solutions engineered for cloud environments. We continue to push innovation in the public cloud, and as a result we have become a leading security vendor on AWS and Azure. Our strong relationship and continued collaboration with AWS and Azure is enabling cloud adoption and making successful migrations possible for thousands of customers.

Another key channel for us is the MSP route to market, where we had another solid quarter driven by our expanded Barracuda product offerings through the Intronis platform. As acquiring Intronis over a year ago, we have successfully expanded the number of solutions delivered to include products in all three of our key focus areas, email security and management, networking application security and data protection.

Enabling our MSP partners to deliver a broader range of easy to deploy and manage security and data protection services is a key element of our strategy to expand our MSP network and increase our share of the market.

This is an important route to market as a growing number of small and medium businesses with limited IT budgets are moving to a pay as you go model to reduce their upfront IT investments and relying on MSPs to manage and secure their networking data.

We believe our strong results this quarter reflected differentiated value we provide to our customers and partners. We continue to drive innovation in our solutions to expand email security, networking application security and data protection and which can be deployed across cloud and hybrid environments and managed from a single pane of class. We believe we are well-positioned globally to drive continued growth and create long term value for our shareholders.

With that, I will now turn the call over to Dustin for a more detailed review of our third quarter financial performance and fourth quarter guidance.

Dustin Driggs

Thanks BJ. Revenue in the quarter was $88.8 million, an increase of 11% year-over-year. Our total subscription revenue grew 17% over the third quarter of last year to reach $68.3 million. Subscription revenue accounted for 77% of total revenue up from 73% in our prior fiscal third quarter.

Our average contract lengths remained consistent with the prior fiscal third quarter. On a geographic basis, we drive 76% of total third quarter revenue from the Americas. Revenue from EMEA was 18% of total revenue and Asia Pacific was 6% of total revenue. I would like note that the Asia Pacific region delivered their largest quarter for new business in the regions history. We revamped our leadership and resale channel in key areas of the region and we believe we are now seeing the benefits of these changes.

Our number of active subscribers in the third quarter exceed 309,000 which was an increase of 15% year-over-year. Renewal rates which we calculate on a dollar basis were 90% in Q3 or 92% in constant currency and 98% on an annualized basis.

Turning to third quarter billings, as BJ mentioned our core product billings outpaced our expectations for the quarter and grew 30% year-over-year to $61.6 million. The subscription ARR for our core products was $155 million, representing 25% year-over-year organic growth. Our legacy on-prem billings were $35.9 million reflecting the seasonally lower third quarter renewal pool, the related subscription ARR remained at $117 million.

As expected, we continue to see a transition from on-premise solutions to cloud delivered services. Since the release of Barracuda Essentials for Office 365, 38% of revenue in essentials is from customers migrating from on-premise solutions. While this transition does have an impact on the legacy on-prem billings the overall trend is a net positive to Barracuda in terms of customer life time value and core billings growth.

And lastly, our non-core billings were $2.9 million, a 28% decrease from the prior year, and reflected discontinuation of CUDA Drive and the Barracuda Phone System.

Our total gross billings for the quarter were $100.4 million. Total subscription ARR grew to $279 million which represents a 13% increase year-over-year. Please refer to the supplemental presentation posted on our website for a breakout of our billings and ARR and a reconciliation of billings to revenue.

Returning to the P&L, our non-GAAP gross margin in the third quarter was 79.6%, a 60 basis-point increase from the third quarter of last year. The decrease in the quarter reflects additional investments made to increase our data center capacity to accommodate growth for our cloud delivered services.

Non-GAAP operating expenses in the third quarter were $51.9 million or 58% of revenue compared with 70% in the third quarter of last year and 59% in the prior quarter. We ended the third quarter with headcount of 1,508.

Non-GAAP research and development expenses in the third quarter were $14.8 million or 17% of revenue compared with 19% of revenue in Q3 of last year and 18% in the prior quarter.

The sequential decrease in non-GAAP research and development expense was related to a onetime $700,000 reclassification of compensation expense to stock based compensation in the current period.

Non-GAAP sales and marketing expenses for the third quarter were $30.5 million or 34% of revenue compared with 42% of revenue in Q3 of last year and 34% in the prior quarter. Non-GAAP general and administrative expenses for the third quarter were $6.6 million or 7% of revenue compared to 9% of revenue in Q3 of last year and 8% in the prior quarter.

We delivered $16.6 million in non-GAAP operating income more than doubled the amount we generated in the third quarter of last year. Our significant year-over-year improvement in operating income reflects the strong leverage created in our model as we narrowed our product focus while accelerating investments in our core focus areas.

Given the opportunities we see in the market and our growing momentum in our core focus areas, we plan to continue to increase our investments in these areas in order to further expand our market position and capitalize on the growing opportunities.

Returning to Q3 results, the non-GAAP tax provision was $5 million in the quarter. Our non-GAAP net income in the third quarter was $11.6 million or $0.22 of earnings per share on a diluted share count of 54 million shares.

Turning to GAAP results, we reported third quarter GAAP earnings of $0.03 per share. This compares to GAAP earnings of $0.05 per share in the last quarter and a loss of $0.03 per share in the same quarter of last year.

Cash flow from operations for the third quarter was $15.1 million, which compares to $5.3 million generated in the third quarter of last year. Capital expenditures in the third quarter were $1.3 million.

And finally, deferred revenue at the end of the quarter was $401.3 million compared with $391.7 million at the end of the third quarter of last year. Before we move to guidance, I would like to note that for the third quarter and on a go-forward basis, we are changing the way we report adjusted EBITDA and free cash flow.

For adjusted EBITDA we will omit any adjustments for changes in deferred revenue and deferred costs. And for free cash flow we will no longer adjust for the cash payment impact of acquisition and other charges. These changes do not impact our current and historical presentation of GAAP results.

A reconciliation of these metrics can be found in the supplemental presentation posted on our website. In the third quarter, under our new methodology, we generated $18.9 million of adjusted EBITDA or 21% of revenue compared with $7.9 million or 10% of revenue in the same quarter of last year.

Free cash flow in the third quarter was $13.8 million, which compares to $3.2 million in the same quarter of last year.

Now turning to guidance, for Q4 FY17, we expect billings to be in the range of $100 million to $103 million. We expect revenue to be in the range of $87 million to $89 million. Guidance for non-GAAP operating income for the fourth quarter is between $10 million and $12 million.

Non-GAAP earnings per share for the fourth quarter is expected to be between $0.13 and $0.15 per share with an assumed share count range of 54 million to 55 million shares.

That concludes our prepared remarks today. Now BJ and I are happy to take your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] And our first question today comes from Jayson Noland from Baird. Please go ahead with your question.

Jayson Noland

Okay, great congrats on the quarter and I guess I will start with the essentials package, you added another 1000 customers and you saw the net new customers increase from 30% to 50% maybe if you could talk about why so many net new, is there something you are doing or is it just dynamic of the go-to-market?

BJ Jenkins

Yes, thanks Jason, this is BJ. Email security has been growing rapidly. First, there is a lot of customer demand out there and movement from on-prem and Office 365, so there is certainly some customer awareness. You put that together with a rise in attacks like ransomware and customers are looking for a full security suite that will help them protect their email environment and specifically with something like ransomware, the fact that we have strong cloud based email security along with backup and data protection for those customers who are impacted to recover from I think is driving a lot of awareness and uptick in demand.

I think the other thing we see is that about 40% of our demand is coming from partners and we’ve been doing a lot to educate partners on the Essentials package. I think a lot of them are partnered with Microsoft and moving a lot of customers to Office 365. And the opportunities to pair that with leading security and data protection is driving a lot of partner demand for us also. So, this has been a focus area for us. We’re really happy with the performance and believe it will continue to grow strongly.

Jayson Noland

And then a follow-up BJ, you’d seen some traction in the Fortune 1000, not a big focus area, but maybe an update there, and if this part of your market requires any incremental OpEx investment?

BJ Jenkins

Yes. I think a lot of that is obviously coming from Public Cloud, and Public Cloud is an area that we invested in over three years ago and still we’ve been a first mover in Public Cloud, and in fact this quarter the first to get firewalls in the Google Cloud. And so I think that’s paying off. There is going to be ongoing investments as that business scales for us, but the early investment we think has gotten us very deep relationships with Microsoft and Amazon that are paying off. Our products that are very well architected for cloud environment, so we think that’s paying off.

And as of this quarter, we’re now over 50 Fortune 1000 customers. So, in our model and the way we operate, we’re actually getting those customers to come and choose us because of how the products are architected in the investments we made in the partnerships, so that continues to grow at a very healthy clip for us.

Jayson Noland

Okay. I’ll leave it there. Thanks BJ.

BJ Jenkins

Thanks, Jayson.

Operator

And our next question comes from Sterling Auty from J.P. Morgan. Please go ahead with your question.

Ugam Kamat

Hey. This is Ugam Kamat on for Sterling Auty. Thanks for taking my question. Just from the renewal rates. So just to touch on the renewal rates, renewal came in at 90% and it was much lower than what we have seen in the past and even on FX adjusted basis, it’s lower than the 96% renewal rate that we saw last quarter. If you could throw some light on what’s really happening to the renewal cohort [ph], it would be very helpful?

BJ Jenkins

Yes. Thanks for the question. If you look at the renewals rates, we’re very comfortable with the long-term projection of low 90s, that’s going to vary quarter to quarter. And even within this quarter we’re happy with the renewal performance. If you look at that 90%, there was 2% currency headwinds, so its 92% renewals if you go constant currency.

And then if you look at our renewal pool, on an annualized basis we were at 98%. So, we still feel the solutions are very sticky. When we look at the units renewals underneath, they long-term continue to stay constant and feel that our solutions are providing a lot of value to customers and enjoy high renewal rate.

Ugam Kamat

All right. That’s helpful. And just to touch upon on appliances, you have been transitioning your business to subscription, but it looks like your appliances have continued to hold up. How should we think about it going forward?

BJ Jenkins

Yes. Well, I think long term, we have a fundamental belief we’re going to continue to grow subscriptions versus appliance. But if you look at our core focus areas, a part of that core focus area is backup which involves appliances and next- generation firewalls and web application firewalls which is -- they’re not on the cloud and on-premise could be a physical appliance also. And so that appliance line will vary quarter to quarter depending on how each of those businesses do.

And in Q3, we did see a return to organic growth for our backup line which obviously drives the appliance number long term and we had very strong performance with the -- record performance for the NG and the web [ph]. And so, the long term trend will be greater subscription growth. You’ll see the appliance line fluctuate depending on how some of those sub categories do.

Ugam Kamat

All right. Thank you so much.

BJ Jenkins

Thanks.

Operator

And our next question comes from Rob Owens from Pacific Crest Securities. Please go ahead with your question.

Rob Owens

Great, and thanks for taking my question. BJ, you mentioned that you have over 50 Fortune 1000 customers on the cloud. And I guess if we look back historically at Barracuda, although wasn’t really your focus, you still were able to capture some customers in this set. So, I’m just curious over the last year with the transition more so to cloud, is that opening the door more so. Can you speak to the fact that maybe this is a higher percentage of total customer mix that is even Fortune 1000 and Global 2000, or is it relatively consistent with kind of the one-off customers that you’d see there historically?

BJ Jenkins

Thanks, Rob. For us, this to us is a new and incremental market that we would not be able to get that in our traditional model, and it’s one of the things that as we look at the Public Cloud growth, we get excited about these [indiscernible] customers given our traditional, high velocity sales model that we would be engaging with. As we invested in Public Cloud, we have gotten our traditional customer base that we’ve focused on. One of the benefits here is as we deepen the partnerships with Microsoft and Amazon, this we’ve stated in our sales model that they bring – they had brought us leads and opportunities in these larger accounts. The products are architected well and perform very well for these larger customers, which drives follow-on buys and then we think we’ve been clipping off more and more of the Fortune 1000 as both Microsoft and Amazon teams have gotten comfortable with our solution’s ability to perform at that level in Public Cloud.

So, we look at that as incremental to our traditional motion that’s been out there. Maybe by other commentary that I could give you on this is that the requirements that we see come out of Public Cloud have been very similar to the product requirements that we see in the MSP market where multi-tenancy, you need a lot of different characteristics than you would on-premise. So what we’ve developed for Public Cloud is also been applicable to drive out into the MSP market and it has given some amplification to the investment efforts we’ve made in the products in those areas.

Rob Owens

Great. Thanks. And as we contemplates your upcoming guidance for the fiscal fourth quarter, at the high end of the range its flat, at the mid point its down, yet you’re entering fiscal fourth typically strong from a billing standpoint. You’ve seen strong billings even with acceleration if we were to look at net billings over the last couple of quarters. So, help us understand the puts and takes that would lend to guidance that effectively has revenue somewhat flattish quarter over quarter?

BJ Jenkins

Thanks, Rob. I’ll probably jump billings first and then come into Rob Owens [ph], if I missed anything here to ask then I’ll jump in. But on the billing side as we look at guidance, couple of things here, first, we’re still in the – we’re really pleased with Q3 and the progression we’ve made there. When we look at Q4, we’re still in the transition dealing with the non-core assets on a year-over-year comparison standpoint. We did some impact in December on currency and given some of the currency movements in the market, we are anticipating some currency headwinds in Q4.

We actually have one less selling day in Q4 also and you know this is a daily business. So you take that and then continue kind of move to virtual and growth in the MSP platform which is more monthly billing that led to the guidance. We still feel that’s strong growth, but it takes those things into account. On the revenue side, similar, it’s more of the waterfall coming from the previous year’s billings and the contracts coming in obviously. But we have one less selling day in Q4 for revenue also which impacts what we got into.

Dustin Driggs

Hey, Rob, this is Dustin. So, just adding on to what BJ said. So yes, there is one less revenue day. And then the other thing that we’re seeing as we look at that waterfall is obviously Q3 and Q4 last year when we saw some of the drop off in the legacy portion of the new bill – of the gross billings. Some of that’s coming in and it’s being reflected into our revenue guidance for Q4.

The good thing is that we’ve seen very good strong rebound and real good solid organic growth within that core category that’s going to basically flow back into that revenue line as we look at quarter or two out after that. So there are some timing related to how that slowdown actually comes from that legacy business transition into our waterfall, and we see a quick recovery out of that as we look at some of the more recent trends in gross billings.

Rob Owens

Great. Thanks.

BJ Jenkins

Thanks Rob.

Operator

Our next question comes from Erik Suppiger from JMP Securities. Please go ahead with your questions.

Erik Suppiger

Thanks for taking the question. First off, you’ve had Intronis here for about a year, can you comment on what contribution that’s making at this point and how we can think about that in terms of the growth going forward? Then secondly on the email, can you comment how much business are you seeing from McAfee as they end-of-life, they’re cloud solution? Thank you.

BJ Jenkins

Thanks, Eric. We decide to purchase up in October of last year. I think at that time we had told folks, it was mid 20s on the revenue side. And we’ve been very happy with the performance of the MSP and believe it’s a good opportunity for us. We’ve added email security, our Essentials offerings to the platform. We’ve added our NG line to the platform and also our backup appliances. It’s been growing into mid to high teens and has been doing that profitably for us. And we believe this is an area – it’s an area we are investing and adding heads and believes it can continue to grow at a healthy clip for and we’re excited about the demand we’ve seen.

On the email side, we do see some demand coming over from McAfee in our traditional SMP market, that some of the demands were, again if we look at the net new customers we’re getting some of it from our traditional marketing engine, some of it from partners and some of it from both partners and end-users who have deploy McAfee solution. I wouldn’t quantify what percentage that is, but we are seeing inquiries from both partners and end-users who are moving off for the McAfee solution.

Erik Suppiger

What is your outlook for the business that’s been coming from McAfee? Is that going to taper off now with that end-of-life coming?

BJ Jenkins

It’s hard for us to say. I mean we’re getting consistent inquiries, but usually when you get into an end-of-life its up until when that product is end-of-life where you see the demand and then you have to go find it somewhere else.

Erik Suppiger

All right, very good. Thank you.

Operator

Our next question comes from Melissa Gorham from Morgan Stanley. Please go ahead with your question.

Melissa Gorham

Great. Thanks for taking my question. I just want to follow-up on the email security discussion. So, BJ you talked about working with some of your partners who are also selling Microsoft and Office 365 to which is a driver for the email security solution. I’m just wondering if you could comment on the expense which you’re competing with Microsoft versus partnering with them and does that change it all in the past few months or quarters?

BJ Jenkins

No. I think its – thanks Melissa. I think it stayed consistent. Microsoft is actually working with us in this area. They obviously have a goal to move as many of their customers to Office 365 as possible. And Microsoft everyday is improving their security posture and it’s done a good job at offering packages that start to help their customers being a better security position. Our job is to continue to innovate around what they do and we think there are lot of areas where customers need to vigilance, they need to be improve their security posture and our Essentials package helps them do that.

I think one of the ways we’ve innovated and really put value on top of Microsoft is the email threat scan tool that we’ve talked about. Many of these customers using Microsoft that we go in and we run the threat scan and they find latent threats. And in doing that they are able to monitor and make sure there are always checking to make sure they are putting themselves in the best position.

So, I think they’ve been a good partner. They are always up in their game and getting better of what they do. And there are certain areas we can innovate on top to continue that value to the customers. So, I think that’s what we’ve been doing and I think it’s working out well for us. And we see a future where we can continue to do and drive strong growth in email and email in our view and in the SMB market has been the number one threat factor for our customers especially for things like ransomware and its I think a place where the Barracuda Essentials messages and helping drive strong demand for the solution.

Melissa Gorham

Okay, great. And then BJ you talked about how the cloud solution is helping you, I guess gotten new customers, I think you gave percent of new customers adopting the cloud. To what extent are those customers are coming back and then buying a broader portfolio of Barracuda solutions and maybe even buying some on-premise stuff to complement the cloud?

BJ Jenkins

I think we’ve seen in Public Cloud first on land and expand where many of these customers start with small instances or testing applications and the cloud use our solution and then when they go to a full production rollout we really expand the amount of dollars that they spend with us. So we’ve seen that happen on a regular basis with the majority of customers that we deal with in Public Cloud.

And I think the second benefit that we have seen is these are net new customers for us. And as they get experience with out products, how well they operate for both the security, but it ease us in the management perspective in Public Cloud. We are also getting opportunities to come, play on the hybrids, play in their data center and the reasons why again are work really well in the distributed environment, strong secure connectivity and then single pane of management, ease of management for these customers.

So, we do think Public Cloud has been an incremental market in the fact that its net new demand for us, but then its also helping us go back into the traditional markets and expand what we do with those customers.

Melissa Gorham

Thank you.

Operator

And our next question comes from Andrew Nowinski from Piper Jaffray. Please go ahead with your question.

Andrew Nowinski

All right. Thanks. Just a few follow-up questions for you. I guess, first may on the core billings growth it accelerated to about 30%, it’s the highest growth that you’ve had in the long time. I guess, can you give us any color were there any large deals or one time anomalies that drove that growth this quarter?

BJ Jenkins

Andrew, thanks, its BJ, when you look at that core category we had strong performance across all three of the main factor, so email performance well and better than we expected. Ng and web [ph] was a record quarter and we saw return organic growth and back up. As we return organic growth and back up we do get some larger deals and that segments probably been over the course of the history. You’ve seen we’ve had lumpiness there. There were some big deals and backup, but we performed well across all three factors which drove that 30%.

Andrew Nowinski

Got it. And then on email threat scan you know a customer really finding now are predominantly using Microsoft email or they using nothing at all. I’m just trying to understand who you are displacing using that new threat scan tool?

BJ Jenkins

It’s been a mix of Microsoft Only and then Microsoft Plus and other security vendor. So it is both. And I think it just goes to show how rapidly the threat environment continues to evolve and it’s hard for any company to completely protect an environment. I think where we get excited about the threat scan and where its going is we’ll give a chance to monitor and constantly look at the health of your email environment and we think that’s going to be important feature for customers going forward.

Andrew Nowinski

Got it. And just last question from me, I guess, your DSOs spiked up a bit compared to last quarter, any color there and what you expect for Q4?

BJ Jenkins

I’ll start on this. Look, I think the last couple of quarters in general we’ve had good linearity in the business, strong linearity, we think the demand for security and the SMP market has been very strong and steady. When you just look at how this quarter wents, last year we had one day after Thanksgiving which maybe little bit hard. This quarter we had three days after Thanksgiving and we had very good closed to the quarter. And so I just think sometimes its all those days fall and when those deals are coming in, but overall linearity has been very good for the business.

Andrew Nowinski

Great. Can you [Indiscernible] that they were in the range of where we’d want to be even from DSO perspective. I think we came off a very good quarter last quarter from a DSO and cash flow perspective and I think we’re returning back to kind of a normalized range in this quarter.

Andrew Nowinski

Got it. Thanks.

Operator

Our next question comes from Gur Talpaz from Stifel. Please go ahead with your question.

Gur Talpaz

Great. Thanks for taking my question. So, with regard to the migration from on-prem email to cloud, how should we think about the pace of legacy content security customers here migrating to the newer cloud solutions? You talk about some customers migrating from appliance towards cloud. You think that pace will steady, you think it accelerate? That would be helpful. Thank you.

BJ Jenkins

Thanks, Gur. It’s obviously as we came out with Essentials, it fluctuated quarter to quarter for us and in this quarter in particular we had very strong demand for the cloud based. The overall trend is going to continue. What we are doing though on the legacy side, which I think will help strengthen our position there as we’ve announce now advanced threat detection for the physical email gateways.

So some of the reasons why customer may move from physical to cloud, we have more feature parity on both sides which I think it helped for a customer who perhaps want to say with their physical gateway. But the long term trend will still be we believe acceleration on the core cloud delivered security areas at the expense of legacy.

Andrew Nowinski

That’s helpful. We talked the last you noted I think very short sales cycles for the Office 365 solution. Has that help this quarter, I believe it’s less than a month last time we talked?

BJ Jenkins

Yes. I think as we’ve done some larger customers, its expanded a little bit, but it still a traditional Barracuda sales cycles, so I think 30 days are less overall, but we are starting to close some larger deals now where you’d see more traditional 60 or 90 day sales cycle on them, which is extending a little bit. But you know the velocity part of that business stay the same. And we’re doing very well, a 1000 employee or less its been a really strong suite spot for us with email.

Andrew Nowinski

That’s great. And then maybe one last question. The last time we spoke, you noted that the cloud was sort of the great equalizer among security vendors, do you still see that being the case a day and how you see yourself competing against some of the more I would say established or in French enterprise security vendors in the cloud? Thank you.

BJ Jenkins

I do think that’s one of the big opportunities obviously for security companies and the transition just being down at reinvent and seeing the number of customers, they are points to the opportunity. Again I feel like we made newly investment that’s focus on this, which is paying off. I think our products are well architected. I think there are security companies that are having to make greater adjustments in their product architectures or how they approach deploying their products in Public Cloud that make them more complex. And the investments we’ve made and the relationships not only with Microsoft and Amazon, but new cloud integrators like 2nd Watch or how things that’s move quickly in this environment which I think is important to help customers as they move these workloads. So, there’s obviously a lot of investment coming in from a lot of the traditional security companies. I think we’re well positioned and we’re going to increase our investments in here to capitalize on the opportunity.

Operator

Our next question comes from Hamed Khorsand from BWS Financial. Please go head with you question.

Hamed Khorsand

Hi. Just to update here. I mean, last quarter and this quarter you’re talking about investing more on R&D and sales force, but it really didn’t been lead up to anything on a income statement. Can you quantify that and BJ also quantify what kind of benefit that you’re seeing if any from the increased investment that you’re proposing?

Dustin Driggs

Hi, Ahmed, this is Dustin. So, I think what we’ve always said is that we are always going to balancing productivity and top-line growth. So we have been seeing opportunities and that’s reflected in the results in the top-line. So we feel like there are opportunities for us to invest in sales and marketing and in R&D going forward you can see a little bit of the incremental sequential increases in sales and marketing and in RDS we have – as we have projected as we guided to from Q2 to Q3 it now gets through a scale that we guided to though there was sequential increases in investment. I think we see with initial clarity of the areas where we can invest and that’s built into the guidance we’ve given for Q4. We see areas where we can invest in the cloud and in building out our sales force from a geographical perspective and from a cloud security perspective to take advantage of the opportunities that are – that we see in the market.

Hamed Khorsand

[Indiscernible] intention…

BJ Jenkins

Sorry I was just going to add you know when we look out if you think about going forward, you know some of the investment from Q3 was a timing where we got heads on board, but more towards the latter stage of Q3, so you’ll see that come into Q4, so you know there’s – we haven’t got people on board as fast as we may have anticipated in Q3, but you know that are on in board right now and in those focus areas and we think they are targeted towards the right areas. Again like Dustin said its email, its public cloud it’s the areas where we’ve really seen opportunity grow.

Hamed Khorsand

Okay. And it didn’t sound like you bought back any stock in the quarter, is there other area that you are looking to invest either cash in the business?

BJ Jenkins

We didn’t buy back stock in the quarter. You know when you look at where we are investing, it’s a continuation of R&D into our focus areas, so really email being number one but also you know public cloud and MSP we’ve been putting money into that. Second is a continued expansion really in sales and marketing capacity in those targeted areas, I think as we better understood email security demand and you know how that demand is being generated we are accelerating investment both digitally on the marketing fronts but also in sales capacity to meet that demand.

And so, we’ve done that while we’ve also been transitioning out of the product areas also so you know the balance of doing this correctly is something we place close attention to and want to make sure we are investing at the proper pace.

Operator

Our next question comes from Michael Kim from Imperial Capital. Please go ahead with your question

Michael Kim

Hi, good afternoon guys. Can you talk about in the public cloud, trends and average deal size and I think last quarter you highlighted a couple of six-figure deals I’m curious if you continue to see that pace?

BJ Jenkins

Yes, Michael its BJ. In general our public cloud ASP is higher than our traditional business ASP and the sales cycles tend to be longer as customers are making a decision to go from move the work load from on-prem and into public cloud. So the deals are larger and the sales cycles are longer there also. So you know we’ve seen the pipeline grow on a perspective to keep that trend going and obviously investing in sales capacity to keep driving that.

Michael Kim

And I think about a year ago this – year ago from today you talked about the virtual and public cloud business running pretty close to $50 million in growing about 40%. I hope you can might be able to find an updated statistic on that business?

BJ Jenkins

I couldn’t do that for you right now, but it is a part of the core category and so if you think of that core category and how fast it’s growing, I would tell you that public cloud portion of that and the solutions pointed at public cloud and cloud delivered security are the fastest growing parts of the core focus areas.

Michael Kim

Great. Thanks very much.

BJ Jenkins

Thanks.

Operator

And ladies and gentlemen, our last question today comes from Srini Nandury from Summit Redstone Partners. Please go ahead with your question.

Srini Nandury

All right, thank you for taking my question. BJ, can you talk about the Email Threat Scan at dash [ph] periods and can you provide some color on your go-to-market approach with your new and existing customers? And I have a follow up…

BJ Jenkins

So the Email Threat Scan is actually a tool that was developed by the team that we acquired from Sookasa. And they have done a great job developing this, probably because as we rolled it out, was both to end users and partners to go look at their existing email environments and you know shocked to see what position they ran at that particular point in time with their email environment. And as we’ve – from hundreds of scams now and you know it’s a very high 90% plus percentage of environments that have found threats in them.

And so this tool today drives awareness to both the partners and the customers that where they may have felt like they had enough security or had a good plan in place to deal with threats like ransomware, that was where you think they can improve, which obviously for us leads to discussions around the essentials package and how we can help them improve their security posture.

So it was demand generation tool we have not charged for that today, but it has helped us to drive growth and awareness of our central offering. You know down the road we believe this can take on aspects like real time analysis of your environment, and could potentially be monetized, so it’s something we are looking at and we are going to continue to innovate around because we think it brings real value to both customers and partners to be able to constantly see into their email environment and know where they stand against these threats.

Srini Nandury

Understood. If I may, on your data production business, obviously everybody is that one of your customers are actually backing up the data is up, production against ransomware. So, can you give me some color on what percentage of your customers have actually backing up on premises versus cloud? Thanks.

BJ Jenkins

Well I guess, I would say, our solution, our data protection solution today is positioned as an all in one where the appliance is on premise, in a virtual or physical, and has the full copy of data on it so that you can recover quickly on-prem. And then it obviously has a cloud aspect to it where you can replicate compress – and replicate the data into our cloud. A high percentage of customers in use, either the cloud for their off-site replication or buy two boxes and replicate between them so that they don’t – that they have some form of off-site data protection. It is very rare in our world for a customer not to have some form of what we called the data recovery or another copy either in our cloud on another machine.

So our sales force works with the customers and the partners to know that’s the right way to deploy and the majority of systems out there have some form of either machine to machine replication or machine to cloud replication for disaster recovery.

Operator

And ladies and gentlemen, with that we’ve reached the end of the allotted time for today’s question and answer session. I’d like to turn the conference call back over to management for any closing remarks.

BJ Jenkins

Thanks, Jamie. And I just want to thank everyone today for joining in on the call, and especially want to thank all of Barracuda’s employees, partners and customers for their support. And we look forward to talking to everyone soon. Have a great day. Thanks.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We do thank you for attending. You may now disconnect your lines.

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