Mimecast Limited
Q2 2021 Earnings Call Transcript

Published: 3 Nov 2020

[Robert Sanders:]

Good evening. Welcome to Mimecast Earnings Call for the Fiscal Second Quarter 2021 Ended September 30, 2020. I'm Robert Sanders, Director of Investor Relations. With me on the call tonight are Peter Bauer, our Co-Founder, Chairman and CEO and Rafe Brown, our CFO. Tonight's conference call is being broadcast live. A replay of this call will be available after the live call has ended. We will make forward-looking statements regarding future events and the future financial performance of the Company. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. The COVID-19 pandemic creates additional uncertainties when making forward-looking statements. We are providing guidance on a good faith basis aligned with SEC recommendations. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements contained in today's press release and on this conference call. These risk factors are further defined in Mimecast's most recent Form 10-K filed with the Securities and Exchange Commission. During this call, we'll provide both GAAP and non-GAAP financial measures. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results. A reconciliation of GAAP to non-GAAP measures and the reasons for our representation of the non-GAAP information is included in today's press release, which can be found in the Investor Relations section of our website. The date of this call is November 2nd, 2020. Any forward-looking statements we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events.

[Peter Bauer:]

Good afternoon, everyone and thanks for joining us. I'm pleased to share with you that we delivered results at the high end of our guidance range this quarter due in large part to our solid execution amid continued pressures relating to the COVID-19 pandemic. In our second quarter, we drove revenue of $122.7 million, that's up 19% year-over-year with strong free cash flow and EBITDA growth and we added approximately 500 new customers. While Rafe will take you through more details about financial performance and our outlook later in the call, I want to share with you how we're thinking about the road ahead from a business and market perspective. With a focus on the threat landscape affecting customers, the impact of COVID-19 and the work we're doing to both protect our customers and grow our business profitably. As we all know, the pandemic has posed challenges for companies of all sizes and across industries including Mimecast. In particular, market pressures are muting the impact of some of the actions we've taken to accelerate our growth. As we confront the challenges of slower project decision-making in the enterprise and the economic impact especially on the smaller business segment, we are ensuring that we offer the best value to customers by expanding and innovating our capabilities, while at the same time running our business efficiently and profitably with Rule of 40 thinking as an important context. We remain focused on achieving the targets that we set out in the long-term model, which we described in our Analyst Day earlier this year in February. Though COVID has the potential to impact the timing of how this plays out, we're focusing right now on the elements we can control. Winning new customers, taking care of them, selling them additional services, all the while taking steps to build our bottom line. So for example, we're continuing strategic hires that we expect to have positive impact on advancing our enterprise strategy, but we're reducing overall hiring. We have also shifted towards virtual meetings and events, given how successful we have been in using remote collaboration tools, we expect many of the related cost savings to be durable often a return to a more normal work environment, as we rethink where and how we work and how we engage with customers. To that end, we're evaluating hybrid work structures that allow people to balance office and remote working time, which we expect to drive real estate savings over the long-term. These shift enable us to continue to build the bottom line, while also further investing in R&D and other strategic growth initiatives. We are building our leadership in the industry by continually evolving our platform to anticipate customer needs and the changing nature of cyber threats. Through successful execution of the strategy, we have consistently delivered top line growth.

[Rafe Brown:]

Thank you, Peter. I'm pleased to report that we exceeded the high end of our guidance for revenue, adjusted EBITDA and free cash flow for the second quarter of fiscal 2021. Our results continue to demonstrate our ability to deliver both top line growth and bottom line margin expansion amid a challenging operating environment. Before I jump into our financial results for the quarter, I would like to take a moment to discuss the impact of COVID-19 on our business. When the pandemic began to take hold in our core markets in March, we undertook an extensive review of our business to understand what levers we had at our disposal to protect our customers, support our team and derisk our business. Despite the challenges of the past two quarters, we learned a great deal about our ability to work remotely and believe there are a number of important lessons that will allow us to build ongoing efficiencies into our business. For example, we believe we can drive long-term improvements in our facilities, travel, marketing and event driven budgets. We are also closely managing headcount increases to ensure we are responding to the business demands of this now prolonged pandemic. As Peter noted, we work tirelessly for our customers to deliver world-class protection in the face of ever increasing risks. As the impact of COVID-19 continues and as infection rates are seemingly reaccelerating, our customers and our team safety and health remain our top priorities. Let's now turn to our financial results. In the second quarter, we generated revenue of $122.7 million, which represents an 19% improvement over the prior year in absolute dollar terms. Adjusting for $200,000 of currency tailwind, our constant currency growth rate over the prior year also stood at 19% for the quarter. Note that since providing guidance in August, foreign currency fluctuations positively impacted our second quarter results by $300,000, bolstering our top line results for continued year-over-year increases in average order values or AOV. Calculated at October 26 FX rates, AOV for all customers stands at $12,700 up approximately 9% over the prior year in constant currency terms.

[Peter Bauer:]

Thank you, Rafe. Cyber resilience is more important than ever. We have an industry-leading technology platform and a predictable business model. As trends shift towards cloud architecture for email security and customers consolidate their other email service needs, we believe we are uniquely positioned to capture additional market share. There remains a very large market opportunity and favorable market drivers that position us for disciplined, profitable growth for years to come. And we believe we have the right strategy and the right team in place to deliver. In the near-term, we will remain nimble and execute with discipline taking actions within our control to deliver strong value to shareholders, even in a tighter growth environment. Operator, let us please now open the lines for questions.

[Operator:]

Thank you. And our first question is from Shaul Eyal with Oppenheimer. Please go ahead.

[Shaul Eyal:]

Thank you, good afternoon gentlemen, congrats on the performance and improved outlook. Two questions on my end, Peter or Rafe. Back in your during your Analyst Day February the beginning of RSA while seems right now likely ancient history, you've provided some metrics about the Office 365 customer base and how under penetrated that landscape is. Can you talk to us maybe about any changes you've seen since that Analyst Day? Have you continued to see ongoing success penetrating that customer base and shifting them into the Mimecast platform? And I have a follow-up.

[Peter Bauer:]

Yes, great. Thanks, Shaul. Yes, so at the Analyst Day in February, we certainly outlined some of the size of the market available to us in Office 365. Just as a reminder, today over 20,000 organizations use us in addition to make their Office 365 investments more secure. I think what we've seen during COVID generally is a little bit of a slowdown in project decision making and because of economic pressures, some organizations simply sticking with what they've got for the time being. Having said that, organizations that are in a position to make decisions and implement new systems and improve their security, certainly we've seen a continuation of that theme and we continued to build our Office 365 customer base with those organizations quite well since February 2.

[Shaul Eyal:]

Got it, got it. And Peter, you've also mentioned the archiving being the highest value product offering in your prepared remarks from incorrect, I know it's hard to provide for sort of metrics about maybe the bundle versus unbundled archiving offerings, but can you wait maybe provide us with a little bit of color whether the archiving it's mostly going to out bundled or unbundled during the quarter or kind of just generally speaking over the course of the past few quarters now?

[Peter Bauer:]

Great. So we see probably the greatest uptick of archiving taken as an attachment alongside other solutions of ours. So, customers may come along because they looking for our email security solution and then learn about the opportunity to do archiving with us alongside that. And archiving as a diverse set of use cases that can range from security requirements to data resilience through the compliance eDiscovery, even storage management getting out of the legacy archiving business. So we are quite often picking up archiving business along with the security sales motion. We do have certain situations typically large enterprise situations where customers are buying archiving standalone and those are our typically bigger deals and from a logo kind of point of view those would be the minority of deals. Again this last quarter, we added 200 new archiving purchases to offset. And then we also have an archive extension the Sync & Recover offering used to be called Archiving power tools with the Sync & Recover capability 300 additional customers added Sync & Recover during this last quarter. So nice growth in our archiving business there.

[Shaul Eyal:]

Got it. Thank you so much. Good luck. Good job.

[Peter Bauer:]

Thanks, Shaul.

[Operator:]

Thank you. Our next question comes from Matt Hedberg with RBC Capital Markets. Please go ahead.

[Matthew Hedberg:]

Hey, thanks for taking my question guys. I guess I wanted to ask about Europe. There were certainly some more positive comments on Central Europe, which is really great to hear, I know you guys invested a bunch in Continental datacenters there over the past couple of years. I wanted to ask a little bit more about sort of the expectations for that particular region. And then also UK, I know obviously you guys have a lot of exposure there, a bit more update on the UK would be helpful as well.

[Rafe Brown:]

Yes, thanks. So we are quite pleased with the Central European team, it is still coming off a much smaller base in some of our more established locations, but it's nice to see them getting their feet under them and really coming together to execute. We actually think there's quite a bit of long-term opportunity in Central Europe, I mean to a great extent we're just scratching the surface with our operations there. So this should be a growth driver for us for years to come. Turning to the UK, it's a bit of a complicated situation in the UK right now because there is -- we're hearing now they're going back on lockdown due to COVID, but we also are dealing with the Brexit side of the house. That said, we've seen some nice strength on a number of deals, a couple of which were featured in Peter's call out that he went through on the call. So much like the rest of the world business has to be done and the team is out there hustling to keep moving the ball forward despite some of these shorter-term challenges.

[Matthew Hedberg:]

That's great. And then one of the things that certainly you guys highlighted on the call I thought it was great to hear was public sector success. Clearly, it is a huge market globally and it sounds like there were some good progress there this quarter both here in the US as well as abroad, maybe a bit more on that. Just in terms of kind of the health of that market, when we look out another couple of years, how important of a driver could that be to sort of your long-term growth rate you talked about at Analyst Day?

[Peter Bauer:]

Yes, so Matt, in the prepared remarks I called out a number of solid public sector wins in our international markets and that's really building on our public sector customer base that we started building up internationally some time ago. Well, I think what we're really excited about over and above that is this North American Public Sector opportunity and particularly as we make progress with our FedRAMP certifications now having the FedRAMP ready status having dedicated grid infrastructure, datacenter infrastructure for that client base. And beyond that besides just the specific agencies, there are obviously a number of people in the supply chain around public sector that are looking for these certifications to give them confidence that they are working with cyber security providers that are going to be acceptable to their major public sector clients. So we actually think there's quite a lot of spend and sort of halo ring effect around that of additional spend that we're setting ourselves up to have greater access to and really an increase in the opportunity for our teams.

[Matthew Hedberg:]

That's really good to hear on both sides both Continental Europe and public sector. Thanks a lot, guys.

[Rafe Brown:]

Thank you.

[Operator:]

Thank you. Our next question comes from Saket Kalia with Barclays. Please go ahead.

[Saket Kalia:]

Okay, great. Hey guys, thanks for taking my questions here. Peter, maybe for you, I think you hired a new Head of Channel Sales recently. Can you just refresh us on what percentage of the business roughly is coming through the channel currently? And how you think about your channel strategy going forward?

[Peter Bauer:]

Great. Thanks, Saket. So yes, we recently announced a new appointment on to my Chief Revenue Officer's team that's John Kareeni who is now running Global channel sales for us, he started a couple of weeks ago. So in terms of our channel mix, it's actually quite a high percentage of our business that is done through channel today. And that obviously as a total mix across our entire base has some history. So as we've gone into new markets sometimes the initial part of the business is done on a direct basis as we recruit new channel partners and we've been really pleased with our channel progress over the last couple of years and really looking to refine that and develop that in a couple of directions. On the one hand as we made progress up market with the enterprise, looking at what are the right type of channel partners to help us continue that growth is that we've demonstrated there. And then secondly down market in the MSP and the MSSP space where we have a considerable number of partners, but probably room for improvement in terms of programmatics and how we work with those partners. So we're excited about that opportunity with the channel on both ends of the market.

[Saket Kalia:]

That makes a lot of sense. Rafe, maybe my follow-up for you. Great to see the EBITDA beat this quarter. I think the guide for next quarter implies margin down sequentially a little bit, I know you talked about some travel maybe starting to come in later on this year, but is there anything to consider just in terms of seasonality of expenses or pace of hiring that would maybe drive those margins down a little bit here in the third quarter?

[Rafe Brown:]

Yes. As we look to the back half of the year and increasingly start preparing for the following year, there is some more hiring activity that we have targeted in the next couple of quarters, very much focused on some of the things Pete called out in our strategy to making sure we're funding R&D heads for key projects, as well as on the go-to-market side some enhanced resources on the enterprise side of the house, which is a big priority for us as you know. And as you noted, we do expect some travel in the fourth quarter if things free up of course. And then finally just the -- our annual raises kicked in at the beginning of this quarter, so that's probably also touched on the numbers as well.

[Saket Kalia:]

Got it. Thanks, again, for taking my questions, guys.

[Peter Bauer:]

Thank you.

[Robert Sanders:]

Thank you.

[Operator:]

Thank you. Our next question comes from Keith Bachman with Bank of Montreal. Please go ahead.

[Keith Bachman:]

Hi guys, thanks for taking my question. My question is related to bottoming and just wanted to get your thought process on a bottoming sequence, how does it unfold and to be more specific, excuse me, the net retention rate I thought was actually pretty good this quarter 105, you've forewarned us that it was going to drop a little bit. When do you see that bottoming and I know that your calculation is on a latest 12 months basis, so it's a little bit different. And the corollary part is might your revenue growth actually increase before your net retention rate bottoms? So that's my first question, I have a follow-up if I could.

[Rafe Brown:]

Yes, no thank you for that. I think the virus is humbling people who are trying to forecast exactly how quickly it will come and go. Certainly right now as we sit here looking at the virus rates picking up that makes a particularly challenging, the way we've approached this consistently through the year is try to be as transparent as we can and the details of a number of metrics as you've pointed to like on the net revenue retention side. What we do expect is over the coming quarters, there is still going to be pressure on those down sell rates and things like that coming out of markets where the virus is really hitting them hard. And so we expect to see in line with the guidance that we gave earlier that we'll gradually be working through the virus that will hopefully start to get a better view of a recovery along with the virus hopefully in the coming quarters, but I think we have to be quite cautious on that front. I think your broader question on the revenue versus the down sell in churn rates, our fundamental growth drivers are in place whether it's going up market to enterprise customers, whether it's getting new products out there, expanding our markets or taking away business from some of those legacy players. So we're seeing positive proof points if you will on that side of the house that the fundamentals are in place. We just need to keep our eye on them and hopefully we'll get clear sailing as we move along.

[Keith Bachman:]

Okay. Well, let me ask my second question on net customer adds and you indicated that you'll be around 500 for the next couple of quarters. Are you seeing anything, any differences in the change in the win rates? Is that one of the reasons why you think it stays at 500 or is it just that the pipeline does it suggest that you can do more than that, in other words win rates of the same? And I wanted to add a couple different dimensions there is -- within the net retention rate, or excuse me, the net win rate, there are some emerging companies like iron scales or abnormal security that might be standing up with the Microsoft 360 solution that perhaps you're not seeing the same kind of opportunity associated with 360 situations. But, a) can you just talk about your win rates and then b) the competitive situation that might feed into those win rates? Thank you and Peter, congratulations on the ribbon cutting ceremony in Canada.

[Peter Bauer:]

Yes, thanks, Keith. Yes, we got your city and one of our data centers.

[Keith Bachman:]

Yes.

[Peter Bauer:]

So okay, so customer adds, two things to consider there. Yes, I think we would like more customer ads for sure, but two things at play, one being, remember, we are focusing more upmarket now. So where we would have accumulated some of those logos through more work down market, we're seeing a little bit less of that and a focus on bigger customers with greater seat counts and you're seeing some of that flowing through in terms of our average order value. I think secondly in the COVID economy there is -- there are many organizations that are a little bit of a standstill from a new project perspective. And so momentum, velocity through pipeline is challenged in certain geographies, certain sectors and on an account-by-account basis for sure. So those factors are coming through. Yes, I guess interesting question in terms of other models to supplement Office 365 and does that impact customers' appetite? I think the reality is that our value proposition, which is a comprehensive wrapper around 365 that covers not just sort of tactical problem around a phishing issue or an impersonation issue, but a comprehensive shielding of bad things coming at the Office 365 environment, spanning mail security also capabilities for web security, protection from Office 365 downtime, data protection, recovery capabilities, compliance capabilities, sophisticated reporting and then API capabilities that wrap all of those and allow when to integrate really well into the broader security environment. I think that's a very compelling value proposition and we are seeing that playing out as being an enterprise grade solution that we have a lot of confidence in the demand cycle for that in the Office 365 base.

[Keith Bachman:]

Okay. So don't feel like your win rates are changing, is the short answer?

[Peter Bauer:]

So I think as I described, the win rates as a result of COVID I think are impacted for sure, but I don't believe that it's impacted as a result of competitive niche players, yes.

[Keith Bachman:]

Okay, thank you.

[Operator:]

Thank you. Our next question comes from Terry Tillman with Truist Securities. Please go ahead.

[Terry Tillman:]

Yes. Thanks, Peter and Rafe. Just two questions from me. First in terms of I think one of the comments was on the enterprise side. In terms of an expectation that you start seeing an improvement or kind of recovery in bookings in 4Q, I guess, kind of, where does that confidence come from? Are you just seeing improving sales coverage from some of these go-to-market investments or are just a conversation, does the verbal interaction suggesting that some monies are just going to start freeing up or the resources will start freeing up as we get into the new calendar year? And then I have a follow-up.

[Rafe Brown:]

Yes, that comment really centers around what we're seeing on deal activity and specifically around the pipeline generation activities on the enterprise. Clearly in the early -- in Q1, pipeline generation activities dropped off across the board. What we started to see is in the bigger organization that's what popped back more quickly than the rest. And so we're now couple of months into that. We're seeing good activity. And so I think that's what's giving us that confidence that sequentially we should start to see some of those deals, enterprise deals do take a bit longer to mature and come to fruition, but that pipeline activity would indicate that we should start to see more deals coming later this year.

[Terry Tillman:]

Okay. And Peter just maybe a question as it relates to emerging products, our research has picked up or suggested MessageControl actually had some interesting kind of traction quickly. I don't know if that's the right emerging product that you'd want to call out, but I would love to hear your perspective either on that or something else that maybe we should kind of hone in on they could start to add up to something more than just an emerging product? Thank you.

[Peter Bauer:]

Yes, that's great question. So, yes, the product portfolio and the way we've built it out and expanded it I think has a lot of potential and we saw some encouraging and good signs there across the portfolio, IEP adding 700 new customers this last quarter, which was great to see and obviously another part of our Zone 2 value proposition is the awareness training product, 400 new customers there. Each of the components doing quite well, I think Rafe called out DMARC 100 new customers, that's the brand new offering in Zone 3. And obviously web security making an additional contribution to the base with 200 new customers too. So we feel good that our product expansion strategy is showing signs of working well within the base and also providing on rents to new customers and we think MessageControl will ultimately complement that over time too and certainly the technology and how we built that out is we're busy building that out on our platform is the Mimecast cyber graph using machine learning and graft database technology to add additional efficacy and insight into the message flow for organizations. We think is a nice differentiator and potentially something that can be an additional revenue generator in time too.

[Terry Tillman:]

Thank you.

[Operator:]

Thank you. Our next question comes from Sterling Auty with JPMorgan. Please go ahead.

[Sterling Auty:]

Yes, thanks. Hi, guys. In your prepared remarks or in answers to other questions, you talked about how in terms of customer acquisition some strength up market, but then in Central Europe saying all sizes. What I'm curious about is, if the net customer additions are supposed to be around 500 for the foreseeable future, what should the mix of those customers look like in terms of their size that's going to comprise that customer addition profile?

[Rafe Brown:]

And still you're talking by customer count, correct?

[Sterling Auty:]

Correct. So in other words, so should average order value go up, because there is a bigger percentage of those that are larger customers or the profile remain consistent?

[Rafe Brown:]

Yes, I'm within. So, of course, the biggest impact on the raw customer number is often the smaller customers, but as you're talking about this, we have to look at both elements of both the customer accounts and the AOV's. So as the year progresses, we would expect and we're working towards making sure we're driving bigger deals if you will from two perspectives, one more products being sold to customers, including up-sell to our base and our continual trend of selling to larger customers. So I think this kind of moves that -- turns out a battleship pace if you will, it takes time for those to play out, but that is the trend we're seeing in the business and as we've been reporting and that's what we really look to see over the next few quarters as well.

[Sterling Auty:]

All right. Got it. Thank you.

[Operator:]

Thank you. Our next question comes from Brian Essex with Goldman Sachs. Please go ahead.

[Brian Essex:]

Hi, good afternoon and thank you for taking the question. Peter, just had a quick question for you and then a follow-up. Last time we spoke you talked about you're hiring profile into this year how you'd hire ahead of the pandemic and then the pandemic happened and maybe you're going to hang on to those hires and maybe not hires aggressively or at a lower pace into next year and enter the next fiscal year with the more matured sales force. How should we think about any adjustment to that strategy as you're throwing some better profitability to the bottom line, might you kind of forward given the better growth rate that we've seen and penetrate accounts where you might have better opportunities like in Europe as you highlighted? And then what do you think that that's going to -- what opportunity do you think that would drive in terms of your ability or reaccelerate revenue kind of heading into like next fiscal year?

[Peter Bauer:]

Yes, great question, Brian. So I think the overarching philosophy here is really informed by kind of -- looking at where all the growth opportunities, particularly during the economic challenges and the COVID crisis, where are best growth opportunities for us to invest in. And how do we realign our workforce around those and how do we hang back a little bit from areas that are naturally going to be softer. And in doing so benefit from some efficiency by getting that mix or optimizing that mix. And part of that has also been slowing down hiring and seeing some of the benefits of that flowed on to the bottom line. But I think our big growth opportunity here and what we'll be hunting for before during and after this crisis has gone is really around that move up market and that big enterprise opportunity, making sure that we are executing well in these expanded geographies like Central Europe and I mentioned the traction that we're starting to get there and then executing on this multi-product strategy, this expanded product portfolio that we've got with the email security 3.0 strategy and a broader solution framework that we've laid off. So we'll make sure that we're well stocked to be able to grab hold of those opportunities and transform make the most of those as we move forward into next fiscal.

[Brian Essex:]

Okay, that's helpful. And is there I guess, Rafe, is there a way that we can maybe quantify what you think might be the quarterly savings generated by operating in a remote environment and what your levers might be for maintaining margin expansion in that environment as you might expand in the next year?

[Rafe Brown:]

Yes. So we've been trying to call out that the very obvious COVID savings which frankly starts with travel and there is a shortlist of things that are particularly unique toward timing -- time here and especially once we start giving guidance for next year we'll be able to be a little bit more refined. But we certainly think there is savings opportunities to start with gross margin has continued to uptick over the last few quarters and kind of on a March up towards that 80% margin that we've talked about. And then we think more broadly things like hybrid work environment, so you're getting much more efficient use out of the same real estate platform. We found quite a bit of success with a bunch of these virtual events. It's not right for every situation, but those are the kind of things that can drive a lot of travel savings that are good for the environment, good for the bottom line and we think those are something we can maintain well into the future even as we kind of hopefully enter into a more normal work environment. And then, I would say lastly we're going to continue on those fundamentals that we had in mind back before this all began when we set out our long-term targets if you will for 23% to 25% free cash flow. We think there is room for G&A over time to get more efficient. We think we can throughout the organization continue to drive efficiencies of scale. So hopefully, as we come through this we can take what we've learned from this unique working environment and get to a kind of a best of both world's environment coming out of it.

[Brian Essex:]

Got it. That's helpful. Thank you very much.

[Operator:]

Thank you. Our next question is from Brent Thill with Jefferies. Please go ahead.

[Brent Thill:]

Thanks. Just wanted to clarify the seat count, I think in February you mentioned 13 million, today you're mentioning around 15 million. So it looks like seats growing faster than customers, I just wanted to clarify that stat.

[Rafe Brown:]

Yes, pardon me, as over the last few calls if you know Pete announced some very big customer wins that have very large seat count numbers behind them. And so we are continuing to as we again move up market start to see some real nice benefits from some of these very large customers that are helping.

[Brent Thill:]

Okay. And then another thing I think many of us have heard during the pandemic is going to the cloud was kind of the number one objective, customers went to Microsoft and to Google, really it was like that was their focus and ultimately now that they have a little more time on their hands, they're coming back and realizing architecturally may not be the best decision. Are you starting to see some of those customers now say, look, I've actually got some time to refocus back on this that those customers are in the pipe and you feel that they're coming back to you? I'm just curious if you could talk more directionally about the pipeline, how you're feeling around transitioning some of those customers because I think there is a effectively a very different impact numbers that they're seeing versus kind of what you're seeing. So I think I was just trying to reconcile what might be going on, that may be one example of something we're hearing in the field that they may actually just becoming back then, have the time that they had to get -- they had a race to get in and now they can?

[Peter Bauer:]

Yes, I think there are many different pieces of the market, yes. I think by the time the pandemic hit, there was a significant amount of the market already on Office 365, those that went some of those fragments were moving, all of us are certainly were -- we're seeing some of those addressing their security issues. It's really a mixed bag because there are equally companies that are unable to move forward, will make changes with new different projects or still playing catch up in terms of getting those infrastructures right and enabling remote working sometimes distracted by reorgs and other challenges like that. So it's a little bit all over the show, but certainly the idea that there may be some sort of pent-up demand as the crisis dissipates I think is an alluring thought and we're working hard to continue to build pipeline and maintain our visibility even amongst more distressed organizations to make sure that when they're back and ready to launch projects, we're the preferred provider to help them with this.

[Brent Thill:]

Thank you.

[Operator:]

Thank you. Our next question comes from Catharine Trebnick with Colliers. Please go ahead.

[Catharine Trebnick:]

Thanks for taking my question, guys. Nice quarter. Hey, you know you did on your prepared remarks talk about Canada and new data centers and could you outline the opportunities there? And then the follow-on question is, you have gotten FedRAMP ready, right? What are you doing in terms of your sales force for the federal government versus a year ago you had hired someone to really go after North America state and local government? Thanks.

[Rafe Brown:]

Great, thanks. Catharine, so the Canadian opportunity is large in GDP terms and in terms of the organizations that we can go and target, not just in public sector up there, but significant private sector, solid SMB market as well, which is really broader suite. So we feel good about the Canadian opportunity and our sales team up there is doing their work and capitalizing on the differentiation that we have with local services. In terms of the US public sector business that's -- that sales team has grown. FedRAMP Ready is a milestone along the journey. We're still working towards our ATO to operate, which will create even more opportunity and access, but some of the preliminary market opportunity today we're already capturing as you said the state local education and some of the sort of bring around that of organizations. So we'll continue to build out. We weren't preemptively due to much a spend in that area and so we've got a little bit more line of sites what's happening economically as well as the timelines for ATO for Mimecast.

[Catharine Trebnick:]

All right, thank you.

[Rafe Brown:]

Thanks, Catharine.

[Operator:]

Thank you. Our next question comes from Joshua Tilton with Berenberg. Please go ahead.

[Joshua Tilton:]

Hi, guys. Thanks for taking my questions. Just two quick ones from me. I just wanted to follow-up on the profitability question. So when we look to the remainder of the year, last quarter you expected travel to pick up in the second half, this doesn't look like it's going to have ounce for the fourth quarter. So the way to think about is that if we all work from home in Q4 and you don't travel to meet customers, should we expect the bottom line be going into the end of the year?

[Rafe Brown:]

Yes, it would is the short answer. We were -- hopeful they'd be traveling again, we got that in our model and I think this is consistent. We're putting that out there, so you can see how we're modeling the business.

[Joshua Tilton:]

Okay. And then just one more from me on the Zone 2 products, looks like they had a great quarter in terms of customer addition. So how do we balance this relative to the 12% upsell number? Is it this like a land and expand type situation? And then just to clarify, have your expectations changed at all for NRR for the remainder of the year since last quarter?

[Peter Bauer:]

So, yes, so on the Zone 2 customer count numbers, that does reflect both new and upsell, so that's a combination there. Those two products are getting -- they're getting good interest. I think this is one of the things we look for with new products as the sales team becomes very accustomed to selling them, they find traction, you get this positive loop whether it is on new or upsell business. So I think that's what's -- where you're seeing those that traction there. In terms of the net revenue retention numbers, we're still on course with what we talked about last quarter, I betted out in detail and I mentioned that overall we are modeling 103% to 104% on a net revenue retention and we are pleased this quarter still be at the 104%.

[Joshua Tilton:]

That was helpful. And then just maybe if I could squeeze one more in, how do we think about the gross margins going forward as you increase the utilization of this new candidate datacenter and maybe even some of the public sector infrastructure?

[Rafe Brown:]

Sure. I think the best way to view that is back in February when we gave out our long range targets, the target we set out for our self-there is an 80% gross margin in that 3% to 5% -- three to five year timeframe. So we've had some really nice upticks and a lot of the hard work of the team has paid off and showing up. We think that will continue to improve over time, but somewhat gradually.

[Joshua Tilton:]

Thank you very much guys. Well appreciated.

[Rafe Brown:]

You bet.

[Operator:]

Thank you. And our last question is from Nehal Chokshi with Northland Capital Markets. Please go ahead.

[Nehal Chokshi:]

Yes, thank you. Just want to talk MessageControl now that you've got for about a quarter now. Can you talk about the opportunities you're seeing with MessageControl in terms of potentially help how to address some of the more advanced phishing threats? You hinted that with bolstering or Zone 1 technology last call.

[Rafe Brown:]

Yes, great. So two pieces to that, so we closed the MessageControl acquisition at the start of last -- at the start of the quarter, yes, the start of this last quarter. And so a bunch of technical work Looking at architecture and how to merge that into the platform, so that it can become a more mainstream part of the offering. And then in the meantime continuing its life for a period of time as a standalone offering and using that really to bolster and supplement our core product and as differentiate in some of the enterprise opportunities that we're working in. So great technology, great talented team and we are excited to have them as part of Mimecast and we will keep you posted in terms of progress and product capabilities that we bring out in subsequent quarters.

[Nehal Chokshi:]

Thanks. What I was going with that is that some of these smaller players are touting the ability to leverage APIs of the cloud email providers as being able to have a better mousetrap, I believe MessageControl control utilizes the same sort of approach. So, will you continue to utilize our approach and bring some of the IP that you have in Zone 1 towards that delivery mechanism of leveraging the API utilizing the MessageControl IP there?

[Peter Bauer:]

So we haven't made any announcements around that, but the option of deployment model that doesn't require an MX record change certainly is an interesting one and to be able to bring the full weight of the Mimecast capabilities into a model like that is interesting and compelling for us. Obviously, there are considerable benefits of having the API as well as the in-line traffic capabilities around some of the other offerings that we have be that secure messaging and encryption or the continuity capabilities and others. So we think that, yes, there are opportunities to provide alternative deployment models like the ones that you described them.

[Nehal Chokshi:]

Great, thank you very much.

[Peter Bauer:]

Controlled office today.

[Operator:]

Thank you. And we have no further questions in the queue, sir, you can continue with your closing remarks.

[Peter Bauer:]

Great. Folks, thank you very much for joining our call today. I would like to just express my appreciation to our staff, who worked really hard to deliver these results under probably a little not ideal conditions and they appreciate that cyber resilience and security is really important to our customers and to the world in general. And so we appreciate their efforts and their work. We appreciate the support of our customers and our partners to in continuing to build our Mimecast business and stop bad things from happening to good organizations in the world. And with that, we'll speak to you again in about another quarter's time. Thank you and good night.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thank you for participating and you may now disconnect.