Mimecast Limited
Q3 2018 Earnings Call Transcript

Published: 13 Feb 2018

[Operator:]

Good day, ladies and gentlemen and welcome to the Mimecast Third Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] And as a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Mr. Robert Sanders. Sir, you may begin.

[Robert Sanders:]

Welcome to Mimecast's earnings call for the fiscal third quarter 2018 ended December 31, 2017. I'm Robert Sanders, Director of Investor Relations. With me on the call tonight are Peter Bauer, our Co-Founder, Chairman and CEO, and Peter Campbell, our CFO. Tonight's conference call is being broadcast live via webcast. A replay of this call will be available two hours after the live call has ended. During the course of this call, 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. 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 this conference call. These risk factors are further defined in Mimecast's most recent Form 20-F filed with the Securities and Exchange Commission. During this call, we will present 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, and we encourage you to consider all measures when analyzing Mimecast's performance. A reconciliation of certain GAAP to non-GAAP measures 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 February 12, 2018. 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. Now, I would like to turn the call over to Peter Bauer. Peter?

[Peter Bauer:]

Welcome, everybody. We're delighted to be sharing our third quarter results with you this evening. First off, on tonight's call, I'll highlight some of our key business results and factors driving our business. Next, I'll discuss investments that we've made in talent, technology and facilities to underwrite our successful longer-term growth. And finally, I'll review some customer stories to illustrate how Mimecast is helping organizations to achieve greater cyber resilience. So turning to third quarter performance, we’re pleased again to deliver results that exceed our guidance. Revenue of $67.3 million grew 39% year-over-year as reported and 36% in constant currency. This better than expected performance was aided by new customer additions with 1100 new customers coming onto our platform this quarter. We had success bundling multiple services for customers, which resulted in higher average order values and we concluded 20 engagements over six figures. Later in the call, Peter Campbell will discuss our financial results in more detail. Recent investments we've made in organically developing and expanding the range of sellable modules in our platform are helping our growth and appeal with customers. Our two newest services, both introduced earlier this fiscal year, Internal Email Protect or IEP and Sync & Recover are both seeing good traction. Both products are also helping to drive adoption of targeted threat protection and our multipurpose cloud archive, as these add-on modules expand the use cases covered by these co-offerings. For example, these products address new threats that our customers are facing through compromised insider accounts and also helping them to address new regulations such as GDPR. With regards to GDPR, which is a new European privacy law, we're seeing an increased number of customer inquiries and we're being proactive about educating the market and packaging solutions to help organizations comply with these pending regulations. Although not a requirement of the GDPR, data residency is also a concern for many organizations and it is being discussed in the same conversations. So, our recently announced data centers in Germany, which are due to come online later this year fit well into these conversations. While Mimecast has clearly defined our capabilities to help organizations become compliant, many of these companies that we are speaking to have less defined sets of requirements and this may be one of the reasons that we’ve yet to see any meaningful change in customer demand around GDPR. Now, let's look at some of the exciting new investments we've made in our company in the third quarter, the most important of which is our people. So, we welcome Stephen Ward to our board of directors. Stephen brings to Mimecast more than 20 years of experience in cyber security and technology risk assessment acquired through his career in both the private sector with JP Morgan Chase and public sector with the US Secret Service. Currently, he serves as Chief Information Security Officer at TIAA, a large financial institution. Janet Levesque joined our team as Senior Vice President of Systems Risk and Security. She is tasked with global oversight of our internal technology, security and infrastructure. And then Marc French joined us as Chief Trust Officer responsible for driving global strategy to ensure customer confidence in Mimecast’s services. In addition to people, we continue to invest in our technology. We recently acquired a technology called Ameyo [ph] that brings us additional machine learning based threat detection capabilities and several talented software engineers. Our proprietary underlying architecture Mime|OS is pluggable, allowing new technologies like Ameyo to be quickly integrated into our platform. And the Ameyo technology is currently being integrated into our TTP offering and will further enhance the protection we offer our customers. Additionally, as we have done for over 15 years, we continue to invest in our organic R&D efforts to innovate and drive our success. I'm pleased to report that Mimecast was just granted a US patent for associative search systems and method. In simple terms, this technology helps our customers find information stored in the email, which can be useful when leveraging the archive as a knowledge repository or when performing eDiscovery. Now with so many new faces at Mimecast, we've outgrown our space in Watertown, Massachusetts which has been the home of our US operations for the past 53 months. I'm excited to announce that during January, we moved into our new North American headquarters in Lexington, Massachusetts. We designed this facility from the ground up in a newly renovated building to meet our individual company needs and support our growth well into the future. The state-of-the-art office will enhance innovation and collaboration amongst our staff and support our inclusive culture. Of these and other investments we're making today will drive Mimecast’s success into the future. We're addressing a very large market opportunity and are positioning the company to continue to build our customer base for many years to come. We have a unique multi-tenant, multiproduct platform, relevant product modules that solve important customer issues and committed people to support tens of or even hundreds of thousands of customers using our platform and we're constantly working to improve every aspect of what we do. At the core of our business of course is our focus on customers. So I'd like to talk about a few customer wins from this past quarter. Firstly, a provincial government with 39,000 employees had been a Mimecast customer for nearly ten years, relying on Mimecast for basic mail hygiene. As this customer prepare to move to office 365, they sought a more holistic approach to strengthen their cyber resilience and deployed Mimecast’s M2A bundle. Now, this solution includes the basic mail gateway services, protection from advanced threats, e-mail service uptime assurance and our multipurpose cloud archive. Secondly, a Texas based financial institution with over 6,000 employees was running on Office 365 and had experienced some spear phishing attacks and downtime and sort ways to enhance their security and resilience. We were evaluated alongside other vendors and were selected due to our ability to defend against advanced threats and our continuity services, which keeps employees productive even in the event of an Office 365 e-mail outage. So they selected our M2 bundle. Thirdly, a global hospitality company with 17,000 employees also an Office 365 experienced whaling attacks. They also struggled with message track and trace and looked for a DLP solution to more easily protect sensitive data. This organization with multiple IT teams across all seven continents look for advanced technology that could simplify their IT and so they selected our S2 bundle to better protect their organization. And finally, an international law firm headquartered out of the UK with more than 10,000 employees was hit with a ransomware attack that caused significant disruption across their organization. Access to e-mail and other business systems went offline. Now, this firm look to replace the overly complicated mix of on-premise and hosted appliance gateways with a more effective solution that could protect users. And in order to better protect their data, they also decided to migrate from a legacy on-premise archive on to Mimecast’s multi-purpose cloud archive. So this firm has subscribed to our M2A bundle. As our organization continues to grow and mature, I'm very pleased with the way we're operating globally. All our regional teams are growing our customer base and delivering good results. We know the success we're experiencing today was built on top of the investments we've made over many years. For this reason, we continue to invest to capitalize on the larger opportunity in front of us and to facilitate our growth into the future. Now, I'd like to turn the call over to Peter Campbell to take us through the financials in more detail. Peter?

[Peter Campbell:]

Thank you, Peter. In the third quarter, revenue once again exceeded our guidance and adjusted EBITDA was at the high end of our range. We continue to balance growth and profit even as we capitalize on the large opportunity in front of us. We generated revenue of 67.3 million, which represents growth of 39% as reported and 36% in constant currency over the third quarter of 2017. Adjusted EBITDA was 6.7 million, representing an adjusted EBITDA margin of 10% compared to 7.6% in the third quarter of 2017. We continue to experience very strong customer retention and upsell as well as new sales during the period. Keeping our customers happy and selling them additional products is a core skill of our business and the foundation we build on that drives our growth. Net customer additions of one 1100 was an increase over the 900 customers added in the second quarter, bringing our total customer count to 29,200. We showed strong execution in our core mid-market, while also closing a number of deals in the large enterprise segment. This combined with strong upsell to our existing customer base positively impacted our average order value, which increased to $9900, up from $9100 in the second quarter. Note that foreign exchange accounted for just over half of the $800 increase. Our targeted threat protection continued its strong pace of adoption. We had 1700 new and existing customers buy this service in the third quarter. Over 90% of our new customers bought TTP and almost 700 existing customers also purchased it. TTP is now deployed with 15,100 customers worldwide. In total, 52% of our customers are using targeted threat protection. We believe there is considerable runway in the market for customers that currently do not have this protection. We now have 500 customers using Internal Email Protect and 300 customers using Sync & Recover. Sync & Recover also helped to drive increased adoption of our archiving service this quarter. Customers continue to buy multiple products from us. This occurs at the initial deal when we sign them as a customer as well as over their journey with us. This has led to an increase in the average number of services per customer, which now stands at 2.9, an increase from the 2.8 services reported last quarter. Currently, 32% of our customers now buy four or more services from us. When customers purchase multiple services, the margin on the incremental sale is higher, the result of our multiproduct, multi-tenant architecture. Additionally, as customers use more of our services, they stay with us longer. Our gross revenue retention at 111% remains strong and is consistent with last quarter. Our exceedingly strong customer retention numbers underpin this results. This together with the upsell of our products and especially TTP continue to drive a high level of gross revenue retention. Turning to expenses and profitability, we recognized a 74% GAAP gross margin, consistent with last quarter and an improvement over the 73% reported in the third quarter of 2017. In Q4, we will be rolling out our German data centers, which will negatively impact our margin. We will also be investing in additional customer service resources, as we staff up for the new year. These items will result in a nominal reduction in our gross margin, while the German operation gets to scale. We anticipate gross margins to be in the 71% to 72% range over the next several quarters. Third quarter GAAP operating expenses were 50.7 million, up from 38.2 million last year. R&D expense was 15% of revenue compared to 12% for the same quarter in the prior year. A small portion of the increase in R&D expenditure relates to foreign exchange, as many of these hires are in the UK and the British pound has strengthened over the US dollar during the period. The remainder of the increase is a function of headcount additions in both the UK and the US. We expect that this increased level of R&D expenditure will continue through FY19. Sales and marketing expenses reduced to 46% of revenue from 52% in the third quarter of 2017, driving the gains we have seen in adjusted EBITDA. While we expect to see consistent long-term leverage in our sales and marketing expenditure, we will see some seasonality in the timing of these investments. We expect to increase our investment in sales and marketing in absolute value terms and as a percentage of revenue for the fourth quarter. This is a function of accelerated hiring in advance of our new fiscal year on April 1 as well as additional expenditure related to increased sales commissions that typically occur in the fourth quarter of the year. G&A expense was 14%, which is consistent with the prior year. Adjusted EBITDA in the third quarter of 6.7 million was at the high end of our guided range of 5.8 million to 6.8 million. Our adjusted EBITDA margin was 10% versus 7.6% in the third quarter of 2017. For the fourth quarter, we expect our adjusted EBITDA to go down slightly from the third quarter, but to increase over the prior year. While there is some seasonality in our quarterly results, we expect to see 200 to 300 basis point gains in adjusted EBITDA each year. We reiterate our long term adjusted EBITDA goal of 20% to 22%. We will continue to and always have balanced growth with efficiency as we scale this business. Third quarter GAAP net loss was 2.6 million or $0.05 per basic and diluted share, based on 57.5 million weighted average shares outstanding. Non-GAAP net income for the quarter, which reflects our GAAP net loss, exclusive of stock option expense and related tax effects, was 1.6 million or $0.03 per share based on 61.2 million diluted shares outstanding. With the new tax legislation that came into effect in December of 2017, we have depreciated certain assets on an accelerated basis reducing the amount of taxable income in the US. With this change, the taxable income is now fully covered by our available NOLs. As a result, we have an adjustment to non-GAAP income tax expense in the third quarter in the amount of 1.1 million, which positively impacts our non-GAAP EPS by $0.02. In the fourth quarter, we could see an additional reduction in non-GAAP income tax expense of 0.4 million, related to the impact of this new legislation. In the fourth quarter of fiscal 2018, we expect to incur one-time expenses of approximately 3 million related to the exit of our Watertown, Massachusetts facility, which will negatively impact EPS. These expenses are not expected to repeat in fiscal 2019. We generated 4.5 million in free cash flow in the third quarter compared to 2.2 million for the same period in the prior year. Operating cash flow was 12.7 million, up from 5.8 million last year. Purchases of PP&E in the quarter were 8.2 million, of which approximately 1.5 million related to the build out of our new facilities in Lexington. And as we look at the fourth quarter, we will see one-time outlays and capital expenditure of approximately 3.5 million related to additional expenses on the build out of our Lexington facility, along with approximately 3 million related to the purchase of equipment for the establishment of fully paired German data centers. The facility and German data center expenses are consistent with the 8 million identified in our Q2 call and our one-time additions to our normal level of capital expenditure. We still expect our fourth quarter cash flows to be positive, however, they will be nominal. As of December 31, Mimecast had 128.9 million in cash and short term investments. Our cash balances have increased by 17.2 million year-to-date, driven by free cash flow generation and 9.5 million in proceeds from the exercise of stock options. Turning to guidance for the fourth quarter. For the fourth quarter of 2018, constant currency revenue growth is expected to be in the range of 28% to 29% and revenue is expected to be in the range of 71.1 million to 71.8 million. Our guidance is based on exchange rates as of January 31, 2018 and includes a positive impact of 3.9 million related to the weakening of the US dollar compared to the prior year. Adjusted EBITDA for the fourth quarter is expected to be in the range of 5.4 million to 6.4 million. Adjusted EBITDA margins are seasonally lower in the fourth quarter as we make investments for the following fiscal year. For the full year 2018, revenue is expected to be in the range of 259.6 million to 260.3 million or 36% in constant currency. Foreign exchange rate fluctuations are positively impacting this guidance and by an estimated 4.9 million related to the weakening of the US dollar relative to the pound and the rand versus the prior year Relative to the prior annual guidance we gave in November, foreign exchange rate fluctuations are positively impacting this guidance by an estimated 3.5 million. 2018 adjusted EBITDA is expected to be in the range of 23.9 million to 24.9 million, demonstrating continued progress toward our long-term adjusted EBITDA goals of 20% to 22%. In summary, I'm pleased to be delivering solid results for our third quarter on both the top and bottom line. Our strong performance is a result of consistent global execution in customer retention, sales execution and the development of industry leading products. We will continue to focus on balanced growth and profitability as we execute through the rest of this fiscal year and beyond. We will now open up the line for Q&A Operator, can you please poll for our first question.

[Operator:]

[Operator Instructions] And our first question comes from the line of Saket Kalia with Barclays Capital Markets.

[Saket Kalia:]

First maybe for you Peter Bauer. You’ve had a nice uptake in TTP adoption, obviously a lot of other new products to offer as well. But maybe just zeroing in on Internal Email Protect a little bit or IEP, could you just talk a little bit about how the IEP trajectory will be different? I guess perhaps compared to TTP. I guess I'm just curious about how you would compare and contrast the two in terms of customer feedback or uptick or anything that you kind of look at when comparing the two?

[Peter Bauer:]

Yeah. Great, Saket. So we introduced IEP, which is Internal Email Protect in about April last year. And as you know, the use case there is dealing with east west traffic, adding the technologies that we used to scan in and outbound email to that internal traffic stream and particularly delivering that as a cloud service to Office 365 customers who are unable to deploy what they may have been able to in the past to do this particular job on their on-premises exchange service. So as Pete mentioned in his prepared remarks, so far, we have about 500 customers that have adopted the product. I think when we look at the sort of the linearity of the adoption there, it is encouraging. It's early days though, the sample set is relatively small. I would say it's a little bit ahead of TTP, but I'm not sure whether that is an indication of what the long-term trajectory of it is. But certainly, I would say that when we introduced TTP, we had a much smaller customer base to sell into. So I think with a new product, now, we have a meaningfully larger customer base to take that into. I think that also is one of the reasons behind the popularity of this product today.

[Peter Campbell:]

Just to add to that, I mean I think what we’ve said in the past before as well is that TTP with over 50% of our customers now having that, has been a runaway success. There are multiple modules in TTP. There are three modules; URL protects, an attachment protect and an impersonation protect. And while we expect that the IEP, which is another derivation of that, in east west traffic, will continue to incrementally affect our revenues. We wouldn't expect it would be the same runaway amount of revenues that we saw from TTP. But that some rather new products would be good incremental revenues that we expect to kind of build on top of quarter-over-quarter.

[Saket Kalia:]

And then maybe for my follow-up. Obviously, nice success on some of the larger deals, I think what you’ve said was 20 deals that were at least six digits. I guess the question is, can you, Pete Campbell or Pete Bauer, just talk a little bit about how the length of the sales cycles on some of those larger deals has trended over the last few quarters and how should we be thinking about the impact of larger deals in 2019?

[Peter Bauer:]

Sure. Good question, Saket. I think, I mean, the first thing is I think we call that, as Pete called out, 20 deals and this was a new record, I believe, of deals over 100K for us in the quarter. We’ve called out this number kind of intermittently in the past. I think we've also spoken to the fact that while that a certain percentage of our revenue, approximately 40% of our revenue is related to customers that are above 1000 seats. So it's not new to us, but certainly we're very pleased with the incremental growth that we're seeing in the larger customers and I think we've talked in the past that while our great skill is from the very smallest to the very largest customers, we're still very much focused on that very large market. As we look at that -- deals of that size, I think naturally as we continue to grow and continue to grow our base, we will see more deals like that. We've seen them in the past and we're certainly happy about the 20 that we saw this quarter and I think we'll continue to see deals of that nature going forward. And as far as FY19 is concerned, I think that will certainly be a meaningful part of our growth. It has been in the past and will continue to be in future, but at this point in time, we're not looking to call out any specific numbers on that.

[Operator:]

And our next question comes from the line of Matt Hedberg with RBC Capital Markets.

[Matt Hedberg:]

I’ll offer my congrats as well. I guess within the Office 365 customer base, can you comment on how cross-selling is doing there with some of your multiple products. I know historically, you’ve had a higher crosssell rate within that base and then maybe how pricing is holding up on an ARPU perspective?

[Peter Bauer:]

Sure. I think we've talked about that in the past and we continue to see that customers that move to Office 365 and that number has gone up again this quarter and we're now looking at approximately 29% of our customers that buy also 365. We're continuing to see customers that move to 365 wanted the same ability to have a layered approach to security. They want to have a continuity solution, in case 365 goes down and they want to have another copy of their archive. They want to make sure that they're able to get that data. When they had it, when it was in house and as they move to 365, we’re seeing that continue with an increased take up in each of those products across our 365 base. And I think as I mentioned that in the past as well, when we see customers take multiple products with us, they tend to be much stickier, although our retention rates at 111%, 110%, or still very high. But much stickier when they have multiple products and their margins are also higher.

[Matt Hedberg:]

That's helpful. And then, you guys are seeing billing success and obviously, some margin expansion well, which is great. You called out GDPR as a driver here. And as you think about investments in to fiscal '19, are there additional data centers on an international basis kind of thinking beyond the German market and the UK market, how do you kind of think about the rest of the continent in terms of some additional acceleration there?

[Peter Bauer:]

Sure. It’s a good question. I think we've talked about the German data center that we're rolling out this year. And as we are kind of looking to this year and FY19, I wouldn't be looking at really on another data center pair, but we are looking at really of that data center pair in Germany in calendar ’18 and the first quarter of our fiscal ’19. I think GDPR is an opportunity for us. We've talked about that being an opportunity in the second half of this year. We're certainly seeing pipeline continue there and we expect that we will benefit from Q4, but we think the GDPR benefit will continue past May deadline and into our fiscal ’19. And I think, as we look at the European opportunity and we look at the global opportunity, we've always done this on a fairly measured basis and data center investment is a significant investment for us. It’s about $5 million total to set up a data center pair. So what we're going to be looking at as we come into the new year is looking at building out that data center, building out the growth in Germany and in Europe proper and continuing to focus on that. We don't expect to see heavy incremental revenues from that in FY19, because it is a long term investment and we're going to be capitalizing on that over time.

[Operator:]

And our next question comes from the line of Shaul Eyal with Oppenheimer.

[Shaul Eyal:]

And congrats on Mime’s strong quarter and guidance. I want to maybe start and stick on the GDPR point. So Mimecast is probably part of a handful of companies within the cyber security arena that are seeing GDPR as creating some sort of a tailwind or as you’ve indicated, a drive for the company. Why is that? Is it the geographic distribution? It is something specific to email archiving continuity? Because, some of your even head to head competitors, not to talk about some of the bigger players within the arena are not actually seeing similar trends. So just want to try and maybe do to compare and contrast in that respect?

[Peter Bauer:]

Sure. So I think, there are a few things. I think certainly the archiving product, the ability to get at the information about your base and to be able to surface that back quite rapidly is very compelling when you've got a number of companies that are looking to deal with their unstructured data and looking to surface back in a fairly systematic and methodical way in fairly short timeframes. And, the penalties that are being talked about in Europe for GDPR are quite large as you know. So I think it's a compelling event for companies to ensure that they're able to get at that data and surface it back to their constituents rapidly and accurately and I think our archive can help them with that. I think also the breach notification rules, which have been present in the US for some time and now coming into Europe, I mean, companies certainly don't want to get breach period and would want to make sure that they have the best possible solutions to cover that off and sure that doesn't happen. I think it’s created an impetus for a number of companies to be reevaluating what they have and making sure that they have a company that can protect them quite thoroughly any issue that they would experience in that. You would be very public. But I also think as we look at GDPR as a growth mechanism for us going forward, we have talked about benefiting from it in the second half. We've seen some benefit in Q3. We do think that we will benefit in Q4, but as I said, I do think it's going to make its way and I think what companies are experiencing is that most companies don't expect to be ready by the May 2018 deadline and I think that company’s decisions around how they're going to cope with those rules will extend past that deadline and beyond. So while I do expect some benefit in Q4, I don't expect it to be a massive bump. I think it's going to be a more gradual incremental trend that we're going to see past May 2018 and beyond.

[Shaul Eyal:]

And maybe as a follow-up from a competitive landscape and for a change, actually not asking about the bigger competitor, but actually about a recent public competitor going public, sorry going private, excuse me for that. Any early signs of disruption that might assist you with some near term displacement opportunities.

[Peter Bauer:]

Peter Bauer here. So in our long history of what we would describe as consolidating this market ourselves, consolidating it onto an integrated platform, a cloud platform, a multi-tenant platform and delivering it back to customers in a simpler and more cost effective form factor, we played in multiple categories for many years and throughout that time, there's been numerous M&A events, there's been many situations where the ownership structures and the form of our competitors has changed. It is consistently over time always turned out to be a very positive thing for us in terms of the distractions, the de-focusing, the impact to staff, the impact from a customer service and channel management perspective. So they've always been an assortment of issues that have resulted from these. And so while we don't know everything that's going on in each situation, we're pretty sure that it's generally a net positive for us when something like this happens with a competitor.

[Operator:]

And our next question comes from the line of Sterling Auty with J.P. Morgan.

[Sterling Auty:]

I apologize if you said it and I missed it, having phone connection issues, but I thought in the press release in terms of guidance, there was a talk of giving a preliminary range for fiscal ’19. I missed that range if you said it.

[Peter Campbell:]

Hey, Sterling. We haven't said that yet. We did give guidance for 2018, but we didn't give any preliminary outlook on ‘19.

[Sterling Auty:]

Okay. So that was a misprint in the press release?

[Peter Campbell:]

I need to go back and look at that, but it shouldn’t be.

[Sterling Auty:]

And then separately the average order value even ex the foreign exchange benefit was still up nicely. When you look at the contributing parts to that, is that a level that you believe is sustainable or how much of that is seasonality? So in other words, how should we think about the trend in average order value from here?

[Peter Campbell:]

Yeah. Good question. So, it was 9900, up from 9100 and we talked about half of that was related to foreign exchange, because as you know, we guide in kind of value at the January 31 ForEx date. So if you look at half of that being from ForEx, the remaining half comes from both upsell and it comes from new and larger customers. So as Peter talked about 20 customers being over 100K in the quarter and that’s certainly having an effect, but also retaining our base and upselling it and keeping that base is a core competency of the firm. So our cohorts grow year over year over year. I do think that you'll continue to see that trend as we continue to sell more product into that base. It's difficult to predict even absent the foreign exchange, how and to what extent that will trend each quarter. It is a function of customer size and upsell. Our sales have been historically fairly solid as has been our retention of that base and that's certainly a contributing factor. I wouldn't be able to hazard a guess as to how that's going to move, but I would expect it to trend northwards over time.

[Peter Bauer:]

Sterling, just to circle back on your question, we checked the press release, it refers to 2018 full year guidance. Our fiscal 2018 ends 31 of March, so apologies for the confusion on that. It’s our fiscal 18.

[Operator:]

And our next question comes from the line of Keith Bachman with Bank of Montreal.

[Keith Bachman:]

I had two related questions and so I'll just ask them concurrently. On the Mimecast opportunities within 365, the Office 365 environment. I understand that you're calling out 29% of your customers are involved in Office 365, how do you see that runway playing out? In other words, what's the opportunity set if you had to characterize the TAM? And within that, what do you think your share is in the Office 365 environment against that backdrop? And the related question is, you're currently -- you moved up to where your average customer has 2.8 products and 32% or at four or more. How high can that go? What are the natural boundaries or barriers against the opportunity to keep the upsell motion continuing over the next number of quarters or even years?

[Peter Bauer:]

So just to talk about Office 365, first. I think when we talk about it in the context of the broader Microsoft Exchange ecosystem, so we estimated somewhere between 300 million and 350 million corporate email users using a Microsoft type solution for email. We think that in fact, our customer base is a pretty good proxy we think for Office 365 adoption in the marketplace. So, if we’re at about 29% now, we think that that's probably a good reflection of the folks that have actually moved over to Microsoft's exchange online service. So where we’ll let.

[Keith Bachman:]

So will you grow at the same rate of conversion than you think as Microsoft converts its installed base to 365, you would grow kind of at the same rate or kind of urgent you think then?

[Peter Bauer:]

We think that our base, the proportion of our base that is on Office 365 will roughly tracks the movement of Microsoft's base from on premise exchange to Office 365. And so we see that migration certainly as a tailwind. It’s a catalyzing event for a customer to look at cloud based suite that provide the resilience and layered security capabilities that they need as they make that migration. So it certainly has been really helpful to us in building our market share. We also think that that transition will continue for a while. I don't know what the sort of saturation level is in terms of Microsoft's customers moving over. But if one assumes that 75% of the market is ultimately on 365 and if we're sort of a third of the way there after five plus years of migration, is probably at least another five maybe more years of migration that goes on in the markets. So we're pretty excited about that. And then I think in terms of your broader question around number of SKUs that customers are buying from us. Yes, certainly, you can see in our revenue retention numbers that we have a very good practice of not only retaining our customers, but cross-selling them on to new products and that's given us a 110%, 111% revenue recapture right consistency over several quarters. And then of course the move from 2.8 products per customer up to 2.9 products per customer, obviously across the base of north of 29000 customers. That is, seems like a small number, but it's across that average base. We're really happy with the broader adoption and so called out the percentage of customers with more than four products on top of that.

[Operator:]

And our next question comes from the line of Catharine Trebnick with Dougherty.

[Catharine Trebnick:]

My question has to do with the channel. Of your revenue this quarter, how much was through the channel and then what really is your channel strategy going forward. And the reason I'm asking that is, there was, I had excellent feedback among all the value added resellers that there's a lot more focus from the marketing organization on them. So I just wondered if there was any changes afoot that we are unaware of.

[Peter Bauer:]

Thanks, Catharine. So I think we’ve said in the past that the range of business coming in from channel, we like to see that in the two-thirds to three quarters percentage of our new business coming in, in any quarter and I think that’s been consistently on the high end and maybe even slightly over the high end of that in this last quarter. So we are very happy with that and we have made several investments into channel over the last year and recently. So we really think there is a big opportunity in the North American channel in particular. We've done very well in the UK channel. We've done extremely well in the South African channel marketplace and. So North America and Continental Europe are two real focus areas for us and building out our channel practice even further over the next year.

[Operator:]

And our next question comes from the line of Gray Powell with Deutsche Bank.

[Gray Powell:]

Just a couple if I may. So maybe on the broader macro, just how do you feel about the overall spending environments in calendar 2018 versus 2017 and do you see tax reform in the US as something that could be maybe a potential catalyst to help spending just on broader security improve.

[Peter Bauer:]

Great. So, Pete, you talked to the tax thing, but in terms of general levels of demand, look, I think it's encouraging to see good growth numbers coming out on a macro basis. We certainly think that that is more helpful to CIOs and to CCOs that are looking to expand their budgets and make investments in important areas of resilience and security. I think the bigger driver though is the stress environment and the realization that it can be very damaging to an organization to have a breach, to have an outage, to have data compromised. So, we think that that is a pretty perennial driver of demand and we've certainly experienced that consistently, both through good times in the economy and even thinking back to 2008 where times were very bad, we grew strongly and consistently through that time. So it's nice to be in good economic times and it makes it easier for our customers to free up the budgets, but we think particularly e-mail security as such an Achilles’ heel for so many organizations, but that's the primary driver along with the move to the cloud generally that is driving adoption for us.

[Operator:]

And our next question comes from the line of John DiFucci with Jefferies.

[AJ Ljubich:]

This is AJ Ljubich on for John. I was wondering in light of some of the larger customer wins, how much of that has to do with the conversation around the cloud, because some of our own proprietary survey work has shown substantial demand for cloud deployed security, which obviously should benefit Mimecast and I'm curious how much do you see, do you see increasingly cloud only RFPs or competitive takeoffs, have you seen any improvement in sales cycles for some of those larger deals, given perhaps increasing comfort around cloud deployed security solutions.

[Peter Bauer:]

So I think the important thing to point out is this for us to do $100,000 deal or north of that, it doesn't necessarily require it to be an extraordinarily large organization. So, there's a huge mid-market opportunity where customers can be spending hundreds of thousands of dollars with us and we have a product portfolio that has got the breadth of value to be able to capture that type of revenue opportunity in these accounts. Having said that, yes, I think as time goes on and as cloud matures, so larger and larger organizations are not only more comfortable with adopting solutions like ours as a cloud service, they're also starting to realize that there are considerable network benefits, scalability benefits and reliability benefits that accrue to them when they participate in a network that is designed like ours. So a good style network that's underpinned with highly distributed micra services has got pools of computing resources that are able to apply very diverse forms of detection technology and interrogation to email and benefit instantaneously from detection that may be picked up across a very diverse customer base. So, the benefits that they receive by being part of our network that would be much slower in coming forward to them, if they were on their own, running their own appliances and managing the networks themselves. So I think both of those factors are really driving interest with the higher end of the mid-market in our situations.

[AJ Ljubich:]

And then just one more, if we look at the quarter, it was definitely strong in terms of customer ads and the growth of AOV. And if we look at the top line growth, still very strong, but it is a slight acceleration and sort of dipping below that 40% growth that we had before, which is reasonable just given the Law of Large Numbers but curious especially as we have sort of line of sight into fiscal ’19 at this point, how do you guys think about sort of an intermediate term sustainable growth rate and some of the puts and takes that might be embedded there?

[Peter Bauer:]

Sure. I think as we kind of come in and through the year, we've been very specific about our growth rate, both from a constant currency perspective as well as an actual perspective and we have talked about the tougher compares that we expected to see in the second half of this year, so our third quarter and our fourth quarter. Kind of that said, our growth for FY18 is strong and looking at the guidance of about 36% for the year. We do have a large opportunity in front of us in terms of the selling of existing products to our existing base, selling it kind of new products to the existing base and new and existing products to a very large kind of global market opportunity that we've only begun to capitalize on. So, we do realize there's a big opportunity in front of us as we kind of look forward for Q4 and into fiscal ’19, but we are comfortable with the guidance that we’ve given in the context of that opportunity.

[Operator:]

And our next question comes from the line of Tim Klasell with Northland Securities.

[Tim Klasell:]

Let me throw my congratulations as well on a nice quarter. Two quick questions. One is related to the products and the migration to Office 365, when you look at your customer base, the ones that are coming in from a or moving over to Office 365, what's different around what they take, let's say, from a non-Office 365 customer. Is it larger, another specific products that maybe they're more likely to than the traditional or the non-Office 365 customer?

[Peter Bauer:]

Thanks, Tim. I think we have talked to this before, we are continuing to see it. So while most of our customers take our security, our gateway product, has a slightly higher percentage that take our gateway products, so we're just under 100% that take our gateway products that are on 365. As we’re looking at our continuity products, for those of our customers who are on Office 365, higher percentage, it was 60% to about two-thirds of our customers with continuity. We're approaching a higher number north of 70%, 75% that have continuity who are on 365 and similarly for archiving, we’re seeing more of our customers who are on 365 take our archiving product with continuity and with security and lastly, we're seeing them take more TTP as well. It's slightly higher for our customers that are on 365. And I should point out and I think it also is tied into kind of a question previously is that the price points that we see are fairly similar, whether on 365 or not on 365. So the incremental kind of ARPUs for a customer on 365 is generally higher than one who's not, as they're taking kind of more products with us, but that’s sort of the trend that we're seeing, they're more likely to take three and four products than those customers who have not yet moved to 365.

[Tim Klasell:]

And then of the two new products that you sort of mentioned on the call, which ones do you think will have the greatest impact, I'm not looking for a quantitative, but qualitatively which one will have the greatest impact do you think in calendar year ’18, maybe calendar year ‘19.

[Peter Bauer:]

So I think as I said a little bit earlier, we do expect them to have an incremental benefit. I think, if you look at our existing base and their retention and upsell of that base as well as the new customers we have, we certainly see some incremental revenue from those products. But I think the core of our revenue and our revenue growth will come from our kind of base products of security, continuity, archiving and TTP.

[Operator:]

[Operator Instructions] And our next question comes from the line of Gabriela Borges with Goldman Sachs.

[Gabriela Borges:]

For Peter Bauer, the conversations that you’re having today on Office 365 with customers that are debating between going with Microsoft in-built securities versus the email and Mimecast security tools, I’m just curious if you could compare and contrast the conversations that you’re having today on why Mimecast versus maybe a year ago, because I know that your product portfolios [indiscernible] would be helpful.

[Peter Bauer:]

Yeah. Great. Gabriela, so I think without sort of banding it specifically as a year, I think what happened is the early adopters on Office 365 were pretty gung-ho that Office 365 was going to be able to cover all of their use cases, all of their needs that they could rely 100% on any security offering that Microsoft had, that the promise of an archive that was built in would be fit for all of their use cases and that there may never ever be any downtime or interruptions or risk of performance issues on Office 365. And so, the early adopter class was -- took a lot more, I guess, convincing just because of the inherent belief and desire to believe that that might be the case. What we've seen is that cohort has experienced additional needs beyond what Office 365 delivers and has started to return to us and adopt our technology and inquire about our technology. What we found though is that the next wave of Office 365 adopters, more of the sort of pragmatists cohort have gone in understanding or accepting that they would need to bring additional capabilities with them into their Office 365 deployment. And service frequently, we're having conversations with those types of customers ahead of the migration or during the planning phase of the migration and forming part of it. So I think we're seeing that it's not so much a case of, is Microsoft developing and evolving themselves. I think that there are certain things that they are perhaps architecturally less well set up to address. We also have a very dynamic and determined community of adversaries out there and so frankly, the security required teamwork, teamwork between Microsoft, the customer, and the industry like ourselves, the security industry to really provide an effective framework for defense and resilience for these customers.

[Gabriela Borges:]

A follow-up is for Peter Campbell, which is on the seasonality that we should be expecting in the net new customer ad number. I remember last year though, there was a little more volatility because the timing of the SaaS transition over from McAfee and the micro customers that you had in the model, could you just help level set us, if you look through the March quarter and then maybe in general for the quarters after that, what type of seasonality should we expect in customer ads, based on the headcount that you have internally in the pipeline that you’re seeing today.

[Peter Campbell:]

Sure. So I think last year, we saw, it was maybe a little bit of an anomaly, particularly in our third quarter of last year is there was a kind of last minute rush, a very, very tiny micro-sub 10C customers looking to move off the McAfee cloud solution and that continued a little bit. That continued through the year, but it was certainly a kind of mad rush at the end of our Q3 and a little bit into our Q4. As we’ve kind of looked at this year, it’s kind of back to a more normalized 900 and 900 in the first two quarters of this year. We've also talked about, we've seen with that lower customer numbers, certainly increases in AOVs as the AOVs and new customers we’re adding is higher. And we’re not seeing the kind of on-rush of this Micro customers anymore. The 900 and 900 in the first two quarters of this fiscal, seeing an increase of 1100 in to third quarter, I mean I think that's more in line with what we would expect going forward, obviously difficult to predict the exact size and number of each customer that’s going to come on, but I think -- I don't think you go far wrong to go forward on that basis.

[Operator:]

Thank you. And I'm showing no further questions. I'd like to return the call to Mr. Robert Sanders for any closing remarks.

[Robert Sanders:]

I’d like to point out we did have a misprint in our press release today. It says that we are introducing guidance for 2019 revenue growth. We are not introducing guidance for ’19 revenue growth at this time. We’ll give guidance for ’19 when we have our fourth quarter earnings call. That will conclude the call for tonight. Thank you all for joining us.

[Operator:]

Ladies and gentlemen thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.