Mimecast Limited
Q2 2017 Earnings Call Transcript

Published: 10 Nov 2016

[Robert Sanders:]

Welcome to Mimecast's earnings call for the fiscal second quarter of 2017 ended September 30, 2016. I'm Robert Sanders, Investor Relations Manager. 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 included in our press release and further defined in Mimecast's most recent Form 20-F filed with the SEC. 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 with 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 November 9, 2016. 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:]

Thank you, Rob. Good evening everyone and thank you all for joining the call today. It's very exciting for me to deliver our fiscal year 2017 second quarter results. I'm pleased to report that this was another record quarter for Mimecast. We exceeded the high end of both our revenue and adjusted EBITDA guidance. Our revenue growth rate accelerated in the second quarter to 29% as reported and 38% adjusted for constant currency, a healthy increase from the 24% and 32%, respectively, reported in the first quarter. This acceleration on our revenue growth rate is the result of several successive quarters of strong customer additions. So now in this second quarter, another 1,900 new customers subscribed to one or more seven integrated products on our platform. This increases our expansion opportunity across our now 21,800 customers and gives us confidence our growth can continue into future periods. Our revenue retention rate again expanded from 110% to 111%, demonstrating that we are capitalizing on that opportunity. We operated the business efficiently during a period of rapid expansion and delivered adjusted EBITDA above the high end of our guided range. Now our results show that the momentum behind our business continues and the drivers of growth remain robust. Our Targeted Threat Protection service is leading the industry, delivering superior protection against malicious URLs, ransomware and whaling attacks. Customers are migrating to hosted email services like Office365 and choosing Mimecast in greater numbers as they continue to benefit from our comprehensive suite of cyber-resilient solutions. And customers continue to struggle with aged products from legacy vendors and are turning to Mimecast for solutions that keep pace with today's performance requirements and rapidly evolving threat and risk landscape. Looking at our global business, we have great strength this quarter across all our regions with gains in market share in each of our four major theaters. Our top ten deals globally this past quarter delivered four from North America, and each of Europe, Australia and South Africa contributed two deals. While our North American region continues to be our largest and fastest-growing, our geographic diversification and global strength is an indication that companies around the world face similar challenges with email security, data retention and protection. We also expanded into new markets. In the second quarter we added go-to market resources in the United Arab Emirates with a small sales team based out of Dubai. We're also pleased to have strengthened our presence in mainland Europe this quarter. A leading E.U. agriculture company with over 35,000 employees was using multiple on-premise security solutions and not getting adequate protection. This company went to the market looking for a cloud-based email security gateway to protect against whaling, spear phishing and malicious emails. They saw that the reputational damage caused by these advanced email attacks ultimately impact revenue, so, major concern for this customer. Mimecast competed here against all the leading email security vendors, and we won because of the effectiveness of Mimecast's email security technology and our integrated platform. We also continue to have success with large accounts because we offer the flexibility that these complex multinational organizations need to balance both centralized as well as regionally delegated policy administration. In Australia where we're establishing ourselves as a leader, we won the business of a prominent Australian higher education customer. Like in other parts of the world, this organization was experiencing an increase in URL-based threats and impersonation attacks. And these attacks were causing significant disruption and occupying disproportionate IT resources. So by deploying Mimecast with Office365, this organization now has a safer and better-performing corporate email experience. Office365 adoption continues to represent a catalyst for the adoption of Mimecast services. This quarter, customers choosing Mimecast to protect their Office365 subscriptions increased to 17%. That's continuing the steady increase in this important component of growth. By providing layers of security and offsite data archive and a solution for our time assurance, Mimecast makes customers even more successful and secure with Office365. And to illustrate that, I'd like to share some more examples and customer stories from our Q2. First, a large U.S. based oilfield services company, also using Office365 to serve its global workforce of over 8,000 employees, they needed a more sophisticated cloud archive. Their requirements centered around e-discovery, search, compliance, and policy-based data destruction. Mimecast was selected for our tight integration with Office365 and our ability to meet their specific archiving needs. Secondly, I wanted to mention a notable customer win this quarter deploying Mimecast to protect their Google Apps environment. This customer, a U.S. based solar energy company with about 4,500 employees, was facing impersonation attacks on a regular basis, and saw the solution to handle these targeted threats. Additionally, the company was looking for a stronger solution for archiving and e-discovery. We won this business in a competitive bid because we could offer a single integrated platform to protect them alongside Google Apps. Finally, I'd also like to discuss some success that we've had this quarter in attracting customers rolling off McAfee solutions. As you know, over the last several quarters, we've seen a large number of customers come to us that were previously using cloud-based solutions from McAfee. Our architecture is extremely well-suited to serving the needs of these types of organizations that were previously hosted by McAfee. However, in the second quarter we began to see customers moving off McAfee's on-premise equipment onto Mimecast's SaaS platform. In fact, two of our larger deals this quarter were displacing McAfee on-premise solutions, including a national retailer in the U.S. and a London Stock Exchange listed financial services company. From customer success, I'd like to turn the discussion quickly to technology. In the second quarter we introduced our new data logging API that allows Mimecast customers and partners to integrate data to their security and information event management through data analytics platforms. This integration can help customers bring together data on current email threats detected by their Mimecast service, with data from the rest of their security state for analysis and action. Leveraging our new data logging API, we also launched the Mimecast app for Splunk. Splunk users can now download the application from SplunkBase and customize the reports to meet security and compliance requirements. And this capability is proving popular with larger and more sophisticated security teams that we're engaging with. We also expanded our senior management team this quarter with the addition of Robert Nault and Dino DiMarino. Robert joins us as Senior Vice President and General Counsel based in Watertown, Massachusetts. Previously, Robert was SVP and General Counsel at Constant Contact where he led the legal team through tremendous growth, IPO and several acquisitions. Dino joins Mimecast as Senior Vice President of North American Sales, also in Watertown. Prior to Mimecast, Dino ran sales for RSA across the Americas. So we're thrilled to have their skill and experience on our team now. So in summary, we've delivered solid second quarter results that exceeded our guidance. Revenue growth accelerated to 38% on a constant currency basis, and we exceeded our adjusted EBITDA guidance. The drivers of our business are robust. We saw strong growth in each of our four major regions and we've completed successfully to gain additional market share again this quarter. Our brand awareness is growing globally and our channel relationships are strong. Looking back at the quarter, we realized a record percent of our new revenue from former McAfee customers. 650 customers adopted Mimecast to enhance their security and resilience on their Office365 deployments. And over 1,400 additional customers adopted our Targeted Threat Protection. So I'm very pleased to be sharing this progress with you today and would now like to hand over to Peter Campbell, our CFO, to take you through the numbers in a little more detail.

[Peter Campbell:]

Thank you, Peter. Q2 was another great quarter for the company. Revenue growth and adjusted EBITDA exceeded the high end of our guidance range. We continue to see strong net new customer additions across all geographies, best-in-class renewal activity, and another quarter of increased upsell into our existing customer base. All of these factors combined to create a record quarter for us. Second quarter revenue was $44.4 million, above our guided range of $41.5 million to $41.9 million. I am pleased to report that our revenue growth accelerated sequentially in both constant currency and on an as-reported basis. Revenue grew 29% on an as-reported basis and 38% in constant currency over the second quarter of 2016. Headwinds in the British pound and the South African rand negatively impacted our growth by $2.8 million and $0.5 million, respectively, for a total foreign exchange impact on revenue of $3.3 million. We saw strength in all geographies and across all customer segments. We continued to benefit from improved linearity in all regions as customer additions and renewals in the first months of the quarter tracked better than planned. The North American market continues to be very strong for Mimecast. North American revenue growth increased to 45% after adjusting for one-time credits which reduced revenue in the prior year. The region now represents almost half of our global revenue. More than two-thirds of the 1,900 customers we added in the current quarter came from the, showing continued momentum in this region. We are in the early stages of penetrating the U.S. market and expect to see continued strong revenue growth for the foreseeable future. In addition to our investments in sales and marketing, the three elements that drove our accelerating growth in the quarter were sales of our Targeted Threat Protection products to new and existing customers; the movement of companies to the cloud, specifically to Office365; and success selling our products to the McAfee customer base. Sales of our Targeted Threat Protection products continue to enjoy strong demand. During the quarter, over 1,400 customers bought this service and it is now deployed with over 6,000 customers. Demand for this leading-edge product continued from both existing customers and new customers. Almost half of our sales of TTP in the quarter were to new customers. TTP continues to be a strong driver for new customer acquisition as we offer the most advanced solutions to deal with customers' email security issues. In total, 28% of our customers are using Targeted Threat Protection, representing a substantial upsell opportunity for us. Customers are enhancing their cyber-resilience by deploying Mimecast's comprehensive cloud-based solutions, creating multiple layers of security. During the quarter, the number of our customers who are using our services in conjunction with Office365 increased to 17% from 16% last quarter. Amongst our smaller customers, the penetration rate has reached 20%. Mimecast also benefits as customers adopt multiple services. We are seeing that our customers who use us in conjunction with Office365 are more likely to purchase not only our security product but also our continuity and archiving products, as they adopt our broader strategy for protection of their assets in the cloud. 80% of our Office365 customers have adopted continuity and more than 60% have also purchased our archiving products. As you know, when customers purchase additional products with us, the margin on the incremental product is higher and they stay with us longer. Additionally, we are seeing an increase in new business from customers switching off legacy providers like McAfee. Our new customer additions were driven not only by our large and under-penetrated opportunity in the midmarket but also by the opportunity created by customers looking for a solution to replace their legacy offerings. Sales to former McAfee customers reached a new high in Q2 as these customers seek to find alternative vendors that can provide the most advanced solutions against evolving threats. During the last three quarters we have witnessed a marked increase in our customer additions from each of these growth vectors, TTP, cloud migrations and legacy vendors. Some of our largest deals this quarter were from the McAfee installed base and we believe customers using McAfee's on-premise products are just beginning to migrate as these products have a longer support period before their end of life. We are optimistic in our ability to continue to migrate former McAfee customers to Mimecast. Going forward, however, the profile of these customers is likely to change, from a larger number of smaller customers to a smaller number of larger customers, as we begin to onboard customers previously served by McAfee's on-premise solutions. In addition, a number of new customers that have come to us from McAfee have come in partnership with managed service providers. These managed service providers typically have an outsized number of sub-20-seat micro-customers, which represent very small revenue opportunities to Mimecast, although they add to our overall customer numbers. Going forward, we have made the decision to focus our sales resources away from these micro-customers as we pursue the vast opportunity available to us in the broader midmarket, which optimizes the revenue and upsell potential of our sales teams. As a result of these factors, we anticipate that the number of additions from McAfee's MSP partners may slow. However, these micro-customers represent a small amount of revenue and we would expect the AOV [ph] from new customer adds to increase commensurately. We saw increased customer additions across all segments this quarter. Additionally, we saw higher order values from new customers in each segment, as we had increased success selling multiple products to our customers at the outset. Our revenue retention increased again this quarter, resulting from strong demand for additional products from our base of customers. This quarter we experienced 111% revenue retention rate, ahead of the 110% we realized last quarter. This continued improvement in our revenue retention rate is the result of the combination of strong customer retention and increasing upsell into our customer base. Now let's turn to expenses and profitability. For the second quarter, we recognized a 72% gross margin, an improvement from the 70% recognized in the second quarter of 2016. Gross margin fluctuates due to the addition of hardware and employees needed to onboard and serve our growing customer base. We anticipate our gross margin will remain in the 70% to 72% range over the next several quarters. Second quarter was another quarter of investment for us, with operating expenses of $34.4 million as we continue to support our growth. Specifically, we are investing in our sales force and marketing initiatives. Sales and marketing expense as a percentage of revenue was consistent with last quarter at 52%, but increased to $22.9 million from $21.5 million. I should point out that we recognized commission expense in the period in which they are incurred rather than amortize them over the year. Consequently, our sales and marketing expense in the quarter was higher than originally anticipated due to the outperformance of our revenue. Our investments in sales and marketing continue to drive increased performance. These investments are increasing awareness of Mimecast, particularly in the U.S., and enable us to capture more of the very large market opportunity in front of us. While we recognize the enormous opportunity to grow our business, we have been mindful to extend our resources in a sustainable way. This measured investment approach should enable us to grow in a large market for a very long time. Adjusted EBITDA in the second quarter of $2.7 million exceeded our guidance of $1.6 million to $2.4 million. Adjusted EBITDA margin was 6%, which reflects our balanced investments in R&D and sales and marketing, with an eye on the bottom line. Adjusted EBITDA was positively affected by the additional revenue generated by the large number of new customers we've been adding, as well as the timing of expenses related to servicing those customers. In the current quarter, as we continue to see a higher level of new customer additions, we increased our investment in sales and marketing proportionally. As we see the market opportunity in front of us, we will invest to take advantage of this opportunity. However, as a percentage of revenue, we expect to see sequential improvement in operating expenses for the second half of fiscal 2017. We expect our adjusted EBITDA as a percentage of revenue to continue to gradually increase throughout the year. Our three to five-year target for adjusted EBITDA margin is unchanged and remains in the range of 20% to 22%. For the second quarter, GAAP net income was $0.3 million or $0.01 per basic and diluted share, based on 54.6 million ordinary shares outstanding. Net income was positively impacted by the effect of exchange rate changes in the British pound at the end of June. We have intercompany debt balances from our operating subsidiaries to the U.K. parent company. With the drop in the British pound, the subsidiaries are now able to repay their debts to the parent company with less local currency, resulting in foreign exchange gains on these intercompany debt balances. The net effect in the quarter was a $2.7 million gain in foreign exchange, below the operating income line. Without the effect of this gain, we would have experienced a net loss of $2.4 million. As of September 30, the majority of the existing intra-company loans have been capitalized and, as such, we do not expect to see significant movements on these balances going forward. Our non-GAAP net income, which reflects our GAAP net income exclusive of the effects of stock option expense and inclusive of the $2.7 million foreign exchange gain I just mentioned, was $2.6 million or $0.05 per basic share for the second quarter. Looking to free cash flow, during the second quarter we generated $3.3 million in free cash flow. We expect to continue to generate free cash flow for the rest of the year. This can fluctuate based on the timing and payment of capital equipment and other investments. Reviewing the balance sheet, as of September 30, Mimecast had $110.5 million in cash and cash equivalents. Total debt was $3.9 million at the close of the quarter, of which $3.2 million represents the current portion of debt. Now I'd like to turn the focus to guidance for our third quarter of fiscal 2017 and our outlook for the full year. Regarding revenue for the third quarter of 2017, we expect revenue to grow 31% to 32% year over year in constant currency, or to be in the range of $44.9 million to $45.4 million. Our third quarter revenue guidance is based on exchange rates as of October 31, 2016 and includes a negative $3 million impact from the strengthening of the U.S. dollar compared to the prior year. This impact was mainly due to the British pound but offset slightly by positive impacts from the South African rand and the Australian dollar. Regarding adjusted EBITDA, we expect this to be in the range of $2.6 million to $3.4 million for the third quarter. This is consistent with our continued strategy of investing in R&D and the build-out of our sales and marketing organization globally. We saw improved linearity and sales achievement during the quarter. Accordingly, we reinvest some of the excess into sales and marketing expenditures to better capitalize on the opportunity in front of us. Now, from a full year perspective, we expect revenue to grow between 32% and 33% year over year in constant currency and to be in the range of $177.5 million to $179.4 million. We are raising the midpoint of our guidance by $4.7 million for the year despite the fact that at current exchange rates we are seeing a $2.5 million increase in foreign exchange headwinds over our prior guidance, bringing the full year foreign exchange impact to $10.3 million. We expect adjusted EBITDA to be in the range of $10 million to $12 million for the full year as we continue to invest for growth, especially in sales and marketing in the second half of the year, but consistent with our strategy of sustainable investment. We expect to show continued progress toward our long-term operating margin goals in the second half. When providing guidance, we have taken into consideration the geopolitical and macroeconomic uncertainties around the world and balanced that with the recent strength that we have seen in our business including new customer adds in the two most recent quarters and our high retention recurring SaaS revenue model. In summary, we had a very strong first half. Our revenue growth accelerated again this quarter in both constant currency and on an as-reported basis despite the impact of currency fluctuations. I am especially proud of our retention rate, a reflection of the value we deliver to our customers. Customers of all sizes across the globe continue to choose Mimecast to protect their most important assets. As a result, we are confident in our ability to penetrate our large market opportunity and to sustain growth for a very long time. So with that, I would like to thank you for your time and open the lines to your questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Sterling Auty from JPMorgan. Your question please.

[Sterling Auty:]

Yes, thanks. Hi guys. So, one question, one follow-up. So, question, on the McAfee opportunity, what is the indicator or what is the trigger point that is causing the customers to make that move? Is it that they've either fully depreciated down-premise asset or there's another point of pain? So, what is the trigger that you see that says they're ready to come onboard?

[Peter Bauer:]

Right. Thanks, Sterling. So, really two things mainly. I think the legacy on-premise email security equipment, the level of innovation and investment that's gone into many of those platforms by the vendors that sold them has really not extended to deal with the more modern targeted attacks. So, URL based threats, weaponized attachments that contain the latest ransomware and polymorphic attacks and impersonation attacks. So, really the effective of these solutions is failing customers and that's seeking them -- that is driving them to seek change. I think the second and another very important aspect is that, as customers look more and more to use cloud-based email services like Office365, the idea of backhauling their traffic onto their networks through these on-premises appliance-type strategies is far less attractive. And so they look for more of a card to card based model for deploying email security alongside their cloud email investments.

[Peter Campbell:]

Yeah. Just -- Sterling, hi, this is Peter. Just to add to what Pete was saying, and I think you would have noticed in some of our prepared remarks as well, is that I think the cloud end-of-life was obviously happening earlier than the on-premise end-of-life, and we certainly benefited from that in the most recent quarters. But we started to see this quarter, you know, last quarter and into this quarter, some more of those on-premise opportunity start to move. And I think, you know, you mentioned sort of depreciation of hardware having -- equipment over time, and I think we're just at the very beginning of that opportunity and we'll start to see that play out more in subsequent quarters.

[Sterling Auty:]

Makes sense. And then as a follow-up, you gave a number of good metrics in terms of, you know, giving us idea of the installed base, the expansion, taking multiple products, etcetera. But I wonder if it's possible just to think about, you know, the billings within the quarter, how much of that was coming from existing customers versus new customers and how does that compare to either a quarter or a year ago? Just to get a feel for the shifts in terms of how much is being driven by expansion of existing customers versus new customers coming out to the platform?

[Peter Bauer:]

Sorry, just to clarify, Sterling, are you looking at with respect to specifically McAfee or all of our business?

[Sterling Auty:]

All of your business.

[Peter Campbell:]

So we've seen, you know, we talked to in our customer adds that we had, and that is a key measure for us, and we also talked in the past about our average order value being fairly steady quarter over quarter and year over year, and so, customer adds being a big indicator of our forward growth and our forward momentum. So we added 1,900 customers in the most recent quarter, so those are all new customers that we've added and that's obviously a big driver of future growth. I think more recently, in the prior quarter, we talked about our average order value being about $8,500. And we also talked to our gross revenue retention and how that is a measure not only of the stickiness of our product and the ongoing value that we provide to our customers but it also is a very strong economic indicator, because when a customer comes to us, they come to us for a very long period of time. We've seen that number increase, as you saw, 211% this quarter. And the way in which we've talked to that historically is we've talked about how that AOV has been maintained as a factor of upsell over time. So we don't specifically break out the new versus upsell proportion of our ongoing business, but rather we look at customers in total times our average order value, as a forward measure of our business. But we don't really break out the specific elements of how we're benefiting from upsell to our customers versus all the new customers that we're adding. We look at them as two vectors of growth bringing one total together.

[Sterling Auty:]

Understood. Thank you guys.

[Peter Bauer:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Saket Kalia from Barclays Capital. Your question please.

[Saket Kalia:]

Hey guys. How are you?

[Peter Bauer:]

Good. Thanks, Saket.

[Peter Campbell:]

Hey, Saket.

[Saket Kalia:]

Hey, Peter and Peter. Thanks for taking my questions. Maybe just to start out, clearly a very strong kind of customer addition number. It sounds like a lot of that strength came from McAfee, particularly the lower value but higher volume MSP customers that you talked about and that dynamic may change. But can you just level-set for us how much of the customer adds this quarter came from some of those lower-value McAfee customers? And then just maybe talk us through how long of a tail does the MX Logic and on-premise switch have for Mimecast?

[Peter Bauer:]

Great. So maybe let me start with the first -- sorry, with your second follow-up question there. I think that, you know, that's a key question that we think about quite a bit, how long does the McAfee opportunity continue for and how much growth can we derive from that. I think, you know, we got to think about it in three ways. Firstly, there's the SaaS piece, the old MX Logic product and the opportunity to move customers from that, and that's been the fastest to move over to us. Then comes the on-premise piece, and we're starting to see some movement from that. And then the third piece is obviously the long-term opportunity to upsell those customers that we've acquired. I think on the SaaS piece itself, we're definitely seeing a peaking but it's hard to tell as to, you know, when it peaked, when one could say it's peaked. So we've definitely in this past quarter had our best McAfee conversion rate, but we do think that the runway is large, and we'll keep you posted in terms of when we see that perhaps slowdown on the SaaS side and as it's picking up on the on-premise side.

[Peter Campbell:]

Yeah. Just to -- hey, Saket, it's Peter, Peter C. here -- just to add to that. You know, we do continue to add customers from many legacy providers, and obviously the kind of end-of-life of McAfee has seen an increased number of customers come our way, as they look for companies that can provide leading-edge solutions to the issues that they're facing. You know, we don't call out specific numbers in terms of what we've seen in McAfee, but I can tell you that, in terms of the last couple of quarters, we've seen somewhere around 10 and less than 20 but more in the kind of lower teen, lower to mid-teens, 10% to 20% of our new business coming from McAfee. And given we're such a high subscription SaaS business, this is quite a small proportion of our overall revenue. But it's certainly been a great driver for us and we've been benefiting from that. We expect to continue to benefit from that in the foreseeable future. But you're looking at sub-20% of our new business coming from that particular vector.

[Saket Kalia:]

That's really helpful. Maybe just from a follow-up, and for you Peter C., you know, we talked about some of the sales expansion activities, Dubai, mainland Europe for example. What kind of follow-on investments have you baked into the guide for the next couple of quarters, whether that's more marketing or more hiring? Just maybe talk us through a little bit either quantitatively or qualitatively.

[Peter Campbell:]

Sure. So, you know, there is a couple of pieces there. There are a couple of pieces there that you're talking to. And I think the first one you talked about, geo. I mean I would, in looking at our investments that we make in sales and marketing and look at the opportunity in front of us, we look first at our core markets and of course, you know, I talked to the fact that our U.S. market grew at 45% last quarter, which is a significant increase for us, you know, we're really benefiting from increased awareness and investment in this market and we're going to continue to increase our investments in this market. And, you know, that investment is effectively baked into my forward guidance. You know, I look at other geos, Pete talked about our expansion into UAE. We have a number of customers in UAE. We are a global business, 50% of our revenue is outside of the U.S., so we have customers all over the world. So those investments are much more minor. They're more initial investments and initial, just looking at -- taking advantage of some smaller opportunities there, but the real focus with the sales and marketing investment is in our core markets, with a real gear to the U.S. And that's what we're going to continue to do going forward. When you're talking about it being baked into our guidance, as I said about this quarter, as we saw greater-than-expected linearity and customer adds, which we experienced in the first two quarters, we increased our investments in that period in order to take advantage of that opportunity. There's still a lot of runway here for us, and, you know, we're going to continue to build that out. But we'll do it in a sustainable way, and I do expect that, although as I see increased linearity and as we continue to achieve on what we've kind of put in place here, then I'll continue the increase in sales and marketing but I'll do it in a sustainable way that'll see a sequential increase in adjusted EBITDA for the second half of the year.

[Saket Kalia:]

Understood. Thanks very much guys.

[Peter Bauer:]

Thanks, Saket.

[Operator:]

Thank you. Our next question comes from the line of Shaul Eyal from Oppenheimer. Your question please.

[Shaul Eyal:]

Thank you. Hi, good afternoon guys. Congrats on the strong set of results, outlook as well. Peter Bauer, maybe just a question on customer additions, 1,900 this quarter, 1,900 last quarter, I believe around 1,800 six months ago. Is that the new number give or take we should be thinking about in the call it near to midterm?

[Peter Bauer:]

Shaul, yeah, great question. So I think Peter spoke a little bit about us seeing some good uptick from the McAfee partner base, particularly the MSP base, and that's giving us a good boost in terms of customer numbers. I think right now we're not seeing any slowdown in terms of the momentum that we've got in that segment, but we are focusing our sales resources more towards the upper end of the midmarket. And so we expect over time perhaps that the number, the numeric count of logos that gets added to perhaps [taper] at some point in some quarters down the track, but really to be replaced by doing a smaller number of larger deals. But still very healthy customer adds. We're very focused on new logo acquisition as an organization.

[Peter Campbell:]

Yeah. Just, hi, Shaul, just to add to that, this is Peter Campbell again. You know, we've certainly seen, you know, we've certainly seen a large number of new customers come onboard in the last three quarters since we IPO-ed, and I think that talks to the sales and marketing investments that we've focused in each of our core markets, and we certainly benefited from the McAfee end-of-life as well as, you know, the move to 365, and our Targeted Threat Protection product, which is a leading product that deals with these most advanced threats. So we certainly benefited from that. And I think some of the smaller kind of McAfee customers, as Pete said, you know, we're focusing our sales and marketing on the larger midmarket opportunity, and some of the smaller customers that did, you know, how we have benefited from that, but these are, you know, at and around about a percent of revenue. So there's a very, very small amount of revenue related to these tiny customers. And, you know, our focus going forward, you know, will be on the larger customers, but I don't see, you know, I don't see it changing dramatically certainly in the current quarter. I think that'll happen over time.

[Shaul Eyal:]

Got it. And just a housekeeping question for your, Peter Campbell. On your adjusted non-GAAP EPS of $0.05 you guys have recorded for this quarter, I think you guys are using the basic number of sales outstanding or are you using the fully diluted? Like which ones should we be looking at?

[Peter Campbell:]

I believe the weighted average sales outstanding, which is 54.6, the balance sheet number at the end of September was 54.8.

[Shaul Eyal:]

Got it. Okay. Thank you for that. Appreciate it. Good luck.

[Peter Bauer:]

Thanks, Shaul.

[Operator:]

Thank you. Our next question comes from the line of John DiFucci from Jefferies. Your question please.

[John DiFucci:]

Thank you. Peter Bauer, this growth, 38% on a constant currency basis, that's better than you've done in years. I'm just curious, was the linearity different in the quarter? In other words, did you sign more deals earlier so you have more revenue in this particular quarter? Or was it just simply the business momentum that you've been talking about throughout the whole call?

[Peter Campbell:]

We're looking at each other to see who should answer the linearity versus the momentum part. But I think -- let me take it first and then Pete can add to it. Hey, John. So we have increased linearity in the quarter. I think we saw customer adds come on in July and August certainly than previously, and we benefited from just a continuing momentum, as we kind of, you know, I think we're in the right place at the right time with the right product, and we've seen a continuing momentum and we've invested in that momentum and we continue to benefit from that, in all our markets, across all customer sizes, but in particular in the U.S. where there's been a focus of investment. That, I know you're talking about that 38%, I'm quite proud of that and proud of the team for achieving that. And I just, I think the other thing that underlies that is the fact that our U.S. growth was 45%. So I think it is a linearity question in terms of driving that 38% constant currency growth, but it's also a momentum story. I don't know, Pete, I might have taken your thunder there, but I just want to --

[Peter Bauer:]

Hardly. Thanks for that, John. Did that answer your question? I can expand a little bit on the momentum and how that impacts linearity as well.

[John DiFucci:]

No, I think that's good. It sounds like there's -- it was -- there was some benefit from an earlier sort of linearity but also the momentum is obvious in a number like that. But I guess my follow-up, and you mentioned the U.S., and the U.S. has been focused area for you, it's a huge opportunity for you and it really -- it looks like it's working. At the same time, you're bringing a head -- a new head of North American sales in Dino DiMarino. And I'm just curious, I believe that's a new role for you. And if so, what is he tasked to do, other than obviously run the U.S., North America? Are there any -- should we expect any changes to the sales approach, like a more targeted group going after larger deals? Anything at all that -- any change in the structure of sales or the go-to market strategy here?

[Peter Bauer:]

Yeah, I think that's a great question. So, you're right, it's a new role that was created. We previously had a VP-level leader in place, and we've expanded that and created a high-level agreement [ph]. I think one of the great things, and obviously Dino is working directly under Ed Jennings who's Chief Operating Officer that is responsible for sales and marketing and services globally. So there's a real consistency in our approach going forward there. Dino, coming from RSA, has got very strong, larger account sales experience. So he brings some of that DNA to our organization. He also has very deep security sales expertise. And so those two things combined I think just help us and help our overall team to have higher impact and to be able to continue the kind of growth and market share gains that we've been seeing recently in the North American theater.

[Peter Campbell:]

Just to add to that, John, I mean just on the -- there are no real changes to the sales and marketing approach. A lot of the structure, you know, we talked when we came out on the IPO about how we're investing in sales and marketing and we had established the structure for future growth into the fourth quarter of last year. And we're continuing to build on that. And I think Dino's appointment, as Pete said, this is a kind of a high problem to have, it being a function of our rapid growth in this market. We put the structure in place, I think we're lucky to have Dino, I think he's a great new addition. We're not changing the shape or the form of our sales investments other than increasing them on an absolute value basis, and I think Dino is a great leader to kind of lead that charge in the U.S. market.

[Shaul Eyal:]

Great. Thanks guys. But if I could just to the first question, is there any reason we should expect linearity in the quarters, like why was linearity a little bit earlier, if that's the right phrase, earlier this quarter than it has been, and should we expect that going forward?

[Peter Bauer:]

I think it's a function of a maturing sales and marketing platform that we have in place, the partner environment that we've developed, the training that we've given our sales people. Pete Campbell's spoken quite a bit about the sort of increased levels of investment. And then I think the other reality is that, targeted threats don't wait for the end of the quarter. So, customers really have to deal with some of these issues and respond somewhat as they occur and find solutions. And so I think that's also playing a factor in bringing some of these deals to the table.

[Shaul Eyal:]

Okay, great. Thank you very much, and impressive job, guys.

[Peter Campbell:]

Thanks, John.

[Peter Bauer:]

Thanks, John.

[Operator:]

Thank you. Our next question comes from the line of Matt Hedberg from RBC Capital Markets. Your question please.

[Matt Hedberg:]

Hey guys. Thanks. Nice acceleration this quarter. There was a lot of talk on McAfee being a driver for you guys. I'm curious, are you seeing dollar-for-dollar conversion of McAfee email protection to Mimecast email protection? And maybe if you could help talk about how you've been able to upsell those customers to additional products upon conversion.

[Peter Campbell:]

Sure. Hey, Matt. So that's a great question. You know, we've certainly been taking on those McAfee customers. And what we've been seeing actually is an increase in terms of the price points that we're getting. Often they're coming off a single McAfee solution and they might need our advanced threat -- Targeted Threat Protection product alongside basic gateway solution. So we'll see an increased ARPU and an increased average order value from those customers. And I also, as you kind of look at that customer base and the history of our kind of getting new customers, keeping them forever and selling them more products, we still see a big opportunity even with them buying sometimes more than one, two, or even three products at the outset from us. You know, we also have quite a large opportunity still to sell into that base ongoing.

[Matt Hedberg:]

That's great. And then I guess I'm wondering, from an international perspective, can you comment on the pending E.U. breach notification? I believe it's GDPR. Could that be a driver for European sales for you guys? I know you're more U.K. based today, but just sort of curious about that concept.

[Peter Bauer:]

Yes, Matt, absolutely, I think that can be a key driver. We've had quite a lot of work on our side going into preparing for that from a practical point of view and also looking at what the appropriate sort of marketing messages might be as that rolls out and becomes more top of mind. So, yeah, very much, I think something customers really have to think about, particularly if this comes into their archiving strategies and how they're storing and managing data and who's got access to that and what are the retention rules around that. And then of course, the breach notification really drives awareness of when someone has fallen short and creates a little bit more awareness and urgency around making sure that you've got the right solutions in place in that case. And I think we've certainly seen in the U.S. where those breach notifications have been low for some time, and that coupled with the media publicity has certainly helped customers to be aware of where they need to pay attention, and that's a catalyst to sales. So we anticipate some of that spreading into the European theater as well.

[Matt Hedberg:]

Thanks guys. Well done.

[Peter Bauer:]

Sorry, go ahead.

[Peter Campbell:]

I was just going to add to that, Matt, and say, look, we've been selling into the European Union for many years, not only the U.K., and we expect to continue to do that. So I think, additionally, anything that comes out of the E.U. with respect to GDP or the expectation in U.K., even though it's not completely defined right now with Brexit, is that the U.K. would follow those regulations. So we've been apprised of any European regulations around data protection for many years and we'll continue to do so as it's a continuing opportunity for us ongoing.

[Matt Hedberg:]

Great, guys. Thanks.

[Operator:]

Thank you. Our next question comes from the lien of Gabriela Borges from Goldman Sachs. Your question please.

[Gabriela Borges:]

Great, good evening. Thank you for taking the question. I wanted to follow up on all the commentary on the go-to market. As you engage with larger customers, I was hoping you could maybe compare and contrast for us whether the process is any different to when you engage with customers in that 500 to 7,500 user [ph] cohort, particularly as it pertains to things like key selling points in the technology or the length of the customer buying process or anything like that. Thank you.

[Peter Bauer:]

Great. Thanks, Gabriela. So, a couple of differences. Yes, certainly the sales cycles are a little bit longer, perhaps some of the smaller customers our sales cycles can be as short as a few weeks, maybe 30 days, and then with the larger opportunities it could be sort of 90, 120 days for some of those. I think some of the principal differences in the midmarket, typically we will present our solution to a buyer or a buying team that has span of control over most of the areas that we cover, so, as an integrated suite across the security stack, across the archiving, data management stack, and then the business continuity piece, and there's various sort of sub-teams within that. In a smaller or medium-sized organization, the team will have oversight and responsibility for certainly more than one of those. And that gives us an opportunity to really showcase that capability. I think when we get into the larger organizations, the buying can be a little bit more siloed. So there may be a team that's specifically focused on security, maybe a separate team that's focused on the data management, the archiving, compliance, e-discovery, and then perhaps even a different team that's focused on messaging, operations and thinking about gateways and high-availability and backup, and those use cases. So for us, the sales motion is different. It's really a case of getting to multiple of those stakeholders and building a consensus, helping them appreciate how we can simplify IT for them and how we can help them move those workloads to the cloud into a great integrated solution. At the same time, it's very important that we show the best-of-breed status in each one of our solutions as well. And so that's been an area of great progress for us over the past several quarters as we've really been recognized by firms like Gartner for having outstanding capabilities across the full stack, and rather than just being a sort of aggregator of things -- or integrate into an integrated suite, we have best-of-breed capabilities in each of those disciplines and really are fit for enterprise use as well.

[Gabriela Borges:]

That's helpful, thank you. And as a follow-up if I may, on the Targeted Threat Protection, the percentage of new customers taking TTP seems like it took a step-up from last quarter's 60% number. Just any color on what you think is driving that. And as we look at the percentage of the installed base that has TTP, that 28%, where do you think that can be in a couple of years? Thank you.

[Peter Bauer:]

Yeah, great. So you're right, TTP continues to be a very popular solution, a key driver of demand for us, and a key attached to both new customers as well as existing customers buying the solution. We have pretty strong conviction that this is a product that's relevant to all of our customers. So, across the base, I think it's about 95%, 97% of our customers have bought base-level security from us. We think all of those customers can benefit and should have our Targeted Threat Protection solution. So we'll continue to focus ourselves if it's on getting every last one of them over the line.

[Gabriela Borges:]

Great. Thank you for the color.

[Peter Bauer:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Jack Rohkohl from Dougherty & Company. Your question please.

[Jack Rohkohl:]

Thanks for taking my question. Two quick ones on Office365. You know that Microsoft 365 penetration has again gone up in the quarter. Obviously Microsoft has made a number of improvements to their existing features over the last six to twelve months. Have you seen any changes in the competitive dynamic for kind of sales for their existing protection features? Are people more likely to stay on the platform, are there more and more people moving off the third parties? And then second question would be, when you win a customer that's using Office365, are these customers more likely to take a third-party vendor right off the bat when they move their mailbox up to the cloud, or are they typically been using the existing features for some time in deciding they need additional support?

[Peter Bauer:]

Jack, thanks. So I'll handle the second part first and then go back to the first part of your question. So we really see a mix. So as a customer's evaluating Office365, some of them know right upfront they're going to need additional capabilities and they come and source them and they make that either precursor to their move or, you know, it's an important part of their migration to migrate the data somewhere first and move the mailboxes second, make sure they've got a continuity solution in place during that sort of sensitive time of the migration. And then they have a model in mind for how they're going to balance risk and protect their Office365 investments. Some of them may go with Office365 first and go and see what that experience is like, and then discover where the additional needs might be and where they're not comfortable without additional services. And so we see that a lot as well. So I think we get customers from both scenarios. In terms of Microsoft's own investments in security, I think those are very important. I think Microsoft is going to end up with something pretty close to a monopoly for hosted email services. So I hope as a digital citizen that that is, you know, continues to improve its own security posture. But it will be most likely the most attacked surface -- the most attacked service on the Internet. There's such a rich prize behind it and it, I think it's impossible for one organization to be 100% on top of all of the security things, but the stakes are incredibly high, particularly with email security. And having the same flavor of security for everyone, I don't think is compelling for all organizations. So the need and importance of having additional layered third-party best-of-breed security and protection technology working alongside your Office365 environment I think remains compelling for a very long time. We're certainly committed to making that as easy to use and integrated and as broad a suite of protection capabilities. It's not just about keeping out malware and spear phishing, it's certainly about that, and that takes real focus and effort. But it's also about protecting data and having an independent archive and backup and it's also about providing uptime assurance and a plan B for when these performance challenges or downtime issues at Office365. So we think that there's, you know, there's an ongoing opportunity for us, as Office365 becomes more and more popular, to provide this full suite of cyber-resilience capabilities, and at the same time, fingers crossed, Microsoft is successful as a security -- as a provider of security on their own platforms too.

[Jack Rohkohl:]

Great. Thanks for taking my question, and congrats on the strong results in the quarter.

[Peter Bauer:]

Thanks, Jack.

[Operator:]

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Peter Bauer for any further remarks.

[Peter Bauer:]

Yeah, folks, thanks again. We've enjoyed sharing this quarter's results with you and we look forward to speaking with you again in about another quarter's time. Have a great evening.

[Operator:]

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.