Barracuda Networks Q2 2018 Earnings Conference Call Transcript (CUDA)

Markets Motley Fool

Barracuda Networks (NYSE: CUDA)
Q2 2018 Earnings Conference Call
Oct. 10, 2017, 4:30 p.m. ET

Continue Reading Below

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon everyone, and welcome to the Barracuda Networks Second Quarter 2018 Earnings Conference call. [Operator Instructions] Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to Ms. Maria Riley with Investor Relations. Ma'am, please go ahead.

Continue Reading Below

Maria Riley -- Investor Relations

Good afternoon, and welcome to Barracuda's Second Quarter Fiscal 2018 Earnings Conference Call. On today's call, BJ Jenkins, President and CEO, will provide an overview of our second quarter fiscal 2018 performance. Then Dustin Driggs, Barracuda's CFO, will review our financial results in more detail and provide guidance for the fiscal 2018 third quarter. We will then open the call for your questions.

This afternoon, Barracuda issued a press release announcing the company's financial results for the second quarter, ended August 31, 2017. A copy of this press release and supporting financial materials are available in the Investor Relations section of the company's website at www.barracuda.com. During the call, we will make forward-looking statements, such as those containing the words may, expects, believes or similar phrases to provide information that is not historical in nature. These statements, involve risks, assumptions, and uncertainties. For a more detailed description of these risks assumptions and uncertainties, please refer to the company's filings with the securities and exchange commission, including the risk factors contained in our most recent annual report on Form 10-K for information on risks and uncertainties that may cause actual results to materially differ from those described in the forward-looking statements. Also, please note that unless specifically noted otherwise, all financial numbers discussed today are on a non-GAAP basis.

Non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in prepared in accordance with GAAP. A full reconciliation of the non-GAAP measures, as well as a discussion of why we present non-GAAP financial measures are included in our earnings press release that is available on our website. Additionally, on this call, we will give guidance for the third quarter of fiscal 2018 on a non-GAAP basis. We do not provide reconciliations of our forward-looking non-GAAP financial measures to the corresponding GAAP measures due to the high variability of and difficulty in, making accurate forecast and projections regarding the items excluded from these non-GAAP measures. And accordingly, such reconciliations are not available without unreasonable effort.

For additional information, please see our earnings press release that is available on our website. And with that, I will now turn the call over to BJ Jenkins, President and CEO of Barracuda.

William D. Jenkins -- Chief Executive Officer, President

Thank you Maria. Good afternoon, everyone, and thank you for joining us to discuss our second quarter 2018 results. We delivered a strong second quarter, achieving core product, billings growth of 22% year-over-year, and 24% core subscription ARR growth. In total, gross billings grew to $108.5 million, exceeding guidance. Revenue increased to $94.3 million. And on the bottom line, we generated $0.17 in non-GAAP EPS.

Our strong performance in the quarter was primarily driven by continued traction in the areas of the market where we have been investing, especially email and public cloud security. We are pleased to see that our product innovations are generating strong top-line results, including four consecutive quarters of double-digit billings growth when excluding noncore billings. At the beginning of August, we showcased our security platform and solutions at our annual partner advisory board meeting as well as our public cloud partners summit, which was jointly hosted with Microsoft. At these weeklong events, we had a great showing from across our partner ecosystem of VARs, MSPs and born in the cloud partners and benefited from their input on Barracuda's vision, platform, and product roadmap as well as collaborators on top security concerns and needs. Let me share with you if you take away from our discussions. First, for large and small businesses alike, security remains top of mind. High-profile breaches like Equifax, the SEC, and Deloitte further highlight that threats and the consequential damages are real and emphasize why security is the business imperative of the day. Second, Office 365 continues to be the email platform of choice for our customers, and this trend is accelerating.

At the same time, email remains the most exploited threat factor with attacks growing in volume and sophistication, heightening the need for innovative solutions to combat these attacks. Third, customers continue to look for ways to adopt flexible architectures that allow them to prioritize or moves to the cloud at a time that works best for them. Our go-to-market partners are seeking vendors that enable this flexibility and make doing business in the cloud easy and have simple to deploy solutions with comprehensive, layered security, managed across multi-cloud and hybrid environments. And fourth, many businesses are increasingly turning to MSPs to manage their IT and security needs. This trend is accelerating and partners are seeking opportunities to move resources to a managed security services model with pay, as you go and monthly billing. These conferences with our partners furthered our belief that our strategy to position Barracuda as a leading security and data protection provider for today's IT professionals and in the public cloud aligns with customer needs. We continue to make progress across our core product focus areas in the second quarter.

In email, we continue to see strong growth with both new and existing customers for our Barracuda essentials offering. We now have approximately 5,000 customers using Essentials, of which over 50% are net new to Barracuda. Our Barracuda Essentials offering provides customers with a comprehensive and easy to deploy protection and continues to strengthen our ability to drive further into this market and win new email customers. We believe it is important that we continue to bring innovative and integrated products to this market to build on our success and expand our market share. As we discussed last quarter, we introduced Barracuda Sentinel for Office 365, which we believe is a unique offering in the market today. Barracuda Sentinel is a cloud-based service that utilizes artificial intelligence to predict and prevent targeted attacks like spear phishing in real time.

It combines 3 powerful layers of artificial intelligence to stop spear phishing and cyber-fraud, prevent domain spoofing with DMARC authentication and train high-risk individuals with simulated attacks. With our deep heritage and continued advances in email security, Barracuda offers customers a comprehensive and cost-effective email security solution. To demonstrate the power of our solution, I would like to share with you a recent win we secured with a global manufacturer based in Europe that has 2,500 users worldwide. This new customer was migrating their email to Office 365 and was looking for a cloud-based email security solution and targeted attack protection as well as a new backup solution for OneDrive and SharePoint as it was taking them more than 1 week to back up their environment locally. They selected Barracuda Essentials for Office 365 along with Advanced Threat Protection and Barracuda Sentinel to strengthen the security of their email and back up their data more efficiently. In addition to email security, data protection is a critical component of a compartment company's security framework, especially with the increase in ransomware attacks.

In the quarter, we achieved solid billings growth, driven primarily by agrees demand and due in part to new product enhancements. To provide you with perspective on the scale of our data protection operations. I would like to share a few metrics. Today, we support over 85 petabytes of storage in our cloud and ingest into the cloud over 4 gigabytes backup data per second. We help our customers with approximately 3 million backup jobs per month and with over 12,000 recoveries per month on average.

Additionally, we have archived over 13 billion emails in total. We continue to offer different form factors that enable customers to deploy the data protection strategy that best fits their business needs. In the quarter, we added backup replication for AWS making barracuda the only provider offering integrated security and data protection in AWS. This new deployment option offers organizations the ability to utilize the cloud, peroxide storage and enables cloud migrations. Large and small organizations alike are increasingly looking to benefit from the scalability and elasticity of the public cloud.

Best practices for public cloud architect, archer dictate building loosely coupled resources that scale elastically. Barracuda's cloud-ready, next-generation firewall and Web Application Firewall are tightly integrated with native cloud services and support these requirements. This helps eliminate deployment friction and enables better high availability compared with traditional firewalls that are designed to be tightly coupled, centralized policy enforcement points in data centers. We've had a number of cloud across our major cloud platforms and remain committed to innovating to foster adoption. This quarter, we announced new enhancements to our Barracuda next generation, firewall and Web Application Firewalls to include integration with Microsoft Azure, OMS and API enhancements make it easier for customers to automate security controls into their cloud-native applications.

The Barracuda next-generation firewall is a platform-neutral solution that removes barriers to cloud adoption and helps accelerate the migration of more risk-sensitive workloads. We believe the public cloud represents a long-term growth opportunity for Barracuda. We are pleased with our progress to date. We believe it's important to establish a strong presence early on in the public cloud adoption cycle because once solutions are tightly integrated into customers' native cloud services, switching costs are high and complex. A large installed base can offer an opportunity to expand our market share as customers grow their cloud footprint over time. In the second quarter, we added 300 public cloud customers, and billings for our public cloud solutions more than doubled year-over-year, and we will continue to invest to capitalize on the growing opportunity. Barracuda has leveraged our experience dealing with threats across email, network and application security and data protection to develop a knowledge base that protects customers in both the public cloud and on-premise.

Given the scale of our user base and the amount of diverse threats and traffic we see and analyze across all threat factors, we believe Barracuda has one of the most comprehensive views of the global threat landscape. Our threat intelligence is incorporated throughout our solutions and culminates in our Advanced Threat Protection subscription, which we launched last year. This cloud-based service attaches to multiple Barracuda products and combines behavioral, heuristic and sandboxing technologies along with artificial intelligence to protect customers against advanced threats that evade traditional defense mechanisms. We believe it is differentiated from other ATP products as it combines and analyzes the massive amount of threat intelligence it captures from more than 50 million collection points around the world to provide customers a comprehensive, multilayer defense.

The differentiation and strength of our solution is resonating well with our customers and partners, and we are seeing increased attach rates for our ATP offering. In summary, we are pleased with our results and continued traction in the market. We believe we have built strong solutions that give customers access to innovative security products that are affordable and consumable in the form that is best suited for their business. We remain focused on making the right investments to capitalize on the growth opportunities we see in the market and create long-term value for our customers and shareholders. With that, I will now turn the call over to Dustin for a more detailed review of our second quarter financial performance and third quarter guidance.

Dustin Driggs -- Chief Financial Officer

Thanks, BJ. Revenue in the quarter was $94.3 million, an increase of 7% year-over-year. Our total subscription revenue grew 14% over the second quarter of last year to reach $76 million and represents 81% of total revenue, up from 76% in our prior fiscal second quarter. On a geographic basis, we derived 76% of total second-quarter revenue from the Americas, 18% from EMEA and 6% from Asia Pacific.

Our number of active subscribers in the second quarter exceeded 348,000, which was an increase of 17% year-over-year. Turning to our second quarter billings. Our total gross billings increased to $108.5 million, up 8% year-over-year. Total subscription annual recurring revenue grew to $300 million, which represents an 11% increase year-over-year.

Core product billings for the second quarter were $70.9 million, up 22% year-over-year. Core subscription ARR grew 24% to reach $181 million. Our legacy on-premises billings were $36.2 million, down 7% from the prior year, and the corresponding subscription ARR was $115 million. And lastly, our noncore billings in the quarter were $1.4 million compared with $3.1 million in Q2 of last year.

Our dollar-based renewal rates were 91% on an annualized basis. We are pleased with the performance of our annualized renewal rate, along with our active subscriber growth. We view these as a strong representation of our performance and customer traction. If you turn to the P&L, our non-GAAP gross margin for the second quarter was 77.9%, a 50 basis point decrease from the prior quarter.

The decrease primarily reflects changes in product mix, increased expenses related to our warranty and hardware replacement programs and continued investment in our cloud infrastructure. We expect our gross margins to improve as we scale our cloud-delivered services infrastructure. Our non-GAAP operating expenses in the second quarter were $57.9 million or 61% of revenue, which was in line with the prior quarter. We ended the second quarter with headcount of 1,546, and this is down from 1,576 employees in the first quarter.

In the second quarter, our non-GAAP research and development expenses were $16.2 million. Our non-GAAP sales and marketing expenses were $34.6 million and our non-GAAP general and administrative expenses were $7.2 million. Our non-GAAP operating income was $13 million compared with $16.3 million in Q2 of last year. We generated $15.6 million of adjusted EBITDA or 17% of revenue compared with 18% of revenue last quarter and 21% of revenue in Q2 of last year.

Our non-GAAP tax provision was $3.9 million in the quarter. Our non-GAAP net income in the second quarter was $9.1 million or $0.17 of earnings per share, and our GAAP earnings per share was $0.03 using a diluted share count of 54.6 million. Our operating cash flow for the quarter was $11 million and free cash flow was $7.9 million. Our free cash flow reflects normal changes in working capital needs and the timing of payments.

We closed the quarter with cash, cash equivalents and marketable securities of $207 million. Now turning to guidance. For Q3 FY '18, we expect billings to be in the range of $107 million to $110 million. We expect revenue to be in the range of $92.5 million to $94.5 million.

Guidance for non-GAAP operating income for the third quarter is between $13.5 million and $15.5 million. Non-GAAP earnings per share for the third quarter is expected to be between $0.17 and $0.19 per share, with an assumed share count range of 54.5 million to 55.5 million shares. For FY '18, we remain on target to achieve the financial objectives we outlined at the beginning of the year. That concludes our prepared remarks today.

Now BJ and I are happy to take your questions.

Operator

[Operator Instructions] And our first question today comes from Sterling Auty from JPMorgan. Please go ahead with your question.

Sterling Auty -- J.P. Morgan-Analyst

Yeah. Thanks, guys. So BJ, you're, seeing success as you move to the cloud, but you made the comment about the cloud and your integrations will make Barracuda sticky. What makes it sticky in the cloud? On-premise, I think people get that there's a large cost actually do the replacements of the appliances plus there's the training and productivity from the management solutions to administer those items. That's kind of what's driven, a good chunk of the stickiness on-prem. What drives the stickiness in the cloud for you.

William D. Jenkins -- Chief Executive Officer, President

Yes, thanks, Sterling. We're real happy with our performance in public cloud and glad to see at a double again, 300 new customers in the quarter was great progression for us, and we're up to 65 Fortune 1000 customers now in public cloud. when you look at those applications and how they are deployed, there's a couple different elements up from on Prem, but I think to make it even stickier are. The 1st is that you have to integrate with either the AWS platform on the Google platform or the user platform, which is constantly changing, and our products have at this point deeper integration with those platforms and provide more services. Second, as the companies move, these applications into the public cloud odds are starting up an orchestration and policy framework. That's integrated into the platforms and again we are through our investment in our and the made our products are being better than that orchestration and policy enforcement, and that's hard to change as the underlying platform.

Strangely and so I think we've seen that old. You know in the growth of the number of deployments we have, but in the growth of the actual expansionist customers as they deploy more applications in the public cloud, and you know we, we see that continuing going on a going forward. So it's not really the call box. It's more software, you don't work, we don to impact functionality into the platforms and how they work on those platforms.

Natively going forward.

Sterling Auty -- J.P. Morgan-Analyst

Sense, one follow up question -- I think the comment was you're happy with the renewal rate in the customer count, renewal rate I think was down quarter over quarter. Just put that into context. You know what influences that renewal rate is some of that being impacted by legacy customers shifting to the cloud were? Could that renewal rate go or where would be a threshold that you know from an outside you that maybe we might be concerned about or still be comfortable with?

William D. Jenkins -- Chief Executive Officer, President

Yes, great question, Sterling. Thanks for asking it. I think, first, I would say we have gotten feedback over the past couple of quarters that giving multiple renewal numbers was causing some confusion, and we feel annualized, looking at -- without regard to contract length, was the best way to move forward. So that's what we've presented here.

We still think, and I think we've always said that rates in the low 90s are, we think, best-in-class and very strong renewal rates. And you couple that with the growth in the number of active subscribers, the fact that underneath that, the unit renewal rate has stayed consistent. And when we look at new product offerings like our Essentials offering, which has a much higher renewal rate, as that grows, I think we feel like that low 90s is a good place to be and we feel that some of the new offerings, we've got support and tailwinds to that going forward.

Sterling Auty -- J.P. Morgan-Analyst

Got it. Thank you.

William D. Jenkins -- Chief Executive Officer, President

Thanks, Sterling.

Operator

Our next question comes from Alex Henderson from Needham & Company. Please go ahead with your question.

Daniel Park -- Needham & Company

Alright. Good afternoon. This is Dan Park on for Alex. Thanks for taking the question.

So our concern been having some are solid traction customers, especially in email, security and public cloud. I was just wondering if you can elaborate on the competitive landscape, especially as a potential through competition with Mimecast, Proofpoint, with some of the bigger enterprise customers, qualities for all your web products.

William D. Jenkins -- Chief Executive Officer, President

Yes. I think email security, especially for those companies who are focused on a strong. Our cloud based offerings were, you know, definitely all seeing very strong growth. We all operate at different parts of the market. Again, I think Proofpoint's around 5,500 to 6,000 customers in total, and a little over a year we're at 5,000 customers on Essentials. So we're operating, for the most part, on a different part of the market.

I'd say below 1,000 employees, most of the time, they're making a choice to enhance their email security from Microsoft to us. There's not that much competition down there. I think it's when you get to the upper part of the mid-market, that's where we would tend to run into Mimecast first. What I would say is our Sentinel offering that just got released last quarter has really been a differentiator for us and is helping us move higher up into that upper mid-markets and compete effectively because it really is a differentiated technology and uses machine learning and artificial intelligence to stop spear phishing and cyber fraud real time.

And it provides DMARC authentication services that help companies protect their brands and it also helps us identify high-risk individuals inside those organizations and do simulated attacks so that they know and can recognize when these things are happening and hopefully not activate them or click on them to get them going. So Sentinel has been a great game changer for us and I think it's helping us accelerate our growth in email, and we're obviously -- when you look at our core focus areas and the growth there, email has been a big driver of it. So we're excited about that. On the lap side in public cloud, we have put a lot into R&D to make sure that our product works well and is differentiated there.

Things like metered billing definitely make a difference when customers are looking at which platform to choose. Our competition in public cloud has primarily been who you would think traditionally like Imperva and F5, and we've been doing very well in public cloud against them.

Daniel Park -- Needham & Company

Okay. Great, thanks for your time.

William D. Jenkins -- Chief Executive Officer, President

Thanks.

Operator

[Operator Instructions] Our next question comes from Andrew Nowinski from Piper Jaffray. Please go ahead with your question.

Andrew James Nowinski -- Piper Jaffray

Okay. Thanks, guys. Good afternoon. I just had one question. So last quarter, you guys talked about substantial increase in new hires, new sales people.

Obviously, you've launched the new Sentinel product, which is -- sounds like it's having a positive contribution to email sales. I'm just wondering why the new hires and the new product aren't giving you confidence enough to raise your annual outlook for FY '18, given the upside you had in the August quarter already as well.

William D. Jenkins -- Chief Executive Officer, President

Yes, thanks, Andrew. Well, I think we feel the plan's working that we had, and we beat billings again for the quarter. If you look the last 4 quarters, we've had double-digit growth when excluding noncore. So we feel very good about how the business has been progressing.

And if you look at the guide for billings, again, it's a raise over consensus was. So we think we can work -- continue to make great progress on the top line and get every quarter more confidence as our focus areas continue to grow. On the headcount side, when we look at some of the things on operating expenses, the drop in headcount, some of that came from interns, summer interns, that we have working for a period of time and then obviously going back to school. Some of that is a continued realignment of investments away from noncore and legacy into our core focus areas, and as always, we're trying to balance growth and profitability there.

And we think when you look at core growing at 22%, and still, we think delivering strong profitability, we feel good about the progression in the business and the progression on the top line.

Andrew James Nowinski -- Piper Jaffray

All right. Thanks. And then I guess, would you say that your your sales productivity is higher now than I was last quarter? Are you getting more of a contribution? And I understand that your realigning some of the sales people into new areas, but would you say your overall sales productivity is higher?

William D. Jenkins -- Chief Executive Officer, President

When you look at our core focus areas, there's obviously a realignment about. So there are some areas where the sales cycle may be longer, like a public cloud Fortune 1000 deal, only it's larger deal. So that productivity is going to be different than our transactional business for Essentials. I think overall, our productivity has stayed consistent and trending upwards. So we're happy that it's in that direction as we've been realigning investments.

Andrew James Nowinski -- Piper Jaffray

All right. Thanks, guys.

William D. Jenkins -- Chief Executive Officer, President

Thanks.

Operator

Our next question comes from Joel Fishbein from BTIGF. Please go ahead with your question.

Maria Riley -- Investor Relations

Hello, Joel. Are you there?

Joel P. Fishbein -- BMO Capital Markets

I'm here. I'm sorry about that. I had you on mute. Just a quick question for you guys on gross margins and what the drivers are here, and I think you said that there's going to be an uptick.

Could you just -- it dipped a little bit this quarter. I know it's an ebb and flow, but would love to just get your thoughts on that.

William D. Jenkins -- Chief Executive Officer, President

Yes, thanks. Thanks, Joel. We've talked about this in the script, and there's kind of 3 factors that have been impacting gross margin. The first to -- the expansion of our cloud infrastructure to deliver our cloud security services.

And then the second is really this mix shift, which is a shift to edge devices, the firewall and the backup devices for distributed environments. Both of those are negative short-term impact on gross margin or headwind, but they're long-term positive tailwind to gross margin. The third one we talked about was really something that's nonrecurring charges that are associated with our warranty and hardware refresh program, and that impacted us largely in Q2 and we feel like we've got a handle on it. And so when you look forward, I would -- we expect around a 50 basis point improvement in gross margin in Q3, and then another 50 basis points improvement in Q4 as we recover from the impact of those nonrecurring cost that happened as a part of that.

Joel P. Fishbein -- BMO Capital Markets

Okay. Great, thank you so much.

Operator

Our next question comes from Jonathan Ho from William Blair. Please go ahead with your question.

Maria Riley -- Investor Relations

Hello, Jonathan...

William D. Jenkins -- Chief Executive Officer, President

Are you there?

Jonathan Frank Ho -- William Blair

Hi. Can you hear me? Sorry about that. I also was on mute. But I just wanted to get a little bit more detail in terms of the commentary you had around the Equifax breach and some of the recent activity. Are you seeing that change customer behavior or potentially drive more build of pipeline in terms of the solutions that you sell?

William D. Jenkins -- Chief Executive Officer, President

Well, definitely we've -- in email, the conversation is strong in our part of the market. I'd say this is where our customers feel most exposed, where individuals get targeted or they can get penetrated that way. And so I definitely -- we see an uptick in conversations and email. We think we're seeing that in the results too in terms of another 1,000 customers choosing Barracuda in the quarter around Essentials.

I think the second part of that is a little bit different, Jonathan, but because those things happen, many customers are looking to move applications into public cloud, and because these breaches happen, they really take a strong look at what that's going to mean for application protection and security as they move these applications around. And so I think that's, again, driven more opportunities and more discussions with new customers about how they protect applications as they move them into public cloud.

Jonathan Frank Ho -- William Blair

Got it. And then, can you talk a little bit about sort of the relationship between Microsoft's native solution and maybe why customers are switching to your solution rather than just taking what's offered for free from Microsoft or base level solution?

William D. Jenkins -- Chief Executive Officer, President

Yes. I think we've said Microsoft continues to improve their security offerings, but in many customers, we have a threat scan where we'll go in and scan a customer who's using a Microsoft solution and find things that have gotten through. So there's a base level of improvement they get from moving to our solution. We have integrated archive and backup, so there's an ease-up factor in getting many of these functions taken care of around Office 365. And then the third thing is with an offering like Sentinel, this is truly differentiated from anything that Microsoft has right now and can really give you another form of protection that's becoming increasingly important as you look at the impact of some of these spear phishing attacks.

Jonathan Frank Ho -- William Blair

Great. Thank you.

William D. Jenkins -- Chief Executive Officer, President

Thanks, Jonathan.

Operator

Our next question comes from Rob Owens from KeyBanc. Please go ahead with your question.

Elizabeth Wymond Verity -- Keybanc

Hi, this is Liz Verity on for Rob Owens. Thanks for taking the question. Just really quickly on margins this quarter. Yes, I know in the past, you've talked about maybe getting some benefit from Microsoft down the road in terms of matching marketing expenses.

Is that something you might see in the back half of the year? Or anything else we should think about in terms of operating expenses in the back half?

William D. Jenkins -- Chief Executive Officer, President

Yes, it's a great question, Liz. We have focused on -- we talked about the front half of the year. We front-loaded some marketing and sales expenses, and some examples of that are we have our kick-offs, we have our partner conferences, but we also took advantage of matches that Amazon and Microsoft offered in the first half of the year. And so we did front-end load some investments that we think we're seeing the payoff for in terms of the performance of the top line. And so as you look forward into the second half of the year, we're going to continue to invest because we see opportunity, we see the top line growing, but we do feel, if you look at the midpoint of Q3, there are some operating expansion that we think we'll see in the second half.

Maria Riley -- Investor Relations

Hello?

William D. Jenkins -- Chief Executive Officer, President

I think we lost Liz.

Elizabeth Wymond Verity -- Keybanc

Okay, sorry bout that. And then really quickly on the Intronis rebrand. Just kind of overview as how the partner reaction has been to moving to the CUDA brand on that. And then any puts and takes around how we should be thinking about that in terms of revenue contribution versus billings? Because I know it's been more monthly, which has been a little bit of an impact.

William D. Jenkins -- Chief Executive Officer, President

Yes. We've been very happy with the performance of Intronis and they -- we've seen that acceleration in their billings growth rates, so that's been great. The brand, redoing the brand, we have taken Intronis more globally now where the Intronis brand was not known and the Barracuda brand is known, and so that's one of the reasons. The second is we're about the second year of the acquisition and our partner -- there was a different set of partners who didn't really know Barracuda and were very attached to Intronis, so we wanted to be thoughtful to make sure that they were comfortable with our approach in running the business, to expand and invest in the platform, and hopefully, that equated to growth in their business.

And we have that track record for 2 years now, which made it easier to make the transition into the Barracuda brand, and we've gotten a favorable, very favorable reaction, from the partner community around that.

Maria Riley -- Investor Relations

Liz, are you there?

Elizabeth Wymond Verity -- Keybanc

Great. Thanks.

Operator

Our next question comes from Jayson Noland from Baird. Please go ahead with your question.

Jayson Noland -- Baird

Okay, great thank you. I wanted to follow up on office, three sixty five where's, the investment level today, BJ and where? And Where does it need to go in sales marketing, R&D? Is there increased emphasis there? Or how much more do you need to invest, I guess?

William D. Jenkins -- Chief Executive Officer, President

Well, I think we're on a good arc, Jayson, with the business. We've been adding about 1,000 customers a quarter. So it's been a good clip. When we look at investment there, it's really -- we're going to continue to add on the R&D side as we look at something like Sentinel.

These are the types of product investments we need to make to stay ahead of -- and differentiate ourself from Microsoft and Mimecast and Proofpoint. So there will be continued investment on R&D. On the sales side now, it's really continuous training. Most of our sales people know how to sell the product and are in full conversation, so it's just as we roll out new features continuing to train them.

But it's not as much of an add as it is to keep improving the productivity in the space. And I think on the marketing side, as it's growing, we continue to add more dollars toward that market opportunity, and it should be in line with the growth that we're seeing there. So I think it's more on R&D side than anything to keep product innovation going and then leveraging the marketing and sales engine that we have to continue the growth that we're seeing.

Jayson Noland -- Baird

Okay and then just the quick, follow-up I believe you said that the MSP model is accelerating with your customer base. Is that that's just a general statement? Are you seeing something specific to to want to mention that?

William D. Jenkins -- Chief Executive Officer, President

Yes. No, I think definitely 1,000 employees and below, were seeing more and more of customers looking not to deploy their own solution but rather buy it as a service from our MSP channel. And so we've seen some acceleration in growth from Intronis, and we believe that's where it's coming from. We also got that validation at our partner conferences where a lot of the partners we worked with that have been traditional VARs now are moving into a more managed service approach where they're buying a solution that they can, or a platform that they can deliver to these customers on a monthly billing basis.

So I think in that 1,000 employee below part of the market, this progression is going to continue.

Jayson Noland -- Baird

Okay, great. Thank you.

William D. Jenkins -- Chief Executive Officer, President

Thanks, Jayson.

Operator

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

Gur Talpaz -- Stifel Nicolaus

Sure, thank you. So BJ, legacy billings have stabilized at around $36 million to $37 million here over the past 4 quarters, maybe not a super popular subject area, but how we should think about legacy billings here as we kind of contemplate billings growth going forward? Is that the right level of $36 million to $37 million? Or should we think about it perhaps declining modestly as we look forward?

William D. Jenkins -- Chief Executive Officer, President

Yes, thanks, Gur. As we think about the business, we continue to aspire to have core start with the 2, which we've been able to do, and we thought and we've said at the beginning of the year, we thought legacy would probably decline about 10%. And so the 7% this quarter was below that, and so we're happy with that. I think the reason we've been able to keep it below that 10% is we've added elements onto the legacy platforms like the Advanced Threat Protection subscription.

And so if you look at that corresponding subscription ARR, it stayed relatively stable and that's -- while there are less of these legacy platforms out there, we're actually, by attaching subscriptions, getting higher dollar value out of the ones that are left. And I think that trend continues. Both as you they generally about the business, that aspiring to start with the 2 on core and negative 10% for legacy, is how we view the business today.

Gur Talpaz -- Stifel Nicolaus

That's helpful. And maybe just one quick, follow-up on billings. You mentioned your ability, kind of service utility-based models and things of the sort. How do you think about that impacting the model and the billings line as you as you look forward?

William D. Jenkins -- Chief Executive Officer, President

Well, we've been able -- if you look at public cloud where a lot of these utility forms hit, and Intronis, we've been able -- it's been incremental for us. So we've been able to maintain the trajectory because it's been less about cannibalizing our existing business. With the core and the legacy, I think we've been able to manage that well, where I think others are facing this issue maybe a little bit more than we are. So we feel like we're getting through it well.

Public cloud and a lot of the partners that we get in Intronis are incremental for us and are really adding to our growth. So that move toward shorter contracts, metered has been incremental on top of our regular business that we've had.

Gur Talpaz -- Stifel Nicolaus

That's helpful, BJ. Thanks a lot.

William D. Jenkins -- Chief Executive Officer, President

thanks.

Operator

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

Erik Loren Suppiger -- JMP

Thanks for taking the question. Two questions. One, on the public cloud, did you say that you added three hundred customers in the quarter?

William D. Jenkins -- Chief Executive Officer, President

Yes. In the quarter, yes.

Erik Loren Suppiger -- JMP

Can you give us some context around that, how that compares? Give us a sense for what kind of growth that might be.

William D. Jenkins -- Chief Executive Officer, President

Well, I think, last quarter, we said we were over 1,000 customers, and that had been over a period of almost 3 years. So it'll give you a sense of there's there's exploration terms of the number of customers that we're getting in public cloud.

Erik Loren Suppiger -- JMP

Okay. And then on Sentinel, the Sentinel product, you said that's adding some significant differentiation, vis-à-vis the Microsoft offering. Microsoft certainly has the ability to use machine learning on a very large data set. Why isn't -- are you anticipating that they're going to be developing advanced malware protection? Or how are you looking at the developments they've been making there?

William D. Jenkins -- Chief Executive Officer, President

They have it today. They have certain elements today, Erik. And the thing we have to keep doing is moving with speed and staying out in front of them. So we see improvements and we've seen every quarter in Microsoft security offerings.

But the threats change constantly. How they appear changes and how they manifest themselves on individuals changes constantly. So we see a lot of different areas where we can stay differentiated and stay out in front there. And I would just say, overall, look, Microsoft's imperative is to move the customer to Office 365.

Their imperative is not to own the security -- to own every single dollar in that ecosystem. So they have been a good partner for us. They run events with us, around us and in public cloud. And in general, I think, Microsoft has been a great and supportive partner in terms of growing both the public cloud and email security business for us.

Erik Loren Suppiger -- JMP

Very good. Thank you.

William D. Jenkins -- Chief Executive Officer, President

Thanks, Erik.

Operator

Our next question comes from Hamed Khorsand from BWS financial. Please go ahead with your question.

Hamed Khorsand -- BWS Financial

Hi. I just wanted to understand if you're seeing good traction as far as billings and subscriber count, what's driving your handicap to have some sort of downside as far as sequential growth goes in your guidance this quarter?

William D. Jenkins -- Chief Executive Officer, President

Are you talking billings or revenue?

Hamed Khorsand -- BWS Financial

Well, both.

William D. Jenkins -- Chief Executive Officer, President

Yes. Well, there's a couple of things. First when you think about revenue, there's 2 elements: One, this is a daily business, and there's one less day in Q3, which is about $1 million of billings a day we get. So that's one thing.

The second is we -- if you look at it year-over-year, we've divested some businesses, and so the revenue impact of those are not going to be there in this quarter from the waterfall. So that's it on the revenue side. If you look traditionally -- and now on the billings side, if you look traditionally at our billings, there's not a large sequential jump Q2 to Q3 historically. They've been very close.

I think if you look at the midpoint, we're flat sequentially. But we also -- when you look at Q3, we have 3 less selling days in the quarter, and again, we've divested some businesses that are some headwinds to our overall billings. So we feel good about the trajectory of the top line. Core is growing at 22%, and we feel the plan is working.

So I don't feel any -- I feel like it's a good guide.

Hamed Khorsand -- BWS Financial

Okay. And my follow-up here is on the subscriber numbers. The growth you're seeing every quarter, can you decipher how much of that is coming from existing customers adding more subscribers? And how much is coming from new customers?

William D. Jenkins -- Chief Executive Officer, President

Yes. We don't give that breakdown. But there -- if you look at the areas within core and look at email where 50% of the customers are net new and we're adding 1,000 customers a quarter, and public cloud, where we said we had 300 customers in the quarter; compared to last year, we're definitely seeing an uptick in new customer acquisition.

Hamed Khorsand -- BWS Financial

Thank you.

William D. Jenkins -- Chief Executive Officer, President

Thanks.

Operator

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

Michael Kim -- Imperial Capital

Hi. Good afternoon, guys. Just going back to Sentinel, are you starting to -- are you seeing most of the demand with -- in combination with Essentials or some stand-alone deals as well? And from the early going, is it primarily net new logos that are taking on Sentinel or are you having good success with add-on sales?

William D. Jenkins -- Chief Executive Officer, President

Thanks, Michael. Great question. I think out of the gate, we're only 1.5 months in. Most -- a lot of it has been bundled with Essentials just because that's the sales motion and where you get leads, but we are selling it stand-alone.

And it's a little bit different sales motion, but it is the lead-in for creating new opportunities, so I expect that we will be able to get stand-alone Sentinel deals going forward. There's value to a customer who's using Proofpoint or Mimecast or Cisco IronPort or any other email solution out there to add Sentinel and they'll be more highly protected. So our goal is to sell it stand-alone where we can also.

Michael Kim -- Imperial Capital

Got it. And with ATP, have you provided a rough sense of the attach rate at this point and how much further we have to go to see more universal adoption?

William D. Jenkins -- Chief Executive Officer, President

We we haven't given out I can give you know generally. What I would say is we're very happy with the attach rate on central and it's very hard all where the opportunity is for us to really make ATP scale and grow is to go back into all of our legacy appliances and sold out on top of those systems and attached to all of our NG firewall filters or going out. So there is a large focus within the company to increase that attach rate and the scale that part of the business. When you look at you know the attach rates we see up from our competitors in the space to have an advanced threat detection subscription, ARR, World War below where they are so there's an opportunity.

We can cause a good opportunity there for us more focused on it.

Michael Kim -- Imperial Capital

Great. Thank you.

William D. Jenkins -- Chief Executive Officer, President

Thanks.

Operator

And, ladies and gentlemen, our final question today comes from Sterling Auty from JP Morgan as a follow-up.

Sterling Auty -- J.P. Morgan-Analyst

Hey, guys. Just to follow up questions here, one on -- let's do the gross margin. The warranty costs, you said you got it in your hands around it. But was this an increase and DOA units? Or what was the refresh cost that spiked in the quarter?

Dustin Driggs -- Chief Financial Officer

Sterling, this is Dustin. Thanks. So essentially, what we see occasionally is that your roll out new software and new hardware platforms, there is an uptick in customers taking advantage of our technology migration program. And so we have in our hands around it because we know exactly customers that are transitioning from those are the new platforms.

And so we feel like as we talk about a call we talked about on the call, this is a non recurring cost for this quarter, we capture all those costs in the quarter and we expected to be able to read from there as you look in the second half of the year and get leverage from margin real, not having those costs included.

Sterling Auty -- J.P. Morgan-Analyst

Got you. Got you. And then as we think about the leverage that you talked about, and you gave us what the gross margin should do, where else should we start to get leverage in terms of the operating margin? Will we start to get -- you've made some heavy investments in R&D on the cloud. When do we get to the point where we get some leverage out of those investments?

William D. Jenkins -- Chief Executive Officer, President

Well, we think, again, if you look at the midpoint for Q3, we're up almost 170 basis points for Q2. And then if you look historically, Sterling, at our results, sales and marketing tend to trend down in Q4 from Q3. And so we expect that to hold as you think about the second half of the year. The thing I will say is we -- you've seen from us last year when we were investing in a product line and getting into the right state, we really grew profitability and we showed how this business model could generate profitability.

This year, we had the products, we felt good and we've been focusing on accelerating top line growth, and you can look the last 4 quarters at core and you can look at, overall, we've done double digits when you take out the stuff we're getting rid of. So we feel like there's an opportunity in front of us in email and public cloud that we want to take advantage of. This is disruption for a lot of players, and so we're investing in that and we feel the plan is working. So we know, and you've seen leverage come out of this model.

Right now, we feel like there's good opportunities in front of us and we're investing to take advantage of them. And while we do that, I think, in the second half, you can see we will give some leverage back from those front-end loaded investments we made.

Sterling Auty -- J.P. Morgan-Analyst

Got it? Thank you, guys.

William D. Jenkins -- Chief Executive Officer, President

Thanks, Sterling.

Operator

And, ladies and gentlemen, that will conclude our question-and-answer session. I'd like to turn the conference call back over to BJ Jenkins for any closing remarks.

William D. Jenkins -- Chief Executive Officer, President

Thanks. And I just want to say thanks everyone for joining us today and for their support. I also want to thank our employees at Barracuda, the Barracuda partners and all of our customers operate for all the support they've given us. Have a great rest of the day, and we look forward to updating everybody again soon. Take care.

Duration: 56 minutes

Call participants:

Maria Riley -- Investor Relations

William D. Jenkins -- Chief Executive Officer, President

Dustin Driggs -- Chief Financial Officer

Sterling Auty -- J.P. Morgan -- Analyst

Daniel Park -- Needham & Company -- Analyst

Andrew James Nowinski -- Piper Jaffray -- Analyst

Joel P. Fishbein -- BMO Capital Markets -- Analyst

Jonathan Frank Ho -- William Blair -- Analyst

Elizabeth Wymond Verity -- KeyBanc -- Analyst

Jayson Noland -- Baird -- Analyst

Gur Talpaz -- Stifel Nicolaus -- Analyst

Erik Loren Suppiger -- JMP -- Analyst

Hamed Khorsand -- BWS Financial -- Analyst

Michael Kim -- Imperial Capital -- Analyst

More CUDA analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

10 stocks we like better than Barracuda Networks
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now… and Barracuda Networks wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of October 9, 2017

The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.