Posted by Matt Walker on October 11, 2017
Barracuda Networks, a security/data protection solution vendor, yesterday reported $94.3M in revenues for the quarter ended August (~3Q17). That’s 7% growth from the prior year (June-August 2016). This growth rate would satisfy many companies, including lots of vendors selling into telecom networks.
Margins not going in the right direction
For Barracuda, a vendor focused on cloud-based security solutions to a wide range of vertical markets, the 7% is a step down. After going public in November 2013, Barracuda’s YoY revenues grew steadily in double digits. This was organic growth, largely, as the company’s few acquisitions had minimal revenue impact. In the last three quarters, YoY revenue growth has been in the 6-8% range. Some growth moderation is normal, as the company started from a small base. But this comes at a time when Barracuda is still struggling to make money. As shown in the figure, operating margins (operating income/revenues) have fallen in the last few quarters, and they were already low.
IPO in November 2013
Despite low or negative margins, Barracuda has managed to stay free cash flow positive for every quarter since going public in November 2013. For the last 2 years, its average quarterly FCF was +$12.3M. Not a lot for a big vendor like Cisco or HPE (both competitors), but enough to leave a small one like Barracuda with a cash reserve of $207M as of August. That could be handy both for small M&A transactions, or as a buffer against a few more low-margin quarters. (Note that Barracuda’s net income has been in the 1-4% of revenues range for the last 7 quarters).
Several security rivals are losing money outright, including Palo Alto, Symantec, and FireEye, and Proofpoint. This last one is interesting. Proofpoint bills itself as a security-as-a-service provider, playing into a similar cloud-based security market. The company’s latest annual revenues of $376M puts it just $23M ahead of Barracuda (comparing fiscal year to fiscal year). Proofpoint’s current market cap is roughly 3x Barracuda, though. Proofpoint is growing much faster, with revenues up 42% in 2016. That growth has not come with positive margins; Proofpoint’s net loss was 30% of revenues for the year. Many expect Proofpoint (and Palo Alto Networks, and others) to grow out of their losses.
Made in California
Barracuda has physical products (e.g. the Next-Generation Firewall), not just software, and manufactures these appliances in California. To some, that might suggest higher production costs and/or slower delivery to customers. Barracuda’s cost of revenue is relatively low though, averaging 24% of revenues for the last 8 quarters. Turnaround time is also quick. Barracuda says most orders are received in the same quarter as the revenues are ultimately booked. One thing that helps here is, around 70% of Barracuda’s revenue comes from the US market, a figure that hasn’t changed much since going public. Also helpful is Barracuda’s vast distributor network, which should accelerate customer acceptance.
Balancing the revenue model
Barracuda gets revenues from both physical appliances, and subscriptions. In 2013-14, appliances accounted for 30% of revenues, with subscriptions the remainder. Since then, appliance revenues have been falling, down to under 20% of total in 3Q17. That’s not necessarily a problem. Subscriptions bring recurring revenues, after all. Further, if the margins on subscription services are high enough, giving away the appliance for free may even be an option. That’s not the case here.
Barracuda’s renewal rates are high, at 92% for the 6 months ended August. There’s no guarantee that will persist, though. Moreover, customers are opting for shorter contract lengths in fiscal year 2017. This adds uncertainty to revenue projections, and generates more work for the sales force. Average contract length, and Barracuda’s sales costs, should be watched closely.