Zix Corporation
Q1 2020 Earnings Call Transcript

Published: 6 May 2020

[Operator:]

Good afternoon, and welcome to Zix's First Quarter 2020 Earnings Conference Call. My name is Sarah, and I will be your operator today. Joining us for today's presentation are the Company's President and CEO, David Wagner; CFO, David Rockvam; and Vice President of Marketing, Geoff Bibby. I would like to remind everyone that this call will be recorded and made available for replay via a link in the Investor Relations section of the Company's website. Now I would like to turn the call over to Geoff Bibby. Sir, please proceed.

[Geoff Bibby:]

Thank you, operator. Good afternoon, everyone, and thank you for joining our first quarter 2020 earnings conference call. On the call today we have our CEO, Dave Wagner, and our CFO, Dave Rockvam. After the market closed today, we issued a press release announcing our results for the first quarter ended March 31, 2020. A copy of which is available in the Investor Relations section of our website at www.zix.com.

[David Wagner:]

Thanks, Geoff. Good afternoon, and thank you, everyone for joining us today. What an extraordinary time we are living through. The COVID crisis requires remarkable efforts from people, communities, organizations and governments to safeguard our health and safety, and it is impacting people all over the world. Our thoughts go out to all those affected and our sincere appreciation to all frontline workers from all sectors of the economy and especially our healthcare workers, many of whom are also our customers.

[David Rockvam:]

Thank you, Dave, and good afternoon, everyone. At a high level, we delivered on our revenue and EPS guidance for the quarter, demonstrating the resiliency of our business model and our commitment to reliably delivering profitable adjusted EBITDA growth on an absolute basis. Now let's talk about the numbers in more detail. At the end of the first quarter, our ARR totaled $214.3 million, up 15% organically from Q1 of last year. On a combined company basis, cloud-based ARR now comprises 83% of total ARR, an increase of 24% from Q1 of last year. New customers totaled over 5,200 and were up 21% from last year, representing the highest level we achieved as a combined company. For the first quarter, we had just over 100% net dollar retention, which represents our renewals plus new sales into the installed base divided by the renewals that were available at the beginning of the quarter. Our strong gross dollar retention of over 90% growth in new customers and continued success in cross-selling drove yet another quarter of record ARR.

[David Wagner:]

Thanks, Dave. I'd now like to review our first quarter execution in the context of our three primary growth drivers during which I will provide some April color before I transition to my closing remarks as it relates to our first growth driver, which is new orders to new customers. We recorded some notable wins in the first quarter. On the Zix side, one of our top five wins was in Fintech, two were in finance and two were in healthcare. Our largest new customer win in the quarter was a six-figure deal with a healthcare provider who purchased productivity, encryption and advanced threat protection. We displaced the competitive solution because the customer was dissatisfied with the functionality of our competitors encryption and threat solution and was also looking for better support. Another noteworthy new logo in Q1 was a six-figure win for productivity and three Zix solutions, encryption, advanced threat protection and information archive. They were also attracted to Zix by our phenomenal customer support. Phenomenal care isn't just a nice add-on for Zix. It's a real driver to which we can attach our organic higher margin products. Our top five new customer transactions in the quarter averaged three solutions per customer again demonstrating our success selling bundled solutions. On the MSP partner side, we added 55 net new transacting partners during Q1, bringing our total to 4,393 at quarter end. In Q1, we continued to add approximately 200 net new customers per week and new customer acquisition rate in April remained on that trend. Companies migrating to the cloud are looking for partners to facilitate that transition. Our ability to attract new partners and new customers supports this thesis and our growth opportunity. Europe continues to lead the way on new partner acquisition, where our value proposition although new to the market continues to resonate well. We are also seeing good success displacing existing ATP solutions in many of these European partners. At the end user level, again on the MSP side, sales to existing customers accounted for 59% of the MRR increases in the quarter. With respect to new business trial trends, we began the year with increasing sales momentum on both the direct and indirect side of our business. Our AppRiver trial activity was tracking at record levels in January and February. However, in March trial momentum tapered off as the economic impacts of COVID-19 set in and many of our partners pivoted to fundamental work-from-home enablement tasks. Then beginning in April, we've seen trial activity pick back up and in April, we began to see an increase in the rate of new orders to new customers of about 20% as partners finished up work-from-home preparation and reaccelerated cloud migrations. Shifting to our second growth driver, which is sales to existing customers. Four of the top five add-ons in the quarter were in healthcare and one was in finance. Three of the five were encryption-only add-ons, one was for archiving as a third solution to a customer who already purchased encryption and threat protection, and the fifth was a five solution cross-sell, adding Office 365 advanced threat secure file transfer and archiving to our existing encryption solution. Interestingly, the average contract term of the top five add-ons was 29 months, representative of some of the success we are having moving larger customers to longer term agreements, partially offsetting our declining overall contract duration as many customers move to monthly billing. On the MSP side, sales to existing customers accounted for 41% of the MRR increases in the quarter and offset all of the terms, resulting in a net renewal rate of just over 100%. In March, we saw a deceleration of orders from existing customers as existing customers began decreasing users and downgrading Office 365 SKUs. While we believe that flexible consumption-based month-to-month billing is the future of cloud services and is a competitive differentiator in attracting new customers and the type of economy it does offer customers the flexibility to elastically decrease users and license entitlements as they furlough workers. In April, an existing customer MRR decreases offset nearly all of the MRR increases in existing customers for the month. We are also seeing an acceleration of the migration from hosted exchange to Office 365 driven by work-from-home demands that are better served in the cloud and by Microsoft customer incentive for team’s adoption. Looking at our results for the first quarter by solution area, and please be reminded that we do not manage our business by solution category and increasingly our sales are made as bundled solutions. That means that we must use judgment to estimate the value allocated to each solution area. With that context, productivity ARR increased 7% sequentially and 32% year-over-year to $102.5 million. Average revenue per user or ARPU of $101 and $0.01 was down $0.57 from last quarter. The primary reason for the ARPU decrease is the rotation to lower costs SKUs caused by COVID that I mentioned earlier in the call. Net of churn, we added more than 66,000 mailboxes in the quarter, down from 83,000 last quarter. April was positive by approximately 9,000 mailboxes reflecting the trends noted earlier of higher net new, slightly higher churn and a flattening of additional licenses to existing customers. Encryption ARR was $71.7 million, down 1% sequentially, but up 2% year-over-year. The decline was largely due to an accounting change for ARR of our acquired EMS product. ARPU was down $0.09 to $17.96. Our encryption seats declined by less than 1% or about 36,000 seats from Q4, largely due to the continued erosion of the OEMs. Advanced threat protection ARR was $24.1 million, which was up 3% sequentially and 10% year-over-year. Our ARPU was $13.38, which was down 2% from $13.65 in Q4, but up 8% from $13.14 in Q1 of last year. And finally, ARR in our emerging category was down 11% quarter-over-quarter to $16.1 million. Again, accounting changes for ARR of our required total defense product drove the majority of the ARR decline. However, with the end-of-life of ZixOne scheduled for October 2020, we expect emerging to remain flat or slightly declined to the rest of 2020. Our ARPU was $30.31, which compares the $33.58 last quarter. Moving to our third growth driver, increasing retention. Our total company net dollar retention remained at a solid level just north of 100%, representing a slight decline sequentially. This minor regression was primarily due to lower sales into the installed base beginning in March as I mentioned earlier. Core Zix had a very strong retention quarter and as noted above, we continue to have a success extending our larger customers to longer term agreements. In April, Zix core retention remained strong on a small sample size and AppRiver retention dips about 400 basis points due to the economic impact of COVID. I've provided a lot of April business trend commentary in my remarks. This is obviously preliminary, contemporaneous data that's being provided without the benefit of a more robust reviews, controls, associated with our normally reported quarterly results. In summary, we anticipate the total company ARR increased modestly in April from March. Moving on to my closing remarks. In the midst of the COVID induced market disruption, our team successfully launched Secure Cloud right on schedule on April 15. Secure Cloud is our consolidated platform with a suite of productivity, security and compliance applications to deliver a secure modern workplace. The reaction from our partners, customers, press and analysts has been universally positive. Our customers and partners let us know that the re-imagined, re-architected enhanced platform and solutions are exactly what they were looking for. The ability to easily add and manage a suite of services from the newly modernized single pane of glass coupled with flexible billing allows partners to meet the rapidly changing demands of their customers. Reaction from the media has been equally rewarding with channel publications from CRN to ChannelPro demonstrating their understanding of in an appreciation for the power of secure modern workplace. This platform enables our partners to build powerfully differentiated offerings across the wide spectrum of customer needs. They can offer the new customers an on-ramp to the cloud and they can enhance their customer security with advanced features, like attachment quarantining and sandboxing and superior encryption and file transfer solutions. Our part is existing customers are also better off. Now they can audit the health with our customer's Office 365 tenants with a security audit and then immediately remediate through our suite of solutions. In addition, we've enabled partners and customers to archive the explosion of corporate information that's being created in newer channels like Slack, Teams, Facebook and LinkedIn. With secure modern workplace launched, we are even more enthusiastic about our long-term growth prospects and our ability to deliver on our vision of becoming the leading provider of cloud, e-mail productivity, security, and compliance for businesses of all sizes. Despite all this good news, we know that we are not immune to the current market dynamic. Many of our customers, especially our smaller customers, are struggling with decreased demand and are decreasing users as they furlough workers. As a result, we are focused on balancing profitability as we capitalize on the positive market momentum for digital transformation. We believe that we have a durable liquidity position with more than $16 million in cash and $17 million available for our revolving credit facility. We believe that the $9 million of annualized costs that we recently took out of our business coupled with our strong free cash flow generation give us the ability to grow the business and meet our debt obligations. And we believe we have the right strategic plan in place and that our industry-leading solutions and world class team will enable us to capitalize on the digital transformation opportunity that is accelerating. In closing, I have never been more proud of our team and their commitment to deliver phenomenal outcomes for our partners and customers. We don't like recessions, but we know that our success today will better position Zix in a post COVID-19 environment and enable the realization of our vision to be the leading provider of cloud email security, compliance and productivity solutions for companies of all sizes. That concludes our prepared remarks. Operator, we are ready to open the call for questions. Operator?

[Operator:]

Thank you. Our first question comes from the line of Chad Bennett with Craig-Hallum. Your line is now open.

[Chad Bennett:]

Great. Thanks for taking my questions. So just in terms of the guide that you guys just gave for the year, how should we think about the trends that you saw in particular in the AppRiver business in late March into the month of April? How are those in the guide in terms of how should we think about the retention rate there and the net new business rate there and how you're thinking about that for the year? Thanks.

[David Wagner:]

Yes. Chad, so that is obviously on top of mind with all the great things going on at the company, the release of Secure Cloud and positioning there, all that’s fantastic. But the reality of the economic environment is affecting particularly our smaller customers. And we started to see those trends early mid-March and it's been pretty consistent coming into April, especially seeing the new customer flow being strong or perhaps actually 20% up from prior quarters in terms of new business in flows. We're really pleased by that. That makes I think sense, as you think about the work-from-home environment. The churn hasn't gone up much. It's up a little bit. But the big change is in existing customers who previously were accounting for quite a big amount of increase just 41% in Q1 and that increase has really dropped. It's still an increase, but it dropped dramatically in the last seven weeks as existing customers, both furlough workers and do some adjustments especially with the Microsoft SKUs to save some money. And so those are the trends that we've looked at most carefully when we put together the guide for the quarter and for the year and we're looking at – just taking those best acts that we can and incorporate them into the guide.

[Chad Bennett:]

Got it. That's great color. I appreciate it. And then shifting to the Zix business, have your – it sounds like retention there has been fine and obviously you're in all the regulated industries that are very sticky and you're dependent – they're dependent upon you for mission-critical data and applications. I guess have you changed anything either from a retention or existing base or net new on the Zix business for the year?

[David Wagner:]

Yes. On the Zix business, the larger customers across both brands, the larger customers, they aren't immune, but it's not as acute there. What we've seen in prior recessions is retention holds quite well and those compliance oriented buyers. And so we're not expecting increase in churn. It becomes a little harder to do – we're not large projects, but a little harder to make changes. So it would be incorporating a modest decrease in our new business on the Zix side, again all packaged up into that – the full guide for the year.

[Chad Bennett:]

Got it. Okay. Thanks. That's it for me, a nice job on the quarter and managing the business going forward. Thanks.

[David Wagner:]

Thank you, Chad.

[Operator:]

Thank you. Our next question comes from the line of Nick Yako with Cowen and Company. Your line is now open.

[Nicholas Yako:]

Hey, guys. Thanks for taking my questions.

[David Wagner:]

Hi, Nick.

[Nicholas Yako:]

I want to start maybe with the launch of Secure Cloud, and I know it's early, but just curious the plan is to lead with the Zix Secure Suite with new customers going forward. And then just any color on how Secure Suite is priced maybe relative to the à la carte pricing?

[David Wagner:]

So that's a great question. Thank you. We've been leaning towards Secure Cloud with the packaging of Office 365 beginning really in Q4 in a bigger way. And as you saw on the top five deals this quarter, we're getting really good success with that suite approach. When we put the full suite together to get three solutions or more, that’s roughly a 20% discount built into the bundled SKUs, which encourages both the partners to position that way and end customers, when we talk to the end customers to go for the suite approach, and so that's working well for us. The Secure Cloud launch, of course, just happened here in April. And that's the flow that the sellers will be able to get into and later in the quarter and increasingly be using the same try and buy methodology. And we're really excited about what that's going to bring to the sales motion back half of this quarter and into the rest of the year.

[Nicholas Yako:]

Okay, great. That's helpful. And then maybe one on – on the restructuring program, is the bulk of that behind you? And then just any additional color in terms of where some of those costs – would be helpful? Thank you.

[David Wagner:]

Okay, good. So the restructuring program, and allow Dave to chime in a bit too, but we tried to balance it in terms of things that we would call temporary marketing program reductions, travel reductions, of course, executive compensation decrease, deferred salary. Those are things that we would intend to put back into the business as the economy recovers, which of course we hope would just be as soon as later this year. And then others were more deeply structural of early retirement, which were voluntary, which caused changes in some unexpected places in the organization. We did end up doing some voluntary terminations, which of course you have more control over and then data center cost, and those are structural and would be persistent. In total, we were focusing on keeping the company positioned really strong. We do see very strong trends for us in digital transformation. The new customers are still onboarding at a great rate. We want to make sure that we're prepared to continue to provide phenomenal care and continue that – finished up the end 31 works. So we tried to protect the product organization as much as possible in terms of the P&L line changes.

[David Rockvam:]

Yes, and I would just add that about 95% of those changes are made as of now and will carry seven and a half to almost eight months worth of savings. Some of the data center stuff finishes up by the end of the quarter, but we expect almost all of that to be done by the end of the quarter and most of the people changes, the marketing program changes. All those things have been implemented to save seven to eight months worth on the year. And as Dave said, we went across kind of the different parts of the organization. I would say where we tried to make sure we held up was on the sales front and made sure that we're – they have the sales team aligned to take advantage of the opportunity that's there. So we continue to see the strong opportunity out there for us and what the sales team out there being able to push the Secure Cloud.

[David Wagner:]

Yes. And then just to reiterate, any employees who are affected have been notified. We do have a few that are especially early retirement who are working for several months to transition their work.

[Nicholas Yako:]

Okay. Helpful color. Thanks guys.

[David Wagner:]

Thank you, Nick.

[Operator:]

Thank you. Our next question comes from the line of Nehal Chokshi with Northland Capital Markets. Your line is now open.

[Nehal Chokshi:]

Thank you. And congratulations on hitting your guidance, the topline guidance within what was the incredibly tough environment that's really amazing.

[David Wagner:]

Thank you, Nehal.

[Nehal Chokshi:]

Yes, absolutely. I would ask just kind of the same question as first I did that in my way. So for the new guidance at the low end of the range that implies that you're going to be flat Q-over-Q for Q3 and Q4. And then if we look at the midpoint, it's implying a rise of about $1 million each quarter into Q3 and Q4. So let's take the midpoint and why should we expect an improvement in the quarterly trajectory, whereas your Q2 guidance implies, this going to be flat Q-over-Q? And kind of the answer I'm looking for is maybe composite that to two parts. One is your macro assumptions for Q2 versus the back half, and then the fundamental parts of the business that you've been talking about.

[David Wagner:]

Okay, good. Those are great questions. And of course, we gave a lot of detail on the trend for April so that we can share as well as we can with analysts and investors. Yes, what we're seeing in the business. I am not the economic expert. The SMB impact, when we're looking at it, we think we'll be more acute in this quarter that we're in. So we were up modestly in ARR for the month of April, which we take as a good sign to deliver in the ARR growth that we really want to see this year. But we were looking as we were thinking about it as May and June could be that toughest part of the outlook. On the second side, generally the Secure Cloud, we’re super proud of it. We think the positioning is really good particularly in tough economic times where we offer organizations relatively large and small. The ability to have a very elastic user count opportunity, we’re uncertain about and why it looks like they can adjust their users monthly and go up and down, which we think is a really big competitive advantage in a tough market. And so our new business pipeline and new business across the business, the pipeline is actually quite strong. And so we are not giving up on the opportunity to have a really good year. And in 2021 we just felt that with the level of uncertainty that's in the macro environment that we were more prudent to make adjustments early than wait getting against – getting a level of uncertainly we see in the market.

[Nehal Chokshi:]

Okay. That's great. And then you mentioned that essentially you think that May and June maybe the worst for the SMB. So what percent of your ARR is actually exposed to these SMB customers today? And I just need to find how you define SMB as well and what size customer do you consider SMB?

[David Wagner:]

Sure. The 50 users and down would be what I’d consider SMB and that's approximately – we used the breakout of the MSP side of the business, those channel partners, they do have some larger customers, but primarily the legacy AppRiver business that we think about – when we think about the SMB exposure.

[David Rockvam:]

Yes. When we look at that, what we've talked about is, about less than 10% of the really hard hit verticals and small, medium business, our customers, the travel agencies, the travel industry, the restaurants, those kinds of things. So we look at that part as being the most impacted and right now as Dave said, we're just looking at May and June. I think we thought that there would be kind of a quite a bit of seeing the small medium business come forth and asking for extended terms and those kinds of things, and not paying. We're seeing receivables just on par with where they were before. So we haven't seen a drop off on that. And we've seen just a couple hundred thousand dollars worth of requests for kind of extended payment terms, which I think is a pretty small number given the environment that we're in right now. So I think as we at the guidance, April as Dave said was up in ARR, so that was good. The $214.3 million, so just up over that is what we’re saying. And the guidance predicates just what we're looking for May and June as we just don't know at this point as no one does.

[Nehal Chokshi:]

Okay, great. And then finally, can you put a rhyme and reason to why you saw more or less a drop off demand in March and then the resumption in April?

[David Wagner:]

Yes. And I put that into a script. What we heard from the partners that we spoke with is, they were just busied out. Many of the smaller businesses around the country weren't well prepared for work-at-home, so they were busied out, putting in VPN and getting workstations ready to work remotely and so they just couldn't work on the audit demand. Then as soon as that flipped around by the end of the month, they had their end customers able to work-from-home and then they went back to cloud migration, which we're actually seeing an acceleration of as a result of the benefits of Office 365, Teams and Secure Modern Workplace in a work-from-home environment.

[Nehal Chokshi:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Daniel Ives with Wedbush Securities. Your line is now open.

[Daniel Ives:]

Yes. Thanks. Hope everyone is well. So let me – maybe you can just talk about as a management team in this environment where you guys are almost doing day-to-day, that's different and sort of navigating the channel customers, maybe walk through how that's changed from an all hands on deck?

[David Wagner:]

Yes, that's a great question, Ives. I feel I could be more proud of the team and the way that they're working in every part of the company that phenomenal care, the agents are working from home, they're standing up in the morning, standing up at the end, working just tremendously well, remotely. The development team continued to deliver really meaningful products and they've done a great job. But I would point primarily to the sales team, stand up in the morning, stand up at night, really drive and rigor in their process positioning and repositioning with clients. The benefits of secure modern workplace and the benefits that we're bringing them into this market, and so, we're spending a lot of time with partners, a lot of time also with new prospects. The pipeline is good and that's – I don't want to take it with a grain of salt, but you have to be a little more careful with pipeline these days and qualify more carefully. I make sure that the deals are progressing and so I'd say the diligence in the sales front end is that really heightened, not that it wasn't – they're quite heightened now more than ever.

[Daniel Ives:]

Okay. And then in terms of just guidance for 2Q or just going forward, do you sort of assume what you're seeing in April, continues or it's putting more of a discount on that to the environment?

[David Wagner:]

Yes. When you look at the Q2 guide in particular, we were allowing for a little bit worse management and we just – again, we just do not know. But allowing for a little bit worse assuming that maybe PPP allowed some funds to flow through and people paid before . They'll make some adjustments yet in May and June. But that's more just allowing for uncertainty than anything. We're seeing the trends that we're seeing. As we disclose, we're up in April, driven by more new churns, just a little bit higher churn. And then that – again that decrease in existing customers not buying more, or they're buying more is offset by customers who are furloughing workers.

[Daniel Ives:]

Great. Thanks.

[David Wagner:]

Thanks a lot, Dan.

[Operator:]

Thank you. At this time, this concludes our question-and-answer session. I'd now like to turn the call back over to David Wagner for closing remarks.

[David Wagner:]

Well, thank you all for joining us on our call this afternoon and for your support of Zix and we're looking forward to navigating this next quarter and speaking with you all again at the end of July. Thank you very much.

[Operator:]

Thank you for joining us today for Zix first quarter 2020 earnings call. You may now disconnect.