Zix Corporation
Q3 2020 Earnings Call Transcript

Published: 9 Nov 2020

[Operator:]

Good afternoon, and welcome to Zix's Third Quarter 2020 Earnings Conference Call. My name is Christian, 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. Following the remarks, we will open up the call for your questions. . Now I will turn the call over to Geoff Bibby. Sir, please proceed.

[Geoffrey Bibby:]

Thank you, Christian. Good afternoon, everyone, and thank you for joining our Q3 2020 earnings conference call. On the call today, we have our CEO, Dave Wagner, our CFO, Dave Rockvam. After the market closed today, we issued a press release announcing our results for the third quarter ended September 30, 2020, a copy of which is available on the Investor Relations section of our website at zix.com.

[David Wagner:]

Thanks, Geoff. Good afternoon, and thank you, everyone, for joining us today. Our solid results for the third quarter demonstrate our team's continued commitment to driving profitable growth as well as our partners and end customers' adoption of our Secure Cloud platform. Delivering 15% revenue growth, coupled with 25% adjusted EBITDA margins in the quarter demonstrates the growing value Zix is providing our partners through our Secure Cloud platform. Secure Cloud delivers comprehensive digital productivity, security and compliance solutions for businesses of all sizes.

[David Rockvam:]

Thank you, Dave, and good afternoon, everyone. At a high level, in the third quarter, we again delivered on our commitment to drive incremental ARR, revenue and adjusted EBITDA dollar growth. We also produced strong cash flow from operations, generating $15.1 million, bringing the total amount of cash flow from operations to $24.2 million on a year-to-date basis. Looking at our numbers for the quarter in more detail. At the end of Q3, our ARR totaled $222.3 million, up 11% from Q3 of last year. Our continued and sustained ARR growth is being driven by our customers' move to secure modern workplace, which puts significant emphasis on Cloud adoption. We are pleased that our Cloud-based ARR grew by 19% over Q3 of last year and now comprised 86% of total ARR of $190.3 million. New customers in the quarter totaled over 4500; up 22% from Q3 of last year. For the third quarter, we had just over 99% 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.

[David Wagner:]

Thanks, Dave. I will now review our execution of strategy in the context of our three primary growth drivers, after which I will continue my discussion of why CloudAlly was the perfect acquisition for us and what it means for our business going forward. So starting with our first growth driver, which is new customer acquisition. We had some noteworthy wins in the quarter on both the Zix and AppRiver sides of the business. First, on the Direct bar side, our top five wins in the quarter were in our traditional industries, including two in healthcare, two in finance and one in government. All five wins included e-mail encryption and all five wins involve displacing a competitive solution. Our largest new customer win in Q3 was a six-figure deal in the finance vertical. This customer selected Zix, stating that they determined us to be best of breed compared to our most notable competitors. We averaged two products per new customer and our top five new customer wins in the quarter and 88% of all new logo wins in the quarter were deployed on Secure Cloud. On the MSP partner side, we added 54 net new transacting partners in Q3, which compares to the 60 we added in Q2, bringing our total to 4507 at the end of the quarter. In Q3, we added approximately 170 net new customers per week, bringing our total customer count on the AppRiver side of the business to more than 75,000. Our sales momentum on both the direct and indirect side of our business picked up from Q2 levels into Q3 and continued into the current quarter as well. As we shared on our last call, we achieved more than 4300 trials. Our second highest monthly total in July just behind June. Total October trials were just short of July levels. Zix IP trials for Q3 accounted for 27% of the total trials in the quarter, and we achieved a new record for IP trials in October. In terms of our second growth driver, which is sales to existing customers. In Q3, our top five add-ons through our VAR and direct sales team included two in health care, one in banking, one in education and one in construction. We also had a broad mix of solutions represented in the top five, including two in encryption and two Office 365 add-ons. On the MSP side, sales to existing customers accounted for 47% of the monthly recurring revenue or MRR increases in the quarter, which compares to 22% in the prior quarter and 41% in Q3 of last year. Moving on to our third growth driver, increasing retention. Our top five renewing customers by ARR in Q3 were all Cloud customers and 50% of our total renewing customers in the quarter were in the healthcare space. We also had a strong government renewal quarter that included renewals from six long-standing government customers, including one that first became a customer in 2002. As Dave mentioned, our total company net dollar retention was 99% in Q3, which was up from 96% in Q2 and just shy of our historical 100% plus level. It's worth pointing out that our net dollar retention was impacted slightly in the quarter due to a $300,000 decline related to the planned end-of-life of our ZixOne product. Absent this change, we would have been at the 100% level. We have approximately $650,000 of ARR remaining from this product, which is scheduled to taper off through next year. Since the end of the quarter, we've seen our net dollar retention remain near the 100% threshold. Today, Secure Cloud is a leading solution, enabling partners and end customers to achieve a secure modern workplace. Secure Cloud provides small and mid-market enterprises with unparalleled productivity, security and compliance; all from a single platform. The increase of remote work is making uninterrupted access to an organization's Cloud data vital for employee productivity. Remote work is also creating larger tax services, enabling more attacks, bigger breaches and a greater need for data restoration following a breach; which brings me to the strategic nature of the CloudAlly acquisition we announced earlier today. I would like to take a few minutes to share with you why I am so excited to add CloudAlly and Cloud backup and recovery to our solution set and ultimately aim to Secure Cloud. There are three main reasons I really like this acquisition. Number one, it fills the number one partner request of what they want to buy next from Zix AppRiver. Number two, Cloud backup is an exciting and fast-growing market, which is highly complementary and is a natural extension of our current solutions. And number three, in CloudAlly, we have added an extraordinary team of talented, Cloud-first, partner first, technology developers and professionals who share our vision of building superior products that are highly effective, easy to use and deploy and backed by phenomenal customer service. Over the summer, we did a comprehensive survey of our partner community. Of the 229 respondents, 59% had a current incumbent Office 365 backup vendor and 41% have yet to select a backup provider for their customers. Of the respondents, 55% indicated that they would be likely to resell Cloud backup from Zix. And 34% said that they were 80% or more likely to resell Office 365 backup from Zix within two years. As you can see from the survey data, we expect to create a lot of shareholder value from Cloud backup as we work to double our Cloud backup ARR over the next three years. Beyond Office 365, and perhaps even more exciting, is our entry into the Cloud backup space more generally. The total backup market is estimated by Gartner to be $6.3 billion, growing at 2.5% annually. Today, the Cloud backup segment represents about 20% of the total, or $1.3 billion; growing 25%, with Office 365 backup representing nearly half of that Cloud backup market at $600 million. We are focused on the large and growing Office 365 market, and we are excited that CloudAlly has solutions today for Google markets, Salesforce, Box and Dropbox. Each of these Cloud applications represent meaningful additional growth opportunities for Zix and our partners. When you step back and think about it, the rapid adoption of Cloud-based applications and the increasing value of the data sets in those applications, you can see a lot of room for future growth. Which bridges me to my final point. We are really impressed with CloudAlly's born in the Cloud architecture. They've assembled a world-class technology team that has built products based on scalability, channel first, ease of use and data residency; all attributes that integrate very well with our strategy for Secure Cloud. Cloud backup and recovery is a critical component of a secure modern workplace. And adding Cloud backup and recovery, will further improve our position with our partners as we work with them to capitalize on the digital transformation, our joint end customers require in our increasingly work from anywhere world. We are really excited to add the CloudAlly team to the Zix Corporate family. Speaking of new team members, I'm also pleased to announce our new Chief Product Officer, Ryan Allphin. As we think about our long-term growth, we see our Secure Cloud delivering value to partners and customers at the platform level, at the application level and through intelligence and data gathered from the vast amounts of information we will be processing. Achieving this vision will require a product leader that can bring together product development and product management into a seamless organization with a shared technology strategy and product strategy. Ryan's most applicable experiences come from his 14 years at McAfee. At McAfee, Ryan held engineering leadership positions across a wide range of security products before progressing to become the General Manager of McAfee's Security Management Business Unit. Under Ryan's leadership, McAfee achieved the top Gartner Magic Quadrant rating for their endpoint security business. He led several acquisition integrations, earned experienced building Cloud platforms and big data analytics projects. All experiences we expect to leverage as we continue to grow and scale our business at Zix. Digital transformation initiatives are continuing to proliferate, and we are well positioned to capitalize on a new work from anywhere world. With CloudAlly, Zix is even better positioned for profitable growth, higher attach rates and the opportunity to capture an even greater share of the multibillion-dollar business communications market. That concludes our prepared remarks. Operator, we're ready to open the call for questions.

[Operator:]

. Now our first question will come from Chad Bennett from Craig-Hallum. Your line is open.

[Chad Bennett:]

Nice job on the quarter, guys. So I was just hopping between calls and I looked at the M&A press release, and I didn't see an actual purchase price associated with CloudAlly. Did you offer that up on the call?

[David Rockvam:]

No. It's approximately $30 million on the purchase price.

[Chad Bennett:]

Okay. And just, I guess, in terms of thinking about that business, guys, I mean the -- you're correct. The Cloud backup market is a very exciting market. And for sure, complementary to what you do. And you indicated that based on your survey results, you believe some demand -- or significant demand is there just in the base. But I guess it's also just my experience there. It's a pretty competitive space. And I think you guys are somewhat used to that. But just can you talk about the competitive landscape there real quick that at least you're familiar with today?

[David Wagner:]

Yes. So I think you're right. It is competitive. Of course, there are vendors who have been around a long time and have the good part of having the on-prem side of backup, which creates challenges on the Cloud backup. So we're really, really pleased that we were very intentional about Cloud-to-Cloud backup. This is a pure, born in the Cloud, always in the Cloud backup platform. So we think that we're really, really well positioned, as we said in the press release, to handle Cloud-based workloads. That's where the growth is. And we think by zeroing in on an asset that was focused on the Cloud backup, that's really going to help us out a lot. The second thing, if you remember, back to the strategy around the AppRiver acquisition just under two years ago, we recognize that the move to Cloud starts with Office 365 and grabbing those customers, the partners as they lead end customers from on-prem to the Cloud. That's the point at which that resiliency message, the importance of being secure and compliant. That's where that method resonates. And so we think that we really are going to differentiate with where we sit in the partner ecosystem, as the productivity provider of choice is one of the largest CSP's in the country increasingly in the world. We think that's going to be a really nice competitive positioning as well. And then we love the idea of, as you pointed out, it's not just Office 365. Office 365 is about half the Cloud backup market today. But these data sets in Salesforce in Box and Dropbox are increasingly getting high-value employee data in those workloads and being able to restore that data back to court's point in time. Makes an organization much more secure, much more productive, and we really think it's a great new customer and attach opportunity for us.

[Chad Bennett:]

Great. No, great color. And then maybe one follow-up for me. Just on Secure Cloud. I mean the attach rates or kind of penetration rates continue to be very strong, even on the Zix core business are going up quite a bit sequentially. I guess when will we -- I know it's an interesting times and difficult environment. But when do we think that, that kind of moves the needle on net retention or net expansion, so to speak, because obviously, the product attach rates, you gave the metrics go up when you can get someone on Secure Cloud. Do you think we're close to being able to talk about, again, in a somewhat normalized environment, net retention kind of north of 100%?

[David Wagner:]

Yes. That's certainly the goal. And we think we will get back there as the economy recovers as our attach opportunities improve, I did give the October number, which is just a very small hair under 100 at this point. So things have remained really strong and steady since June for us, and we do expect things to expand as the economy expands, hopefully, in next year.

[Operator:]

. The next question is from Andrew King from Colliers Securities.

[Andrew King:]

So if you could just give us a little bit more color into the linearity of the quarter. And if you've seen any of the customers that originally took seats away from their deployment due to weighing staff offices onset of COVID. Have you seen any of them come back either start to add services back or add more seats as they start to add back personnel?

[David Wagner:]

Yes. That's a great question. And we were really clear about that between Q2, I guess, in early Q3. And that's what we saw that brought us from 96% back to the over 99% in Q3, and those metrics, and that pace have stayed really, really steady through October. So we're seeing a really steady, good environment, not like the environment we were in Q4 last year, but we see a real steady environment. Of course, that's on our monthly renewal customers. On the annual renewal customers, the COVID impacts we're still doing renewals on annual renewal customers who may have smaller workforces now than they did at their last renewal, and those will continue to work their way through the cycle between now and the March/April timeframe. That's a little less than 40% of our ARR. So we feel that we're seeing the recovery in the monthly billing customers really consistently balanced by the annual renewal customers, who are still adjusting a little bit as we work them through the ARR renewal process.

[Andrew King:]

Great. And then just looking at the acquisition, can you give us an idea of the breakout of their revenues? How much of that's derived from Microsoft O365 versus other platforms and how that's broken out geography wise?

[David Wagner:]

Yes, they've done a really nice job, of course, getting into the Cloud backup market between really early and early and have done a nice job of covering the core applications. And Office 365 has been the lion's share of their backup market. They have nice customers and nice amounts of customers on each of those platforms I discussed, but I'd say it's almost 80% Office 365 in their partner customer base.

[David Rockvam:]

And then on a geography basis, they're not quite 50% U.S. and then over 50% rest of world. So they have a nice international component as well.

[Operator:]

. Our next question is from Nehal Chokshi from Northland. Please proceed.

[Nehal Chokshi:]

Congrats on a strong quarter, especially the free cash flow, really nicely -- well above our estimate. So for the December quarter, excluding the $1 million from CloudAlly, the midpoint revenue guidance is up 2% Q2, which is stronger than the guidance that you provided for September quarter of up 1% Q2. Dave Wagner, I think you've already alluded to this, but I just want to verify that. Does this mean that you guys are seeing an improving environment? And if so, what are the indicators are giving you this incremental confidence relative to a quarter ago?

[David Rockvam:]

Yes. I'll kind of -- also going to piggyback on Andrew's question about linearity, right? We talked about in -- on the July or the June quarter earnings call that we had a very strong record trials in June and a strong July, which was our second highest. So we were able to tell you on the call that we felt good about things, right, in 4Q, Q3, because of those trials, we saw that revenue come in or start to come in, in July, then having that strong July, made a good August. So we continued to see strength in the quarter, right? So when we see that -- saw that building, August would have been a little -- wouldn't have been as high as high of a month of trials because of vacations across Europe and the U.S., specifically. But then September came back nicely, and that will change into revenue in October. So as far as the quarter goes, we saw good momentum and traction throughout Q3, which allowed us to a little bit stronger guidance and feel for Q4. And then adding on top, the $1 million from CloudAlly pushes us over-the-top end of what we said. So I think we were at $2.10 to $2.17 in April when we guided and brought that up just a little last quarter and then this quarter, with the results we saw in Q3, able to bring it up the rest of the way to get to the top end of that revenue range.

[Nehal Chokshi:]

Okay. Great. And then I want to drill a little bit more into these trials, especially the AppRiver customers that are trialing the Zix Security IP. What's the typical characteristics of the companies that are trialing the Zix Security IP that are already an approval customer?

[David Wagner:]

Yes. So the average customer size is right around 25 mailboxes. So these, on average, are smaller customers. Of course, the IP set, especially encryption archive, tend to work better at the larger end customer size. So when you get into the Zix IP, they tend to be slightly larger. But we're still talking, Nehal, on the AppRiver platform averages in the 20% to 30% range and not larger customers. I mean, AppRiver does have some large customers. We have partners who work up into the thousands of users, but a lot of small businesses, over 75,000 small businesses, all over the country and increasingly in the U.K. are that customer base that tend to be on the smaller side.

[Nehal Chokshi:]

And these customers that are on the smaller side, did they already have an existing secure e-mail gateway provider?

[David Wagner:]

So we're garnering end customers, lots of different ways. A lot of times, we recruit a new partner, the new partner, will -- that will be a great opportunity for us to make sure that they're positioning additional security and compliance products as they come across. And so we collect customers there. We gather new customers from the exchange to Office 365 motion, and so we attach there as well. The attach rates, we would like to be higher, so that we're still in the -- as Dave said, we're in the 1.1 total, probably 1.2 in on the AppRiver Secure Cloud side. So we need those to grow higher, and we're getting them higher literally every month, but they're inching higher as opposed to racing higher, and we're continuing to -- I'm really happy with the trend and the trajectory, and we're staying on it, particularly being successful with the newer customers and the newer partners coming on to the ecosystem.

[Operator:]

At this time, this concludes our question-and-answer session. I would now like to turn the call over back to Mr. Wagner for his closing remarks.

[David Wagner:]

Well, thank you all very much for taking the time to join us for our Q3 earnings call and a very exciting announcement of the extension of the company into Cloud backup and recover with CloudAlly. We look forward to speaking with you all early in 2021.

[Operator:]

Thank you for joining us today for Zix's third Quarter 2020 Earnings Call. You may now disconnect.