Zix Corporation
Q4 2020 Earnings Call Transcript

Published: 25 Feb 2021

[Operator:]

Good afternoon. Welcome to Zix Fourth Quarter and Full Year 2020 Earnings Conference Call. My name is Olivia, 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 Chief Marketing Officer, Geoff Bibby. Following their remarks, we will open the call for your questions. I would like to remind everyone that this call will be recorded and made available for replay via link in Investor Relations section of the company's website. Now I would like to turn the call over to Geoff Bibby. Sir, please proceed.

[Geoffrey Bibby:]

Thank you, operator. Good afternoon, everyone, and thank you for joining our fourth quarter and full year 2020 earnings conference call. On the call today, we have our CEO, Dave Wagner; and our CFO, Dave Rockvam. After the market closed, we issued a press release announcing our results for the fourth quarter and full year ended December 31, 2020, a copy of which is available on 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. The fourth quarter marked a strong finish to a successful and transformative year for Zix. We delivered profitable growth again in 2020, highlighted by 14% ARR growth, 26% revenue growth and 29% adjusted EBITDA growth. Revenue of $218.5 million; annual recurring revenue of $237.7 million; adjusted EBITDA of $50.9 million; and cash flow from operations of $31.3 million, all marked record levels for our company. Achieving these results in the face of unprecedented challenges is a testament to our team, our partners, our customers and the resilience of our operating model.

[David Rockvam:]

Thank you, Dave, and good afternoon, everyone. As Dave mentioned, we again delivered on our commitment to drive profitable revenue growth, increased adjusted EBITDA and generated more than $31 million of operating cash flow for the year. Looking at the numbers in more detail, at the end of Q4, our ARR totaled $237.7 million, up 14% from Q4 of last year. Our continued and sustained ARR growth is being driven by our customers' move to a secure modern workplace, which emphasizes cloud adoption. We are pleased that our cloud-based ARR grew 21% over Q4 last year and comprises 87% of our total ARR, or $206.6 million. New customers added in the quarter totaled over 4,200. 99% of new customers in the fourth quarter were onboarded on the Secure Cloud. In Q4, those classically Zix customers onboarded to Secure Cloud averaged 1.6 services per mailbox, which is above the 1.1 average per services per mailbox historically across the company.

[David Wagner:]

Thanks, Dave. Heading into New Year, our theme at Zix is Transform 2021. Transform is just a fancy word for change, but we're focusing on the idea that change is something that happens to us. While transformation is intentional. A transformation modifies our underlying beliefs and enables more natural and power change. And while we continue to transform the core recipe for success remains execution of our growth drivers

[Operator:]

. And our first question coming from the line of Nehal Chokshi with Northland Capital.

[Nehal Chokshi:]

Yes and congratulations on the solid results and nice guidance, by the way. Let's talk about the guidance, though. So your guidance, 14% Q-o-Q revenue guidance, given that you did have these solid results for Q4, can you characterize what you have seen in the March quarter so far to provide this guidance, which I would characterize as in line to slightly better than expectations?

[David Wagner:]

Yes. I think in line is what we're seeing. Things have been progressing nicely, in line for us since Q2, as you've been watching things grow. I think from the commentary, you're seeing that this security built-in message with our partners is working really well. And the CloudAlly success, not a really big business, but that cloud backup and the buzz around that and these three strongest months, those are the kinds of things that have us confidence in the continuation of the relatively strong trends we've been seeing.

[Nehal Chokshi:]

Okay. Great. And then just to be clear, your ARR numbers, you say it is organic. Does that include or exclude the CloudAlly contribution?

[David Rockvam:]

That does include the CloudAlly contribution. So it would be one point or 2 less without the CloudAlly in there.

[Nehal Chokshi:]

Okay. Good. I think it was going to be bringing about $8 million of ARR in calendar '20?

[David Rockvam:]

That's right.

[Nehal Chokshi:]

Okay. Yes. All right. So if I subtract that out, I'd come up with ARR up about 3% Q-over-Q, cloud ARR up about 4% Q-over-Q, which is about the same rate as the prior quarter. But it does reflect an ongoing year-over-year detail of both the ARR and cloud ARR. That's because the year ago Q-on-Q increases were larger. So the question is, is that -- one, is that analysis correct? And then two, let me first make sure that analysis is correct before I follow-up on that.

[David Rockvam:]

Yes, that's correct.

[Nehal Chokshi:]

Okay. All right. And so does the slower Q-o-Q growth relative to a year ago, continue to be driven by pandemic-induced job cuts? Or is it something else going on?

[David Wagner:]

It's been exactly that. As we've seen, getting back to the 100% ARR growth is a great thing, and we're pleased with that momentum. If we think it talks to the power of the rotation, the cloud and our position, helping our partners take advantage of that. But the overall environment is not as strong as it was a year ago.

[Nehal Chokshi:]

Got it. Okay. And then finally, you did talk about your net revenue retention rate. It did improve. It improved about 100 basis points Q-o-Q, correct?

[David Rockvam:]

That's right.

[Nehal Chokshi:]

Okay. And can you just discuss what were the drivers of the improvement, the components of that between churn versus upsell, relative to the quarter ago?

[David Rockvam:]

Yes. It was a combination of both, actually. So we're very pleased that churn, specifically around productivity, advanced threat protection, archiving and CloudAlly, the -- it continues to stay strong. As Dave mentioned on the call, a little bit higher churn on the encryption and on hosted exchange or specifically the on-premise encryption. So -- but we continue to see good strength from our core retention of well over 90%. And then on the upsell, we did continue to see good strength in the upsell. What we have seen out there in Q3, Q4, and you can see it from our new customer wins, still strong new customer wins, but that's a place where we've seen with COVID, it's a little bit harder to get out there with the new customers and with the new partners, but the strength has continued to be in that base while we come out of this.

[Operator:]

Your next question, coming from the line of Chad Bennett with Craig-Hallum.

[Chad Bennett:]

So just kind of questions on Secure Cloud and now that we've seen a significant amount of the cloud ARR base kind of converted or in that product or suite, and it sounds like a lot of the new -- net new logos are directly flowing in there. Are we at a point where you can talk -- either one of the Davids, on Secure Cloud net retention or net expansion there? And then kind of in conjunction with that, it's good to see that, obviously, the services or products per mailbox ticking up, which is what you're trying to accomplish, I believe, with Secure Cloud. But when do we see kind of the needle move on overall gross margins also and that starts to lift those a little bit? Any commentary there?

[David Wagner:]

Yes. First of all, on the Secure Cloud rotation, what we were really successful with in 2020 was getting the new customers, 99%, coming on to Secure Cloud. 2021, to be clear, is the year where we'd be bringing over large cohorts of customers from the Zix Cloud and the Secure Cloud. That movement, as I discussed, starts actually next month during this quarter. And that's a nice opportunity for us to bring those customers in, to start to see the opportunity to drive even higher attach with some of our existing customers. So excited about that part coming up. The retention inside Secure Cloud is really strong. It's driven largely by the shift, the fundamental shift towards channel and MSP. And so as you break it down, our channel retention is even stronger than our direct retention. So really leaning in to those MSP cohorts, seeing the growth in those 2012 to 2020 cohorts that I talked about have grown greater than 50%. Those are really positive trends that underpin our confidence in the guide in the year. The gross margin piece, we're really focused on the gross margin dollars. The Office 365 is a really powerful tool, and you go from Microsoft's results, they're performing in a powerful way. And so as that mix shifts up, it dilutes our margin percentages. but really confident in the attach and to continue to grow the gross margin dollars that we deliver to the bottom line.

[Chad Bennett:]

Okay. And then maybe just -- sorry, a follow-up on CloudAlly. I think you mentioned, David Wagner, that they had their best 3 months of ARR growth year-over-year. I think you commented once you announced that deal that you expect that business to, I believe, was it double over the next couple of years from an ARR perspective?

[David Wagner:]

Yes. Exactly. Exactly.

[Chad Bennett:]

Okay. Are we on track with that and kind of how do you think about that?

[David Wagner:]

Yes, that business is out of the gates, really, really strong. The team is integrating and executing. One of the things that's working better than we thought is the Salesforce back up market. That -- there's a lot of really important data sets in Salesforce and they're increasingly pointing their customers to the need for a backup of that data, and we have a really strong Salesforce back up. So that a couple of really nice wins and growing trends there in addition to the Office 365 piece, which was the core of our investment thesis. So we're just really pleased with the team, how they're performing, the product, the adoption rate by our existing partners. And again, full integration doesn't really come to Q3. So the early start is really nice.

[Chad Bennett:]

Okay. And then maybe one last one. I think you commented on it a little bit on the previous question. But just what are your thoughts as we stand here today in 2021, just on the stability of net retention and churn relative to maybe kind of the end of the last year? Do you feel like things are improving? Or you have more visibility there than maybe 2, 3 months ago?

[David Wagner:]

No, the good thing is that relatively strong we've experienced since June, July has stayed in a pretty relatively strong position since then. We're looking forward to a much stronger second half when the vaccines around, people are really moving again. It's -- as you know, the overall macro is -- from the way we see it, stayed pretty steady since July and it's a good thing in that, it's steady at the 100% net dollar retention. We're looking forward to being able to drive higher, which we think comes with the increasing economic activity, we can help -- we look for in a couple of months.

[Operator:]

. Our next question, coming from the line of Brian Colley with Stephens.

[Brian Colley:]

Congrats on the quarter. I just wanted to start off maybe digging in on the top line beat and kind of what you guys -- what products drove the strength in excess of your guidance? And then also, maybe if you could just touch on what you guys are assuming from a macro perspective, just curious if you're baking in any sort of economic recovery or better cybersecurity spending environment in the back half of this year?

[David Rockvam:]

Okay. I'll take the front part of the question around the beat on the revenue side. Of course, we continue to see strength in the Office 365. So that provided a part of the beat for us. And then I would say end of Q3 and Q4, the attach of the Zix IP products onto the -- what was historic AppRiver platform, we saw that -- you heard we are on our -- or a number of trials, we had 30% -- almost 30% of trials were with IP and with that, we had our highest ARR growth from Zix IP onto the AppRiver base that we've had and seen. So that helped bring up the revenue. So it was a little bit higher than we expected into Q3 and then going into Q4. So that Zix IP into that AppRiver base and then the Office 365, I'd say. And then I would say archiving continues to be performing nicely.

[David Wagner:]

Yes. And at the macro level, I think, I'd point to our guide, 12% to 14% -- and 12% to 14% revenue growth in Q1, 12% to 14% revenue growth in Q4, means we're planning on a steady year. We do think the new customer acquisition trends will start to improve in the second half. But the beauty of the ratable model as those wins will contribute more in 2022 than 2021. So this year is steady as you go, what we think are good trends, but they're, again, slightly less than we were experiencing a year ago at this time.

[Brian Colley:]

Got it. All right. That's helpful. And then as a follow-up on that, I mean, just touching on one of the initiatives that you mentioned for this year, migrating your legacy Zix customers over to the Secured Cloud, you mentioned higher churn rates in that customer base. I'm curious if there's any investments you think you can make in the business that can lower that churn rate?

[David Wagner:]

Well, a lot of it is execution. The hosted exchange is really the one that we're really focused on. We enjoy a higher gross margin on hosted exchange business than Office 365. But we know that the future of Microsoft and the future of productivity is in the cloud. And so to sit and watch that base go down is we don't think it is the right thing. We're more aggressively marketing our customers. We're not moving customers who don't want to move, but we're making sure that our existing customers know that we've got a strong Office 365 presence, building bundles and packages that are higher-margin bundles and packages to accelerate that HECs churn to create, continue the long-term relationship at a higher margin. And obviously, it's better than losing the customer. And so it's that HEC piece that I was alluding to that we're going to get more proactive on that, given where we are in the cycle and make sure we're managing those partners and customers into us for the longer term and not losing them to another provider that's coming in with the cloud offer.

[David Rockvam:]

Yes, I would just add on to that. The additional expense you're seeing a little bit, I talked about, the guidance is $56 million of EBITDA for the year. We've got $3 million coming in for expenses that we cut really in 2020, because you didn't have travel, not as much marketing, assuming a higher variable compensation attainment than the 61% we made last year. You bring those in, right, the $3 million-plus you get to more like a $59 million number. So the $56 million numbers is in an alignment when you look at some of those things we had to bring back in. And then on the EPS side, kind of being relatively flat, that has to do with that R&D and why I bring it up here is we did spend and continue to spend on the tools that we need to make sure that we bring those customers across properly, that they come into a really strong secure cloud platform. And so that's a little bit of the additional expense we're taking to try and make sure that, that goes smooth for our customers.

[Brian Colley:]

Got it. That's really helpful. My last question was just on the international business. Obviously, seeing really strong growth there. I'm curious if you could provide some disclosure on what your international ARR growth rate has been or what it was in 2020 and kind of what you see that being in 2021? And maybe what the potential is maybe over the next 2 to 3 years?

[David Wagner:]

Yes. It's growing really well. We have a really strong team there. And as they've grown from nascent 2 years ago, this year was a doubling. It's still sub -- meaningfully to sub-10% of ARR. But we could see them getting 10% of ARR in the next year, 1.5 years. Just the market there, the IT providers needing to move to a cloud, needing a platform to help them migrate their businesses, Secure Cloud fits that really well. We're making big investments now to launch later in April, which isn't that far way now into the German market, which we see being able to, in 3 to 5 years, match where the U.K. is in a 3-year investment period. So that just sits under 10% or another 10% of our ARR with that investment profile in that market.

[Operator:]

Our next question coming from the line of Andrew King with Colliers Securities.

[Andrew King:]

Congrats on a great quarter. So just over the course of the pandemic, we've seen a slowdown in your ability to add MSP partners as a result of the pandemic. Can you talk a little bit that impact from this last quarter? And then also what your expectations are for that going forward into 2021?

[David Wagner:]

Yes. So we should put the number out. This quarter was a little bit better than last quarter in terms of the number of MSPs added. So we're continuing to add MSP. It's just a little bit slower than, again, than the pre-pandemic pace. But the focus for this year is a laser focus on larger MSPs. And so we're building out 2 careful OKRs, one is to attract MSPs who can do meaningful amounts of our IP. And so we're segmenting a little more carefully around the ability to really represent the secure, compliant, resilient part of the product suite in that targeting. The other thing we're targeting is growing our existing MSPs. That's the real engine that we get built is bringing those MSPs on over time, getting all of their customers on to our platform and then supporting their growth as businesses. And that's a really powerful part of our model that we're continuing to lean into and really targeting the growth of our existing partners as well as that attracting new larger partners.

[Andrew King:]

Great. And then just last quarter, you guys announced the hiring of a new product officer, Ryan Allphin. Can you talk a little bit about what he's done in his first 3 months there? And how he fits into the larger strategic view of the company?

[David Wagner:]

Well, yes, thank you for asking. He's a tremendous, really big add to leadership team. Ryan brings experience not only in building platforms, but looking carefully at the data sets and artificial intelligence, and how to think carefully about how we take the information that we have uniquely have for our partners and customers and helping to improve the experience with machine learning, artificial intelligence. So I think as we move forward, you'll start to see more effort to capitalize and ultimately monetize the data assets that we have and can build from. But he's bringing it like we expected, a great architectural view and a longer-term product vision that I think is going to be really helpful.

[Operator:]

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

[David Wagner:]

Well, I'd like to thank everybody for taking the time to spend with us this afternoon, this evening and look forward to speaking to you again in that 60 to 90 days on our Q1 earnings call.

[Operator:]

Ladies and gentlemen, thank you for joining us today for Zix Fourth Quarter and Full Year 2020 Earnings Conference Call. You may now disconnect.