Zix Corporation
Q1 2019 Earnings Call Transcript

Published: 3 May 2019

[Operator:]

Good afternoon. Welcome to Zix First Quarter 2019 Earnings Conference Call. My name is Victor and I will be your operator this afternoon. 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 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 a link in the Investor Relations section of the Company’s website. Now, I’d like to turn the call over to Geoff Bibby. Sir, please proceed.

[Geoff Bibby:]

Thank you, Victor. Good afternoon, everyone, and thank you for joining our first quarter 2019 call. With me today are Dave and Dave, our CEO and CFO. After the market closed, we issued a press release announcing our results for the first quarter ended March 31, 2019, a copy of which is available on the Investor Relations section of our website at www.zixcorp.com.

[David Wagner:]

Thanks, Geoff. Good afternoon, and thank you everyone for joining us today. The first quarter of 2019 was positive in a number of meaningful ways. We closed the acquisition of AppRiver, successfully executed on the $8 million of cost savings, delivered 22% MRR growth at AppRiver and delivered 74% new first year orders growth at Zix. We topped off Q1 by winning the largest deal in the company’s history with a Top five U.S. Bank. The last couple of quarters have been energizing and Q1 2019 represented a new high in terms of the progress achieved and momentum gained. Standalone Zix recorded 10% revenue growth to $18.4 million, making it our second consecutive quarter of double-digit topline growth. Standalone Zix also achieved record new first year orders of $4 million driven by the one large deal and also by the continued strong performance of our channel partners, sales teams and by our increasing attach rates. The fact that Q1 2019 was the fourth quarter in a row with new first year orders growth of more than 20% demonstrates the success of our high velocity sales model and the power of attach, all part of our strategy to align our business to the cloud and deliver a broader range of solutions for our customers. Standalone AppRiver is also seeing strong momentum in their business, which complements the strong Zix organic results.

[David Rockvam:]

Thank you, Dave, and good afternoon, everyone. Q1 was another strong quarter for Zix. We’re pleased to once again generate revenue and adjusted EPS above our guidance demonstrating solid execution from our sales teams as well as the market’s increasing adoption of our email security solutions. Zix standalone revenue and new first year orders reached record highs, enabling us to achieve double-digit topline growth for the second quarter in a row. We also achieved record Zix standalone total orders of $22.4 million, which was up 52% year-over-year. As Dave mentioned, AppRiver had a very strong quarter on their own generating 21% organic ARR growth largely due to the significant traction the team has been having with Microsoft productivity solutions. All in all, Q1 2019 represented the successful execution of Zix and AppRiver’s work toward our three to five-year vision of significantly scaling the business and driving higher profitability.

[David Wagner:]

Thanks for the financial overview, Dave. I’ll now review our progress as an integrated company in the context of our three main growth drivers. I will then provide an update of where we are with the AppRiver integration before we open the call up for questions. As a reminder, our three growth drivers are new orders to new customers, sales to existing customers and increase in retention. Our first growth driver is new orders to new customers. From a core Zix perspective, we continue to drive strong adoption of our solutions by new customers. Four of the Top five new customers purchased the bundle that includes advanced threat protection and email encryption while the other one was for standalone email encryption. Our largest new customer win for the quarter was in the government vertical for a state healthcare department. They were using a competitive legacy email security solution and end-to-end encryption was their primary requirement. So, the breadth of our offerings and its ease of use drove their decision to move to Zix. This win will further solidify our already strong presence in healthcare in their state. From an AppRiver perspective, we look at new customers both in terms of adding new MSPs to our platform and also adding new end users to existing MSPs. Looking at some of the top new MSP wins in the quarter. We have three in the U.S.; one moving from Microsoft direct, one moving from a distributor and one just now transitioning to an MSP model. Two more large new MSP wins were in the UK, where we are just getting started. In terms of total new end users, AppRiver added on a net basis just over 1,600 additional productivity customers in the quarter with approximately 45,000 total new unique users, again net of churn. Now let’s take a closer look at our second growth driver, which is sales to existing customers, 71% of core Zix new first year orders during the quarter came from our installed base. This higher percentage was driven by the large bank deal, strong upsell and attach. So, let me spend a moment on each. Our largest add-on during the quarter and the largest deal in Zix’s history was with a Top five bank we mentioned earlier. This Top five bank signed a three-year deal for all of our encryption products; Gateway, ZixMail and EMS. While all elements of our encryption offering are important to this customer, our ability to win the deal was driven by the fact that we have a very broad range of deployment options, including both on premise and cloud delivery to support their hybrid environment and their long-term vision of moving to the cloud leveraging a hybrid model. So our on-premise capability which we bolstered with the acquisition of EMS in 2017, was crucial to this win. We were also favorably positioned to win the deal due to our deep commitment to maintaining a service that meets the highest standards of compliance, including adherence to the Americans with Disabilities Act requirement. As the leader in email encryption, we believe we devote more R&D resources to email encryption than any other vendor in the market. This large customer appreciates the importance of strong security standards, strong compliance, ease of use and a vendor with a robust roadmap to meet their evolving needs over time. We are obviously excited about the strong enterprise endorsement of our core product suite and expect to be able to leverage these capabilities in future enterprise deals. The four remaining add-ons were in healthcare; two accounts added encryption only, one added encryption and threat protection and one added archiving. Moving on now to our third growth driver, increasing retention. Standalone Zix retention for the quarter was at our 90% target. Looking at the net dollar retention, which includes add-ons, our net dollar retention was well over 100% and was still over 100% even if you exclude the Top five bank deal. This is an important milestone for Zix as we continue to execute on our attach strategy. AppRiver net retention rate was over 95% in the quarter and AppRiver net dollar retention was also greater than 100%. With a broader range of services now available to our partners, we will be working to drive this rate even higher. It’s a key metric as we drive our strategy and revenue synergies from the deal. I’ll now spend some time talking about where we are with the integration of AppRiver before we open the call up for questions. As I stated previously, we are focusing on five guiding principles; integrating to become one company with one culture, channel enablement, brand integration, cross selling and building a combined product roadmap. In terms of overall integration, we’ve made tremendous strides in integrating the two businesses without missing a beat or causing disruption in how we take care of our partners and customers. Both teams are collaborating exceptionally well and delivering on key milestones, oftentimes well ahead of schedule. We’ve already integrated our networks, phone systems and collaboration platforms. We have functionally integrated most of the organization with the exception of the customer facing sales and support organizations, which we expect to run separately for the foreseeable future. Our culture and brand integration work is also on track and set to be complete on schedule in early Q3. But perhaps the most visible indicator of the strength and velocity of the integration was last week’s launch of ZixEncrypt, which we completed in just 64 days. The fact that we were able to integrate ZixEncrypt so quickly into the AppRiver platform speaks to the close cultural alignment of the teams and also to the strength of our local leadership teams, which carefully managed a complex integration every step of the way. This brings me to our second priority, which is enabling channel partners to aggressively pursue cross-sell opportunities. In this pursuit, both sales organizations continue to work in parallel and will continue to do so for the foreseeable future as there is very little overlap in the partner base. This is because the buying motion is so different between our customers who prefer to purchase the solutions recommended by the managed service provider and those who take more control of the IT procurement process. We’re encouraged by the introduction of ZixEncrypt to AppRiver’s partners. We had trials start within hours of availability. We’re also excited about the archiving opportunity. ZixArchive is now scheduled to be integrated in June, almost 60 days ahead of plan. On the Zix side, Office 365 was just introduced to the Zix sales channel beginning on May 1st. Secure hosted exchange is technically tied to the AppRiver email security solution so we will be offering it for sale to the Zix channel in a more controlled limited fashion until we keep – complete the roadmap integration for email security. From a channel perspective, virtually all of the partners I’ve met and spoken with over the past couple of months have enthusiastically welcomed the combination of Zix and AppRiver. Email security is top of mind for most SMBs and for MSP partners. Our research shows that 74% of small business leaders have cyber security top of mind every day. They perceive the risk of a cyber attack to be greater than the risk of fire, flood and theft combined. So, the ability to partner with one vendor, ZixAppRiver, for Microsoft productivity products and best of breed email security for compliance is a big win for them. They’re also excited about the improved economics when they cross sell advanced email security, ZixEncrypt and ZixArchive, to the customers. With ZixAppRiver, they have the opportunity to deliver superior protection to the customers, become stickier with their client base and drive higher profitability in the business. All ingredients we believe are key to a successful business relationship. And finally, we will be focused on building an integrated product roadmap that captures the best of both Zix and AppRiver to drive the most value for our partners and customers. The accelerated integration of ZixEncrypt and ZixArchive demonstrates how well we’re doing on technical integration. As we finalize these accelerated deliveries, we will continue to work deliberately with intentional agility on the longer-term integrated product roadmap. We are excited about the opportunity of bringing the best of our two email security solutions together into one even more powerful solution and the opportunities to further expand the power of our platforms as we bring them together over time. In closing, Q1 was another important benchmark quarter for Zix. We achieved record standalone results, delivered double-digit organic growth and made rapid progress on the integration of Zix and AppRiver. As one team, we significantly enhanced our go-to-market capability and our ability to more aggressively cross sell across the base of more than 80,000 customers. Execution of our strategy has positioned us to benefit from the rapid migration to the cloud and the associated increasing use of outsourced IT providers. It’s the opportunistic time for Zix to ascend to the next level and become one of the leading cloud-based email security and productivity providers. We’re excited about the challenge and opportunity ahead and we are working tirelessly to make that vision a reality. Now with that, we’re ready to open the call for your questions. Victor?

[Operator:]

Yes, sir. And our first question comes from the line of Mike Malouf from Craig-Hallum. You may begin.

[Mike Malouf:]

Great. Thanks for taking my questions and congrats on the integration so far. Looks like it’s gone much smoother than one would have thought.

[David Wagner:]

Thanks, Mike.

[Mike Malouf:]

I’m wondering if maybe we could just explore little bit more on the Office 365 opportunity as you start selling it into the Zix space. Can you talk a little bit about that and how you go about approaching that with your customers?

[David Wagner:]

So, our focus is going to be first on our smaller customer base, the customers that we have with mailboxes – less than 250 mailboxes per customer, that’s going to be our focus. I think our first and best opportunity is what we call the dark to cloud migration so customers who have not yet taken advantage of the ability to move to Office 365, testing our base of those customers and their appetite to move to the cloud at this time. And we also believe there’s a large set of customers, especially the smaller customers, that are using a vendor that doesn’t have the same kind of phenomenal care that AppRiver is known for and we’ll be making sure our customer base knows that we’re here with outstanding support at a price that’s very, very similar to what they’re probably getting directly from Microsoft but through another partner as a great option to consolidate their service. So, we’re looking forward to that opportunity. It just went into the market, as I said, yesterday so that’s something that we’ll have more data on I would expect when we get to our Q2 earnings call in July.

[Mike Malouf:]

Can you give us a sense of how much of your guidance into the back half is predicated on success of that?

[David Wagner:]

So when we built the guidance range, at the lower end of the range we were focusing on the standalone momentum that was in the two businesses, which of course the results last quarter were very much at the high end of that. And then the top end of the range is where we’d expect to see the success of cross sell coming through, both ZixEncrypt and ZixArchive into the AppRiver partner customer base and Office 365 into the Zix base. And I think you’re automized in terms of the average revenue per unit of the office productivity suite. It’s a high price per unit so in terms of the topline expansion, that would be - if we’re more successful, that’s where the topline would come from.

[Mike Malouf:]

Okay, great. And then just one more question. When we think about gross margins, can you remind me – maybe this is a good one for David to do. Can you remind us where you think gross margins for AppRiver can trend and what will be the impact on gross margins after it starts bundling in sort of the Zix products? Obviously we have Encrypt, but we have threat coming down the line and just try to give us a sense of the impact on the gross profit margins for that? Thanks.

[David Rockvam:]

Good question, Mike. It’s Dave Rockvam. Looking at that – our core products on the offerings that Zix had before, we ran this 80% gross margin level. If you look across AppRiver’s advanced threat protection and their other offerings that were proprietary, they were running in that same 80% range. So, we put a new chart in the deck and it’s not highlighted in there; but when you take a look at that, you’ll see encryption, advanced threat protection and then our other category which in mostly proprietary. Those businesses can run in that 80% gross margin range, productivity is running in the high 30% gross margin range. So blended together, we – that’s where we get the 60% to 65% target range. So, hopefully that gives you some color there.

[Mike Malouf:]

Okay, great. Thanks a lot. Appreciate it.

[David Wagner:]

Thanks.

[David Rockvam:]

Thanks, Mike.

[Operator:]

Thank you. And our next question comes from the line of Catharine Trebnick from Dougherty & Company. You may begin.

[Catharine Trebnick:]

Yes, thanks for taking the question. Can you just quickly review where – you had given two things and I have been juggling three phone calls tonight. I apologize for you to repeat. But I was trying to get early on what you said the Zix between AppRiver organic growth was. I think you gave that at the beginning and I jumped off quickly and joined again, Sorry.

[David Rockvam:]

Right. On the ARR perspective, the ARR growth for Zix was 15% and the growth for AppRiver was 21%, Those are pure organic numbers taking out any acquisitions either company had.

[Catharine Trebnick:]

All right. Thank you. And then you had mentioned – now Zix has primarily been domestic and you’re now reaching into the UK through your relationship with AppRiver, is that correct?

[David Wagner:]

That’s right and that’s something we’re really excited about. The AppRiver platform for servicing MSPs we think is a really good model to distribute cloud-based security products in Europe. And so AppRiver had recently hired a Director of Sales for Europe based in the UK and he and his team are just getting started in that market, but already two of the five larger MSP – new MSP wins in the quarter showed up in the UK. So we’re early, early days there, but we’re excited about the opportunity and the success the small team had in Q1.

[Catharine Trebnick:]

Okay. And then the other question is would you say you’re – if you look at the prior data at AppRiver, they have a pretty old email encrypt system and it looks like you guys have been pretty aggressive in getting yours into AppRiver. What would you say the average seat size this quarter was for your email products?

[David Wagner:]

So, it was that 29 given the data I shared with the 1,600 unique new productivity customers with the 45,000 net of churn so it was 28 users per customer was the average new customer size at AppRiver and that’s really tightly aligned with the life to date average seat count as well.

[Catharine Trebnick:]

Okay, thank you.

[David Rockvam:]

Thanks.

[Operator:]

And our next question comes from the line of Tim Klasell from Northland Capital. You may begin.

[Tim Klasell:]

Yes, just a few questions here. First, congratulation on the $8 million in synergies way ahead of schedule. But that sort of begs the question, is there maybe a little bit further to go there and maybe what could – what should we be thinking there?

[David Wagner:]

No. It was really important to us to get that taken care of as soon as possible. So we are really pleased that the leadership team at AppRiver working collaboratively with Zix, we were able to get all of those cost savings out of the way. So everything going forward, as Dave was saying, will be synergies created by volume is what we’re really anticipating is to continue growing in the mid-teens organic rates and becoming a little bit more efficient, a little bit more effective with each stage of scale of growth is what we’re expecting to happen.

[Tim Klasell:]

Okay, great. That’s very helpful. And then jumping over to the sales force. Now obviously AppRiver is now going to have sort of the Zix encryption product and that’s also ahead of schedule, but how are you incenting the sales force? What is going to be the channel to promote that product and what should we be seeing when we speak to industry sources about what you’re doing with getting Zix product into the AppRiver customer base?

[David Wagner:]

Yes. So into the AppRiver – ZixEncrypt and ZixArchive ultimately into the AppRiver partner and customer base. The proposition is really several fold. But first, it’s that best of breed encryption and archiving solution for compliance that is really at the very, very top of the competitive offerings in the market. So the MSPs are going to be able take advantage of that. The second thing they’re going to take advantage of is the fact that as 100% organic IP, we’re able to give them the kinds of margins that are normal in the resale of organic IP and that’s a lot higher than what they’re getting on the Microsoft offering. So, what we are focused on is the gross margin per customer per user per mailbox and the incentive for the partners as they move up from their golds or platinum would be driving that blended mix. And similarly with the sales team, we’re introducing incentives that align with that same thinking, which is what’s the gross margin ARR that they’re delivering from the – either through the channel partner or at the end user level.

[Tim Klasell:]

Okay, great. And then let’s reverse that question rather Office 365 into the Zix sales force. How does that – how are you going to incent them? How are you going to roll that into...

[David Wagner:]

The real incentive there is – Microsoft is a great solution, everybody knows it. The Zix’s solutions complement it extremely well and it’s a really natural alignment to buy your email security with the same vendor, one phone call with phenomenal support. So, that’s the first is the value that they’re going to get by combining with one vendor their solution set and that’s really the – and then the better support that comes with AppRiver. And we talked a lot about this earlier, but the net promoter scores run in the 70s and as high as 80 for AppRiver, it’s really phenomenal care and that matters a lot to businesses. And then on the channel margins, they’ll be adjusted for the fact that we don’t make as much margin on Microsoft. So the retirement of quota will be lower on the Microsoft products, but the ARPU is so much higher that the dollars that the partner and sales person supporting that partner get from a sale is really that margin dollar that’s going to drive them to really want to make sure they’re having that conversation of whether it makes sense to align their purchase of the productivity suite with the security products of one vendor.

[Tim Klasell:]

Thank you. That’s been very helpful.

[David Rockvam:]

Thank you, Tim.

[Operator:]

Thank you. And at this time, this concludes our question-and-answer session. I’d like to turn the call back over to Mr. Wagner for his closing remarks.

[David Wagner:]

I just thank you everybody for your time and attention this afternoon and we look forward to updating you further on our progress on our Q2 earnings call in late July.

[Operator:]

Thank you for joining us today on Zix’s first quarter 2019 earnings call. You may now disconnect. Everyone, have a great day.