Zix Corporation
Q3 2019 Earnings Call Transcript

Published: 31 Oct 2019

[Operator:]

Good morning. Welcome to Zix's Third Quarter 2019 Earnings Conference Call. My name is Don, 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 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 Web site. Now, I would like to turn the call over to Geoff Bibby. Sir, please proceed.

[Geoff Bibby:]

Thank you, Don. Good morning, everyone, and thank you for joining our third quarter 2019 earnings call. With me today are our CEO, Dave Wagner; and our CFO, Dave Rockvam.

[David Wagner:]

Thanks, Geoff. Happy Halloween and thank you everyone for joining us this morning. The third quarter was a continuation of the same strong operating performance we’ve been achieving since the acquisition of AppRiver back in February of this year. We delivered 15% organic revenue growth for the second consecutive quarter and we expanded our adjusted EBITDA margins to 24% with organic ARR growth of 18%. Organically, we’re delivering on the Rule of 40 and inorganically year-over-year, total revenue for the third quarter was up 168% and adjusted EBITDA was up 116%. The 18% organic year-over-year ARR growth in the quarter means that we crossed the 200 million ARR threshold which is an important growth goal as we continue to achieve a greater scale that we believe will make us even stronger in the years to come. When we acquired AppRiver, our strategic goal was to become the leading provider of cloud, email security, compliance and productivity solutions for companies of all sizes. So as pleased as I am with the growth and profitability we are delivering as a larger company, I’m even more pleased with how our year-to-date 2019 results validates our progress towards our strategic goal.

[Dave Rockvam:]

Thank you, Dave, and good morning, everyone. As our results for the quarter clearly demonstrated, we are firing on all cylinders and we are continuing to recognize meaningful financial benefits as well as operational and sales process efficiencies as we move forward in our ongoing integration with AppRiver. Now let’s talk about the numbers in more detail. At the end of the third quarter, our ARR totaled $200.3 million, up 167% from Q3 of last year and 18% on a purely organic basis. On a combined basis, cloud-based ARR now makes up over 80% of total ARR. For the third quarter, we had just over 102% net dollar retention which represents our renewals plus our 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. Revenue for the third quarter increased 168% to $47.8 million from $17.9 million in the same quarter last year. With $47.8 million of revenue, we exceeded our guidance for the quarter.

[David Wagner:]

Thank you for the financial overview, Dave. I will now review our progress executing our strategy to become the leading provider of cloud email security, compliance and productivity solutions for companies of all sizes in the context of our three main growth drivers. Then I will provide an update of where we are with the DeliverySlip integration before we open the call for questions. As a reminder, our three growth drivers are new orders to new customers, sales to existing customers and increasing retention. Our first growth driver is new orders to new customers. During the third quarter, we saw demand for all of our solutions from customers and many industry profiles. Notably, only one deal was in healthcare and only one was in finance, our traditionally strongest verticals. The other three were a homebuilder, a charitable organization and a restaurant chain. What these latter three have in common is that they are all enhancing their compliance posture to better protect their financial or healthcare data in their custody. The largest win in the quarter was a mid-six figure deal with one of the largest non-profit healthcare systems in the U.S. to provide encryption and outbound compliance filtering for more than 100,000 employees. This customer left Zix in 2018 as a result of cost concerns associated with the migration Office 365. 16 months later, they moved their cloud email to G Suite and re-contracted with Zix. This win highlights both the value of the Zix solution for our customers and also the importance of supporting all mail environments. The new finance win during the quarter was a regional bank who purchased three services; encryption, threat protection and Office 365. As I mentioned, the other three top five wins in Q3 came from a variety of different industries. As many of you know, we are historically strong in compliance-oriented verticals. So to see growing demand from a variety of other verticals is a positive sign for us. Also notably, it was the first time that a Zix’s archive customer made the top five as a standalone offering, demonstrating the traction that we’re seeing to that solution. We are also continuing to see strong momentum with our MSP partners. We added approximately 1,500 net new customers to the AppRiver family in Q3 bringing our total number of AppRiver end customers to more than 66,000. We also added 29 net new partners, bringing our total number of monthly transacting AppRiver partners to 4,251. The AppRiver MSP motion is a trial and buy model where we and our partners drive demand to our portal for the end customer to start a 30-day free trial. We, again, conducted more than 8,000 trials for the third consecutive quarter and we have now conducted more than 27,000 trials year-to-date which is up 36% from the same period last year. The other great thing about our try and buy model is that we enjoy extremely strong conversion rates of about 90%. Now let's take a closer look at our second growth driver, which is sales to existing customers. Two of the top three add-ons came from the government vertical. Two were in healthcare and the final add-on was in the finance vertical. Our top add-on customer which wasn’t healthcare purchased Office 365 as well as encryption and advanced threat protection. Our second largest add-on was a county government that purchased archiving, advanced threat and Office 365 to augment their existing ZixEncrypt solution. One of the other top five add-ons were one is for ZixArchive and the last two add-ons expanded their existing ZixEncrypt deployments. In total, of the top five add-on group, they increased to an average of 2.2 solutions per customer demonstrating again our success in increasing attach rates. Looking at our results for the third quarter by solution area, productivity ARR increased by 7% sequentially to $87.6 million which represents an increase of 23% year-over-year. Average revenue per user or ARPU of $103 was essentially unchanged from last quarter. Net of churn, as I mentioned, we added more than 54,000 mailboxes in the quarter. Encryption ARR was essentially unchanged sequentially at 72.8 million and was up 6% year-over-year. ARPU was down 2% sequentially to $17.96, primarily as the result of the volume pricing granted to the largest new customer wins. Our encryption seats grew by 61,000, again net of churn. Advanced threat protection ARR actually decreased 2% or $300,000 to 22.8 million in the quarter. This decrease was primarily the result of a price increase that I mentioned on last quarter's call. Our ARPU was up 2% quarter-over-quarter to $13.34 was up 18% year-over-year contributing to a 26% total year-over-year growth in this solution category. I think it’s worth mentioning that approximately 220,000 of the 1.7 million advanced threat seats are on the Roaring Penguin solution that AppRiver acquired before we acquired them. We may experience excess churn of these seats as we migrate this mostly on-premise customer base to the cloud over the next four to five quarters. Our emerging category grew 8% quarter-over-quarter to 17.1 million of ARR driven by growth in both our archiving business and in total defense, our consumer endpoint business. Moving on now to our third growth driver, increasing retention. As Dave mentioned, our total company gross retention was 102%, up from 101% last quarter and was over 100% for the third consecutive quarter. Increasing retention is one of the key drivers of our increasing overall revenue and ARR growth, so we are really pleased with the success we’re having to-date as a larger combined company. As we continue to process to more tightly integrating the company, we plan to continue to migrate more partners and customers to the new AppRiver-based platform. We had great success transitioning hundreds of customers last quarter. We will be transitioning hundreds more this quarter and then thousands in the first half of next year. We believe the migration to the newer platform will ultimately result in higher retention and attach rates, but could cause some churn in the shorter term. All-in-all, we are really pleased with our improving customer retention and see it as another validation of our core strategy. I’d like to focus my final remarks sharing more detail on why I see our Q3 results as validating our core investment thesis around AppRiver. Of course, our success selling more than 54,000 net productivity seats primarily through our MSP partner base, resulting in 7% sequential growth and 23% year-over-year growth in productivity supports our first core assumption that email boxes will continue to rotate to the cloud. The second core assumption was our ability to cross-sell. As I mentioned earlier, the number of ZixEncrypt and ZixArchive trials more than doubled quarter-over-quarter early support of our cross-sell opportunity. The cross-sell example that I’d like to spend a little more time drilling into though are the Office 365 cross-sell into the Zix customer base. In the third quarter, we closed 27 Office 365 accounts through the Zix channel, up from 13 in the second quarter. Of the 27 Office 365 accounts in the third quarter, 9 were net new accounts and 18 were sales into the installed base. There are a couple of key points of validation in these wins. First, the number of wins was up more than 100% quarter-over-quarter demonstrating that the market is responding to this packaging. Second, two-thirds of the 27 wins were dark to cloud projects, meaning that prior to contracting with Zix and AppRiver, the customer was still running an on-premise exchange server. This validates our pre-acquisition survey work showing that the majority of the Zix customer base is still on-premise for the mail server and that their looking for a trusted partner to support their transition to the cloud. The third point of validation is around our partner-first strategy. In the third quarter, we added 10 existing Zix partners to our community of partners that can resell the Office 365 bundles, including the Zix IP. We were not expecting this level of partner traction this soon and we are also pleased with the support Microsoft is providing in our focus to expand our channel program. The fourth point of validation is the attach opportunity. The average number of services for these Office 365 add-on customers is 2.8 versus our overall average of 1.2, clearly demonstrating the opportunity for us to continue to drive our attach rates higher. The great results above are being achieved only as a result of the high level of collaboration and teamwork between all of my Zix and AppRiver colleagues. I get to see every day how well the Zix/AppRiver team is executing to deliver phenomenal value for our partners and customers. These results are a little harder to demonstrate objectively, but I do think it’s important that you hear about some of the major accomplishments the team is driving that will come to market in 2020. As an example, I’d like to share more about our DeliverySlip acquisition integration. Not only have we delivered strong retention rates for our different customers with net customer revenue retention of 97%, but we are also beginning the cross-selling motion of large file transfer earlier than anticipated with nine customers that the Zix go-to-market team added in Q3. We are getting really strong feedback from the Zix customer and partner base about this added capability. We completed the migration of the technology fully under Zix/AppRiver control and into our datacenters in Q3 and the roadmap has been flushed out giving us confidence that we will deliver a Zix branded integrated large file transfer capability in Q1 with exciting further enhancements coming in the quarters ahead. In conclusion, the third quarter was another major step forward with many key milestones validating our strategic direction. We are continuing to make great progress as one combined larger team and the combined efforts of our go-to-market team are driving increased sales activity across both go-to-market motions, and increasingly across our complementary product offerings. With our organic ARR growth expanding to 18% last quarter, we have the visibility to increase our full year 2019 guidance. And heading into the end of the year, we expect to improve our profile of profitable growth through enhanced cross-selling and increase attach rates. This success should allow Zix to continue revenue growth and profitability improvements into 2020 and beyond. That concludes our prepared remarks. Operator, we’re ready to open the call for questions.

[Operator:]

Thank you. . Now our first question will come from Mike Malouf from Craig-Hallum. Please proceed.

[Mike Malouf:]

Very well done on this integration so far. With regards to that, I’m wondering if you could frame for us just a little bit of the opportunity with the Zix selling of Office 365. That was always sort of in your back pocket with regards to the ability to cross-sell that direction and I’m just wondering if you could go over your sort of current thoughts about the size of that opportunity as you’ve had a little bit of experience here? And then if you could also tag onto that as you look into DeliverySlip and putting out a Zix branded large file transfer product out, how significant that could be for 2020 if you’re successful? Thanks.

[David Wagner:]

Those are great questions, Mike. So as we plan the Office 365 cross-sell into the Zix installed base, we built our initial functions looking at the 1.3 million encryption customers in accounts with less than 250 users. And so that opportunity translated to $20 million to $25 million of ARR. What we’re seeing in the first, whatever it is now, 40 accounts sold, we’re seeing an average mailbox size of closer to 150 on average. So we’re seeing better traction into slightly larger customers than we would have originally expected. So we’re still early in the 40 transactions, but it’s looking like 250 was lower than where we’ll see good traction. I would expect to see the average coming down as we get into more and more accounts. But the fact that we’re running at average well over 150 tells me that we can move up higher than just the 250 in lower accounts that we originally modeled. So that would indicate some upside over time from that area. Moving on to the large file transfer question, as I talked about when we closed the transaction, the survey work prior to that acquisition suggested an opportunity for really high attach rates for large file transfer to the existing Zix offer, and we are getting really good feedback as we introduced this capability to customers. We are the place where they expect to get that functionality. We had a meeting yesterday with a partner who has really big roots since the title industry and she is conveying real appetite for that segment, but of course it varies subject to wire transfer product and need strong protection of their information. So that is a little bit ahead of schedule and I’m expecting good things from that as we head into the back half of next year.

[Mike Malouf:]

Okay, great. Thanks a lot. I appreciate the help.

[David Wagner:]

Thanks, Mike.

[Operator:]

Our next question comes from Tyler Wood from Northland Securities. Please proceed.

[Tyler Wood:]

Thanks for taking our questions. When you talk about the trials of the Zix security just going back into the AppRiver base, are those still all free trials at this point or should we expect that to start showing up in billings in 2019 or we have to wait for 2020 for those to turn from trials to signings?

[David Wagner:]

No, the trials turn to orders on the 31st day unless they’re cancelled. Our overall rate is 90% conversion, so we’re not at that 90% yet. We’ve got a lot of partners trying it and then backing out, but the conversion rates are strong. So we’re seeing early numbers. What’s encouraging to me even though the absolute numbers aren’t really big or even meaningful yet from an ARR perspective, we are seeing the existing customers once they convert adding more and more users. So it’s building on a nice snowball effect. So we are on track with what we expected in terms of cross sell. We’re really honing our messaging and our marketing work as we come into the fall to accelerate those trials further, but I don’t expect a material ARR impact in this year and I expect that to move in more materially next year.

[Tyler Wood:]

Great, that’s helpful. And then just higher level on Office 365 opportunity. How penetrated do you think Office 365 mailboxes are within the SMB market more broadly? And then anything worth mentioning on Microsoft’s strategy in terms of securing those with their stuff?

[David Wagner:]

Yes, so those are both great questions. We had a pretty thorough survey into the Zix base prior to acquisition that has us seeing 30% to 40% of our mailboxes to the cloud, so the majority is still on prams . We don’t have a tighter survey work into the smaller customer base through the MSPs, but the accelerating mailbox adds that we’re seeing indicate that we’re still in the early middle innings on the smaller business as well. So we see a really strong appetite for this transition to the cloud. As I mentioned in the script, one of the things that’s becoming more and more clear to me is the value that the AppRiver implementation and support team provides to our partners and customers as they make that transition. An end customer is going to make that transition once. A smaller partner may make a mailbox migration once or twice a year. And we are there with the we have done in nearly 1 million mailbox migrations to really support them and add a ton of value. In the overall Microsoft ecosystem and now having met nearly monthly with the Microsoft go-to-market leadership team, we’re now understanding how well they see us fitting into their ecosystem is providing this value as a hyperscaler would be their term – as a hyperscaler into the SMB, SMC and SME space. So that all feels really good. Microsoft is a great company executing great things and they’ll continue to build good products. Security will continue to be important to them and a focus. But they understand and fully support a broad ecosystem of ISVs, they always have, to help with specialized used cases. So most acutely our ZixArchive can archive Slack teams and LinkedIn channels that the Microsoft archive doesn’t support and in some cases probably will never support. And so we’re adding real value and compliance-oriented used cases on top of the Microsoft’s version and they see that as really beneficial to building out their ecosystem. So we fit in a position where we support Microsoft on both sides of what they’re trying to do. On the SMB side, we enable this on-boarding transition support and ongoing care of the customers that they don’t have coverage for. And on the higher end we provide really strong specialized used cases for security compliance that they don’t need to want to build into their core system. And if you think about the financial vertical and the healthcare vertical, there are lots and lots of medium-sized businesses; SMEs, SMCs and SMBs that need that level of compliance and security as regulations advance, as cybersecurity concerns become more acute to our market. So we really like our position and Microsoft appears to like it as well.

[Tyler Wood:]

That’s helpful. Thank you.

[David Wagner:]

Thank you.

[Operator:]

. Our next question will come from Nick Yako from Cowen & Company. Please proceed.

[Nick Yako:]

Hi, guys. Thanks for taking my questions. Could you comment on the international business and how you’re thinking about the opportunity outside the U.S.? And then maybe where you are in terms of the build-out and any additional near-term investments you plan on making?

[David Wagner:]

That’s a great question, Nick. Thank you. So international is still really early stages for us. I mentioned on the last call that we had doubled our UK ARR in the first half of the year and that team continues to execute really well doubling from 1 million to 2 million, so adding $0.5 million to the quarter. They remain on that trend. We added I guess a few people to that team late in the summer building for 2020 continued growth, and so we feel really good about that team. We feel really good about how our value proportion and platform supports customers in Europe and we see the European transition to the cloud being earlier in transition with a longer term. So we will be making measured investments to extend our international presence. But I would expect them to be measured investments in the coming year.

[Nick Yako:]

Okay, that’s helpful. And then one just quick follow up. Dave, you mentioned a billings drag from OEM. Just wondering if you could provide any more details around that and when that should normalize?

[Dave Rockvam:]

Yes. We would expect it to normalize early next year. In 2018 and then the beginning of the year 2019, we were ramping down on Cisco, Google and Semantic in particular OEMs as we moved away from that as part of our strategy moving more towards the MSP model being the best model for the go-forward Zix/AppRiver platform. So in 2018, we ramped those down. We did see some incremental billings to kind of finish those off, so we’re kind of bumping up against those numbers as they were kind of done as more I guess a larger one-time kind of billing. And then this year those billings kind of came through a little more – as those customers moved our direct platform, those come through a little bit more across the quarters, so that can clean up. And then the Semantic we’ve got a handshake on having that cleaned up for the quarter. So we didn’t end up doing any of the billings as we wrapped that up. It’s going to end up in a good position where this 1.5 million of ARR that we have there, we’ll have for quite some time in the future with the way we’re closing it off and it’s finishing up almost exactly with where we had planned it in Q2, so feel good about that. So we’ll come through that by the end of the year as those finish up and expect to start moving up better in the coming quarters from there.

[Nick Yako:]

Okay, great. Thank you.

[David Wagner:]

Thank you.

[Operator:]

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

[David Wagner:]

I’d just like to thank everybody again for joining us early this morning. We wish you a great and productive day.

[Operator:]

Thank you for joining us today on Zix’s third quarter 2019 earnings call. You may now disconnect.