Zix Corporation
Q2 2016 Earnings Call Transcript

Published: 27 Jul 2016

[Operator:]

Good afternoon and welcome to Zix's Corporation Second Quarter 2016 Conference Call. My name is Andrew and I'll be your operator this afternoon. Joining us for today’s presentation is the company's President and CEO, David Wagner; CFO, David Rockvam and Vice President of Marketing Geoff Bibby. Following their remarks, we will open up 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, Andrew. Good afternoon, everyone and thank you for joining our second quarter conference call. With me today is our CEO, David Wagner and new CFO, David Rockvam. After the market closed, we issued a press release announcing our results for the second quarter ended June 30, 2016, a copy which is available in the Investor Relations section of our website at zixcorp.com. Please note that during the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the company. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. It’s important to note also that the company undertakes no obligation to update such statement. We caution you to consider risk factors that could cause actual results to differ materially from those in the forward-looking statements contained in today’s press release and in this conference call. The Risk Factors section of most recent Form 10-K filing with the SEC provides examples of those risks. During the call, we’ll present both GAAP and non-GAAP financial measures. Non-GAAP financial measures are not intended to be considered in isolation from of substitute for or superior to our GAAP results. We encourage you to consider all measures when analyzing the company’s performance. A reconciliation of certain GAAP to non-GAAP measures is included in today's press release, which can be found in the Investor Relations section of our website. During this call, Dave Wagner will begin with his opening remarks. Then Dave Rockvam will walk us through the financial details for the quarter and our financial outlook. Afterwards Dave Wagner will return to discuss our operational highlights, key initiatives and business outlook. Then we will open the call to your questions. Now I’d like to turn the call over to our CEO, Dave Wagner.

[Dave Wagner:]

Thanks Geoff. Good afternoon and thank you everyone for joining us today. Our financial performance in the second quarter was strong across the Board. Continued demand from both direct and indirect customers for our industry-leading email security solutions was a key driver in our ability to exceed our quarterly revenue guidance and delivered double-digit adjusted EBITDA and adjusted EPS growth. The quarter was also highlighted by the achievement of several company records, including records for annual contract value, customer retention, and new first year orders. These results demonstrate how we are continuing to execute on our strategic initiative to secure new and larger wins in the increasingly important email security market. So before I discuss more about our operational highlights and outlook, I would like to introduce our new Chief Financial Officer, Dave Rockvam who joined our team about a month ago. Dave brings a wealth of experience in the data security market as well as more than 20 years experience in Investor Relations, financial planning, and business and corporate development. I'm confident his experience, energy, and business acumen will prove to be instrumental in helping us scale the company for future growth. So with that, I'd like to turn the call over to Dave, who will walk us through the financial details for the second quarter. Dave?

[David Rockvam:]

Thank you, Dave for the warmer [ph] introduction and good afternoon, everyone. It's a pleasure to have this opportunity to speak with you today. I just want to start by taking -- talking a little bit about what attracted me to Zix and where I think I can ultimately bring value to this organization. In my career, I’ve spent more than two decades in the data security industry, managing significant P&Ls and learning what it takes to help run a successful SaaS business. Whether it's from a finance, business development, or management perspective, Zix has always been a company that attracted my attention because of its industry-leading solution, strong financial base, and compelling subscription business model. I joined Zix because I saw tremendous opportunity to apply my deep industry experience in fast focused businesses. In particular, I believe I have what it takes to not only help the company further embrace the SaaS business, but also to help Zix build on a strong position in email encryption market where I can proudly say, we have one of the most versatile, convenient, and easy-to-use solutions out there today. Looking ahead, my golden objective as CFO would be to further strengthen and capitalize on our healthy financial position, provide important strategic insights to help maximize our profitable growth initiatives, and actively interface with the investor community to promote our unique market position and competitive advantages. With that, I'd like to now turn to our financial results for the second quarter ended June 30, 2016. Revenue for the second quarter increased 12% to $14.9 million from $13.3 million in the same quarter last year. This increase exceeded our revenue guidance range and was driven by the addition of recurring revenue from new customer contracts, strong revenue retention, and a non-recurring revenue catch-up payment of approximately $250,000 from Google. This particular payment involved us working with the OEM partner to go back and renew certain expired customer accounts. New first year orders for the quarter were $3 million, an increase of 20% over Q2 of last year as well as a new company record. The record performance was driven by strong bookings from the enterprise direct sales team. These bookings included a $640,000 new first year order from a cyber security provider that has built a service offering incorporating only the best-in-class solutions. It goes without saying we are pleased to be selected as their email encryption partner. On a GAAP basis, our gross profit for the second quarter increased 13% to $12.3 million from $10.9 million in the second quarter of last year. As a percentage of total revenue, our gross profit for Q2 2016 was 82.4%, a 70 basis point improvement from 81.7% in Q2 of last year. Our GAAP operating income for the quarter was $946,000 or 6.3% of total revenue compared to $1.7 million or 13% of total revenue in the same period a year ago. The decrease was primarily due to severance payments associated with the change in the CFO position as well as $1.1 million of legal expenses associated with some pending intellectual property litigation. It’s worth mentioning, however, we did successfully filed a dispute with a technology company in the second quarter, which resulted in a cross licensing agreement with no cost to Zix outside of the legal fees. This just goes to show that we will not hesitate to commit our capital for the protection of our highly-valued patent portfolio and we will continue to do anything we can to ensure our solutions receive the integrity they deserve in the marketplace. Our GAAP net income totaled $559,000 or $0.01 per diluted share. This compares to $1.1 million or $0.02 per diluted share reported in the second quarter of last year. Regarding income taxes, we expect to continue reporting non-cash income tax expense consistent with the amount for last year resulting in an effective GAAP tax rate of approximately 39%. This expense is largely non-cash due to our NOLs. We expect the cash component of our taxes to remain low going forward. Turning to our non-GAAP financial metrics, which exclude non-cash stock-based compensation expense, non-cash tax expense, executive severance, and expenses related to litigation, our adjusted gross profit was $12.4 million or 82.7% of total revenue. This was an improvement from $10.9 million or 82.1% of total revenue in the second quarter of 2015. The increase was primarily due to higher subscription revenue during the period. Our adjusted R&D expenses were $2.2 million, which were up from $2 in the second quarter of last year. As a percent of total revenue, our adjusted R&D expenses in Q2 2016 were 15%, which was down slightly compared to the 15.3% for the same period a year ago. Our adjusted selling and marketing expenses for the second quarter of 2016 were $4.9 million or 33% of total revenues compared to $4.7 million or 35.6% reported in the same period a year ago. The increase was primarily due to investments we’re making to strengthen our brand, increase our market presence, and enhance our professional sales capabilities so that we can accelerate our growth. For the second quarter of 2016, our adjusted general and administrative expenses were $1.9 million or 12.5% of total revenue. This $1.9 million is about flat from the amount we reported in Q2 of last year. Our second quarter non-GAAP adjusted earnings per fully diluted share, totaled $0.06, which is consistent with our guidance for the period and a $0.02 or 63% improvement over the second quarter last year. And finally our adjusted EBITDA for Q2 2016 increased 39% to $3.9 million from $2.8 million in the same period a year ago. As a percentage of total revenue, adjusted EBITDA improved from 21.3% to 26.3%. This level of adjusted EBITDA margin is consistent with our long-term objectives and demonstrates that we have a sound business model that affords us the ability to continue achieving profitable growth. Please see today's earnings release, which is posted on our website for further details including reconciliation of GAAP to non-GAAP results. Cash flow from operations for the second quarter of 2016 was up 15% to $3.5 million from $3 million in the same period year ago. During the quarter, we used $8.8 million to repurchase approximately 2.3 million shares of our common stock at an average price of $3.88 per share. As of early July, we now have fully exhausted the $15 million share repurchase program we implemented in January. Find back a total of 3.8 million shares of our common stock at an average price of $3.92 per share. We continue to maintain a strong balance sheet with $20.7 million in cash and no debt. CapEx for the quarter was $1.1 million and have planned to be approximately $2.4 million for the year. The increase in CapEx for the quarter from our -- the increase in CapEx for the quarter from our initial forecast provided on our last earnings call was due to the demand for hosted solution being higher than anticipated, which required additional investment of fulfilled demand. Overall however our CapEx for the first half of 2016 was still less than our CapEx for the same period a year ago. Our backlog, which represents the dollar value of committed contracts, was a record $80.9 million as of June 30, 2016, which was up $7 million or 9.3% compared to the same date last year. Of this record amount, we expect to recognize approximately $44.6 million or 55.2% as revenue over the next 12 months. Later on the call, Dave Wagner will discuss more about our key metrics regarding our financial performance and progress against what we highlight as our seven growth pillars. I would just like to add that I feel strongly about our performance in the quarter and I’m confident that we can execute on the seven growth pillars of our long-term strategy. Over the years, the company has demonstrated that it's capable of producing a robust and growing subscription revenue stream along with making the right investments in our core Email Encryption Solutions that can generate profitability and cash flow. Now the Leadership Team is focused on leveraging that past success to help drive Zix to the next level of growth and profitability which will be an exciting new chapter within the company and one I am pleased being part of. Now shifting gears to our financial outlook for the third quarter ending September 30. We currently anticipate revenue to range between $15 million and $15.1 million, representing an increase of 7% to 8% compared to Q3 of last year. We're forecasting fully diluted GAAP earnings per share to be between $0.01 and $0.02 and non-GAAP adjusting -- non-GAAP adjusted earnings per fully diluted share to be $0.06. For the full year ending December 31 based on our year-to-date results and pipeline of business, we anticipate revenue to range between $59.6 million and $60.2 million. This would represent an increase of 9% to 10% compared to revenue in 2015 as well as narrowing the range on the low and high side as we tighten our forecast. We forecast fully diluted GAAP earnings per share to be between $0.06 and $0.08 per share. We continue to forecast non-GAAP adjusted earnings per fully diluted share to be $0.24, representing a 14% increase from fiscal 2015. This completes the sales analysis of our financial results. Please reference our Form 10-Q, which we plan to file by August 3. Now I’ll turn the call back over to Dave.

[Dave Wagner:]

Thanks for the overview Dave. Between my opening remarks and Dave’s more detailed financial review, you can hear that a lot of things that like for us in the second quarter and we are encouraged with the overall result. Now I'd like to provide a little more detail on how the early successes we achieved in Q2 connect to our longer-term objective that the leadership team and I laid out for the company. Some of you may not have had the opportunity to participate in our Annual Shareholder Meeting or webcast on June 8, so I will repeat the seven growth pillars that the team and I are focused on. First, securing new customers to our direct sales force and expanded focus on a network-of-bars and MSPs to augment our sales effort. Second, accelerating growth through our OEM partners Google and Cisco. Third, expanding the number of user licenses within our current customer base. Four, up-selling more of our products to increase average revenue per user; fifth, further increasing our renewal rate with existing customers; six, investing in our core email encryption solution and finally seventh, exploring English-speaking international markets to present attractive opportunities to expand our business. Our record new first year orders of $3 million, which increased 20% year-over-year speaks for themselves. So now I’ll go ahead and share a little more detail about them. 55% of our new first year orders were delivered through our direct sales effort, 36% through bars MSP, 7% through our OEM partners and finally 2% from web sales. Our success driving new first year orders in the quarter was largely generated from our team that focuses on enterprise with more than 1001. Dave talked about the large cyber security service provider that we sold to during the quarter, but even excluding this order, we achieved the highest enterprise new first year orders since 2007. In addition to the record value of enterprise new first year orders, I'm particularly pleased that 80% of our enterprise sales reps are at or above quota at mid-year. The successive enterprise has three primary drivers. First, we're recruiting from within our organization to support our expanding sales force, which enables us to reduce the training time for enterprise rep. This allows them to hit the ground running and immediately add value to our end customers in the sales process. Second, the adoption of cloud-based email solutions like Microsoft Office 365 by enterprise clients is driving them to reexamine their email security requirements. When enterprise client reevaluate their risk in the current environment, they often choose a best-in-class email encryption solution like Zix. And finally the third key driver is the increasing need to email encryption. We're being told by leading analyst firms that inquiries from their enterprise client base for encrypted email solutions fill up 35% year-over-year. As the undisputed leader in email encryption space, we are well positioned to take advantage of these enterprise trends. Looking at the OEM side, the 7% contribution to new first-year orders was less than we expected even though our overall new first year orders result was particularly strong. Despite being lower than expected, we remain on track for increasing the contribution from our OEM partners this year. Cisco in particular, delivered a top 20 U.S. financial execution in the quarter. These are the kinds of enterprise clients that we're targeting in the early stages of our relationship. Our pipeline with Cisco continues to be build albeit at a slower more deliberate pace that we previously communicated on 2016 earnings call. With respect to our third growth pillar extending a number of user licenses within our current base and our record new first year orders quarter, we had strong sales enter the base as well as into new account we're 30% of our new first year orders came from existing accounts and 70% from new accounts in the quarter. A great example of the enterprise trend I mentioned earlier occurred in Q2 with a win at a North Texas Healthcare Provider, who was previously using Microsoft message encryption. After they moved to the cloud the Compliance Officer contacted a Zix partner expressing extremely frustration with Microsoft cloud-based email encryption solution. They also wanted a solution that they could deploy rapidly and easily to new practices as they continue to grow through acquisition. Based on those requirements, that healthcare provider purchased 1,000 seats of ZixGateway and 2,000 seats of ZixQuarantine. In addition to attracting new customers, we are keenly focused on our fourth pillar, which involves up-selling more of our product, particularly ZixQuarantine and ZixInsight into our existing base. On June 1, we announced the availability of ZixQuarantine and ZixInsight to our hosted SMB customers, and we achieved our first sale soon to this segment of our base in the first month of availability. In total we sold a combined $200,000 of ZixQuarantine and ZixInsight new first year orders in the quarter increasing our ACB 57% year-over-year for $1.2 million. We have still penetrated less than 10% of our installed base and over time we expect this number will continue to grow. Finally, with respect to our fifth growth pillar, which focuses on increasing our renewal rate, we received a Google catch-up renewal of approximately 250,000 in the second quarter which Dave mentioned earlier. This catch-up renewal helped drive our revenue number above our guidance level for Q2. The focus on increasing the renewal rates also resulted in us achieving the highest core renewal rates since we've been tracking that metric for the last five years. We will continue to look for ways to improve our renewal rates. Investments in products and market expansions growth pillars six and seven, are activities that the leadership team continues to focus on and you can expect to hear more about that in future quarters as our plans move to actionable items that we will use to demonstrate our progress. Before I close, I’d like to update you on just a few more additional metrics. First, total orders were up 18% year-over-year to a record $20.4 million and as Dave mentioned earlier these orders brought our backlog to a record $80.9 million. Last quarter we introduced the staff metric annual contract value or ACV. ACV represents annual contract value of our customer subscription. As a SaaS business, we believe this particular metric is more telling of our highly recurring business model and provide greater visibility and understanding of the state of our business. Our ACV at the end of the second quarter totaled a record $59.5 million and was up 9% from Q2 of last year. From an industry perspective, the breakdown of our annual contract value was 51% from healthcare, 27% from finance, 7% from government and 15% from other vertical. Now breaking down ACV by product, Zix email encryption, our flagship product accounted for $57.3 million of total ACV, which was up 8% from Q2 last year. ZixQuarantine and Insight our DLP products that I previously mentioned totaled $1.2 million of ACV up 57% from Q2 last year. And finally, ZixOne our bring-your-own device security product had ACV of $1 million up 24% year-over-year. We're encouraged by our financial performance in the second quarter, which we believe represents an early validation of the work we’re doing as a team to execute on our growth pillars. Other than new first year order pipeline outlook for the current quarter is not as strong as the outlook we had coming into second quarter, we are well on track to execute our plan for 2016 and we look forward to building on our success this year and beyond. So in closing, Zix is in a very strong market-leading position in email encryption market. Recent news that Democratic National Committee Email Server hacked, highlights the vulnerability of unprotected data and the importance of protecting email with encryption. Our solution is by far the most complete and comprehensive email encryption solution in the industry and it is backed by an extremely deep and talented team that cares as much about protecting our customer’s businesses as they do. This provides us a great opportunity to expand our market-leading position. I'm proud to be a part of this team and I remain enthusiastic about the opportunities ahead of us. And now with that, we’re ready to open the call up to your questions. Andrew?

[Operator:]

[Operator Instructions] And our first question or comment comes from the line of Mike Malouf with Craig-Hallum Capital. Your line is now open.

[Mike Malouf:]

Great. Thanks guys for taking my questions. Can we start off with just a $650,000 from the cyber security company? Can you tell us a little bit more about that and what that means for you and is there another big opportunity there with this company as they -- I just didn’t quite understand that so, if you could help us with that, that would great?

[Dave Wagner:]

It’s a firm we’re really pleased to partner with. It’s a firm that’s focused on verticals in the market where we're not particularly strong, so it is highly complementary. It's an opportunity where they’ve got existing customers that they believe have demand for their solutions and they have a base where they expect to be able to extend that. But for now, it starts out as a really strong relationship as Dave said where they’ve chosen a best-in-class encryption product to work with their overall cyber security offering they provide to the client.

[Mike Malouf:]

And so this initial order is for what? Is it like -- is it for a particular customer that they had or what is it?

[Dave Wagner:]

A set of customers, yes.

[Mike Malouf:]

A set of customers. Okay. So it’s like an initial sale that they have done and then they’re going to come back to you with more if they're successful in rolling this out.

[Dave Wagner:]

Yes, there’s no -- yeah.

[Mike Malouf:]

Okay, great. And then…

[Dave Wagner:]

We felt they would expect it to have growth over time.

[Mike Malouf:]

Say that again I’m sorry.

[Dave Wagner:]

Nothing required, but the expectations in both parties particularly to grow that business.

[Mike Malouf:]

Okay, great. And then is the $250,000 catch-up order from Google, is that in the new first year orders or is that not in there?

[Dave Wagner:]

No, we don't count that in, in many ways, we just don't, and the reason we don’t is that they went back and paid for the month they were using, and paid us -- it works like a renewal.

[Mike Malouf:]

So is this sort of a one-time fee into the revenues?

[Dave Wagner:]

Yeah, it’s just -- yeah, it’s a one-time fee. We’re catching up and we would expect them to remain clients [indiscernible].

[Mike Malouf:]

Got it. And then my last question, can you talk a little bit about the Cisco relationship? You talked about it being a little bit weaker and slower to ramp than you had hoped. What’s going on there and why is that?

[Dave Wagner:]

So we've been pretty consistent with our messaging since I’ve been here, but it’s taking longer to get a bigger strategic client engage. We had a couple of milestones we met this quarter. We met the milestone of completing the ZPT roadmap we had quite available in Q4, but the complete roadmap product is delivered in late April or early May, it’s one of the big milestones for us. We had the milestone that I mentioned on the call of a top 20 financial institution that being a kind of enterprise. Clients we’re addressing had great visibility at the Cisco live event in Vegas a couple of weeks ago. So we’re seeing the kinds of strategic interactions. We’re seeing a building pipeline. We’re seeing – it’s taken time. There’s two levels at a time. The first level is getting a go-to-market team in motion at Cisco, incorporating it, and then there’s a sales cycle. We’re initially focused on larger enterprise client counts which have their own sales cycle that goes with it. So yeah, we would have liked more, but we are still confident that we’re going to have a good year with them.

[Mike Malouf:]

Okay, great. Thanks for taking the questions.

[Dave Wagner:]

Well, thanks Mike.

[Operator:]

And our next question or comment comes from Joe Maxa with Dougherty & Company. Your line is now open.

[Joe Maxa:]

Thank you. Hi, guys. The $650,000 order, that was a first year order, new first year order?

[Dave Wagner:]

That’s right.

[Joe Maxa:]

Okay. So that’s just one year in length and that will come back perhaps every year. Is that how we should think about this going forward?

[Dave Wagner:]

Yes. David mentioned but it’s a three year commitment of which the new first year order amount was approximately $650,000.

[Joe Maxa:]

Okay. So then, would we expect it to be the same amount each year?

[Dave Wagner:]

That would be the expectation. We will be working with them to help them continue to grow -- to grow their business. But right now, that is the first year orders we get it, and we actually hope they will still grow. But it would be a recurring part of the business.

[Joe Maxa:]

Okay. So help us handicap new first year orders for Q3 obviously not as strong as Q2 as you mentioned, but look back two years it was pretty weak, last year I think it was maybe a record at the time. Are we looking low 2s or are we looking more like two years ago, more like last year, how does the -- what does the pipeline suggest?

[Dave Wagner:]

Yeah, your question was actually answered [ph] better than I could. [Indiscernible] the new first year order number moving up and down, most things, the focus on making sure in moving average perspective continuing to move up. So we had as you know a lower in fact Q1 a really nice Q2. We’re expecting something in between that, and this is really my second full quarter. And last quarter, I mentioned the pipeline felt stronger than it was in the first quarter. From where I sit today, the pipeline was not quite as strong as it was last quarter especially more in between where the last couple of quarters have been.

[Joe Maxa:]

Okay. And then you did mention retention being the strongest on record, do you have some metrics that you can share what exactly that retention is?

[Dave Wagner:]

We’re getting closer to being able to really roll that out. We probably have at least one more quarter of work, maybe two more to get a full retention getting [ph] down the way that I think is supportive. But that core number is we have a team that focuses on the majority, the vast majority of our customers, and that team [indiscernible] for five years and they kept very careful records of what Zix core, which represents over 80% of our ACV that’s the one that achieves our record, which was over 90% in the quarter as we get it, tighten down, I expect to be able to give you tighter numbers, but that’s out for now.

[Joe Maxa:]

Okay. All right. Thank you.

[Dave Wagner:]

All right. Thank you, Joe.

[Operator:]

[Operator Instructions] And our next question or comment comes from the line of Michael Kim with Imperial Capital. Your line is now open.

[Michael Kim:]

Hi, good afternoon guys. Can you talk about maybe or quantify the expansion in enterprise sales capacity and where internally are you including from, is it maybe repurposing some guys focusing insight sales or is there other functional areas?

[Dave Wagner:]

That’s exactly right, we've got to realize sales that can really work the way in the organization as a team about up to probably four different major stellar levels than we’ve been able to successfully move in the past six or eight months. People all the way up and down that chain which is helping us but most acutely what I was talking about was the success we’re seeing most recently in moving folks from our corporate 100 to 1,000 user sales people who are largely inside sales. They’re moving them to the field to focus on larger count working well for us and we’re seeing them nice productivity last there.

[Michael Kim:]

Great. And on the enterprise side, are you seeing the most or highest level interest in regulated verticals or some non-regulated customers starting to become more important?

[Dave Wagner:]

The numbers I gave 51 and 27 healthcare and finance effectively. So the regulated ones are still the core, but we are seeing that other at 15%. It’s definitely increasing in other as well and we’re seeing the other increasing first at the enterprise level as I think is a good trend and one would expect to be a non-regulated enterprise to kind of tickle our head up and particularly as I mentioned as they're looking to shift their Office 365. We look at their environment and the expectation is in line in lot of cases.

[Michael Kim:]

Great. And then with regards to your other OEM partner Google, outside of the catch-up payment, can you provide an update on how that's progressing with game?

[Dave Wagner:]

We’re pretty standard, I guess in total 7% is even a big number. Like I said that’s -- so neither of our OEM partners performed at perfect level. Google was engaged closely with some of those renewals which we like -- it's a well consistent performance from them than it has been for over a year now. So that’s just a consistent performance from Google.

[Michael Kim:]

Okay, great. And then lastly just on BYOD, what’s your sense on ZixOne and the pipeline and some of the customer feedback that you’re hearing for moving to BYOD solution?

[Dave Wagner:]

So the customers for whom that solution fits -- it fits really well. It’s different than the rest of the market as you know Michael. So it’s good, it's up 24%. We had a little more customer attrition in the quarter that with not completely unexpected. So we will continue to see growth there albeit not as fast as we saw last year.

[Michael Kim:]

Okay, great. Thank you very much.

[Dave Wagner:]

All right. Thank you, Michael.

[Operator:]

And 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.

[Dave Wagner:]

Well, thanks again everyone for joining our call today. We appreciate your continuous support and we look forward to speaking to you again in about 90 days on our next call. Operator?

[Operator:]

Thank you for joining us today for our presentation. You may now disconnect.