Zix Corporation
Q4 2008 Earnings Call Transcript

Published: 18 Feb 2009

[Operator:]

Good day ladies and gentlemen and welcome to the Zix Corporation fourth quarter and year end 2008 earnings conference call. My name is Wayne and I will be your operator for today. At this time, all participants are in a listen only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator's instruction) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Peter Wilensky, Vice President of Corporate Development and Corporate Affairs. You may proceed sir.

[Peter Wilensky:]

Thank you, Wayne. Good afternoon and thank you for joining Zix Corporation’s fourth quarter and year end 2008 conference call. This call is being recorded and a replay will be available after the call's conclusion from our website or by dialing 1-888-286-8010 and entering the access code 2789401. This information can also be found at investor.zixcorp.com, which is the investors' portion of our website. Zix Corporation's Chief Executive Officer, Rick Spurr, will begin with an overview of the Company and discussion of our businesses followed by discussion of the Q4 and full year 2008 financial results by our Chief Financial Officer, Susan Conner. Mr. Spurr will then provide closing remarks. Afterwards, we will be available to answer questions from analysts and institutional investors and we will also be taking questions by email which can be sent to our Investor Relations mailbox, [e-mail]. Before we begin, I would like to read a paragraph regarding any forward-looking statements that may be made during this call. This conference call may include certain forward-looking statements that are based on the current belief or assumptions made by or information currently available to ZixCorp's management team. Forward-looking statements may include words such as anticipate, believe, estimate, expect, may, project, would, could, should or other similar expressions. ZixCorp's actual results, performance, prospects or opportunities in 2009 and beyond could differ materially from those expressed in or implied by these statements. Information concerning risk factors that could allow actual results to differ materially from those expressed in or implied by these forward-looking statements is contained in ZixCorp's filings with the Securities and Exchange Commission, as well as in ZixCorp's earnings press release issued earlier today. Except as required by Federal Securities Regulation, ZixCorp undertakes no obligation to publicly update or revise any forward-looking statement for any reason after the date of this call. With that, I am pleased to turn the call over to Rick Spurr.

[Richard Spurr:]

Thank you, Peter. Good afternoon and thank you for joining today’s conference call. Despite the extremely challenging times facing out nation and the world, ZixCorp continues to grow and we believe that our Company remains well positioned to weather this difficult economic environment. We ended the year on a pretty strong note. We exceeded fourth quarter guidance on every measure

[Susan Conner:]

Thanks, Rick and good afternoon everyone. First, I will start with revenue. We achieved companywide revenues for the fourth quarter of $7.2 million which was slightly ahead of our previously provided guidance of $6.8 million to $7.1 million. This is an increase of about $200,000 or 3% over the fourth quarter last year. The fourth quarter revenue was made up of $6.1 million from email encryption and $1.1 million from e-prescribing. The email encryption revenue increased $800,000 representing a 15% increase over the comparable 2007 figure. This increase was driven primarily by our continual addition of new users to the subscriber base while at the same time renewing 93% of the existing subscribers with subscriptions or approved renewal during the quarter. Sequentially, the $6.1 million for email encryption in the fourth quarter compares to $5.6 million for the third quarter or an increase of 9%. E-prescribing revenue for the fourth quarter was $1.1 million, which compares to $1.7 million for the fourth quarter last year. The $600,000 decrease primarily resulted from two things; first, a decline in the transaction or usage-based fees because in the second quarter of 2008, we reached the ceiling of the cap on the transaction or usage-based fees allowed under our contract with the single healthcare payer customers. And secondly, a decrease in deployment related revenues as the rate of new deployments during 2008 of approximately 725 had declined over the 2007 level of 1950. We expect our e-prescribing revenues in the first quarter of 2009 to be relatively flat against the fourth quarter of 2008 in light of the slowdown in deployments during 2008. With the new contracts announced in the fourth quarter however, we do expect our revenues will pick back up again as deployments begin growing in the second half of 2009. For the full year ended 2008, our companywide revenues were $28 million versus $24.1 million for 2007 or an increase of 16%. Email encryption revenues were $22.6 million in 2008 compared to $18 million in 2007 or an increase of 26% and e-prescribing revenues were $5.4 million in 2008 compared to $6.1 million in 2007 or a decrease of 11%. The changes in revenues for each of our business segment between the two years are consistent with the explanations I gave related to the fourth quarter. We ended 2008 with a bookings backlog of $37.4 million which is an 18% increase over the bookings backlog of $31.8 million for 2007. In summary, we are pleased with the year-over-year growth in revenues for email encryption and are very encouraged with the new e-prescribing contracts that we signed during the fourth quarter. Let us now move to our gross margin results and details on our expenses. We achieved an overall companywide gross margin for the fourth quarter of $4.8 million or 67% of revenues. This compares to $4.3 million or 61% of revenues for the same quarter last year. The email encryption gross margin for the fourth quarter was $5.1 million or 83% of revenue which is the highest ever as compared to a margin of $4.2 million or 79% in the same period last year. The improvement was due to an $800,000 increase in revenue and a $100,000 decrease in the cost of revenues primarily related to professional services. These improvements are a natural result of our subscription business model and relatively fixed cost structure. Our e-prescribing gross margin was negative at $200,000 or 21% of revenues compared to a positive $86,000 or 5% of revenues for the same quarter last year. This reduction in our gross margin performance is due primarily to a $600,000 reduction in revenues as reported earlier particularly offset by roughly $300,000 in lower cost to revenues driven from a reduced rate of deployment. Overall, companywide gross margin for full year 2008 was $18.2 million or 65% of revenues compared to $13.2 million or 55% for 2007. I will now move on to operating expenses. R&D and SG&A expenses increase 7% in the fourth quarter of 2008 to $6 million when compared with the same period last year when we spent $5.6 million. This increase was primarily driven by a $282,000 or 21% increase in R&D expenses where we added headcount to support the development of new products and services for both of our product lines. On the topic of operating expenses, I would like to bring to your attention our plan for the coming year as it relates to salary performance raises. Although we do plan to have some targeted hiring during the year, our plan for 2009 does not include any raises for management or their employee group during the year. We are very focused on the weakened economy and have our Company's could be impacted. Thus, we are taking these initial steps to ensure we stay focused on delivering continued financial performance in 2009. Our capital expenditures for the fourth quarter and yearend were $543,000 and $1.238 million respectively. Depreciation expense for the quarter is approximately $307,000 and is recorded in the various P&L line items with the majority or 75% of it being recorded in cost of revenues. Finally, turning to cash flow. The Company had positive cash flow in the fourth quarter of approximately $100,000. These results yielded an ending cash position of $13.2 million. Consistent with previous quarters during 2008 included in the fourth quarter result is $271,000 of common stock that we issued to employees as compensation in lieu of cash for earned commissions and bonuses. We do not anticipate continuing this practice going forward. To our total year 2008, positive cash flow totaled approximately $1 million which compares to a $500,000 cash burn in 2007. We continue to stay focused on operating our business for positive cash flow and feel that it is a prudent thing to do during these economic times. On a GAAP basis, our Company-wide net loss for the quarter is $900,000 which compares to $1.4 million net loss for the same period in 2007. The full year 2008 loss was $5.4 million which compares to an $8.1 million loss for 2007 which also included several nonrecurring items totaling $1.9 million in gain which we had previously discussed with you. As everyone knows, we report our financial result in accordance with US Generally Accepted Accounting Principles or GAAP. However, we believe certain non-GAAP financial measures used in managing the business can also provide users of our financial information with additional meaningful comparisons between current results and results in prior operating periods. So, beginning in the first quarter of 2009, we will begin reporting adjusted earnings per share along with adjusted gross profit, adjusted operating income and adjusted net income or loss. Each of these non-GAAP measures will exclude noncash stock-based compensation cost. The adjusted earnings per share, adjusted operating income and adjusted net income or loss will also exclude certain one-time event which may occur in the future or which have occurred in prior comparable reporting period. We use these non-GAAP financial measures in making financial operating and planning decisions and believe that reporting of these measures can assist the users of this information in evaluating our performance. I want to reiterate non-GAAP financial measures should be viewed in addition to and not as an alternative for our reported results prepared in accordance with GAAP. Accordingly beginning with the first quarter of 2009, we will provide with our press release an appropriate reconciliation between adjusted earnings measures and the results prepared in accordance with GAAP. For purposes of this reconciliation, our 2008 noncash stock compensation charges were approximately $625,000 per quarter. Having said this, we project our adjusted earnings per share for the first quarter of 2009 to be between a $0.02 loss and a $0.01 loss. These earnings are supported by a revenue guidance ranging from $7.1 million to $7.4 million, again reflecting growth in email and flatness in e-prescribing due to lower deployment in 2008. We expect deployments to be between 250 and 350 for the first quarter. Finally, although cash will continue to be a significant focus for us and we will continue to report our cash performance to you, we will no longer provide guidance on this going forward. I will summarize by saying while I am pleased to see the continuing improvement in our overall performance, we realized that there is still work to be done and remain committed to it. With that, I will turn it back to Rick. Rick?

[Richard Spurr:]

Thank you, Susan. Let me conclude by saying that the email encryption business continues to be a strong business for us driving revenue growth for the Company, improving margins and generating good cash flow. We are witnessing a shift in the industry towards softer service coupled with cloud computing which we believe plays right into our hands because that is who we have always been. Our 2008 results do not indicate an impact from the economic downturn and we may benefit in some cases because of the more attractive cash flow implications of our offering. So at this point, we are still targeting solid growth for the business and expect to remain a leader in the industry. In our e-prescribing business, there has been a great deal of activity in and around this technology which has brought greater attention by physicians, legislators, the general population and most importantly, from our perspective payers. I know it has been progressing more slowly than any of us would have hoped and I appreciate the patience and support of our shareholders as we have continued to build this business. All I consider at this point is that I feel very good about the ongoing discussions we are having with various payers drawn out, though they may be. I believe we are closer than ever to a significant development in this business and I look forward to updating you on our progress in the future. Overall, I remain optimistic about the progress that we are making in both businesses and I am committed to the continued improvement in the execution of our strategies. Thanks again for your support and attention today and I will now turn the call over to the operator for questions. Thank you.

[Operator:]

(Operator's instruction) Your first question comes from the line of Jackson Spears - The Robins Group.

[Jackson Spears:]

Could you help us a little bit on the e-prescribing side? This tax stimulus bill gives massive incentives for electronic health records. I believe it ranges from about 40,000 to 60,000 physicians and it is clear that what the government wants is a total solution, not a standalone solution. Do you think your model is flawed and why would not the payers start to shift the strategy?

[Richard Spurr:]

I heard you say that we think our model is flawed, what was the second part of that question, Jack?

[Jackson Spears:]

The payers, I was saying about the payers now. They only get, there is like 4,000 physicians to e-prescribing. You need a total solution and you are only a standalone e-prescribing solution.

[Richard Spurr:]

I understand that part. Okay so let me address the standalone e-prescribing as an entry point to HIT adoption. We have seen that money that money does not cause doctors to run out and we search and install technology. We have seen that time and time again and so what we believe must also be present is the existence of the set of standards that everyone knows they can adhere to and remain compliant going forward and secondly and very importantly, a set of support processes and training and installation around the actual implementation to accommodate the work flow change and the change of the practice. Our programs have always been built with all of those components addressed. So the new HIT stimulus bill, while we do believe it will make a significant difference, we do not think it is going to have any near-term impact. Longer term as we said in the script, we know that we are going to have to provide our physicians both existing as well as new with an easy migration path or integration with the full EMR suite should they choose to do that through some mechanism. Now let me talk about the payers. So, I am not a payer but we talk with them and I have been told by many of them that they are not interested in the investment required to support the electronic medical record transition, not just for the acquisition of the technology but much more importantly the cost associated with moving data in the systems and then creating an ongoing method or mechanism for the ongoing update of those records. The return on investment to the payers is very clearly and tangibly due to lower drug cost and the availability of tangible justification for the broader EMR suite is not yet widely accepted. So, our payers at least continue to be very interested and focused today on e-prescribing and it is not clear there is any movement on their port to support EMR.

[Jackson Spears:]

Your competition and mainly all scripts are growing about 20% a month. You are hardly growing, did not it raised some serious questions whether you have the right model?

[Richard Spurr:]

That is a good question. I do not know, I cannot comment on their growth because I do not know…

[Jackson Spears:]

You publicly stated it, 20% a month and there are over 25,000 physicians that have adopted this solution for e-prescribing method.

[Richard Spurr:]

So, again, I am not familiar with their measures or they are talking about physicians or prescriptions or e-prescribing or electronic scripts or, there is a lot of different ways you can slice it. One of the few vendors in the industry that actually reports on clearly defined active doctors and explicitly on scripts, I do not know if they have common measures. But let us just for the moment assume that it is an accurate statement and that we are stuck in the mud and that they are growing it 20%. Let us just give them the benefit of the doubt on that. We are on very different paths. They are on a direct to doctors, slug it out, one practice, one doctor at a time and we are on a strategy that invest heavily upfront in the payers and looks to scale in a high-speed way and the tortoise and the hare analogy. Now, the question investors have to make is have we placed our bets well or not and I think that is the decision people have to make. We think it is the right decision. We see activity with our payers that would suggest as much, and that is but all I could say at this point on that topic.

[Jackson Spears:]

You mentioned about some partnership possibilities here. Would that be another way of off loading some of your cost and like with the Caremark or [57.56] partner with them because you have offered a part solution going after the small doctor or practice doctor?

[Richard Spurr:]

Those ideas are among those that we are exploring, so the idea of reducing our costs through some partnering relationship and broadening our distribution is among the ideas we are considering.

[Jackson Spears:]

So if we were to run the clock six to three months or six months forward, would you think it is likely it have one or more of these partnerships completed?

[Richard Spurr:]

I am sorry, Jack, I could not comment on that.

[Jackson Spears:]

On the email side, could you walk us through how well you are doing with the OEM? Is there any, you have indicated I think with Google, you are at $800,000 versus $300,000 a year before. What kind of monthly growth are you seeing in your OEM partnerships?

[Richard Spurr:]

I am glad you asked, Jack. Actually the numbers that you threw out and that we talked about, we said were driven largely by Google. Actually those numbers represent our entire OEM channel new first-year orders. So the entire OEM channel new-first year orders for 2007 were approximately 300,000 representing about 5% of our total new first-year orders. Last year in 2008, the number was closer to 800,000 so a very substantial growth in both actual volume as well as percentage contribution. We had previously reported that through the first half of 2008, we matched all of the 2007 results and we went on to say that we had very strong third quarter and we had a good fourth quarter as well. So, this is where these channels work. I mean you get in and just slug it out, it may start to show growth. I think it is too early to project trends based upon the very healthy growth we have seen but we are optimistic about the possibilities.

[Operator:]

Your next question comes from the line of Jon Hickman - MDB Capital Group.

[Jon Hickman:]

Susan, well I do not care who answer this I guess, but in your script you said something about paying employees for work done with stock and stock options and you were not going to do that anymore. Is that on top of the standard stock-based compensation expense?

[Susan Conner:]

Yes, that was on top of. The 625 number that I said, that is the noncash comp number. That is the FAS 123R number and then the other amount that I quoted in my script is on top of that.

[Jon Hickman:]

Okay. So you are telling me that next quarter, you are going to do adjusted, you are going to adjust your, I mean you are going to give these other financial metrics adjusted for the stock-based compensation. Are you taking anything else out? I mean is this adjusted EBITDA or just..?

[Susan Conner:]

Right now from what I can see, the only adjusted items we will have in the first quarter is for the FAS 123R so that is all I am seeing for the first quarter and obviously as we move to the quarters and move through coming years, there maybe other items that would be wanted to be adjusted out. I am trying to get pure operating earnings per share. That is what I am trying to present.

[Jon Hickman:]

Then take out depreciation to it.

[Susan Conner:]

I had planned on keeping depreciation in.

[Jon Hickman:]

Well it gives you real cash earnings per share.

[Susan Conner:]

Yes, but I paid money for those items that I am depreciating so I am just taking the hit for doing that.

[Jon Hickman:]

Okay. Then I had a question about the, I guess this is more of a strategy question kind of follow up the last caller, you had four or five contracts now since the Medicare legislation was adopted.

[Richard Spurr:]

Accounting the Massachusetts contract that we said we expect this week, yes the number is four.

[Jon Hickman:]

Okay, and you talked like you anticipate more coming. In fact, you talked like there is going, the growth might accelerate here. So I guess I am trying to get you to tell us that the legislation is really having an effect that you can really something different even though it is not, I mean I guess there is some marginal vision here in the numbers but what you are seeing in your discussions, and can you elaborate on that? Can you make us feel better?

[Richard Spurr:]

Sure.

[Jon Hickman:]

Just feel warm and fuzzy, whatever?

[Richard Spurr:]

Sure. The legislation as you know pays doctors for usage. That fact all be important is not seemingly, there is no tying a wave of change based upon the fact that doctors had an opportunity to made money. However, the passage of the legislation is viewed by the payers as a huge, huge stamp of approval on electronic prescribing and many of them as I think you may know are turning around and announcing right on the back of the legislation, their own mandates for electronic prescribing for physicians in their network. So the momentum and influence of the law is more geared to all of the payers led by the largest one in the nation, the United States government saying, 'Hey electronic prescribing saves lives and oh, by the way, it saves money,' and you see the payers responding to that.

[Jon Hickman:]

Are you still there?

[Richard Spurr:]

Yes.

[Jon Hickman:]

Okay, just one more question then, so one of the thoughts that I had when this legislation for FAS was that you might see some of your doctors who had been trained on this system and have been installed in their office who had become inactive or who were never active, maybe take the device out of the drawer and start using it. Have you seen anything like that?

[Richard Spurr:]

We have seen some of that. It is not, it is meaningful but not overly so if that was a big deal, we would be reporting on it. We are seeing some up tick but again, the numbers are what the numbers are. You see the numbers and number of active doctors is still less than 3500.

[Operator:]

And at this time, we have no additional questions. I will be turning the call back over. You may proceed, sir.

[Richard Spurr:]

Okay, everybody. Thank you for your patience. Thanks for listening. We know what we said. We feel good about things. We are fortunate to be in a company that is not in a stable position and built on in incredibly engineered model and we have some great opportunities in front of us we believe. So again thanks for listening.

[Operator:]

And that does conclude today's presentation. Ladies and gentlemen, you may now disconnect. Thank you for joining.