Zix Corporation
Q1 2009 Earnings Call Transcript

Published: 29 Apr 2009

[Operator:]

Thank you everyone for joining us to the first quarter 2009 Zix Corporation earnings conference call. My name is Ericka and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will facilitate a question-and-answer session towards the end of this conference. (Operator's instruction) I would now like to turn the presentation over to your host for today's call, Mr. Peter Wilensky, Vice President of Corporate Development and Investor Relations. You may proceed, sir.

[Peter Wilensky:]

Thank you, Ericka. Good afternoon and thank you for joining Zix Corporation’s first quarter 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 83271977. This information can also be found at investor.zixcorp.com, which is at 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 Q1 2009 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 beliefs of, 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 would like to turn the call over to Rick Spurr.

[Richard Spurr:]

Thank you, Peter. Good afternoon and welcome to the discussion of our first quarter results. We had a solid quarter in Q1 in a difficult economic environment driven by our email encryption business where our revenue was up 18%. I believe we are well positioned not only to weather the storm but to thrive as well. We previously discussed the strength of our economic model so I will not dwell on that today but the stability and predictability of recurring revenue in our subscription model should be reassuring during these challenging economic times. However, we are not sitting on our hands and simply trying to wait it up. We believe there are attractive opportunities that we can take advantage of. Let me start with the larger of our two businesses, email encryption. In the first quarter, we had healthy year-over-year revenue growth, continued improvements in our margins and strong renewals and while our new first year orders of $1.1 million were not quite what we were looking for, it was a decent result given the circumstances. Certainly the economy can explain the significant part of the issue with companies everywhere tightening their belts. The competitive landscape has also changed with consolidation occurring in our industry. Although there are far fewer meaningful vendors offering email encryption today, our major competitor is quite large both in terms of resources and in terms of the breadth of their email security suite of products. On a positive note, develops in the industry would seem to foreshadow a potential increase in demand for these services and in a situation of rising demand, fewer competitors would mean reduce supply which should translate in the good business prospects for those companies still in the game. What are the drivers for this potential increase in demand? On an industry wide basis, the current environment of increased regulation and scrutiny has more companies looking for compliance solutions in general. For example, states such as Nevada and Massachusetts have recently passed laws requiring the strict protection of personal information communicated via email essentially requiring the use of encryption. We expect to benefit directly in certain cases where prospective customers are looking for a compliant solution. But of equal importance is the indirect benefit through our channel partners. While we have been telling companies about the inherent vulnerability of the email for years, having industry leading IT companies such as Google, Symantec and our other channel partners carrying this message within vast reach and extensive marketing activities should be quite powerful. We believe the general focus on compliance and security has driven and will continue to drive business for us through the channels such as the recent announcement of our deal with Washoe County, Nevada through our partner Code Green Networks. In addition, one of our core markets healthcares is in the process of digesting recent revisions to the HIPAA rules. The expansion of HIPAA in the recently passed stimulus package both increases the scope of the law to cover "business associates" as defined under HIPAA and institutes strict new rules requiring notification for any breach of confidentiality and in the case of larger breaches, publication of such breach in the general press with accompanying tougher penalties in the event of a violation. Although we had not estimated the size of the potential impact on us from this change, just remember that when we started in this business, we focused on HIPAA compliance and today, most of our revenues had a substantial part of our orders still are driven by HIPAA. One only has to consider that each one of our current healthcare customers has multiple business associates who will now be covered under HIPAA to realize that this development could be significant. As the recognized for email encryption within healthcare with relationships with several national health plans, Blues organizations across the country and over 1000 hospitals, we believe we are particularly well positioned to benefit from the changing HIPAA. With the one probably out being that since most of the regulations do not go into effect until early next year, the impact may not be immediate. In a community of interest like healthcare where the members of the community need to break in to the network, the shared architecture of our Zix directory with the management of encryption keys in the cloud is attractive because it provides instant access to all of the existing members of the community. The viral effect of this network which recently top 16 million members and is growing at 100,000 new members per week is what many companies strive for and we are the only company in this industry to have this type of shared structure. These regulatory changes will benefit the entire email encryption industry but in addition to the new regulatory landscape, there are other drivers which should specifically pertain to us. The first one has to do with the fact that we have long been pursuing an OEM strategy alongside of our direct sales. This OEM strategy is designed to have our email encryption services bundled with other suppliers' products, typically anti-spam and antivirus products. I have already alluded to the presence of a large diversified competitor in the industry who in fact offers anti-spam and antivirus and their own email encryption. Our existing partners compete with this company and often require email encryption to match that competitive offering. Our new partners have added our service for several reasons including the need to complete their product suite in the face of increasing demand for email security services and because the ease of integrating our service into their platform. To those points, our recently announced partnership with Webroot was in part driven by their need to offer a full suite of services in response to this competitive threat and in part due to ease in integration with our service. The fact that we are the leading SaaS provider of email encryption services made us the natural selection for Webroot. So, now with Postini, Google, MessageLabs, Symantec and Webroot among others, we believe Zix Corp is clearly the vendor choice for email security service providers. The other driver we should provide opportunities for us is our new participation in foreign markets particularly in Europe. With truly global partners like Google and Symantec which enclose the UK based company such as MessageLabs, partners with significant international operations such as Webroot and now, a UK based datacenter to comply with EU and corresponding member country security and privacy regulations, we are well positioned to broaden our customer base into Europe. While, we have only secured a few international customers to date having strong partners able to take us into accounts overseas offers us a great deal of opportunity. Turning to our e-Prescribing business, there has obviously been a great deal of buzz around healthcare IT or HIT since the enactment of the American Recovery and Reinvestment Act of 2009 otherwise known as the stimulus bill and specifically the HIT part of the law called the high-tech act. Within this law, e-Prescribing is one of the few elements actually listed as part of a qualified EHR system. We believe and clearly people in Washington agree that e-Prescribing is a fundamental technology on which a modern healthcare system, a connected healthcare system can be built. On the one hand, e-Prescribing in and on itself delivers critical information to the point of care regarding patients safety and the costs and thus so, in the manner that can improve the efficiency of the care delivery system. On the other hand, truly e-Prescribing represents an infrastructure to deliver real time patient's specific information in general, to the point of care. This platform of connected physicians which certainly can also be used to deliver non-prescription related yet still vital information maybe the strategic e-Prescribing asset that has the highest long-term value. The ability to deliver comparative effectiveness research in real time to clinicians at the point of care would be an example of alternative data that could provide useful decision support. This value of the platform is what we have been discussing for sometime. There is an emerging to date on what is the right technological structure for clinical applications, traditional, on premise, silo technologies such as the typical electronic medical records or new collaborative constructs that easily share information. Characterized that way, I am sure one could guess that our pocket script e-Prescribing service falls into the latter camp. This view also clearly aligns with the concept of the platform for delivering information to the point of care, being the basis for a connected healthcare system. This debate is playing out in defining such concepts as "meaningful use" and "certified electronic health record". Two critical elements in the high-tech act whose ultimate definition will impact the course of this business for ZixCorp. We are not alone in our belief of the power of this platform. Many of our payer customers view e-Prescribing as a first phase in the ability to connect to physicians at the point of care. Like us, they view e-Prescribing as the initial hook to get clinicians connected, after which a whole host of possibilities opens up for the kind of information and decision support that we could deliver. The platform's value is greatly determined by the number of users which is one reason why we continue to pursue larger deals, to have the payer sponsor the deployment of our technology and build out the platform as well as helping us to take this business toward profitability. We have been engaged in conversations for some time regarding a few such deals but unfortunately at this time, I do not have more concrete developments to share with you. So, with intangible discussions that could significantly increase the size of our e-Prescribing user base and we have a vision of where this business could lead longer term. In the meantime, we have signed several smaller deals in the last few months to add to our current pipeline of prescribers to deploy including a sponsorship for up to 400 prescribers with Blue Cross Blue Shield in Massachusetts in Q1. We recently released the new version of our PocketScript software that not only helped us remain fully certified with our industry partners but also significantly enhances the delivery of robust information to position at the point of care, to support their decision process. Our deployments were up over last year with 350 deployments last quarter. Although last year's lower deployment level was a significant contributor to the $900,000 drop in revenue for this business in Q1 versus last year. On a per prescriber basis, our script count increased with total scripts up more than 12% over the first quarter of last year on essentially the same number of docs as our active prescribers become more experienced with the technology and lower volume prescribers attrit and are replaced by newer high prescribing docs. These doctors were increasingly learning about the benefits to their practices and their patients of being connected to real time data during the prescribing process. Of course the incentive payments under the MIPPA legislation passed last year could also be a contributing factor but we believe the increasing recognition of e-Prescribing as a fundamental component of a modernized healthcare system should drive both acceptance and usage. Obviously, we need to get more significant deals and the ones we have announced recently in order to move the needle along this business and we are continuing to work everyday at. As the debate continues on reforming our healthcare system, on the role that HIT will play on that reform, the optimal technological configuration to reach the desired goals, we will continue to evaluate all aspects of this business and the best way to capitalize on upcoming developments. With that, I would like to turn the call over to our CFO, Susan Conner to discuss the financials for the quarter. Susan?

[Susan Conner:]

Thanks, Rick and good afternoon everyone. First, let me start with a few comments about our reporting of both GAAP and non-GAAP or adjusted financial measures beginning this quarter. As everyone knows, we report our financial results in accordance with US Generally Accepted Accounting Principles or GAAP. However, we believe certain non-GAAP financial measures used in managing the operations of our business can also provide users of our financial information with additional meaningful comparisons between current year results and results in prior operation period. I will always refer to these non-GAAP measures as adjusted amount. As I shared with you on our yearend conference call, we will begin reporting adjusted gross profit, adjusted operating income or loss, adjusted net income or loss along with adjusted earnings or loss per share. Each of these non-GAAP measures will exclude non-cash stock-based compensation cost as required under FAS 123R and in a non-cash adjustments to our provision for income taxes. These non-GAAP measures had also excluded certain one-time events which may occur in the future which have occurred in prior comparable reporting periods. We used these non-GAAP financial measures in making financial operating and planning decisions and believe the reporting of these measures can assist the users of our financial information in evaluating our performance. We included with our press release a reconciliation of our GAAP to non-GAAP measures. In addition, we posted this reconciliation to the Investor Relation section of our Company' website. Now, let us move to the first quarter financial results beginning with revenue. We achieved company-wide revenues for the first quarter of $7.3 million which was within our previous guidance of $7.1 million to $7.4 million and it represents a slight increase over the first quarter last year. Our first quarter revenue was made up of $6.2 million from email encryption and $1 million from e-Prescribing. Email encryption revenue increased $1 million representing an impressive 18% increase over the comparable 2008 figure. The increase consisted of $200,000 from our OEM channels over the $200,000 of revenue recorded in the first quarter of last year and an $800,000 increase for non-OEM customers. These increases were due to the growth inherent in the successful subscription model with steady additions to the subscriber base coupled with a high rate of renewing and existing customers. These subscriptions were up for renewal during the quarter. The renewal rate for the first quarter was 95%. e-Prescribing revenue for the first quarter was $1 million which compares to $1.9 million for the first quarter last year. the $900,000 decline primarily resulted from three things; first, a $340,000 decrease in the transaction or usage base fees because in the second quarter of 2008, we have reached the ceiling or cap on a transaction or usage base fees allowed under our contract with the single healthcare payer customer. Secondly, a $250,000 decrease in deployment related revenues as the rate of new deployments during the proceeding four quarters ending March 31, 2009 of approximately 840 had declined from a level of 1,650 for the proceeding four quarters ending March 31, 2008; and third, a $350,000 one-time revenue patch up in the first quarter 2008 resulting from the achievement of certain performance related metrics in a single contract. Sequentially, the $1 million for e-Prescribing in the first quarter compares to $1.1 million for the fourth quarter of 2008. We expect our e-Prescribing revenues to remain relatively flat for the next two quarters. We ended the first quarter with a company-wide bookings backlog of $38.4 million which is a 10% increase over the bookings backlog of $34.8 million for the first quarter of 2008. We anticipate approximately 60% of the backlog being recognized into revenue within the next 12 months. In summary, we are pleased with the year-over-year growth in revenues for email encryption and remain cautiously encouraged with the new e-Prescribing contract that we signed during the fourth quarter of 2008, a single contract signed in the first quarter and the payer discussions currently underway. Let us now move to our adjusted gross profit results and details on our expenses. We achieved an overall company-wide adjusted gross profit for the first quarter of $4.9 million or 68% of revenues. This compares with $4.7 million or 65% of revenues for the same quarter last year. The email encryption adjusted gross profit for the first quarter was $5.3 million or 84% of revenue compared to $4.3 million or 81% in the same period last year. The improvement was due to the $1 million increase in revenue while cost remains flat with our relatively fixed cost structure. Speaking to the relative fixed nature of our cost in our email encryption business, we believe this generally occurs due to the following. First, over the last year, we have focused on improving the scalability of our deployments by automating certain customer services. Secondly, through a simplification of the products required to support our customer services and through the related process improvements, the majority of our deployments are now conducted remotely which removes the cost of on-site new customer visits. Third, we also benefit from the inherent nature of technology and as technology improves, we can perform in a higher level of efficiency and at a lower cost point. And finally, all of these noted improvements assist us in offsetting the normal or natural occurrence of increasing costs that seem to occur with the passage of time. Our e-Prescribing adjusted gross profit was negative at $357,000 or 35% of revenue compared to a positive $436,000 or 23% of revenue for the same quarter last year. This reduction in our adjusted gross profit is due primarily to the $900,000 reduction in revenues as I discussed earlier. With regards to operating expenses, adjusted R&D and SG&A expenses were relatively flat in the first quarter of 2009 at $5.6 million when compared to the same period last year. It is great to see we are able to continue to grow our revenue without growing these expenses. As indicated last quarter, we are very focused on the weakened economy and how the Company's performance is being or could be impacted to ensure that we deliver continued financial improvement to our performance. Our capital expenditures for the first quarter were $144,000 and depreciation expense for the quarter is approximately $319,000 and is recorded in the various P&L line items with the majority or 75% of it being recorded in cost of revenues. Turning to cash flow, cash and cash equivalents at March 31, 2009 were $12.2 million reflecting a timing difference in payments of $1.1 million from two long-time customers expected in the first quarter but not received until the middle of April. We consider this temporary decline in cash at first quarter end of $1 million a normal part of the payment in receipt cycle. However, I would like to reiterate that we intend to end 2009 with at least much as much cash as we ended 2008 with and we will continue to manage the Company overall to cash flow breakeven or positive cash flow. Our company-wide adjusted net loss for the quarter is $700,000 which compares to a $1 million loss for the same period in 2008. Our adjusted net loss per share for the quarter is $0.01 which compares to a $0.02 loss for the same period in 2008. I will close with our financial outlook where we project our adjusted earnings or loss per share for the second quarter of 2009 to be between $0 and $0.01 loss. These results were supported by a revenue guidance ranging from $17.3 million to $7.6 million again reflecting continued growth in email and flatness in e-Prescribing due to lower deployment that was discussed earlier. We expect deployments to be between 300 and 350 for the second quarter. We remain committed not only to continuing to find new growth strategies for our email business but also to improving our overall Company performance. With that, I will turn it back to Rick. Rick?

[Richard Spurr:]

Thank you, Susan. Let me conclude by saying that despite the current economy, I believe we are in good shape. In our email encryption business, we have reasons to be optimistic about future demand for our services including recent legislative developments and continuing to sign high quality OEM partners. In our e-Prescribing business, we are pursuing and are engaged in some meaningful payer contracts and monitoring developments in the changing healthcare environment. Our overall prospects remain positive and I believe will emerge from this downturn well positioned to thrive in the future. Thank you for your time and attention and with that, I will see if there are any questions.

[Operator:]

(Operator's instruction) Your first question comes from the line of Jon Hickman - MDB Capital Group.

[Jon Hickman:]

Rick, can you give us any color on what is going on in the industry of people who are looking to cashing on the stimulus thing, people who are looking to buy a point solution for email encryption versus a kind of a complete electronic medical record? Is that pulling up your sales of people taking a second look? What is going on there?

[Richard Spurr:]

Let me make sure I understand the question. I think you said stimulus bill affecting email but then you talked about…

[Jon Hickman:]

I mean e-Prescribing.

[Richard Spurr:]

Okay, just for clarity. So, as we mentioned in our script here, I had asked that question, does the stimulus bill affects both of our products but with regards to your specific question, one way to answer the question is we have not seen the significant change in our business since the announcement of the stimulus bill. That is one way to answer it. The jury is out is I think what we have communicated because it is in the final definition of what constitutes certified EHR that we will get greater clarity around this topic. As we said, e-Prescribing is a very clearly specified element of the new EHRs to find in the law. But the other elements of those certified EHRs are still a matter of debate. So, we do not know what the future will hold but we are certainly very tuned to those debates and watching closely to see that we can whatever turns out maximize the value of our Company.

[Jon Hickman:]

Okay then let me ask another question then. The mandate for Medicare went into effect, I mean it was passed last year in July 1, end of June and it went into effect the first of this year, right? I mean doctors now can get incentives if they use an electronic prescription system for Medicare, right?

[Richard Spurr:]

Doctors are using more well in 2009, they check a box, own a form and they would then receive some money in 2010.

[Jon Hickman:]

They will receive the money in 2010?

[Richard Spurr:]

Correct.

[Jon Hickman:]

Okay, so it just seems like I know it has only been a quarter. Doctors have only been able to get this incentive for a quarter and the money is not flowing into their hands. But it just seems like not match have happened and it is just not enough because the incentive is not enough of a deal to get a doctor interested or could you address that at all?

[Richard Spurr:]

Well, since the stimulus bill was, it is really hard to be specific here Jon. Since the stimulus bill was announced, we have announced for payers sponsorship contracts albeit relatively small, they are all in the 200 to 300 doc range. But we have to keep in mind that we sell to health plans and not directly to doctors and the MIPAA stimulus incentives are about funding to doctors and so, one would hope that funding the doctors would cost doctors to care more but if that is not coupled with a payer sponsorship, we do not have visibility to that. That makes sense?

[Jon Hickman:]

Okay, so you do not know if doctors are calling or picking up, I mean they are not picking up…

[Richard Spurr:]

We do not take an order from a doctor that calls us.

[Jon Hickman:]

Okay, could you track that? I mean…

[Richard Spurr:]

I mean we get lots of doctors' call, but it does not really mean that they call and ask for information but the point is that we do not go out and solicit positions until a health plan has already agreed to underwrite some or all of that expense and those are very specific targeted list of doctors. So, until the health plan gives us those lists and decides and agreed to underwrite part of those costs, we do not go and call doctors and we do not take orders from orders. That is our strategy but that is just far too inefficient, too expensive.

[Jon Hickman:]

I understand that. So, let me go back to my first question one last thing, so is there a chance, are you interested, are you discussing partnering with somebody you have like larger scale ERP and you would be the electronic prescription side of that part going after..?

[Richard Spurr:]

The only thing I can say to that Jon is we have a job to continue to look at all kinds of avenues to enhance the value of the business and I really do not feel comfortable being more specific about that.

[Operator:]

(Operator's instruction) Your next question comes from the line of Harold Weber - Smith Barney.

[Harold Weber:]

Two questions, just a little if you could just clarify these previous points a bit. There has been lots of talk when you look in the journal, President is talking about he expects about 75% of doctors within five years to be using e-Prescriptions. What do you feel is not allowing that to ramp up as quickly as we believe that it should and that is one question and the other part is could you explain a little bit from last year, you guys talking about the mobile encryption story? How is that progressing?

[Richard Spurr:]

Sure. So, on first point, the obstacles to adoption we believe are the cost to the doctor and to the initial set up along with mechanisms that make that easy for a doctor to transition from paper-based scripts to electronic scripts and we think we know a formula that will work to satisfy that. It is payer subsidies along with a turnkey solution funded by those subsidies and we think we have proven some success with that model but we do not have sufficient, we do not have payer saying, "Hey, I love this so much. I want to really step it up and accelerate it," and that is what we are working on. Absent to that formula to address those two issues, it would be our opinion that things will continue to move slowly. Just so to remind you, if the doctors does not seem to do the trick and of course, do not go out and help these doctors and create turnkey solutions without money. So, that is our position, our thought on the matter. The second thing you asked was about mobility with encryption. We announced in supplies the ability to use encryption with mobile devices. We do not sell separate products for that regard and to address that, we simply have our basic technology available such that it can be connected with mobile devices. So, all of our customers theoretically could be using those features. We do not track it individually. It just comes as part of our base package.

[Harold Weber:]

I explored a method of trying to generate some revenues out of that?

[Richard Spurr:]

I am not sure I understood your question.

[Harold Weber:]

I said, have you thought about a way to explore generating some revenues out of that in addition?

[Richard Spurr:]

You mean charging separately for our mobile feature?

[Harold Weber:]

Yes, because some users, I believe there would be a market for that, clearly.

[Richard Spurr:]

Okay, well I appreciate that input.

[Harold Weber:]

Okay.

[Richard Spurr:]

Any other questions?

[Operator:]

And we have no further questions in queue.

[Peter Wilensky:]

So, we have one question from investor.

[Richard Spurr:]

We had a question from an investor that I guess we got via email, Peter, is it the way this works?

[Peter Wilensky:]

Yes.

[Richard Spurr:]

The question is, when My Doc Online was not considered an asset, you sold it. Have you considered doing the same with PocketScript? So, just for everyone's knowledge My Doc Online was a physician-patient portal product that at one time Zix's owned and so the fundamental question is have we considered doing the same with PocketScript. Our answer remains the same; we have a responsibility to continually assess all of our options as it relates to maximizing the value of Zix years. We continue to do that and it is inappropriate for me to be any more specific. So, I guess that is it. Thank you again as always for your continued time and attention and diligence and support of Zix and thanks again. Everybody, have a great day.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a wonderful day.