Zix Corporation
Q4 2010 Earnings Call Transcript

Published: 23 Feb 2011

[Operator:]

Good day, ladies and gentlemen, and welcome to the fourth quarter and year end 2010 Zix Corporation Earnings Conference Call. My name is Crystal, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to host for today, Mr. Geoff Bibby. Please proceed.

[Geoff Bibby:]

Thank you, Crystal. As Crystal just mentioned, my name is Geoff Bibby, I am Vice President of Corporate Marketing for Zix Corporation. Thank you for joining our fourth quarter and full-year 2010 conference call. You can find our earnings press release on our investor website at investor.zixcorp.com. The earnings release contains instructions for accessing a recording of this call. Our Chairman and Chief Executive Officer, Rick Spurr will provide an overview of the company's performance in the quarter, and then our Controller, Mike English, will give you our details of our financial results. Later in the call they will answer questions from analysts and institutional investors. Listeners can also submit questions during the call to our investor relations' mail box at [e-mail]. Rick and Mike will provide forward-looking statements on matters such as forecasts of revenues, earnings, operating margins, and cash flow, projections of our contracts or business, and comments on trend information. The company undertakes no obligation to publicly update or revise any forward-looking statements. Forward-looking statements are subject to risks that could cause actual results to differ materially from our expectations. The risk factors section of the company's most recent Form 10-K filing with the SEC gives examples of those risks. Rick and Mike will refer to various non-GAAP financial measures such as adjusted gross profit, adjusted operating expenses, adjusted earnings, and adjusted EBITDA. You can find in our earnings press release and on our website detailed explanations of our non-GAAP financial measures along with reconciliations of our adjusting items to the most directly comparable GAAP financial measure. Now, I'm very pleased to turn the call over to Rick.

[Rick Spurr:]

Good afternoon everybody, and thank you for joining Zix Corporation's fourth quarter and 2010 full-year conference call. I am very pleased to announce another quarter end here of consistent and strong growth from the company on virtually every level. As we have stated over the past few quarters, we continue to build a solid and predictable business based on our successful subscription business model. Additionally, our results clearly indicate we are transitioning to mainstream demand for email encryption. As data security and integrity issues continue to make headline news, we're also benefiting from recognition of a powerful cloud-based offering along with the growing need for regulatory compliance. As we stated in our earnings press release issued earlier today, we successfully wound down the E-Prescribing business on December 31 2010 as planned. And as such, our financials for the fourth quarter and the year have been restated to reflect our continuing email encryption operations while treating E-Prescribing as discontinued operations. The $33.1 million of email encryption revenue we reported for 2010 represents a 25% increase year over year. Included in that number was $8.8 million in encryption email revenue for Q4, which represents a 25% increase over the year-ago quarter and the strongest email encryption quarter in the company's history. New first year orders for email encryption during the fourth quarter were $2.1 million, giving us a total of $8.7 million in new first-year orders for the year, which represents a 34% increase over 2009. So, we experienced very solid sales performance for email encryption in 2010. We also were able to continue to build our email encryption bookings backlog to the highest levels in the company's history, now at $50 million, a 16% increase over Q4 of 2009. As you all know, we have reported a GAAP profit in each of the preceding three quarters of this year, and we are pleased to report another GAAP profit for the fourth quarter and, for the first time in company history, a GAAP profit for the year as a whole. Our non-GAAP net income for the quarter, which excludes the deferred tax asset valuation discussed in the press release, was $2.5 million, or $0.04 a share, and increase of $0.02 per share year over year. We finished the year with non-GAAP net income of $8.4 million, or $0.13 per share, an increase of $0.12 year over year. We generated $7.2 million in cash flow during the year, an increase of $6.6 million over last year, and giving us a cash balance of $25 million at the end of the year. Another significant accomplishment is that our shared cloud-based Zix directory has now eclipsed 25 million members, including some of the most respected institutions in the country. Our success was driven by strong performances across our three core verticals

[Mike English:]

Thanks, Rick. Good afternoon to everyone. Before I review our financial results I wanted to first explain a couple of significant changes to our income statement, resulting from the completion of the E-Prescribing wind-down and reduction of our deferred tax asset valuation allowance. First, the GAAP income statement is restated to reflect the impact of discontinued operation, E-Prescribing operation. This means the revenue and expense numbers on the GAAP income statement exclude E-Prescribing for all periods presented. There in now only one line item for the discontinued operation called “income, loss from discontinued operations.” Secondly, as mentioned in our last call, we have historically recorded a full valuation allowance related to the deferred tax assets generated by historical losses. It was considered appropriate under generally accepted account principals. Now, due to our positive earnings for the year ended December 31 2010 and the positive earnings from continuing operations for 2009 and 2008, as well as our expectations of future positive earnings, we recorded a $35.3 million decrease to the deferred tax asset valuation allowance, resulting in a tax benefit of that amount in Q4. This is based on guidance under generally accepted accounting principals and applicable tax law. Now, let's move on to the fourth quarter and the full-year 2010 results. As Rick mentioned, we are pleased to report strong results for the fourth quarter and the full year in our key financial metrics

[Rick Spurr:]

Thank you, Mike. Let me close by making some observations regarding guidance. To reiterate, our revenue guidance for 2011 is $38 to $40 million and our adjusted EPS guidance ranges from $0.14 to $0.16. Comparing to actuals for 2010, on a continuing operations basis, email to email, this gives a revenue growth range from 15-21% and an adjusted EPS growth range of 27-45%. This demonstrates the attractive leverage in our business model. In addition, visibility is quite high in that using the low end of the revenue range, $38 million, 72% of revenue is already contractually committed in our backlog. Using the high end of the range, $40 million, 69% is already committed in our backlog. With that summary of the numbers, and before I turn it to the operator, I'd like to acknowledge that David Cook has resigned from the Zix Corp board of directors. I'd like to thank David for his service on the board and his many contributions to the Zix Corporation. I'd also like to thank our shareholders for their continued support, our partners and customers for their business, and of course our employees for their dedication and hard work. With that, let me turn it back to the operator for questions.

[Operator:]

(Operator Instructions) Today's first question come from the line of Mike Malouf with Craig-Hallum Capital. Please proceed.

[Mike Malouf:]

Hey guys, thank for taking my question.

[Rick Spurr:]

Sure.

[Mike Malouf:]

My question is on new first-year orders. I know that you had been bouncing around for about 2.4 which you did last year, down to about 2.1, which you did this quarter. And you also talked a little bit about acceleration coming, and with five quarters in a row sort of in that range, I'm wondering if you could just comment a little bit about acceleration ability or your ability to accelerate out from that $2.1-2.4 million range?

[Rick Spurr:]

Sure. Just to reiterate for everyone, we were running at 1.4 for a very long time, two or three years per quarter on average. Then in the fourth quarter of 2009, it jumped from that average of 1.4 up to, as you said Mike, 2.4. Then we were 2.2 in the first quarter, 2.1 in the second quarter, 2.2 in the third quarter, and 2.1 in the fourth quarter. So it clearly ramped up very quickly, as we've said, because of just increased demand across the board and our ability to satisfy that demand and has been consistent in that 2.1 to 2.2 range as you say. The question of course is our ability to grow that even more, to accelerate that, and as you know, we don't give guidance on new first-year orders specifically because it's very difficult to predict. We've got lots of reason for optimism given that growth factors and issues that we've discussed and (inaudible)of verticals. But we have no way to really predict when and how fast that would accelerate. We are seeing activity across a much, much broader set of users. We're seeing more pipeline activity from very large users, a great number than we've seen in the past, and we're certainly seeing a lot more activity at the lower end of the spectrum where we had access to smaller business primarily through our third-party distributors. So it's unpredictable, we've set aggressive targets for ourselves. We obviously have a business plan that reflects that aggressive target. We have quotas out to the sales people, and we're off and running. But I can't really predict the future for you here, Mike, or us.

[Mike Malouf:]

Sure, if I could just follow up a little bit. In 2009 it looks like, given the numbers that you've said, based on my calculations, that your direct sales produced new first-year orders of about $4.35 million. And then in 2010, they produced sales in new first-year orders of about $4.04 million. So it looks like the direct sales were actually down 7% for the 12 months of 2010 versus 2009, and I'm just wondering if you can comment a little bit, is there some cannibalization going on in the channel or you talk about quotas for your sales force to date, missed quotas? Or was there some - ?

[Rick Spurr:]

Good question. The reason for that is that the way that the sales force works harmoniously with these channels. So the OEM guys stand alone – Google and MessageLabs and Web Route and the others. But the 106 now value-added resellers and managed service providers – actually, think of them as reporting up through our sales guys. So our sales guys are motivated to help them, train them, encourage them, in some cases getting them leads to create our overall coverage model and higher levels of productivity. So it's very important that you don't get them fighting against each other, you've got to get them working together to get the sorts of growth that we've experienced. So when you see the channels go crazy like that, it's because the sales guys on the direct side are, in many cases, giving them deals and helping them achieve that growth.

[Mike Malouf:]

Okay, great. And then one other question. I get a lot of questions about the market and about how the overall market is growing, and I'm wondering if you can just comment a little bit about what is the overall market's growth at this point as you look forward over the next year or two? Thanks.

[Rick Spurr:]

So another one of these unpredictables, but everybody that's out there has some sort of market estimations, and there aren't many of them, but there's a couple of large third parties. They're all calling it in the 20% range, and we don't have any reason to disagree with that. We saw 25% growth year-on-year in revenue last year, but we command a pretty high price, so sometimes you'll see our revenue outpace the seat growth. But the simple answer is people are predicting 20% compounded growth rate year on year out through - even into 2015.

[Mike Malouf:]

So I guess based on those numbers your guidance is for market share loss? Is that right?

[Rick Spurr:]

Yeah. Our guidance is our guidance, Mike.

[Mike Malouf:]

Okay, thanks.

[Operator:]

Our next question is from the line of Fred Ziegel with Blue Water Capital Markets. Please proceed.

[Fred Ziegel:]

Hi Rick.

[Rick Spurr:]

Hello Fred.

[Fred Ziegel:]

Let me ask one housekeeping question. When might we get the first three quarter restatements for 2010?

[Mike English:]

End of mid-March, early mid-March.

[Rick Spurr:]

Probably around mid-March we should have that.

[Fred Ziegel:]

Is that going to be with the K?

[Mike English:]

Yes.

[Fred Ziegel:]

Rick, what have you seen, if anything, in terms of expansion of some of the state encryption laws that have been around for a little bit now in Nevada and Washington and Massachusetts. Have there been any additional movement there?

[Rick Spurr:]

I assume what you're asking, Fred, is any additional states?

[Fred Ziegel:]

Right.

[Rick Spurr:]

Yeah, all we know is that there's a lot of activity, but it's anybody's guess as to when things pop out of legislative debates into something that's meaningful. So we don't have any way to predict that, but there is activity going on in a number of states.

[Fred Ziegel:]

Okay. On the fixed mobility what's likely to be the best channel to deliver that, if there is one over the rest of them? Or is it going to be not unlike the other services?

[Rick Spurr:]

I don't view any difference. All of our channels deliver all of our products to all of our customers, and no, we're not believing or thinking that mobility is going to be any more advantageous to certain channels or another. It just raises the bar across the board for our competition for every single placement of our product. Now some customers are going to care more about mobility than others, but that's really a function of the sophistication of their workforce and their policies and work flows, but there's no industry or channel that would jump out at us as being particularly relevant.

[Fred Ziegel:]

Is it phone-centric, or are we going to see tablet support I presume?

[Rick Spurr:]

We have tablet support already in the product, so that's there as well, yes.

[Fred Ziegel:]

Okay. Last question

[Rick Spurr:]

My thoughts are that it's – I always think of the international market as being double the US, but it's all chopped up into different countries and different cultures with a myriad of circumstances in each of those countries, which may provide great opportunity or no opportunity. We've talked before about heading into – investing in products such that it's easily enabled with 12 languages, including all the double-byte languages. We do have some distributors overseas. Google and Symantec continue to have access to our product for sale overseas. We are exploring distribution in Japan, but it's really too early to get any of us excited about that. We haven't reported any meaningful contract closures there. But it's on our radar.

[Fred Ziegel:]

So likely no new data center outside the US for a while except for the one in the UK.

[Rick Spurr:]

We aren't planning one at this time, but if we had a meaningful progress in one of these major markets, and the justification was there, we'd do what we have to do. That again was a relatively inexpensive endeavor on our part, so we'll do it if we can accelerate growth and capture a new market, but absent that, we're not going to go fishing.

[Fred Ziegel:]

Okay, thanks.

[Rick Spurr:]

Thank you.

[Operator:]

Our next question comes from the line of Jackson Spears with Gar Wood Securities. Please proceed.

[Jackson Spears:]

Rick, congratulations on your numbers. Could you walk us through the operating expense line, R&D and SG&A in 2011? What are your plans to expand that now that you have a lot of momentum and a focused business strategy?

[Rick Spurr:]

I was listening, Jack, to the first part. What was the tail end of that?

[Jackson Spears:]

What kind of R&D expense will be going forward, will it be like 10, 12% of revenues? What's the number, and what about SG&A line? And are you going to hire more salesmen going forward?

[Rick Spurr:]

So when we finalized our budget and decided and authorized our expenditures, I told people previously and I reiterate here, our adds to sales and marketing our targeted and appropriate, but given the leverage we have in the top line, you won't see massive influxes of expense there. The SG&A and aggregate, Jack, for 2011, we believe will run in the 40-41% revenue range, and so I think that's slightly down, like a point, from last year if I remember. R&D we expect will be in the 13-(inaudible)% range and that's down slightly from last year on a percentage basis. We've already counted it to a certain degree on cost of goods sold. We believe it will be in the 19-21% range in terms of percentage of revenue. And that's what leads us to the operating income guidance that Mike gave in the high 20s.

[Jackson Spears:]

What kind of tax rate now that you're profitable and you've had that reversal, what kind of tax rate should we assume for 2011 in our models?

[Mike English:]

Well, Jack, on the tax rate basis -

[Jackson Spears:]

On a state and federal level.

[Mike English:]

The federal level is 35.25, but you know we have the NOLs that are out there, so they will have a definite impact on the cash taxes, they'll reduce them.

[Jackson Spears:]

So on a reported basis, what assumption should we use?

[Mike English:]

I'd use the 35.2.

[Jackson Spears:]

Thank you, sir.

[Operator:]

Ladies and gentlemen, that concludes our call for today. Thank you for your participation in today's presentation. You may all disconnect, and have a great day.

[Rick Spurr:]

Thank you everybody. I appreciate your interest.