Zix Corporation
Q1 2015 Earnings Call Transcript

Published: 21 Apr 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Q1 2015 Zix Corporation Earnings Conference Call. My name is Vidly and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder this call is being recorded for replay purposes. At this time I would now like to turn the conference over to your host for today, Mr. Geoff Bibby, Vice President of Corporate Marketing. Please proceed sir.

[Geoffrey Bibby:]

Thank you Vidly and thank you for joining our 2015 Q1 call. You can find our earnings press release on our investor website at investor.zixcorp.com. The earnings release contains instructions for accessing the recording of this call. Our Chief Executive Officer, Rick Spurr will provide an overview of the company’s performance in the quarter and then our CFO, Mike English, will give you 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 mailbox at [e-mail]. Rick and Mike will provide forward-looking statements on matters such as forecast of revenues, earnings, operating margins and cash flow, projections about 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 Investor website, detailed explanations of our non-GAAP financial measures along with reconciliations of our adjusting items to the most directly comparable of GAAP financial measure. Now I am pleased to turn the call over to Rick.

[Richard Spurr:]

Thank you, Geoff. Good afternoon, everyone and welcome. As we begin the second quarter of 2015, we are pleased with our first quarter achievements and excited about the growth opportunities we see ahead. Before I elaborate on the growth drives let me first turn to our first quarter results. Revenue for the first quarter was a record $13.1 million which came in at high end of our guidance and represented a 7% increase from $12.2 million in the same quarter last year. Our new first year orders for the first quarter were $ 2 million, up 4% compared to a year ago. These new first year order results are in lined with the seasonality we typically see in our business in the first quarter of each year. As we see customers set new budges and launch new projects for the year and as you would expect it takes a while for these projects to get underway. Historically our quarter is always the weakest to the year and as followed by strong second quarter and we see that trend continuing. Total orders during the first quarter were $14.3 million, up 15% from $12.5 million in the first quarter last year and the best first quarter in our history. Our backlog which reflects all contractually committed business that has not yet been recognized as revenue was a record $70.3 million at quarter end. This is up over 7% over $65.9 million in the same quarter last year and tops our record backlog of $69.3 million that we reported at the end of last year. On the bottom line, we achieved GAAP net income of $1.2 million or $0.02 per share on a fully diluted basis. Non-GAAP adjusted net income in the first quarter was $2.4 million or $0.04 per share on a fully diluted basis. And during the first quarter, our business generated $2.5 million in cash flow from operations. Now let me share some detail on the composition of our new first year orders in the quarter. Our enterprise sales group that sells to larger accounts contributed about 30% of our new first year orders which has nearly doubled our contribution in the first quarter last year. Our corporate sales team that sells to the small and medium business market achieved just under $1.2 million in the first year orders which is essentially flat year-over-year. Our OEM business represented 7% of new first year orders and was down 45% from the first quarter of last year. However, it’s important to note that in Q1 last year, we recognized a $100,000 order through Google from a large bank which was normally there and due to our then ongoing Google transition. Excluding this large order, our OEM business this quarter was actually up year-over-year. As most of you know the resumption of sales of our email encryption service through Google’s resellers did not take effect until last October. This quarter Q1 is the first quarter where we’re reporting a full three months of Google sales since that announcement. We anticipated that we take the reseller’s time to get trained and reengage but given what we now know we underestimated that ramp up time. Now based on some large deals in the Q2 pipeline and a new level of activity, we’re optimistic about Google and their expected contribution going forward. As we typically do, I will now comment on sales contribution from an industry perspective. Our new first year orders in the first quarter broke down as follows. Finance was 39% followed by Healthcare at 38%, Government was 3% and other was 20%. As most of your know other for us is a category that captures new first year orders from all non-healthcare, non-finance and non-government accounts and it continues to now represent 20% of all of our orders showing a broader addressable market. Now the big news, on March the 5th, we announced a new strategic partnership with Cisco. It was too long ago that Cisco was our largest competitor. Now we are approaching the market as partners combining the strength of their world class distribution and our technology. The partnership will focus on two solutions in 2015. First of all as we’ve noted before, the announced end of life of the current Cisco IEA product has created a number of large potential opportunities with Cisco’s install base between now and the end of the year. The partnership agreement is designed to allow these customers to move seamlessly to a new IEA product that we are building using the original Cisco IEA code base. The update version of Cisco IEA will include new hardware as well as software patches to protect against the latest security threats. Encryption capabilities reporting and end user interaction will remain the same in the new version, so customers will have a seamless transition. We will provide the technical support for this new IEA product and Cisco will begin to accept orders ones the product is released scheduled to be later this quarter. We expect that this first phase of our Cisco partnership will allow us to maximizes our sales to this base of large accounts and will position us well for potential future upgrades. The intact of this first phase on our 2015 new first year orders will be meaningful and will likely fall within the range $1 million to $3 million. The revenue impact in 2015 is still uncertain and is a function of a number of variables still influx, most notably the number of customers that accept the new offering and detaining of installations. The revenue impact 2016 due to this first phase of the partnership will map to the 2015 new first year order amount the $1 million to $3 million range I just mentioned. We’re more excited about the second phase of the Cisco partnership agreement. In the second phase both Cisco and Zix will take a brand new product to market that incorporates the best of both architectures. All of these new sales will become part of ZixCorp’s current network of customers. And as net caps law states, the value of the network will grow exponentially and as new users are added. All users will benefit from this network effect both the new customers and our existing customers. In some cases, prospects preferred at some message content we stored at the customers’ location or at the location of the recipient. This requirement has provided using what we in the industry push method of delivery. The Cisco IEA architecture uses this method. The new product will retain this proven push approach for delivery of selected message but also will offer these new customers our unique transparent delivery from any of their recipients that are part of our existing Zix encryption network and for any inbound messages from our Zix encryption network customers are base of nearly 12,000 companies. As a result, all of our existing customers and all of the new customers will benefit from a larger network of users. Transparency will increase dramatically and the need for passwords will continue to diminish. The new product will also incorporate our existing pull approach to delivery which supports broad based modern days support of mobile devices for recipients. We are planning to release this new product in the fourth quarter of this year. The distribution for this product will be worldwide predominantly through Cisco’s sales and their massive partner network. Zix has built a network of around 300 resellers. The Cisco distribution network is made up of 68,000 resellers. And the agreement is structured to provide them with industry standard margins and incentives. Needless to say this new partnership can take out company to a new level. Now let me turn to update on our new products ZixDLP and ZixOne. First I’ll comment on ZixDLP, our Email Data Loss Prevention solution design to help both new and existing ZixCorp customers address the number one data leakage problem in their organization email. During the first quarter we sold 5,300 new DLP seats and signed new 12 new DLP customers. This represents a 50% increase in new customers versus last year’s first quarter. It’s noteworthy that approximately 20% of these new seats were sold into previously existing DLP accounts. So we’re starting to see meaningful up sell activity reflecting the quality and effectiveness of our DLP product. In terms of customers and license seats, we now had a lifetime total of 93 DLP customers had approximately 160,000 license seats with approximately 85% of these seats in large enterprise accounts. The average per user subscription price for these 160,000 seats is $3.90 reflecting the large concentrating enterprise accounts. We continue to see DLPs are highly complementary offering to our core Email Encryption Solution and our sales teams both corporate enterprise offered as a package solution to account new to Zix. Slightly more than half of our sales have come in this manner and the other half have been up sells to the existing base. Now I’ll provide update on ZixOne, our Bring-Your-Own-Device or DYOD solution. As most of you know this is a unique BYOD solution that matches employees access their work related email without ever storing any corporate email on the device. This approach and its underlying pattern pending technology provide the highest level of security available and have zero impact on the employee’s personal device or privacy unlike to competitive approaches. During the quarter we added 50 new ZixOne customers. At the end of the first quarter, the number of our lifetime ZixOne customers increased 18% to 312. Of these 312 total customers, approximately 40% are new accounts to Zix and 60% have been additions into our installed base. The average number of seats across all ZixOne customers was 68 and new seats sold during the quarter were nearly 3,200. This brings the total number of ZixOne license seats to more than 21,000 from approximately 18,000 last quarter. The average price per user per year looking all ZixOne customers at the end of the quarter was $33. While sales of our two new products in Q1 were lighter compared to the strong spike in momentum that had generate last quarter, we believe this is simply reflection of the same seasonality we see in our Email Encryption business. We expect to see continued growth in these products throughout the remainder of the year and expect them to have a meaningful impact of accelerating our revenue growth in 2015 and for years to come. To conclude, our business is in a far healthier place today than it was a year ago. We’re very optimistic about the significant opportunities we see for growth in our base Email Encryption business with Google’s resellers now fully back on line and ramping and our new partnership with Cisco. We also expect to see increasing contribution from ZixDLP and ZixOne. In summary, with the strength of our pipeline for Email Encryption, our new partnership with Cisco and the contribution from our new products, we’re optimistic about accelerating growth in both 2015 and beyond. Now, I’ll turn the call over to Mike English, our CFO, so he can discuss our first quarter results in more detail. Mike?

[Michael English:]

Thanks Rick. Good afternoon everyone. As Rick mentioned we’re happy with the start of the year performance which include strong revenue results for the first quarter. We achieved record revenue of $13.1 million, a 7% year-over-year increase and at the high end of our guidance. Our subscription model continues to gain strength as we successfully add new and renewal multiyear orders to the backlog and continue to increase our annual recurring revenue stream while maintaining strong cash collections. Our total bookings of $14.3 million were up 14.7% from the prior year. Renewals remained strong and we continue to retail well in excess of 90% of our annual recurring revenue. Our first quarter 2015 ending backlog was a record $70.3 million which is a 7% increase year-over-year. That is our 12th consecutive quarterly increase in backlog. We anticipate approximately 56% of that backlog or $39.1 million will be recognized into revenue in the next 12 months consistent with our SaaS subscription model. In the first quarter, we also achieved a high end of our earnings guidance recording GAAP fully diluted earnings per share of $0.02, up 17.8% from last year and non-GAAP fully diluted adjusted earnings per share of $0.04, up 18.5% year-over-year. During the first quarter, we implemented the ZixOne related cost reductions in R&D and marketing that were previously announced. The call that we said that these cost reductions should result in an approximate $2.3 million annual savings in 2015 compared to the exit expense run rate for the fourth quarter of 2014. These cost reductions contributed favorably to the Q1 adjusted earnings performance enabling us to achieve the high end of our earnings guidance and we are on target to achieve this annual expense reduction for the year. Adjusted gross margin was 83.5%, down slightly from 83.8% from the same period last year. Adjusted operating margin of $2.5 million for the first quarter of 2015 are 18.9% of revenue compared favorably to 17.8% in the first quarter of 2014 and 15.6% in the fourth quarter of 2014. Operating cash flow for the quarter was $2.5 million compared to $1.7 for the same quarter last year. Capital expenditures were $616,000 which was evenly split between upgrades to our headquarter offices in Dallas and purchases of computer equipment. Much of a capital investment in the office was reimbursed through landlord concessions. Depreciation expense was $504,000 of which approximately 70% was recorded in cost of sales. Our balance sheet remained strong. Our ending cash balance of $24.9 million at March 31st, 2015 was up $3.2 million compared to the 2014 ending cash. Regarding our income taxes, we expect we continue record GAAP income tax expense consistent with last year resulting in an effective rate of approximately 39%. Non-cash taxes will remain low also consisted with last year. Looking forward, we are excited about our growth opportunities from our new products. The increasing activity levels through Google and the new distribution opportunity with Cisco. For the full year, we iterate our revenue guidance of $54 million to $56 million. Let me explain how we get there. As many of you know our revenue for a given year is made up of revenue from backlog, revenue from scheduled renewals and revenue from new sales. In 2015, we expect to recognize revenue of $39.2 million from the December 2014 ending backlog. In addition from scheduled renewals, we expect to recognize revenue in 2015 ranging from $10 million to $12 million. The remaining 2015 revenue will come from new sales where we typically recognize approximately 45% of new first year orders revenue in the year of sale. Given the growth drives discussed earlier in this call, we believe that this is an achievable target. We also reiterate full year adjusted earnings per share guidance of $0.19 to $0.21 per fully diluted share. For the second quarter 2015, we expect revenue to be between $13.2 million and $13.4 million and adjusted EPS of $0.04 per fully diluted share. With that I’ll turn it back to Rick.

[Richard Spurr:]

And with that, we’ll open up to questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Mike Malouf with Craig-Hallum Capital Group. Please proceed.

[Mike Malouf:]

Great, thanks for taking my questions.

[Richard Spurr:]

Certainly.

[Mike Malouf:]

The first question on Cisco, if you could just expand just a little bit on your, as you take a look at the market, now this is obviously a little bit of a different market than you had been going after before much larger enterprise market. And I am just wondering if you could talk a little bit about the size and opportunity both here in the U.S. and abroad as you highlighted as well as what kind of competition that we haven’t run into and what is the entrenched provided with some of this larger enterprises? Thanks.

[Richard Spurr:]

That’s big question Mike but be happy to tackle that. We have been participants in the enterprise market but for a long time that we’ve said we take our opportunity for growth is great as there, so our penetration has not been what it has been in the mid-size and small market. So - and we’ve seen this quarter already in without the Cisco agreement that our enterprise sales as we mentioned doubled this quarter. So we’ve made investments to strengthen our core enterprise portfolio but this is a huge step forward not only in terms technology but more importantly in terms of distribution. So the biggest short coming we have had has been just simple feed on the street, people who spend large amount of time in the very large account. So these big businesses are used to having vender sales and reseller people show up every day in some cases and we don’t have that sort of resources. So we don’t have the phase time, don’t have the distribution relationship that Cisco brings us. The opportunity for a company of our size is massive by any measure. If you focused on just this first phase, we’ve outlined the IEA opportunity, replacement opportunity and about 73% of that is U.S. based, 27% is international. And then the second phase opens up a whole new much, much bigger market we think. The IEA itself is not a product that Cisco has been selling aggressively. And so now with the new refresh product to their support they do intend to sell that higher in product more aggressively across the globe and that’s why excited us.

[Mike Malouf:]

And who would be the entranced competitors in that area?

[Richard Spurr:]

Yes, so competitive base is pretty old as we’ve said and it’s made up of lot’s and lot’s different venders at the high end which is your question and your focus. There is company called Tumbleweed that used to sell to the high end back in the early 2000s. There is still some Tumbleweed stuff out there although I don’t think they have invested for years, so there is opportunity. There is a lot of Symantec PGP although not a lot of seats, there is a lot of company acquisition of PGP as the solution base. There is a lot of McAfee and of course some partnership with Cisco, we’re going to replacing some of their base. Proofpoint has been active at the high end, they are still relatively small participant in terms of market share, but they’ve been very active and effective and say over the last three years. And so their - a modern day sort of extant competitor there whereas most of the others are have updated solutions that they are pretty much giving up on.

[Mike Malouf:]

Great, thanks. And just one other question, I know that it sounds like on the OEM side Google is starting to ramp backup which is great to hear. I haven’t heard you mentioned Symantec in a while, can you give us an update on how that relationship is going and I thought that we would see that start to ramp this year as well. Should we start to see that, start to ramp in the back half? Thanks.

[Richard Spurr:]

There isn’t any new news Mike on the Symantec front, we’ve had a steady straight business for them for some time. Their companies going through a great deal of transition, so it’s hard to predict. I don’t want to predict because I don’t have any visibility that future on how the Symantec relationship might develop.

[Mike Malouf:]

Okay, thanks, that’s all I have.

[Richard Spurr:]

Alright, thank you, Mike.

[Operator:]

[Operator Instructions]

[Richard Spurr:]

I know that the RSA Conference the larger security conference started today and we knew that there might be a lot of people in transit are actually out there. I am leaving tonight to join customers and partners out there and I know that some of the analysts are out there as well. So maybe that’s why we are not getting additional questions. Any other questions?

[Operator:]

There are no further questions in queue, I’ll now turn the call back over to Mr. Spurr.

[Richard Spurr:]

Alright, well thank you for your interest and we’re very excited, stick with us and we’ll report on the progress going forward.

[Operator:]

Ladies and gentlemen that concludes today’s conference. Thank you for your participation, you may now disconnect. Have a great day.