Zix's CEO Discusses Q4 2011 Results - Earnings Call Transcript

| About: Zix Corporation (ZIXI)

Zix Corporation (NASDAQ:ZIXI)

Q4 2011 Earnings Call

February 21, 2012 05:00 p.m. ET


Geoff Bibby – VP Corporate Marketing

Rick Spurr – CEO, Chairman & COO

Mike English – CFO


Mike Malouf – Craig-Hallum Capital Group

Frederick Ziegel – Topeka Capital Markets

Jeb Terry – Aberdeen Investment Management


Good day, ladies and gentlemen, and welcome to fourth quarter 2011 Zix Corporation Earnings Conference Call. My name is Amecia [ph] and I’ll be your operator for today. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to turn the call over to Mr. Geoff Bibby, Vice President of Corporate Marketing. Please proceed.

Geoff Bibby

Thank you Amecia, and thank you for joining our 2011 Q4 and fully year 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 for the full year, and our CFO Mike English will give you details of our financial results.

Later in the call they will answer questions from our institutional investors. Listeners can also submit questions during the call to our investor relations mailbox at invest@zixcorp.com.

Rick and Mike will provide forward-looking statements on matters such as forecast 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 investor website, detailed explanations of our non-GAAP financial measures along with reconciliations of our adjusted items to the most directly comparable GAAP financial measures.

Now I am pleased to turn the call over to Rick Spurr.

Rick Spurr

Thank you Geoff. Good afternoon everyone and thank you for joining us today to discuss our 2011 fourth quarter and yearend results. I am pleased to report record financial results for the fourth quarter and full year. From a top line perspective we achieved record revenue in the fourth quarter of $9.9 million, which was up 12% over the fourth quarter of last year and was

on the top end of our guidance range $9.7 million to $9.9 million. We also generated record full year revenue of $38.1 million up 15% from $33.1 million in 2010.

We achieved record bottom-line results, including adjusted net income in the fourth quarter of $2.9 million, up 17% year-over-year, and adjusted net income for 2011 of $10.9 million, up 31% over 2010. These strong bottom-line results highlight the significant leverage in our business model.

We increased full year revenue by $5.1 million and delivered $2.6 million of that to our bottom line. It’s important to note that the 2010 adjusted net income included over $1 million from the PocketScript business, which makes this $2.6 million increase even more impressive.

We continue to grow the backlog which at yearend was a solid $53.7 million, up 8% over the fourth quarter of 2010. New first year orders in the fourth quarter were $1.9 million, up sequentially from $1.6 million in the third quarter and down slightly from $2.1 million in the fourth quarter of 2010.

For the year, new first year orders were $7.1 million compared to the $8.7 million for 2010. The $7.1 million in the new first year orders for 2011 is up 9% when compared to 2009, but is down when compared to the record year we had in 2010.

The slowdown in new first-year orders in 2011 when compared to 2010 is largely attributable to two key factors. First, in the first quarter of 2011, our new sales were affected by some one-time events; a reorganization in our corporate sales force and then tsunami in Japan to name two. Secondly, customers were slow to pull the trigger on news orders during much of 2011 due to the overall uncertainty in the economy.

As we entered 2012, we believe these factors and headwinds we encountered in 2011 are now behind us. We have stability in our sales force, the economy has certainly turned the corner, our team of partners, OEMs, WARs and MSPs is as solid as ever. Our sales pipeline and lead flow is strong and we are encouraged by our opportunities for growth going forward. Our technology is as strong as ever too.

We’ve implemented key technology platform upgrades designed to make our solutions easier and easier to use. Current data available in the market estimates that there are approximately 120 million business email users in the United States with only about 12 million or 10% of those heading some sort of email encryption. So the penetration is relatively low, and the upside is significant.

We believe that the key to increased adoption in the market place is directly related to ease of use. So by expanding our leadership in this area, ease of use, we expect the impact growth in two ways. First of all, greater usage and adoption overall growing the entire market, and secondly, further differentiating our solution to garner greater market share.

Let me be more specific regarding the key technology platform upgrades we have introduced. At the start of last year we introduced ZixMobility, a next generation mobile delivery solution that provides seamless email encryption to users as they navigate from desktop to mobile devices.

Our industry leading delivery mechanism for mobile devices optimizes the screen display for a particular user smartphone, whether it be an iPhone, Android, Blackberry, or tablet. This deliver mechanism is a significant enhancement over most of the competition that require the user to go through several cumbersome steps to read an encrypted email. In fact I would argue that there are so many steps that their approach is almost unusable. With ZixMobility we have brought an easy-to-use solution to the market that enable secure email anywhere anytime.

Over the course of last year we implemented ZixMobility for the vast majority of our customer base and I'm pleased to note that the response from customers and the industry analysts has been extremely positive.

Now, at the start of this year we announced an innovative new TLS or Transport Layer Security feature with the launch of ZixGateway 4.3. This is a significant enhancement that provides the solution that is markedly superior when compared to competition.

TLS solutions in the market today, in addition to being only point-to-point [indiscernible] , that’s a major flaw. They cannot guarantee the encryption of replies. Our gateway-to-gateway solution provides by-directional transparency while guarantying encrypted replies. And unlike completion, we give customers a reporting capability that allows them to determine exactly if and how an encrypted message was sent. Whether it was between ZixGateways, sent using TLS, ZixMail or via the portal.

The reception by our prospects customers and industry analysts has been very positive and we’re excited to add this capability to our list of differentiating features. These upgrades and enhancements to our platform have strengthened our position in the market and our ability to achieve growth going forward.

The Gartner Group, a leading industry analyst firm that focuses on large enterprises estimates that more than 65% of organizations will be exploiting e-mail encryption within the lifecycle of their next contract renewal. We believe we are at the forefront of this upgrade cycle and see this as a tremendous opportunity. With this in mind, for fiscal 2012 and 2013, we want to maintain momentum with our technology advancement, and accordingly, have increase our budgeted R&D spending to over $6 million this year. This compares to $5.2 million spent on R&D in 2011.

Now, let’s discuss the competitive environment and the evolving landscape in our industry. We are seeing a diminishing field of competitors. For example, McAfee one of the largest security software and services providers has not been a major threat.

As mentioned on previous earnings calls, we’ve also seen a significant follow up from Cisco. We speculate that the reorganization that they undertook in 2011 has resulted in a de-emphasis in their e-mail encryption portfolio. For instance, on the product front they have not kept pace with the demands of the mobile space. We believe that these competitors as well as others do not have a core focus on email encryption products but rather participate in the market with email encryption as more of an add-on business.

This lack of emphasis is allowing us to expand our lead when customers do want to bundle email encryption with their other e-mail security services as an add-on, we can still satisfy their requirements with our market-leading technology offered through our strong partnerships with Google and Symantec. Also as part of the evolving landscape we are seeing an increasing level of sophistication and knowledge among buyers.

Just a few years ago, we would need to consistently educate our prospects on the need for encrypted e-mail, new compliance requirements, and the necessity of having a solution in place. Today, enterprises fully understand the importance of utilizing email encryption and are demanding a solution and is less disruptive to work flow and is easy to use.

Earlier on this call, I said that our team of partners, OEMs, VARs and MSSPs or Managed Security Service Providers is as strong as ever. This is partially due to the fact that during 2011, we doubled the total number of VARs and Managed Security Service Providers reselling our service. Specifically, we now have 82 Managed Security Service Providers and 96 value-added resellers.

One of the additions to our MSSP program is EarthLink, a leading IT services, network and communications provider to more than 150,000 businesses and over 1 million consumers nationwide. Our key OEM partners that include Google and Symantec hosted services, also made a solid contribution to our financial results to fiscal 2011 representing 24% of our total new first year orders. Total partner contribution from these OEMs plus the VARs and MSSPs was 52% of our new first year orders in 2011.

I want to talk like a posted services. I’ll mention that in a previous call, we said that we were testing our e-mail encryption services, with Microsoft Office 365 at the request of one of our largest customers. We are happy to report that testing is complete and that large customer is now using our services in conjunction with Office 365.

More on the evolving landscape. There is an development that we think really puts the market on notice regarding HIPAA compliance. Earlier this month the Office of Civil Rights, OCR, responsible for federal government enforcement of HIPAA began their long overdue audit program. This program which was promised in 2009 covers all healthcare entities and their business associates or partners.

OCR has begun with a pilot phase of 20 audits and plans to complete 130 more for the end of 2012. The auditors can look for anything and everything with respect to HIPAA compliance. Secondly, there was recently a HIPAA enforcement action taken by the attorney general taken by the Attorney General in Minnesota. The AG announced a lawsuit against a company named Accretive Health. The lawsuit is significant as it represents the first of its kind against a business associate. We recall that the stimulus bill of 2010 as part of the Hightech Act made business associates subject to HIPAA regulations.

Earlier this month the New York Times reported a significant email data breach involving the FBI, Scotland Yard, and others. Hacker group intercepted and unencrypted email getting the details of a confidential conference call and therefore knew the time of the call, the dial-in information, and the pass code. They joined the call, recorded it, and then for all to hear posted it on the internet.

Incidents like this make it very clear that unencrypted email is not safe. Fortunately we can help.

Before I turn the call over to Mike I want to review some characteristics of our business and our business model that deal with stability and durability. During my 37 year career with several different businesses my experience suggest that every business must produce innovative, competitive, products and services. We must execute efficiently and assure high levels of customer satisfaction. On top of this, most businesses have to worry about short term risks at the same time they are trying to deliver on these fundamentals and deal with long term opportunities and challenges.

At Zix, because of our specific business and business model, our short term risks are relatively limited. This allows us to focus on the fundamentals and the long term. I’d like to take a few minutes to explain why we believe that our business and our business model result in relatively limited short term risk.

First of all, we have a very sustainable competitive advantage in the market. Zix Corp offers the only fully transparent email encryption services available today representing a significant competitive differentiator. Emails between ZixGateway customers are encrypted without any extra steps required to decrypt, not even a password, and are completely transparent to the sender and receiver.

Our ZixDirectory which has been building for the past 10 years, represents a significant barrier to entry. It would be extremely difficult for a new competitor to step into this market and catch us.

Secondly, our model benefits from the network effect, sometimes referred to as Metcalfe's Law. This is where the value of our service grows exponentially as new users are added. Why? Because the customer using Zix with our best method of delivery and our shared directory of public keys has a built-in, easy to use mechanism to send and receive secured email with members in the ZixDirectory. The more members the greater the utility.

Building on this, for now what is 10 years, our ZixDirectory has grown to over 30 million members. That’s 25% of the number of business email addresses in the United States. And the ZixDirectory continues to grow at a rate of approximately 100,000 new members per week. The architecture of the ZixDirectory allows us to scale worldwide.

Thirdly, our SaaS based business model provides a high level of visibility and predictability of our revenue. With contracts that typically last two to three years and with revenue that is recognized ratably only when the service is provided. This model is characterized by a backlog of contractually committed business that assures investors of future revenue.

Our strong back log of $53.7 million will provide over $30 million of revenue in 2012. Adding to this visible revenue stream from our backlog is revenue from contracts that will come up for renewal during the course of 2012. Assuming we meet or exceed our 90% historical renewal rate we expect around another $8 million of new revenues from these renewals during fiscal 2012. Combining our back log and expected contract renewal revenue, we have over $38 million in revenues already in our sites for 2012. To get a full picture we would then add revenue that will flow from new sales in 2012.

A fourth characteristic of our business models that I want to highlight is the high level of stickiness with our customers. To move away from Zix a customer would have to reenroll their entire customer and partner base. That task would cause significant disruption to workflow and would place the burden on customers and partners. It would also give up our unique Zix Gateway to Gateway transparency.

A fifth characteristic is that our revenue comes from a very diversified mix of customers. To date, our largest customer represents less than 3% of our total revenues. With over 7000 corporate customers spread across several verticals, we have a broad and diversified customer reach that is impressive and growing.

Lastly, our business model has fantastic leverage. As I pointed out earlier, in 2011, we grew our top line by $5.1 million and $2.6 million or 50% fell straight through to the bottom line. Again, it’s important to note that the 2010 adjusted net income included over $1 million from PocketScript, which makes this $2.7 million increase even more impressive.

Overall, our adjusted operating margin increased in 2011 to 29% up from 22% in 2010. So our model is scalable, profitable, and yields exceptional leverage.

To summarize, we believe we have a sustainable competitive advantage in the market. We benefit from the network effect. We have a highly visible and predictable revenue model. Our solution is very sticky with our customers. We have a diversified mix of customers and our model produces excellent leverage and profitability. As a result, our business model has relatively little short term risk allowing us to focus on sustainability and growth.

Now, I will turn the call over to Mike, so he can review in further detail our financial results.

Mike English

Thanks Rick and good afternoon everyone. We are pleased to report excellent results for the fourth quarter and the full year in our key financial metrics, revenue, GAAP and adjusted net income, and adjusted EBITDA. All of these are records except GAAP net income where we had a larger tax benefit in 2010. We have now achieved three years of consecutive quarterly revenue growth.

GAAP net income was $15 million for the fourth quarter, which includes an approximately $12 million tax benefit due to reduction in our deferred tax asset valuation allowance. This compares to GAAP net income of $37.2 million for the fourth quarter of 2010, which similarly included approximately $35 million of tax benefit.

We achieved record revenues from continuing operations of $9.9 million for the fourth quarter, which compares to $8.8 million for the fourth quarter of 2010. This was at the top end of our guidance range of $9.7 million to $9.9 million.

For the full year 2011, revenue from continuing operations was $38.1 million, which compares to $33.1 million for 2010. Fourth quarter revenue from continuing operations grew $1 million, a 12% increase over the comparable 2010 figure and full year grew $5.1 million, a 15% over 2010.

Our OEM partners drove approximately $300,000 of the revenue increase in the quarter, a 35% improvement from the fourth quarter a year ago. They drove approximately $1.5 million of the revenue increase for the year 2011, a 51% improvement over 2010. Our direct sales to enterprise and corporate customers, including through our resellers and managed security service providers drove the remaining growth.

We ended the fourth quarter with bookings backlog of $53.7 million, which is an 8% increase over the $49.9 million backlog at the end of the fourth quarter 2010. As a reminder to everyone, our backlog is comprised of contractual commitments that we expect to amortize into revenue in the future as the services are performed. We anticipate approximately 57% of the backlog will be recognized into revenue in 2012.

Let’s move on to look at our various margins as well as the details and our expenses. We achieved fourth quarter adjusted gross profit from continuing operations of $8.1 million, 82% of revenues. This compares to $7.2 million, 81% of revenues for the same quarter in 2010. On a sequential basis, it compares to $7.8 million or 82% of revenues for the third quarter of 2011.

Adjusted gross profit from continuing operations for the full year was $31 million, 81% of revenues compared to $26.8 million for 2010, 81% of revenues.

With regard to adjusted operating expenses from continuing operations, adjusted R&D and SG&A expenses totaled $4.9 million for the fourth quarter of 2011, compared to $5 million for the fourth quarter of 2010.

Adjusted R&D expenses were $1.3 million in the fourth quarter of 2011, compared to $1.2 million in the fourth quarter of 2010. SG&A expenses for the fourth quarter were $3.7 million, a decrease of $160,000 compared to the fourth quarter of 2010.

For the full year 2011, the adjusted operating expense from continuing operations was $19.8 million as compared to $19.5 million for 2010. Adjusted R&D expenses were $5.2 million for the year, an increase of $300,000 or SG&A expenses for the year were $14.7 million flat with 2010.

In summary, we were able to grow revenue by $5.1 million while essentially keeping our operating expenses flat.

Adjusted operating margin for the fourth quarter was $3.1 million, 32% of revenue. This compares to a margin of $2.1 million or 24% of revenues for the fourth quarter of 2010. Adjusted operating margin for the year was $11.2 million, 29% of revenues, as compared to $7.2 million, 22% of revenues for full year 2010.

Our adjusted EBITDA for the fourth quarter was $3.5 million, compared to $2.8 million in the fourth quarter of 2010. For the full year 2011 adjusted EBITDA was $12.7 million, compared to $9.9 million for 2010. The adjusted EBITDA margin for the fourth quarter was 35.5%, which brings the full year margin to 33.2%, compared to 29.8% for the full year of 2010.

Capital expenditures for the fourth quarter were $368,000 and for the full year $1.5 million. Depreciation expense for the quarter was approximately $353,000 and for the year $1.4 million. Depreciation is recorded in the various P&L line items, with approximately 73% recorded in cost of revenues.

For 2011 ending cash including commercial paper investments was $20.7 million, a decrease of approximately $1.3 million from the Q3 2011 ending cash balance. The net decrease was driven by a $6 million repurchase of our common stock, which resulted in the repurchase of approximately 2.2 million shares at an average price of $2.75. This repurchase was part of the $15 million share repurchase program announced in November of 2011. Compared to year end 2010, ending cash including commercial paper investments, decreased $3.9 million, again driven by a share repurchase program that used $21 million of cash in 2011.

Adjusted net income from continuing operations for the fourth quarter was $2.9 million, which compares with $2.5 million for the same period in 2010. For the full year 2011 adjusted net income was $10.9 million as compared to $8.4 million for 2010. Our adjusted net income for fully diluted share of common stock from continuing operations for the quarter was $0.04 versus $0.04 from the same period in 2010 and $0.16 for the full year of 2011 versus $0.13 for 2010.

Before I move on to guidance for 2012, I want to mention the status of our warrants. As discussed during our last call, in the fourth quarter but prior to the October 5 expiration date approximately 1.6 million warrants with an exercise price of $1.54 were exercised, increasing our fourth quarter cash by approximately $2.5 million.

At December 31, 2011 we had approximately 146,000 remaining warrants outstanding with an exercise price of $4.48. These warrants expired in January 2012. As of today we have no outstanding warrants.

Let’s now move to guidance for 2012. For the first quarter 2012, we project our fully diluted adjusted earnings per share to be $0.04 and projected revenue guidance ranging from $10 million to $10.1 million. For full year guidance we project 2012 revenues to be between $41 million and $43 million. Fully diluted adjusted earnings per share are projected to be between $0.19 and $0.20 as compared to $0.16 in 2011.

This guidance will yield an adjusted EBITDA margin percent in the low to mid 30s and adjusted operating margin slightly less than 30%. Additionally, as previously discussed in 2010 and 2011, we reduced the deferred tax valuation allowance generating a tax benefit on the income tax line in our operating statement. This adjustment was required by generally accepted accounting principles and was the result of the company’s growing profitability.

In 2012, we expect that based on our earnings guidance which reflects improved earnings we will once again reduce the valuation allowance and like the previous two years generate a benefit to income tax.

In closing, we are pleased with the 2011 results against our key financial metrics, and look forward to continued strong performance in 2012. With that I will turn it back to Rick.

Rick Spurr

Thank you Mike. As Mike said, we look forward to strong performance in 2012. With that let’s open it up and take some questions.

Question-and-Answer Session


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

Mike Malouf – Craig-Hallum Capital Group

Great, thanks guys and thanks for taking my question. The first thing I want to focus in on in and I want to make sure that I understand that this Transport Layer Security certainly seems like it could have helped your transparency. Have you had any either examples or some experience yet with the TLS on how that’s increased your transparency from your existing level?

Rick Spurr

Yeah, that’s a great question Mike. So, for everyone’s benefit we currently believe our level of transparency with recipients is around 30%. So prior to introducing this new feature our gateway to gateway transparency capability which is unique, we believe allows for 30% of recipient approximately to be picking up all their encrypted email without passwords or any impact on their workflow.

TLS will definitely increase that, but we don’t know whether it will increase it to 50% or 70% or beyond. So we don’t have the statistics yet. But we are building tools which will allow us to measure and report on that over the course of time. TLS is used pretty significantly in the industry or as we said point to point transmissions. So a company might have five major partners and they setup a TLS link, five different links and allow their mail flows over those links.

We have subsequently invoked those links and integrate them into our delivery mechanism to increase the level of transparency. But in that instance it would only be for those fives. So some customers have nine, some customers have five, some customers have lots, 30, and so we just going to have to measure and report it to you over time.

But we do think it’s key, we really think it’s key to better penetration rates and better adoption overall which is the strategy we have articulated.

Mike Malouf – Craig-Hallum Capital Group

That makes sense. And I would imagine that the level of this TLS is probably more powered with larger companies. I know you talked about 7000 companies or at least almost 7000 customers right now. How many of those are what you characterize as large customers that may be really prefer using this technology. And maybe over – I don’t know if you had to use, Mark, maybe over 1500 employees or maybe even 10,000 or something like that.

Rick Spurr

That’s good Mike. Over 1500 employees is a good tier. Of those 7100 customers I think I'm getting this right, it’s either a 1000 or 1500, but I think it’s 1500, 40% of them have more than 1500 employees, now that 40% represents, I'm sorry, I'm sorry, I'm sorry, it’s not correct, it’s not correct. They represent 60% of our seat, so 15 companies with 1500 employees or more represents 60% of the seat, but only 40% of the revenue.

Then the customers smaller than 1500 you get the flip-flop, they represent 60% of the revenue but 40% of our seats. In terms of actual numbers of companies, the over 1500 number I don’t have it memorized unfortunately, but it’s going to be less than 500.

Mike Malouf – Craig-Hallum Capital Group

Okay, great. Yes, so that’s still very small percentage of your customers and…

Rick Spurr

Yeah, it’s really nicely distributed, but it stands – you get a real big customer you get lots of seats, you get a fair amount of revenue, although pricing is pretty competitive, and with a smaller number of those you can have a significant impact.

Mike Malouf – Craig-Hallum Capital Group

Now, moving to the R&D spent, the increase in R&D spent, we obviously don’t have that in our model when we look out into 2012, and I'm kind of wondering for a little bit of more color on that given that you came out with Mobility and certainly this TNS new adjustment on $5.2 million in R&D. What would cause you to make a change and actually get – and decide not to leverage that line item sort of for the first time in a couple of years? Thanks.

Rick Spurr

I acknowledge we did leverage it last year, didn’t increase it last year. It gets a little murkier in prior years because of the prescribing complexities. So we were growing R&D in email as we shut down any prescribing. But, let me comment on why we decided to make the increase from $5.2 to $6 million.

Our data both from this Ponemon Institute Survey and then supported by the Gartner data suggests that it’s the high end of the market. There is going to be – the Gartner’s numbers are over 65%. Our customers are going to be looking to leverage email encryption in their next contract renewal cycle. We know from having been in the market place as long as we’ve been in it that all those large customers always want more than they have, and so we always have a list of requirement and we just felt like we didn’t want to risk missing this opportunity and we wanted to dig deeper if you will into the list of requirements.

The things we are going to execute against now at a more accelerated rate are further improvements for these larger enterprises in terms of feature function and continued investment in ease of use and just overall manageability.

Fortunately, those types of investments for large end customers flows quite nicely down through the entire base of opportunity. So, you get not just stand tall in those bits but it also helps you throughout the entire market place in your mid tier for sole end as well. So many investments we make each and every year have to do with scalability and efficiency just to make sure that we can continue to scale this business at even faster rates without having to add people for support and operations, so partly investment goes there as well.

Mike Malouf – Craig-Hallum Capital Group

The increasing rate of R&D spent is really more of targeting – there have been acceleration in top line out maybe even called 2013 and beyond, is that how I should think about it?

Rick Spurr

Yeah, that’s fair. You know the model well Mike. Strong sales in 2011, oh I'm sorry strong sales in 2012 will be the purpose, the thrust, the function that drives growth in 2013 and then continuing on. So, we’ve got a step it up accelerate improvements and step up our sales, and this is all part of that plan.

Mike Malouf – Craig-Hallum Capital Group

Okay. Thanks a lot for the help.

Rick Spurr

Thank you, thanks for your questions.


The next question comes from the line of Frederick Ziegel with Topeka Capital Markets. Please proceed.

Frederick Ziegel – Topeka Capital Markets

Hi guys.

Rick Spurr

Hey Fred.

Frederick Ziegel – Topeka Capital Markets

Two questions. First, you commented that you are seeing less of McAfee and Cisco. So my question related to that is are you getting more price competition from some other smaller guys like Proofpoint or how would you king of characterize the environment. And then my second question is, on the international side you know MessageLabs has obviously a presence given their heritage. But, in your VAR and Managed Service Provider groups any of those focused on international markets more specifically?

Rick Spurr

Okay, let me take those in sequence, first of all, the competitive landscape. I mentioned McAfee because they are such a large provider in the market place. They haven’t been – I guess it’s not clear for me to say I am seeing less. It is fair to say they are not a threat. They haven’t been and still are not showing up. Cisco has definitely fallen off as I mentioned. Proofpoint is a factor and they are definitely in the market place. Overall, however, we have fewer competitors. The business is consolidating, this is harder and harder to do, people recognize over time how complex it is and the visibility you get at executive level. So, you can't be pretty good, like you got to be flawless. As a result we are seeing fewer and fewer competitors.

On the pricing front, we are not seeing pricing pressure increasing. If anything, it’s our additions to the technology and this fewer number of competitors I frankly feel a little less pressure.

To the international question, this battle of VARs and MSSPs we have, generally you are not going to help us internationally. However, we continue to have a relationship with Symantec and Google both of which help us with international presence and we are having some other discussions with other partnerships that could help us in international markets.

Frederick Ziegel – Topeka Capital Markets

Just back to the first question, if I understand your answer, the 20% or so decline in new first year orders 2011 versus 2010 is not competitive loss, not pricing, putting that simply economic and the reorg?

Rick Spurr

That is definitely our view. As you know we can't see every deal in the market place and conceivably stuff is happening that we don’t have visibility to. But from what we know and from our day to day engagements, sales were not down in 2011 because of pricing or competition. That is the correct statement.


[Operator Instructions] The next question comes from the line of Jeb Terry with Aberdeen Investment Management. Please proceed.

Jeb Terry – Aberdeen Investment Management

Good afternoon gentleman.

Rick Spurr

Hi Jeb.

Jeb Terry – Aberdeen Investment Management

Your first point out of your six points you mentioned competitive advantage and barrier to entry, and the course part of that is the strength of your intellectual property. To that point, Rick I noticed that you’ve found and amended answer to amended answer to RPost litigation yesterday. Can you comment on that point and then your world intellectual property in general?

Rick Spurr

Sure. Let me first share some of the facts around RPost, a little bit of background. At the end of January 31, this company RPost alleged in a lawsuit that Zix was infringing one of our RPost patents. This lawsuit is similar to those filed by RPost against numerous other companies. Zix doesn’t use the technology in RPost patents, so we are not overly concerned about the lawsuit, and the lawsuit process will play itself out over time. That being said, RPost has been saying things in the press about the lawsuit which are misleading and wrong.

Yesterday, we filed counter claims addressing RPost’s misleading and unfair statements, and seeking appropriate relief from the court. So this detail that’s in this counter claim may be helpful and can be found at a government website called www.pacer.com for those that want to delve into that detail.

Jeb Terry – Aberdeen Investment Management

Rick, I should mention, I don’t know if I had heard you correctly, but the lawsuit was filed on January 31, 2010.

Rick Spurr

It was filed in January 31, 2011. If I misstated that I…

Jeb Terry – Aberdeen Investment Management

I think you said it right, okay, sorry.

Rick Spurr

No, that’s okay. So a little over a year ago it was filed, it’s been kicking around, but these things take forever, but again we are not overly concerned because we don’t use their technology.

Jeb Terry – Aberdeen Investment Management

Very good, very good. And to that point, to your intellectual property suite at this point – I mean with your elevated R&D spent I gather that you have added to the patent library, and are there other things out there that might be viewed as a competitive element.

Rick Spurr

Yeah that’s a good question Jeb. So let me just leave it at this. When Zix was founded and over the early days of design, there were lots of patents filed. David Cook, our founder, is an inventor, and he has been filing patents all his life, so he did lots of that. A lot of what we have already today is protected by those earlier patents. We have, however, stepped it up in this regard and have filed two new patents in the last, certainly last nine months, which we are very excited about. But they become things that are highly technical and hard to describe. But those things would allow us to capitalize on some of the unique methods and technologies that were under development.

Jeb Terry – Aberdeen Investment Management

Thanks so much.

Rick Spurr

Thank you Jeb. Okay, I think I am getting signs that there are no additional questions. We are thankful that everybody joined us on the call, and look forward to our next call which should be in April. Between now and then try to be on the road. As you know I am in San Francisco this coming week and anybody that's out there I would invite you to come by and see me. Thank you very much.


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