Zix Corporation (NASDAQ:ZIXI)
Q1 2016 Results Earnings Conference Call
April 26, 2016, 05:00 PM ET
Geoff Bibby - VP of Marketing
Dave Wagner - CEO
Mike English - CFO
Mike Malouf - Craig-Hallum Capital Group
Michael Kim - Imperial Capital
Joe Maxa - Dougherty & Company
David Kanen - Aegis Capital
Good afternoon, ladies and gentlemen and welcome to the Q1 2016 Zix's Corporation Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host, Mr. Geoff Bibby, Vice President of Marketing.
Thank you, Lych. Good afternoon and thank you for joining our 2016 Q1 conference call. With me on the call this afternoon are Dave Wagner, our CEO and Mike English, our CFO. Dave will provide an overview of the company’s performance in the quarter and then Mike will give you details of our financial results. Later on the call, they will answer questions. Listeners can also submit questions during the call to our Investor Relations mailbox at firstname.lastname@example.org.
During the course of this call, we will make forward looking statements regarding future events and the future financial performance of the company. These forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward looking statements, and the company undertakes no obligation to update such statement.
We caution you to consider risk factors that could cause actual results differ materially from those in the forward looking statements contained in today’s press release and in this conference call. The Risk Factors section of the Company’s most recent Form 10-K filing with the SEC gives examples of those risks.
During this call, we’ll present both GAAP and non-GAAP financial measures. These non-GAAP financial measures are not intended to be considered in isolation from of substitute for or superior to our GAAP results and encourage you to consider all measures when analyzing performance. A reconciliation of certain GAAP to non-GAAP measures is included in today’s press release which can be found in the Investor Relation section of our website.
Now I’m very pleased to turn the call over to Dave.
Thanks Geoff. Good afternoon and thank you everyone for joining us today. Before we dive into the quarter, I’d like to let everyone know that you’ll begin to hear Mike and I refer to several new metrics of Zix. These metrics are typical of what you see from a software-as-a-service or SaaS business. As SaaS business, we believe these metrics are more reflective of our business model and provide greater visibility and a better understanding of the state of our company.
Now turning to first quarter results, I’m pleased to report solid revenue and earning’s growth for the first quarter, reflecting the continued strength of our business. We met our guidance for revenue and we are pleased to have exceeded our earnings guidance for the quarter.
Looking at the numbers revenue for the first quarter was $14.3 million which was right in the middle of our guidance range for the quarter, and was an increase of 10% over the first quarter a year ago.
Our adjusted EBITDA was 29% at $4.1 million that represents an increase of 37% year-over-year. We’re excited about this growth and indications about the health of our business. Our backlog which reflects all contractually committed business that has not yet been recognize its revenue with $75.5 million at quarter end compared to $70.3 million a year ago.
During the first quarter, we exceeded our expectations regarding retention rates, a positive reflection of our industry leading solution and our customer’s high level satisfaction. Of the $75.5 million backlog, the annual contract value or ACV, an important SaaS metric is $58.2 million, up from $57.2 million at Q4 and up 9% from $53.4 million from Q1 last year.
On the bottom line, we achieved GAAP net income of $1.6 million or $0.03 per share on a fully diluted basis. Non-GAAP adjusted net income in the first quarter was $3.4 million or $0.06 per share on a fully diluted basis, well above our guidance. And during the first quarter, our business generated $4 million in cash flow from operations.
New first year orders for the first quarter were $1.9 million which was slightly less than expected. However, total orders of $15.7 million were higher than expected and represent the very back first quarter for total orders ever and the second best quarter for total orders in history of our company.
While we saw solid year-over-year growth in OEM sales in Q1 either go to market channel or short of our new first year order expectations for the quarter. Remember, we have an all-time record $2.9 million for new first year orders in Q4 so we are seeing strong demand. The slight shortfall for Q1 seems to be the results of strong full forward from the sales teams into December.
After historically high Q4, our pipeline was lighter in Q1, but demand continues to be strong as reflected by our stronger than expected renewals for Q1 and a healthy pipeline for Q2. Strong demand continues in part due to customize migrations from there on premise email environment to the cloud specifically Microsoft Office 365. Migration to Office 365 has set a positive trend for Zix because our email encryption provides customer’s greater value than email encryption offered through Office 365.
The consistent feedback we hear from customers is the email encryption with Office 365 is not sufficient, so overall migrations from on-prem email environment to the cloud have re-energized companies to improve their email infrastructure with additional services like email encryption.
As Mike will share later on the call our 2016 annual revenue guidance remains the same and we are increasing our EPS guidance $0.24. So we are confident in our long term growth and profitability objectives.
As I said, we had a healthy OEM contribution in the quarter to our new first year orders and the pipeline with our OEM partners is building. OEM sales were up more than 100% year-over-year and contributed 16% of total new first year orders in the first quarter.
Going forward for competitive reasons, we will report sales in terms of OEM versus to that, and we will not disclose specific sales channel contribution. We believe this practice is more consistent which what other software vendors do.
From an industry perspective, the breakdown of our annual contract value was 51% from healthcare, 28% from financial services, 7% from government and 13% from all other protocols.
So overall, despite a lower than expected new first year orders from the quarter, every indicator across our business remain positive. Our business pipeline remains on track and continues to build. We expect to meet our revenue goals for the year and our strong earnings in the first quarter also put us on track to increase our adjusted earnings guidance for the year by $0.24.
Now let me turn to our product to give you an update based upon a breakdown of annual contract value. As of the first quarter, the annual contract value for our recently rebranded DLP solutions now ZixQuarantine and ZixInsight was $1 million up 54% from the same time a year ago. The annual contract value for ZixOne was also $1 million, an increase of 50% from a year ago.
The annual contract value for email encryption was $56.2 million, up 8% from a year ago. As a most significant contributor to our revenue we will standpoint email encryption market for a moment.
We are very pleased per seat further evidence this past quarter and have a security eco-system is waking up the email security concerns. And Howard is reaffirming the importance on encrypted email.
Most recently sound a world large email service providers including Google, Microsoft and Yahoo! stand together develop an IET for Internet, Engineering, Taskforce proposal for improved email security.
A number of recently published articles to touch on these new proposed standards, named SMTP STS or Strict Transport Security. The proposed standard addressed the some of the current security vulnerabilities for sending secured email using TLS or transport layer security.
Zix has been working with our customers for nearly 20 years to provide more secure email and we applaud the development of this new standard. At the end of the day, we believe the proposed STS standard brings more awareness to the vulnerability of email and the need to email encryption. It also gives us the opportunity to further distinguish ourselves as we provide even more value for our customers.
TLS as it exists today and as it will exists in a future is a resource burden to deploy and to administer correctly. Since there will never be a perfect environment with every server is proper configured to TLS businesses will continue to benefit from Zix’s actively managed TLS connection.
Zix email encryption also offers other features and capabilities that many business users demand that cannot get to TLS even with the proposed new STS standard. The value of those revised best reflected our new customer wins and particularly in the placement wins.
The given example of a customer placement in the first quarter I’d like to highlight a healthcare accounts in Massachusetts with 2000 users. This customer’s previous mail encryption solution had two significant issues.
First, a challenging end user experience which was frustrating employees of recipients. The second, the solution’s policies were creating so many false positive that the customer had to turn-off automatic encryption. The first issue creating IP headache and the second issue kept IP up and night worrying about protected health information leaking through emails, season or customer workload, not mine. Zix’s email encryption was a ease of use improve policy sales force solve the customer’s issue.
This is the type of value we offer our customers through our industry leading email encryption we provide an easy to use solution that allows our customers to sleep well at night knowing that protected their email, their companies and their communities.
I look forward to sharing more of these customer stories on future calls, but I will now turn the call over to Mike English, our CFO, to discuss our financial results in more detail. Then, I’ll share some concluding comments before we take questions. Mike over to you.
Thank you, Dave. Good afternoon everyone. As Dave mentioned, we’ve begun the year with both strong revenue and earnings performance. Revenue for the first quarter improved 10% and adjusted EBITDA improved 37% compared to the same quarter last year.
First quarter revenue was $14.3 million compared to $13.1 million in the first quarter of last year. The 10% year-over-year improvement resulted from the addition of recurring revenue from new customer contract and was helped by strong revenue retention. Sequentially, first quarter 2016 revenue was in line with Q4 2015 revenue due to a non-recurring revenue catch up in Q4 2015 that exceeded $200,000.
On a GAAP basis, for the first quarter of 2016 compared to the same quarter last year, gross profit of $11.8 million was up 9%. First quarter 2016 GAAP gross margin percent of 82.3% was down from 83.1% in the same period last year.
As discussed on last quarter’s earnings call investments in CISCO support and deployment resources ahead of orders and revrec are expected to impact this percent especially in the initial stages of the relationship.
First quarter 2016 GAAP operating income of $2.5 million or 17% of sales was up 34% compared to $1.8 million or 14% of sales in the first quarter of 2015 reflecting the positive impact of ongoing cost control and the leverage from our partner distribution model.
This year-over-year earning’s improvement was achieved despite approximately $600,000 higher general and administrative cost of which $500,000 was primarily associated with litigation related to the defense or intellectual property. Similarly, first quarter 2016 net income of $1.6 million or 11% of sales were also up 34% compared to $1.2 million or 9% of sales with same period last year.
Moving on now to our key non-GAAP metrics. As a remainder, we talk about adjusted non-GAAP financial metrics, which include non-cash stock based -- excuse me, which exclude non-cash stock based compensation expense, non-cash tax expense and expenses related to litigation. We include a reconciliation of GAAP to non-GAAP financial results in our earnings release.
Compared to the same period last year, first quarter 2016 adjusted gross profit of $11.9 million or 82.7% of sale was up $940,000 or 9% compared to $10.9 million or 83.5%. Compared to the same period last year, adjusted gross profit as a percent of sales decreased slightly due primarily to the timing of cost of sales investments relating to CISCO as just discussed.
Sequentially, adjusted gross profit as a percent of sales in the first quarter 2016 was flat compared to the fourth quarter of 2015. Adjusted R&D expenses of $2.1 million for the first quarter 2016 remain relatively flat at 15% of sales compared to the first quarter 2015.
First quarter 2016 selling and marketing expenses of $4.3 million were down $380,000 8% primarily due to lower advertising expenses compared to the same period last year. We anticipate slightly higher selling and marketing expenses going forward. Adjusted G&A expenses of 2 million or 14% of sales increased approximately $200,000 compared to the first quarter of 2015.
By half of this year-over-year increase reflects normal changes in employee’s salaries and benefits. Remaining half of the year-over-year increase reflects one time charges relating to sales taxes in employee recruitment. For the year, we expect adjusted G&A to be between 11% and 12% of sales.
First quarter 2016 non-GAAP adjusted earnings for fully diluted share of $0.06 exceeded the high end of our guidance and was $0.02 better than the same period last year. Q1 2016 adjusted EBITDA of $4.1 million or 29% of sales was up 37% compared to $3 million or 23% of sales in the same quarter last year.
Cash flow from operations for the first quarter 2016 was $4 million up 60% compared to $2.5 million for the first quarter 2015.
During the first quarter of 2016, we used $5.2 million to repurchase 1.3 million shares of our common stock and an average price of $4 per share. Through April 25, 2016, we used $9 million to repurchase 2.28 million shares at an average price of $3.95 leaving approximately $6 million remaining on the $15 million share repurchase plan. The plan is set to expire in September 2016.
We continue to maintain a strong balance sheet with no debt. The ending cash balance of 27.1 million at March 31, 2016 was up $2.2 million compared to the same quarter last year. CapEx of $180,000 was about half of our normal quarterly level due to the timing of purchases in the quarter.
Going forward, we expect capital expenditures to return to normal levels of $350,000 to $450,000 per quarter for the rest of the year.
Appreciation expenses for the first quarter 2016 was $534,000 and was in line with our expectations. Regarding income taxes, we expect to continue to record non-cash income tax expense consistent with last year resulting in an effective GAAP tax rate of approximately 39%. Non-cash taxes will remain low also consistent with last year.
The backlog which represents dollar value of committed contracts were $75.5 million at March 31, 2016 up $5.2 million or 7.4% compared to the same date last year. We expect to recognize approximately 55% or $41.9 million of this backlog as revenue over the next 12 months.
Moving on now to our forecasted revenue and adjusted EPS for the second quarter and full year 2016. For the second quarter 2016, we forecast revenue to be between $14.6 million and $14.8 million and adjusted earnings for fully diluted share of $0.06.
For the year 2016, we reaffirm our previously issued revenue guidance of $59.9 million to $61 million. We are increasing our adjusted EPS guidance for the year from $0.23 to $0.24 for fully diluted share.
With that, I’ll return the call to Dave for some additional comments.
Thanks Mike. Before I open the call to questions, I’d like to take a few minutes to describe in more detail the process by which the leadership team and I are developing our strategy profitably grown company. We’ve spent a good deal of time during my first 90 days at Zix working and communicating with our internal team, reemphasizing the importance of strong customer service and the impact of our solutions on the communities that we protect to drive stronger customer service and retention.
Our corporate purpose is clear to protect business communications for our customers and their community. This purpose connects us with our customers and with their end users by emphasizing the network effect of Zix’s gateway which is one of the core value drivers and differentiators of our solutions.
With the strong value of our service the strength of the company today and the tremendous opportunity for future growth the leadership team and I are working on plans to increase the growth rate of the company.
We made an important step last week with the addition of Kelly Haggerty as our new Vice President of product management and strategy. Kelly joined Zix with over 20 years of experience in product’s management roles and organization focus on protecting business communications.
He was the product leader of SurfControl or his strategy lead to revenue growth from $7 million to more than a $100 million. Kelly then worked for over eight years at McAfee where he was the VP for product’s management for SaaS business unit for four years and then in the same role for security, management business units for another four years.
We have products under his leadership experience significant growth. Kelly's core strengthen is in developing a deep understanding of customer requirement and market trends and then adapting technologies to those trends to drive growth. The team is really excited to have him on Board.
We’re also paying keen attention to our customers. We made sales investments in both people and systems to help us increase our sales velocity. And we're making roadmap adjustments to accelerate features that we believe will create additional value for existing as well as new customers.
Last week we announced the availability of our DLP solution ZixQuarantine and ZixInsight to our hosted SMB customers.
As we execute our plan to grow the company, we're focusing first on existing customers and further improving retention. We're also exploration closed market adjacency and English speaking international markets.
As I've said many times, Zix has a tremendous opportunity for growth in the future. The announcement of the proposed STS standard for TLS in March shows the increasing focus of protecting email. Our Secure Email Solution is the most comprehensive and easiest to use in the market today. And we look forward to extending our leadership position.
With that, I'll now turn the call over to our operator to take your questions.
Your first question comes from the line of Mike Malouf from Craig-Hallum Capital. Your line is open.
Hey, thanks for taking my questions.
Dave -- hi. Dave I was wondering if you could just give us an update on how the rollout with Cisco is going and how the new product has being received. I know that -- I think that you had been doing a series of teachings with the sales people at Cisco and I'm just wondering if you could give us some color on that. Thanks.
You're welcome. So, to begin the teachings were really focused at the end of last calendar year and into the beginning of this year where we focused on the sales engineers. This quarter we saw the rollout of some great online video materials further training of the Cisco sales organization. We had the opportunity to participate in event with 30 of the top customers in the United States to share with the value of the ZixGateway with Cisco technology and VTC product.
So, we continue to work very close with them and continue to see the pipeline growing and are getting into some interesting customer opportunities.
And were you able to close any customers in the first quarter?
Yeah. We've been closing customers and building the pipeline and it's an ongoing process.
Okay. All right. And then I wonder -- just as a general question if you could -- now that you've been there for a few months now, just give us a sense of what you think as Zix can grow on a topline basis, I mean relative to the market? Not necessarily a point figure for growth, but just do you think that you can grow with the market?
So, our guidance for this year would suggest approximately 10% revenue growth which our statistic would suggest that a little bit higher than market growth for email encryption. So, we're looking at continuing to take share in the U.S. market. And as I said, we're looking for some adjacencies and some English speaking international markets that would allow us to begin to accelerate that. But to answer your question directly, the guidance of 10% growth is what we're seeing.
So, you see the market the whole sort of global email encryption market as growing somewhere in the single-digits?
Okay. All right. Thanks.
Your next question comes from the line of Michael Kim from Imperial Capital. Your line is open.
Hi, good afternoon guys. Can you talk a little bit about your routes to market and leveraging into new channels, whether it's your new OEM partners or the VAR channel? You mentioned a little bit about extending it to the international English speaking country. Just curious what some of the efforts are taking place to build your channel relationships?
So, the channel program from my perspective joining is quite strong. We have over 340 partners across the U.S. with a mature management structure internally with those partners and that seems to be executing quite well.
So, the real strength Zix's model and its network effect from my perspective begins with community leaders. The large anchor accounts that communicate sensitive business information by email and the interactions that those account have with other members of their community.
So, we're really focusing on the community aspect of the Zix encrypted network and the inter-relationship of our customers protecting information in their communities. So, that's really how we're focused on taking advantage of the strong channel that exists here.
And then internationally do you a lot of the similar dynamics with message traffic crossing globally or are they primarily for intra-company, intra-country traffic?
So, the international market [Indiscernible] the English speaking homogenous market where were focused I think at similar dynamics to the U.S. market and I should say tuning [ph] people that we're investigating have similar dynamics to the U.S. market which is why we're looking at those.
So, yeah -- speaking international to the encryption is tricky, saying that we understand that.
Great. And then just lastly on newer opportunities ZixDLP and ZixOne, missed this earlier, but can you talk about maybe some of the opportunity to accelerate into both your existing customers and driving net new customers to both of those product lines?
Yeah. Both those remain strong, consistent with the growth we've been seeing specifically, we disclosed the ACB of ZixOne as $1 million growing 50% year-over-year, continues a good opportunity there. With ZixQuarantine and ZixInsight, those attach much more closely to our hoar email encryption offering and so that's also at $1 million ACB with 54% growth rate.
We made an important extension just this month and adding that capability to our hosted SMB customers, so we expect to drive more higher attach rate in that area of our business, our hosted SMB is where we gain the fastest new customer growth. We're excited about adding that capability for those customers as well.
Great. Thank you very much.
Your next question comes from the line of Joe Maxa from Dougherty & Company. Your line is open.
All right. Thank you. So, on the new first year orders, I mean clearly down a little bit from expectations, didn’t breakout Cisco and Google for your new metrics you want to give but, a little color on those would be helpful given the strength they had quarter or perhaps last year. And where you may expect those to go this year?
So, the 1.9 million was a little than we expected up wonder whose new perceive revenue want is you highlight as identical that Q4 was exceptionally strong, but it looks like it is a sales team really closed out December in a very strong and powerful way which was very good, leading the pipeline a little bit lighter starting at the year that we would have anticipated.
The market momentum remains quite strong. Our pipeline is for Q2, look very good. So, there's really no cause for concern at all from management perspective on that number. So, in pretty good shape.
So, do you think you'll be seeing a return to similar numbers maybe at Cisco and Google did in Q4 or Q3 as we get into Q2, Q3 this year?
So, I would expect to see OEM growth this calendar year. One of the good things we have is we have the OEMs representing about 16% as you know of our new first ship orders. We have our enterprise corporate teams, which continue to execute.
So, we'll see a balance between those. We do expect to see a good growth across and from our OEM channel this year. Quarter-by-quarter new first year orders can be a little bit lumpy, so I don’t want to give exact split, but I could tell you for the year we feel good about where both of those OEM partnerships are.
So let's talk a little bit about the new first years order versus your total orders, obviously a nice total orders number. Just kind of compare those I mean is the difference -- the big renewal rate coming back customer come back for larger orders or are you just seeing more customers that are generating that product or they want to terminate just some of those types of metrics?
Yeah so our term is remaining pretty steady it might be decreasing just a little bit but remains pretty steady in average of just over 30 months as an average term. So, the big thing at the total renewal is how many are available for new in a quarter and second big knob is how well we do at retaining those customers. In this past quarter, we had a stronger than budgeted retention quarter -- just generally a strong retention quarter against what was a large relatively large opportunity for the renewals.
Okay. The litigation expense is that that 500,000, is that a number that we should be thinking as pretty consistent going through the year or would you expect that to come offers?
Well, it's really impossible to predict how those cases will go. I can’t tell you that we were rigorously depend our IP when necessary. It's an important part of our business and we will stand it. So, that’s what we experienced last quarter. That would be pretty one way to think about next quarter, but it’s really impossible to predict the timing of those that come up every third year so -- and we're rigorously depending--.
So, in the near-term, you have a sense of what you are spending, does it look like Q2 look similar to what Q1 would be?
Okay. Okay. That’s it. Thanks.
Okay. Thank you, Joe.
Your next question comes from the line of David Kanen from Aegis Capital. Your line is open.
Good afternoon guys thanks for taking my questions. First one if you can answer it is what where your first year new orders for ZixOne on the quarter?
So, we didn’t provide that. We had a similar number of new customers and similar seat add what we share with the million dollars for ACB with 50% year-over-year growth in the total ACB value.
Okay. And then on the -- I know you guys have done a great job in terms of executing on renewals, what are the ASPs there, are they stable, slightly higher, slightly lower?
They are extremely stable we’ve been getting modest increases, but I would say they are very, very stable.
Okay. And then can you give me just a theoretical question. Let's say there is a point in time where you guys says you know what ZixOne, it’s just not working, what we look at kind of what we're spending to support it sales and marketing. There is really no return there, its drag overall. Can you give -- what color can you give me if you were to decide in the future that you are no longer going to advance that product because perhaps that requires a much larger investment in terms of adding features and functionality? What are we spending roughly on an annual basic so that product that we could potentially strip out?
So, we don’t disclose R&D spend by product. So, the ZixOne product, in actuality, is a really good application for protecting vivid communication on personal devices that it has a very different approach than any other product in the market where the data does not reside on the device.
So, it has a very strong value proposition. We have 50% year-over-year growth on a $1 million ACB. So that number is -- that’s the number where we obviously looking carefully as we look at all of our products to make the best next and best we can make and that's what we're seeing to with ZixOne as well as our other product offerings.
Okay. So, you can’t really give me a number potentially in what you would save there?
Right. No not able to do that.
Okay. I mean what I'm driving at is perhaps there is a point in the future where collectively management, Board decide you know what this is not generating return and you wind it down and when you look at where you guys have done really well, you've done an exceptional job with leading market share with your Gateway product, DLP has been very successful, albeit smaller.
You've done a great job by capital allocation buying back stock. Those are the things that have worked and I'm just wondering is there a point in time where perhaps focus on that and kind of cut the line so to speak on ZixOne.
Or if you requires investment maybe you still focus on those things and generate returns for your shareholders, okay. And put the company up for sale and let someone else that has a longer time horizon make those heavy investments in ZixOne that explicitly seem to me a require.
I think that -- I mean I could be wrong, but it just seems to me that the product may not be robust enough for competition and that’s why we're not really getting attraction. So, just sort of a comment for the Board?
And then question on international, can you give me a sense in U.K., in Canada, what does the competitive landscape look like and what if any are your impediments into getting into that market?
So, markets are looking at competitively look very, very similar to the, U.S. market, which is why we're looking at those markets.
So, really -- many of the same players you're saying?
Okay. And then you guys -- are there any impediments in terms of the way your product offering right now in complying with some of the requirements that they have in financial regulations, healthcare, et cetera, U.K. and in Canada et cetera or it's pretty similar in transition?
Pretty similar. I wouldn’t call them impediment. There would be modest investment needed, but not -- certainly not impediment.
Okay. Glad to see you guys focusing on that. I wish you luck and I think it’s something that really the Board should seriously contemplate the issues that I put out there because I just seems like after all these years, there's saying actions speak louder than words. I mean that’s the proof. It probably requires investment. And I don’t think the shareholder base has the tolerance for that and the sale of company might be the best option, but I wish you much -- thanks for listening.
Thank you, David.
I'm showing no further questions at this time. I would now like to turn the call back to Mr. Wagner.
Well, I would just like to thank everybody for your time and joining us today on our call and look forward to talking to you in 90 days.
Ladies and gentlemen, this does conclude today’s conference. Thank you for your participation, you have a wonderful date. You may all disconnect.
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