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Executives

Richard D. Spurr - Chief Executive Officer, Chairman of the Board & Chief Operating Officer

Jim Brashear - General Counsel

Analysts

Zix Corporation (ZIXI) Zix Corporation 2012 Annual Shareholder Meeting June 6, 2012 11:00 AM ET

Question-and-Answer Session

Richard D. Spurr

Good morning and welcome to the Zix's Annual Meeting of our stockholders for 2012. We will stick to the agenda tightly today, so that we can move through this meeting efficiently. First of all, I will introduce my fellow members of the board, executives from the team that are with us here this morning, and then some other officials who will help us conduct the meeting.

Now separately, we will vote on the proposals that are on the agenda. I will give an update on business and then at that time we will be able to report the preliminary results of the voting, and then lastly I will take some questions.

Let's get started. I would like to introduce my fellow directors. I am proud to introduce our Mr. Taher A. Elgamal. Let's hold applauds till we get finished here. Also, Robert C. Hausmann, Maribess L. Miller, James Marston and Antonio R. Sanchez III. Thank you very much. (Inaudible).

Up here with me at the table is Jim Brashear, who is our General Counsel and Corporate Secretary. On the far right, Mr. Geoff Bibby, our Vice President of Marketing. To his right is, Russell Morgan, our Vice President of Client Services and Mr. Kadonsky, he is our Vice President of Operation and Michael English, our Chief Financial Officer.

Also, representing our independent auditors, Whitley Penn LLP, is Mr. Jeff Lawlis and a representative from the Broadridge Financial Solutions, our official inspector of elections, Mr. Jim Gonn. Thank you, everyone.

Okay, and now I will turn this over to the Mr. Brashear, who will describe our voting procedures.

Jim Brashear

Thank you, Rick. I'm presenting for the record and after an affidavit certifying that an annual report and Form 10-K for 2011 and a proxy statement and proxy card for this meeting were mailed on about April 27, 2012, to all shareholders of record as of April 13, 2012, which is the record date for this meeting. Accordingly this meeting has been duly called under the Laws of Texas, which is the state of incorporation of Zix Corporation and under Zix Corporation's by-laws.

As Mr. Spurr said, a representative of Broadridge Financial Solutions has been appointed by the board of directors as the independent inspector of election for this meeting and he has executed an appropriate oath of office. The inspector of election has presented for the record a certificate of quorum, indicating that there are representative at this meeting approximately 52,989,631 shares of the company's Class A common stock.

Each share of Class-A common stock is entitled to one vote at this meeting, therefore shares representing 85.77% of the voting power of the company's outstanding shares are represented at this meeting in person or by proxy, so a quorum is present.

This meeting has four proposals before it. Proposal one is the election of six directors. Proposal two is the ratification of the selection of Whitley Penn LLP as the company's independent auditors for 2012. Proposal three is to approve an advisory vote on executive compensation and proposal four is to approve the 2012 incentive plan. Each of these proposals is described in proxy statement. The proposals will be presented in the order they appear in the proxy statement and each proposal will be presented separately.

Voting on these four proposals will be by written ballet. For those of you who have not already voted or wish to change your vote, after Mr. Spurr presents each proposal, you should mark your ballet on that proposal. We will collect the ballets after all the proposals have been presented and the votes have been called. After all the proposals have been presented and considered at this meeting and the ballets collected, the polls will then close and no more ballets or proxies will be accepted.

After Mr. Spurr's company update, I will provide a preliminary report of the voting results. Ballets were given to all qualifying stockholders who requested them at the registration desk, stockholders who executed proxies or voted online or by telephone do not need to vote again by ballet unless they wish to change their vote, so if any qualified stockholder now needs a ballet, please raise your hand we will provide one to you.

During his report or the question-and-answer session, Mr. Spurr may discuss some non-GAAP financial measures in talking about the company's performance and some of his comments may constitute forward-looking statements. These matters are subject to a number of factors that could actual results to differ materially from our expectations.

Those factors are described in the risk factor section of the company's most recent 10-K filing with the SEC. The company undertakes no obligation to publicly update or revise any forward-looking statements. We have provided a detailed explanation and reconciliation of our special items and non-GAAP financial measures on our website at www.zixcorp.com/investors.

An opportunity for questions will be provided at the end of the meeting, so please hold your questions until that time. It's now approximately 10:09, on June 6, 2012, and the polls are now open. The polls will close immediately following the presentation of the final proposal and Mr. Spurr's call for the collection of ballets. Rick?

Richard D. Spurr

Thank you, Jim. We will now consider the four proposals before us. The first proposal is the election of directors. Taher A. Elgamal, Robert C. Hausmann, James S. Marston, Maribess L. Miller and Antonio R. Sanchez III, and myself Richard D. Spurr.

Each individual has been nominated to serve as a director of the Zix Corporation for a one-year term, ending at the annual shareholders' meeting in 2013. This proposal is discussed on page five of the proxy statement. For those of you, who have not voted already or wish to change your vote on the election of directors, please mark your ballets at this time and we will proceed to the next proposal.

The second proposal is ratifying the selection of Whitley Penn LLP, as the independent auditors for the company for 2012. This proposal is discussed on page six of your proxy statement. If you haven't already voted or wish to change your vote on proposal two, please mark your ballets on this item.

The third proposal is an advisory vote on the company's executive compensation. This proposal is discussed on page seven of your proxy statement. If approved, the following resolution will be adopted.

Result that shareholders approve the compensation of the company's named executive officers as discussed in disclosed in the compensation discussion and analysis. The executive compensation tables and any narrative executive compensation disclosure contained in this proxy statement. If you haven't already voted or wish to change your vote on proposal three, please mark your ballets on this time.

The fourth proposal is to approve the 2012 incentive plan. This proposal is discussed on page eight of your proxy statement. If you haven't already voted or wish to change your vote on proposal number four, please mark your ballets on this item. Please make sure you have signed your ballet and indicated the number of shares you own, then hold up your completed ballet and one of the attendants will collect it.

I believe there are no ballets being submitted. That completes the voting on proposals before the shareholders and the polls are now closed.

Okay. Now, I would like to provide with an update on our business. I'll touch briefly on 2011 results and then share some perspective on the quality of our business model and then close with results from the first quarter of 2012.

As has already been reported, our revenue, non-GAAP adjusted earnings per share, backlog and cash flow continue to steadily increase in 2011. Revenue increased to $38.1 million, a 15% over the prior year. Non-GAAP adjusted earnings per share increased 29.4% year-over-year at $0.16 per share.

Backlog ended the year at $53.7 million, growth of 8% year-over-year, and our business produced $13.2 million in cash generated from operations in 2011, an increase of $6 million over cash generated from operations in 2010, and we announced two separate $15 million share repurchases and completed $21 million of those purchases last year. This year in the first half, we expect to complete second share repurchase program.

As I said, I will comment on the results for the first quarter of this year in a minute, but first let me step back a bit from the numbers and describe six business model characteristics that combine to make Zix Corporation a very high quality, profitable and stable company for partners, customers and investors.

First of all, our transparent e-mail encryption gives Zix Corporation a very highly differentiated, sustainable, competitive advantage in the market. Because of our centralized shared architecture, Zix Corp is the only company that can offer fully transparent delivery, which enable e-mail secure e-mail between Zix's gateway customers to be encrypted and then decrypted without any extra steps, not even a password is required making secure email as convenient as regular exchange as any e-mail. No one else in the world has that capability.

Secondly, our business benefits from the network effect. Our value continually increases as more and more users join our shared solution linked through our ZixDirectory. Now exceeding 31 million members and growing at over 100,000 new members per week, the value continually increases, because more and more users become connected over time resulting in an unrivaled convenient customer experience when exchanging secure mail.

The third significant characteristic is the high level of stickiness in our business, which results in very high retention rates. Our contracts average over two years in length, and contract renewal rates measured on a trailing 12-month basis are in the 90% range. Because only a portion of our contracts come up for renewal each year, the results of this model is 95% recurring revenue from year-to-year. Also, our diverse mix of customers is the fourth characteristic that is notable.

ZixCorp has over 7,000 corporate customers spread across multiple industries, and our largest customer represents less than 2% of our total revenues and that type of diversity of course lowers risk in the business model.

The fifth characteristic that adds quality for investors is the predictable nature of our business. As you all know, we are 100% subscription business, where revenue is recurring and is recognized only as the service is provided.

Our backlog representing contractually committed business that has not been recognized yet into revenue exceeds $52 million. This year, this backlog will provide approximately 70% of our annual revenue.

The final characteristic that adds value is the leverage in our business. We can grow and scale our business with modest increases in investment. Last year, for instance, we grew our revenues by $5.1 million, and 50% of that incremental revenue went straight to our bottom line, so it's the combination of these characteristics that really are the product of a very deliberate strategy that's focused on removing short-term risks in our business and placing the company in a strong position for long-term success and profitability.

With its solid foundation it's no surprise that ZixCorp continued its steady growth in the first quarter of 2012, as we reported in our most recent earnings call. We surpassed our revenue guidance by achieving record revenue of $10.3 million, which is 11% increase year-over-year.

We also exceeded our guidance for GAAP and non-GAAP net fee income. We achieved GAAP net income of $2.4 million, our ninth consecutive quarter of GAAP profitability. We delivered $2.9 million of non-GAAP net income, a 13% year-over-year increase.

On a per share basis, GAAP profitability increased 11% year-over-year to $0.04 a share on a fully diluted basis near non-GAAP income of $0.04 per fully diluted share, which is a 25% increase year-over-year. That growth rate is attributable to both, the increase in our net income, the absolute number and the decrease in our outstanding shares.

In the most recent reported quarter, we also produced a 14% year-over-year growth in new first year orders to $1.7 million. Our $9.1 million in total bookings was also up year-over-year. In addition, our backlog at quarter end was a solid $52.3 million.

Cash flow from operations was $2.5 million. Our quarter ending cash balance was strong at $18 million, down $2.7 million from year ending cash balance due to our continued stock repurchases.

We are very confident in our future growing strong relationships with customers and our partners. We continue to invest in technology, innovation and expand distribution to maintain our market leadership and accelerate growth and our business model positions us for long-term success and profitability.

Thank you for your attention. As I mentioned, after we hear the results of the voting, I will take some questions. Mr. Brashear?

Jim Brashear

Thank you, Rick. I have been advised by the independent inspector of election that the preliminary results of the voting are as follows.

On proposal one, the election of director, each director has received the plurality of four votes cast that were required for reelection. On proposal two, the shareholders have, by majority of the votes cast, ratified the selection of Whitley Penn LLP as the independent auditors for the company for 2012.

On proposal three, the shareholders have, by majority of the votes cast, approved the advisory resolution on the company's executive compensation. On proposal four, the stockholders have by majority of the votes cast, approved the 2012 incentive plan. These preliminary results will be verified by our independent inspector of election.

Now, before Mr. Spurr opens the floor for questions, I want to quickly remind you of the procedures for our question-and-answer session.

Please be aware that this meeting is being webcast. If you wish to address the meeting, please raise your hand when Mr. Spurr ask for questions. Wait for microphone attendant. Upon being recognized by Mr. Spurr, stand up, state your name and indicate whether you are a shareholder or a proxy holder, and if you are a proxy holder, please also say the name of the shareholder you represent.

Persons addressing the meeting will be allowed three minutes per questions or statements when they are recognized by Mr. Spurr. Question should be addressed directly to Mr. Spurr. Please confine your questions or statements to one subject at a time.

Mr. Spurr will stop discussions that are unrelated to the matters properly before the meeting, are not in good taste, or unduly prolonged or are repetitious. If your views differ from another speaker's views, please permit the speaker to conclude his or her remarks without interruption.

Mr. Spurr?

Richard D. Spurr

Thank you. Do we have any questions? I have a question from Mr. Finnegan. Market clearly did not like growth rate of Zix's one of the plans to step up sales and marketing, so the one item, one metric as Bob is asking about here that we are very focused on is accelerating our top line growth rate.

The trend is down and that's the only metric that when I talk to investors, they want to see improvement on, which I respect. Our margins are still very high, our cash generation is very high, the model is beautiful as I attempted to articulate a second ago and our investors don't respect that, but they want to see more top line growth.

Just rest assured that that's what we wake up every day and go to bed every night worrying about and we have periodic sessions to do. What we need to do to accelerate that growth. Sales and marketing is one area, other investments, for instance, maintaining leadership and enhancing current offering through R&D investments and of course another option that we have and have in fact exercised.

Last year, on the sales front, we invested significantly in adding new distribution partners to our group of third-party distributors, and in fact over the course of 2010-2010, added 65% to that group where we now have now 191 value-added resellers and managed securities service partners representing our products predominantly here in the United States, so we would expect that that investment and greater feet on the street, broader reach would help us achieve an accelerated growth in 2011.

We also always review and make, what I would call, incremental investments in sales. We can't afford to have a sales person in every account, but we do have a direct on-the-street field sales force that calls in companies with 1,500 employees or more and then we have a group in Burlington, Massachusetts with some-20 individuals, 12 are actual quota-carrying individuals who direct sales for us in the small-medium marketplace and accounts under 1,000. Google only resells Zix in their e-mail encryption offerings, and we also are resold by Symantec and M86 and others.

On the R&D side, we are investing $6 million in 2012 in R&D, which is an increase of $1 million over calendar year 2011, and that is to accelerate the list of features that we believe the market is demanding particularly as we see opportunity in very large customers as they replace older solutions that have been around since the early part of the year, the decade of 2000s, so those are the various things we are doing to accelerate growth.

As I said, rest assured that's our number one priority right now. We don't want to do it at the expense of having a profitable company that's not to say we won't make a decision to opt for a greater growth and expect some margin. We haven't made those decisions yet as we enter 2012, but certainly in 2011, you know that our operating margins are forecast to be in the 30% range this year, so we haven't given up on contingent cash generation and earnings as well.

Any other questions I might entertain?

If there are no other questions, that concludes our meeting. I would like to thank you all for attending our 2012 shareholders' meeting. Thank you.

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