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Edited Transcript of ZIXI earnings conference call or presentation 28-Feb-19 10:00pm GMT

Q4 2018 Zix Corp Earnings Call

DALLAS Mar 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Zix Corp earnings conference call or presentation Thursday, February 28, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David E. Rockvam

Zix Corporation - VP, CFO & Treasurer

* David J. Wagner

Zix Corporation - President, CEO & Director

* Geoffrey R. Bibby

Zix Corporation - VP of Marketing

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Conference Call Participants

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* Michael Fawzy Malouf

Craig-Hallum Capital Group LLC, Research Division - Partner, Senior Research Analyst & Head of Boston Team

* Timothy Elmer Klasell

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* Zack Turcotte

Dougherty & Company LLC, Research Division - Anlayst

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Presentation

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Operator [1]

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Good afternoon, and welcome to Zix' Fourth Quarter and Full Year 2018 Earnings Conference Call. My name is Muriel, and I will be your operator for this afternoon. Joining us for today's presentation are the company's President and CEO, David Wagner; CFO, David Rockvam; and Zix Vice President of Marketing, Geoff Bibby. Following their remarks, we will open the call for your questions. I would like to remind everyone that this call will be recorded and made available for replay via a link in the Investor Relations section of the company's website.

Now I would like to turn the call over to Geoff Bibby. Sir, please proceed.

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Geoffrey R. Bibby, Zix Corporation - VP of Marketing [2]

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Thank you, Muriel. Good afternoon, everyone, and thank you for joining our fourth quarter and full year 2018 earnings call. With me today, as Muriel mentioned, are CEO, Dave Wagner; and our CFO, Dave Rockvam. After the market closed, we issued a press release announcing our results for the fourth quarter and full year ended December 31, 2018, a copy of which is available in the Investor Relations section of our website, at www.zixcorp.com.

Please note that 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. It's important to note also that the company undertakes no obligation to update such statements. We caution you to consider risk factors that could cause actual results to 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 our most recent Form 10-K and 10-Q filings with the SEC provides examples of those risks.

During the call, we will present both GAAP and non-GAAP financial measures. Non-GAAP financial measures are not intended to be considered in isolation from, a substitute for, or superior to our GAAP results. We encourage you to consider all measures when analyzing the company's performance. A reconciliation of certain GAAP to non-GAAP measures is included in today's press release, which can be found in the Investor Relations section of the site.

Now with that, I would like to turn the call over to Dave Wagner for his opening remarks. Dave?

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David J. Wagner, Zix Corporation - President, CEO & Director [3]

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Thanks, Geoff, and good afternoon, and thank you, everyone, for joining us today. With revenue up 10% to a record $18.4 million and adjusted EBITDA up 14% to a record of $5.6 million, or 30.2%, the fourth quarter of 2018 topped off another strong year for the company. Not only did we return to double-digit revenue growth for the quarter, but we also delivered new first year orders growth of more than 20% for the third quarter in a row. With roughly 55% of our new first year orders in the quarter coming from existing customers, we continued to successfully cross-sell into our installed base and increase our attach rate driven by the continued success of ZixProtect and ZixArchive, which made up more than 25% of our total new first year orders for the fifth consecutive quarter.

In short, Q4 results exemplified our strategic focus and execution over the last couple years. From the beginning, we knew that our customers were looking for a complete security bundle as they migrate to the cloud. They are looking to improve their security posture and consolidate with a vendor who provides easy-to-use, highly effective solutions backed by phenomenal customer care. As we assembled the right product offer and made enhancements to our platform, we've been able to drive stronger new first year orders growth, increase our attach rate and accelerate the adoption of our cloud-based solutions. Along the way, we remained true to our commitment to profitable growth, which continues to inform our growth strategy and continues to shape our journey to become one of the leading cloud-based email security providers.

2018 was an inflection point of that journey, the point at which we could see the formation of something special. Our growing success with ZixProtect and ZixArchive were the beginning. We leveraged that success to further strengthen our archiving capabilities with the addition of Erado in April 2018. This further expanded our addressable market and began a transition from a company with a sole focus on email to one that is more broadly protecting all business communications. We also made significant enhancements to our cloud platform, putting our product in a better position to address the market trends and meet our customers' current and future need.

But it's not just a great product that made 2018 a really successful year for Zix. It was also the strong performance from both our sales teams and our channel partners that helped us reach record revenue, orders and annual recurring revenue. During the year, we grew our sales team and empowered them with additional business development representatives, targeted account-based marketing and enhanced tools to support their growth. We expanded our MSP program, added dozens of G Suite resellers and we reduced our reliance on OEM partnerships in favor of partners more aligned with our cloud-based offerings. As a result, our sales teams have been performing in a positive and consistent fashion. We could not be more pleased with their efforts across all customer sizes. In summary, 2018 was a major leap forward for the company on all fronts.

The start of 2019 is continuing that momentum. We came out of the gate strong with our acquisition of AppRiver last month. We significantly expanded our archiving capabilities beyond email to include nearly 50 additional channels including social media, business collaboration tools, texts and video. And we also enhanced the supervisory capabilities for compliance-oriented buyers further strengthening our value proposition and cross-selling opportunities.

Last week, we launched ZixSuite, which is a cloud-based business communications security and compliance solution that combines advanced threat protection, business email continuity, email encryption, email DLP and unified archiving all managed from a centralized interface. This launch is the culmination of years of work across multiple locations and represents a major step forward for our email security platform. It brings together 3 of the company's industry-leading solutions, ZixProtect, ZixEncrypt and ZixArchive, into a highly effective solution that integrates easily with our clients' cloud email environments.

All of these major steps have culminated in some successful alignment of our business to the cloud and a really strong foundation from which to build further. Along with AppRiver, today we are a much stronger business that is even better positioned to help our customers. We're also a business with more scale, with better cost synergies, with more cross-selling opportunities and market tailwinds working steadily in our favor.

Now I'll turn the call over to our CFO, Dave Rockvam, to provide more details on the financials for the quarter. Dave?

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David E. Rockvam, Zix Corporation - VP, CFO & Treasurer [4]

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Thank you, Dave, and good afternoon, everyone. Q4 was a success in many ways including the fact that we achieved record revenue, record ACV or ARR, a return to double-digit top-line growth and new first year orders growth of more than 20% for the third consecutive quarter. We also achieved total orders growth of 21%. And as Dave alluded to earlier, our strong growth for the quarter combined with our disciplined cost management enabled us to achieve the highest level of adjusted EBITDA and adjusted EBITDA margin since he and I joined Zix in 2016, which we are really proud of. Our record results coupled with driving a transformational acquisition in the first quarter of this year really speaks to the dedication of the Zix team.

Turning now to our financial numbers in more detail. Our new first year orders for the quarter increased 23% to $3.1 million compared to $2.5 million in the same quarter last year. The increase was due to the continued market adoption of our advanced threat protection, archiving and hosted email encryption offerings along with higher cross-selling activity. New first year orders for ZixProtect and ZixArchive continued to make up more than 25% of total new first year orders demonstrating the growing demand from both our new and existing customers for these solutions. You can see this balanced mix of sales to new versus existing customers more clearly from our new first year order breakdown for 2018 where 45% came from new customers while 55% came from our installed base.

Revenue for the fourth quarter increased 10% to a record $18.4 million from $16.8 million in the same quarter last year. For the full year, revenue increased over 7% to a record $70.5 million from $65.7 million in 2017. Our 2018 revenue did include 3 quarters of Erado revenue. With $18.4 million and $70.5 million, we exceeded our revenue guidance for the quarter and year respectively.

Our adjusted gross profit for the quarter was $14.6 million or 79.3% of total revenue, which was an improvement on a dollar basis from $13.7 million or 81.4% of total revenue in the fourth quarter of 2017. Our adjusted gross profit margin percent for Q4 was down year-over-year. As a reminder, this was primarily due to Erado and the deferred haircut associated with the acquired subscription revenue as well as a slightly higher cost associated with archiving.

Our adjusted R&D expenses for the fourth quarter of 2018 were $2.4 million or 13.1% of total revenue compared to $2.7 million or 16.2% of total revenue in the fourth quarter of last year. The year-over-year decrease was primarily due to the capitalization of software associated with new features and functions added to our hosted platforms. In total, software capitalization was about $1.5 million in 2018 and we'd expect a slightly higher number in 2019.

Our adjusted selling and marketing expenses for the quarter were $4.9 million or 26.7% of total revenue compared to $4.5 million or 26.9% of total revenue in Q4 of last year. The increase in selling and marketing expense was due to the expansion of our BDR or lead-qualification teams to support the company's growth particularly with our advanced threat protection and archiving solutions. As I've mentioned on previous calls, some of the increase in selling and marketing expenses has been offset by lower commission expenses as a result of our implementation of ASC 606 in 2018.

For the fourth quarter of 2018, our adjusted general and administrative expenses were $2.6 million or 14% of total revenue compared to $2.3 million or 13.6% of total revenue reported in Q4 of last year.

On a GAAP basis, we reported net income of $9.2 million or $0.17 per fully diluted share compared to a loss of $12.9 million or $0.24 per fully diluted share in Q4 of last year. The large increase was due to our expanding profitability, which allowed us to capture the value of an additional $7.8 million of our NOLs or net loss carryforward. For the full year, net income improved to $15.4 million or $0.29 per fully diluted share compared to a loss of $8.1 million or $0.15 per fully diluted share in 2017. As a reminder, the loss of $12.9 million in Q4 2017 was largely the result of a one-time non-cash charge of $12.5 million due to U.S. tax change.

Our fourth quarter non-GAAP adjusted net income excluding deferred tax was $4.6 million or $0.09 per fully diluted share. $0.09 per share matched our guidance for the quarter and represents a slight improvement over the amount we reported in Q4 last year. For the full year, non-GAAP adjusted net income excluding deferred tax was a record $17.5 million or $0.33 per fully diluted share. $0.33 per share matched our guidance for 2018 and represents an improvement of $0.035 over the amount we reported in 2017.

And finally, our adjusted EBITDA for Q4 2018 totaled a record $5.6 million, an increase of 14% compared to the $4.9 million we reported in Q4 of last year. As a percentage of total revenue, adjusted EBITDA for Q4 2018 increased to 30.2% from 29% we reported in Q4 of last year. We are pleased to achieve 30% adjusted EBITDA, which was the guidance we gave following the Erado acquisition.

Cash flow from operations for the fourth quarter of 2018 was up 16% to $4.9 million. At the end of Q4, we had $27.1 million in cash. CapEx and other intangibles for the quarter were $1.8 million, which consisted primarily of normal business capital purchases, internal software development projects and capitalized R&D. For the full year 2019, we forecast our CapEx and other intangibles to be between $5 million and $6 million. This range takes into account the investments to modernize our business systems, integrate our acquisitions and enhance our multi-tenant cloud platform. We also expect approximately $4 million of depreciation and amortization in 2019.

Our backlog, which represents the dollar value of committed contracts, was $73 million as of December 31, 2018, which was up slightly from $72.6 million as of the same date last year. At the end of the fourth quarter, our ACV, or annual contract value, totaled a record $75.8 million, up 13% from Q4 last year. If you remember from our AppRiver acquisition call in January, we referred to ACV as ARR, or annual recurring revenue. Because it is more consistent with how the rest of our industry uses this metric, we will be using ARR instead of ACV going forward.

Now, for our first quarter and full year 2019 financial guidance. We currently anticipate revenue for the first quarter to range between $26.5 million and $27.5 million. We are also forecasting fully diluted GAAP earnings per share to be between a loss of $0.04 and a loss of $0.01 and fully diluted non-GAAP adjusted earnings per share excluding deferred tax expenses to be between $0.03 and $0.04. The financial outlook includes approximately 1 month of AppRiver financial results consolidated into Zix and also includes a required GAAP adjustment on the deferred revenue acquired from AppRiver for purchased revenue accounting. These results will be slightly dilutive to quarterly non-GAAP adjusted net income on a year-over-year basis for the first quarter and we forecast the acquisition to be accretive on a non-GAAP adjusted basis starting in Q2 2019.

For the full year 2019, we expect revenue to range between $164 million and $167 million, which represents an increase of between 132% and 137% compared to revenue in fiscal 2018. On a pro forma organic basis, this would be 10% growth for Zix' core product offering. We are also forecasting our fully diluted GAAP earnings per share to be between a loss of $0.12 and a loss of $0.01 and our fully diluted non-GAAP adjusted earnings per share excluding deferred tax expense to be between $0.30 and $0.33 for fiscal 2019. Due to the increased share count, EPS is down to flat for the full year. However, we would expect EPS to be accretive to shareholders in the second half of 2019 compared to the second half of 2018. On a pure dollar basis, we are forecasting growth of over 20% on non-GAAP adjusted net income excluding deferred tax benefit.

This financial outlook includes approximately 10 months of AppRiver financial results consolidated into Zix and also includes a required GAAP adjustment on the deferred revenue acquired from AppRiver for purchased revenue accounting. Our earnings per share both on a GAAP and non-GAAP adjusted basis include the addition of approximately 16.6 million shares associated with the $100 million investment by True Wind Capital.

Also, reiterating our comments from our conference call on January 15, we are targeting annual recurring revenue of approximately $200 million to $207 million at fiscal 2019 year-end representing a growth rate of approximately 11% to 15% year-over-year. We are also expecting revenue of approximately $47 million to $50 million with a 24% adjusted EBITDA margin in the fourth quarter of 2019. Also, we have identified and executed all $8 million of our cost savings initiatives well ahead of the previously stated 12 to 18 months we stated earlier. These initiatives are now all complete and, as a result, we should see the full impact of those savings in the third quarter of 2019.

Before I wrap up my prepared remarks, I wanted to note that we now have a new slide in our investor presentation that outlines our long-term financial model. We're providing this long-term model to give investors a better sense of our significant growth opportunity after this transformational acquisition. In this model, which can be found on the Investor Presentation page on our IR site, we are targeting the following financial objectives over the course of the next 3 to 5 years: ARR of $275 million to $350 million, gross margins of 60% to 65% and adjusted EBITDA margins of 27% to 30%. The full model can be found on that slide in the presentation I just mentioned, but I wanted to quickly provide some commentary around these targets.

As we've communicated before, with the acquisition of AppRiver, we have not only significantly scaled the business, but are now in a much stronger position to drive higher growth through our expanded product suite, go-to-market channels and cross-selling opportunities. We believe this will enable us to achieve the $275 million to $350 million of ARR I just mentioned.

With respect to gross margins, you'll notice that they are at a lower level than Zix' pre-AppRiver standalone business. This is largely a result of the third-party reseller products, which, despite their lower margins, provide us with significant lead-generation capabilities. It is these lead-generation capabilities that we will be leveraging to scale our growth, ARR and margins, while, at the same time, reaping the cost synergies of the acquisition and making further enhancements to our platform to drive strong adjusted EBITDA margins.

So in essence, our model reflects the strategy we have in front of us to significantly increase our ARR within 5 years while bringing back up our adjusted EBITDA margins near the range they were in 2018. Only, at that time it will be off a much higher volume and scale than Zix could have realistically ever achieved alone. As Dave will elaborate on further, that is the opportunity we have to significantly drive higher returns for shareholders.

And one last financial comment is regarding the debt that we have taken on to acquire AppRiver. As we have disclosed earlier, we have taken out a $175 million term loan. Our Q4 guidance on adjusted EBITDA would give us roughly $46.5 million annualized value, which would put our adjusted EBITDA to debt leverage at 3.75x. This is a level we and our banks are very comfortable with and, with our ability to pay down the loan coupled with growth in our long-term model, we can deliver further deleveraging in the future. In fact, the adjusted EBITDA generated from the long-term model coupled with our net loss carryforwards and the step-up in valuation that we are getting with AppRiver, with the AppRiver asset, we could be in a position to pay down all the $175 million of debt prior to the 5-year loan payback horizon. Now, we're not saying that is exactly what we would do with the strong cash flow generation, but our new capital structure gives us a lot of options that we will explore as we go. And we'll do that with an eye to creating further shareholder value.

Overall, our results for the quarter and the full year demonstrate that the strategy we laid out 3 years ago to drive strong returns for shareholders is really starting to bear fruit. Both our hosted and bundled offerings have performed exceptionally well and are demonstrating that we can be successful on a regular competitive basis whether it's winning new customers or cross-selling to an existing one. With the recent transformational acquisition of AppRiver, we look to extend this success in a more impactful way by capitalizing on our new-found scale, cost synergies, expanded customer base and complementary solutions. All together, this should help us achieve the significant operating leverage illustrated by our long-term financial model, which calls for much stronger growth and profitability within the next 3 to 5 years.

This completes my financial summary. For a more detailed analysis of our financial results, please refer to our Form 10-K, which we plan to file by March 12. Dave?

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David J. Wagner, Zix Corporation - President, CEO & Director [5]

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Thanks for the financial overview, Dave. I'll now review our progress as it relates to our 3 main growth drivers and update you on some of our new product capabilities as well as where we are with the AppRiver integration before we open the call up for questions. As a reminder, our 3 growth drivers are: one, new customer acquisition; two, sales to existing customers; and three, increasing retention.

Our first growth driver is new orders to new customers. As I mentioned earlier in the call, we're seeing a strong uptake of our new solutions by new customers. 3 of our top 5 new customer wins in Q4 included ZixProtect. 2 of the top 5 were for the bundle that included advanced threat protection and email encryption, while the other one was for advanced threat protection alone. We won new customers by displacing key competitors like Barracuda, MacAfee and Microsoft. In fact, in all 5 of our top 5 new customer wins, we displaced competitors.

Customers are recognizing the strength and versatility of our offerings as well as our superior customer service. The results we achieved over the past several quarters demonstrate that we have successfully positioned Zix to better respond to our customers' growing needs and we have situated ourselves right at the heart of one of the most powerful secular trends in our industry, the migration of email to the cloud.

Our largest new customer win for the quarter was in the financial services vertical. This title insurance customer was looking for a superior email encryption service that could easily and effectively protect their business communications through a completely hosted environment with responsive customer service. This customer, like many of our new customers, was using Microsoft Office encryption opportunistically. As their growth accelerated, they wanted to use encryption to meaningfully improve their security posture. They selected Zix as the best-in-class encryption vendor. They recognized the importance of ease of use as the primary driver in an enterprise rollout and they valued the high quality of our email DLP filtering. They will be using our cloud service and will have rolled out ZixEncrypt to 31 different domains in under 60 days. They will eventually roll out more than 25,000 mailboxes across more than 200 domains. Suffice it to say, this was a meaningful new win for us.

Looking at our total new first year orders during the quarter by distribution channel, 55% came from our direct sales efforts, 39% through VARs and MSPs and 6% from web sales and other. Our progress in 2018 to develop our channel program is encouraging. Although still in early days, monthly recurring revenue from our new MSP program more than doubled from September to December and we're up to 30 transacting cloud-based MSP partners. Equally exciting, our new MSP partners, in aggregate, have sold as many seats of ZixProtect and ZixArchive as they have of ZixEncrypt with an aggregate attach rate of approximately 75% and 25% respectively. With the acquisition of AppRiver, we have the opportunity to expand on that progress in an even more meaningful way.

With respect to our success internationally, Q4 was our best international quarter ever. Going forward, we will be shifting our international strategy to an MSP-first approach built on AppRiver's Nautical platform.

Now let's take a closer look at our second growth driver, which is sales to existing customers. Looking on our add-on sales for the fourth quarter, similar to the third quarter, 4 of our top-5 add-ons were in the health care vertical with the fifth being in government. All 5 increased their email encryption ARR while 2 also added ZixProtect. So in addition to the success we're having selling ZixProtect we're also continuing to see existing accounts increase their ZixEncrypt seats. Competitively, as with our new customer wins for the quarter, we displaced or complemented vendors like Microsoft with ZixProtect demonstrating our view and Gartner's view that a significant majority of customers believe that having just Microsoft alone is not enough to fully protect a company's business communications.

As I mentioned, 55% of our new first year orders during the quarter came from our installed base, demonstrating the growing propensity of our customers to attach additional solutions. Our aggregate attach rate for advanced threat protection is now over 15%, which was our 2022 target when we first rolled out ZixProtect in Q2 2017. Clearly, we're ahead of plan with our Greenview Data acquisition, which bodes well for the future.

For ZixArchive, the attach rate is about 2%, but it's still in the very early days for that solution. With the recent enhancements of ZixArchive to include unified archiving as well as advanced e-discovery capabilities, we expect attach rates for this solution to grow nicely in 2019.

As we continue to increase our attach rates and migrate more of our customers to our hosted offerings, we will be able to drive stronger retention as well, which brings me to our third growth driver, retention. Retention for the full year was just under our target of 90%. As expected, the final $1 million of excess churn we talked about in 2017 finally rolled off in Q4 2018, which is what drew the rate slightly below our 90% target. With the excess churn behind us, we now have greater visibility and confidence that we will increase our retention rate from here.

We're continuing to experience great success with our customers' cloud migration efforts, growing 44% in 2018. It's important to note that 53% of our ACV in Q4 came from customers with 100% of their solution in our cloud. This compares to less than 25% when Dave and I joined the organization in 2016, so it's evident that we've made tremendous strides in growing our cloud platform.

We stared 2018 with roughly 800 on-prem hardware customers and reduced that number to 580 at the end of the year. Approximately 62% of the 220 customer decrease were transitioned to another Zix platform. In 2016, we migrated 14 customers. In 2018, we made 137 such migrations, driving home the fact that our cloud platform is where we're seeing the most success, growth and best retention.

As we work closely with our customers, we still have a significant number of customers who plan to remain on-prem for the foreseeable future. In those instances, we've been very successful securing longer-term renewals. As I mentioned on our last call, of our top-25 on-prem hardware customers, 24 have already renewed agreements for an extended term of more than 12 months. This will help us drive higher retention rates in 2019. It's worth noting that our on-prem hardware customers now account for only 15% of our total pre-AppRiver ARR. Based on our conversations with our on-prem customers and their propensity to renew for 3-year terms, we think we're close to the bottom of this transition for the intermediate future and, in fact, our on-prem ARR could rise a bit in 2019 as we migrate some ZCT customers to ZixEncrypt EMS and as we execute on the pipeline for that product.

Now that I've talked about our progress as it relates to our 3 growth areas, I'll spend some time talking about where we are with the integration of AppRiver before we open the call up for questions. As we outlined on our January 15th call, we are really excited about the value-creation opportunities ahead as we execute on the integration of the 2 companies. The combined company has significant scale with approximately $181 million of ARR at year end, accelerated growth opportunities led by email box migration to the cloud, meaningfully expanded channel opportunity with more than 4,500 MSP partners and rich cross-selling opportunities across an installed base of more than 80,000 customers.

The founders of AppRiver, Mike Murdoch, Joel Smith and Scott Cutler, will be transitioning out of the business over the next 30 days and I would like to thank them for what they have built over the past 18 years. They began with a cloud-based email security product and a deep commitment to providing phenomenal customer care through partners. Through the years, their business evolved to include hosted exchange, to which they had a 100% attach rate of advanced email security, and more recently, they have developed a large Office 365 practice as one of the first 2-tier distributors and now the second largest provider of Microsoft Modern Workplace solutions.

The transaction closed just 6 business days ago on February 20 and our combined team was able to collaborate to identify and implement all $8 million of cost reductions. The cost reductions came through: 1, approximately $2 million per year of executive compensation and expenses; 2, approximately $2 million of third-party cost synergies for redundant expenses like PR firms, advertising firms, legal fees, accounting and other; third and finally, approximately $4 million of headcount reductions as the result of approximately 40 employee separations. The employee separations were balanced across Zix and AppRiver and the redundancies were pretty evenly spread across P&L lines. As difficult as headcount reductions are, I am pleased that all of the staff reductions and position eliminations necessary to deliver the $8 million of cost savings have been completed. Executing these changes by Day 1 will allow the teams to begin collaborating right away.

In addition to delivering the cost synergies, we have 4 priorities for 2019. First and foremost, we will be bringing the companies together to form one integrated cloud-based email security company. This means that we will work together to unify our vision, purpose and core values, and we will work closely with our partners, customers and employees to update our brand frameworks and identities. We will work intentionally to integrate marketing, G&A, product management and development during 2019. The customer-facing sales and support organizations will remain largely unchanged as we want to minimize any potential disruption to partners and customers. Because the go-to-market motions are so complementary, we expect these organizations to continue to identify with their existing brands for the foreseeable future.

Second, we will aggressively pursue cross-selling opportunities. We expect to be in a position to sell secure Office 365 and Secure Hosted Exchange to the Zix customer base by early Q2. We further expect to begin selling ZixEncrypt and ZixArchive to the AppRiver MSP partners by early Q3.

Third, we will be continuing our focus on channel development and channel acceleration by actively engaging our partners in the meaningful cross-selling opportunity. We believe that our channel partners will be the biggest beneficiaries of the combination of Zix and AppRiver.

Fourth, as I mentioned, we have already integrated the product management, software development and operations organizations. They are collaborating extensively already this week so that we can aggressively focus on and deliver the light integration of ZixEncrypt and ZixArchive to enable seamless provisioning from the Nautical platform. They will then move on to more meaningful integration as we build an integrated product roadmap together. They will focus on integrating the best aspects of our respective platforms and threat protection services to drive accelerated customer value and further cost savings that can be reinvested in our growth or delivered to the bottom line.

I had the opportunity last week post-closing to meet with a couple dozen of AppRiver's top MSP partners at a regional partner conference. Our third-party survey conducted during diligence indicated that 39% of AppRiver's customers had a high likelihood to purchase an enhanced compliance bundle within the next 2 years. My one-on-one time with these key partner leaders reinforced this study data that our MSP partners represent a strong cross-sell opportunity. They love their relationship with AppRiver and they want to purchase more solutions from them. They are particularly enthusiastic about email DLP and encryption.

As I listened to them, their customer acquisition process begins with their core competency along with a strong local presence that adds meaningful value to their customer relationships. They nearly always provide email services for their customers making AppRiver an important component of most of their relationships. All of the partners I spoke with are looking for opportunities to better protect their clients, to differentiate their service from naked Office 365 and to increase their margins. So there's a very tight, strategic alignment with how they want to grow their businesses and how we are evolving Zix and AppRiver.

Moving to the legacy Zix customer base, a similar third-party survey of Zix customers indicated that about 30% of Zix customers have a high likelihood to purchase either secure Office 365 or Secure Hosted Exchange from Zix in the next 2 years. We already have Zix partners contacting us about Office 365, further evidencing the cross-sell opportunity ahead for us.

So in conclusion, 2018 was a milestone year for the company. We returned to double-digit revenue growth. We increased our attach rates. And we achieved record adjusted EBITDA. We also reaccelerated our new first year orders growth to 20% underpinned by strong cross-selling of ZixProtect and ZixArchive, which represented over 25% of our new orders. Meaningfully, we accomplished these feats not only by broadening our product portfolio, but also by enhancing our go-to-market capabilities, which provides us a solid foundation to build upon for our future.

As we look ahead to 2019, we'll continue to cross-sell products and add additional capabilities that our customers need. Our sales teams prepared intensely to get ready for 2019 and we're off to a strong start. We expect the positive company and market dynamics that have driven our business to continue. We will build on this progress by fully integrating AppRiver and investing further in our cloud-based platform, leveraging our expanded customer base through significant cross-selling opportunities and accelerating the momentum of our full suite of solutions to become the leading provider for protecting all business communications. We're excited to execute the opportunities ahead of us in order to accelerate our growth, enhance our profitability, achieve our 3- to 5-year vision and drive value for our shareholders.

Now with that, we're ready to open the call for your questions. Muriel?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Mike Malouf from Craig-Hallum Capital.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Partner, Senior Research Analyst & Head of Boston Team [2]

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Congratulations on the AppRiver closing. You guys certainly got a lot of bright stuff ahead of you, I think. One of the things that I wanted to explore, though, is if you could just delve down a little bit into the model of AppRiver. It looks like obviously gross margins are coming down because of the channel. But maybe you could just give us a little bit of color with regards to the gross margins. And in particular on the R&D side, it looks pretty low relative to where you're at. And just some commentary on the model would be helpful.

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David E. Rockvam, Zix Corporation - VP, CFO & Treasurer [3]

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Yes. Thanks, Mike, and thanks for the kind words. As we look at the model going forward for AppRiver, so yes, their gross margins are, as we talked about, lower than Zix'. As we start to build out the model going forward, as Dave said, there's opportunity as we start to put in really proprietary technology in the encryption and the email archiving side. So there's opportunity there for us, which is good.

Going forward, this move to Office 365 continues to move quickly so I think our guidance really reflects that we expect to have continued success there and then adding on kind of each dollar we're selling of an Office 365 or Hosted Exchange offering, we want to be able to add on a dollar of proprietary technology at the higher margin to get that blend up on the gross margin side.

When you look across the R&D side, it is, yes, a little bit lower than ours. They really invest strongly in the Nautical platform, and in their advanced threat protection is where they've been investing strongly. So that's one place where we have some leverage in the model there, especially as we move down the road and bring together our advanced threat protection and bring together our platforms. And as Dave said on the call, we can -- we'll either be able to reinvest that for future growth or there will be -- could be some potential for opportunity to have further savings there. So we do expect the R&D to be -- to continue on their side to be a little bit lower. And you can see that that blends with our model to get us more -- coming out of the year more at this 9% to 10% overall company margin on R&D.

On selling and marketing, with their 70-plus percent coming through channel, much lower cost of sales on selling and marketing. So that's kind of why you see that blend coming in there. And then, of course, just G&A, the synergies of the 2 companies bring that down and in line. So with the gross margins forecasted Q4, projected in Q4 in the model of 61% to 62%, the operating expense synergies that we get across it enable us to get to that 24% at the end of the year.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Partner, Senior Research Analyst & Head of Boston Team [4]

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Got it. That's really helpful. And then if I could just keep going on that same slide. When you look out at the long-term model of $275 million to $350 million ARR, when you sort of sit back and say, "Okay, this is what we need to reach the upper"; or conversely, "This might -- this is probably the headwind we would face if we were only reaching the lower end." Can you talk a little bit about just those 2 scenarios?

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David J. Wagner, Zix Corporation - President, CEO & Director [5]

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Well, yes, the higher end reflects the opportunity we see to really meaningfully engage in the cross-sell opportunity. And to further tie in Dave's response to your question and my response to this one, what we're seeing in the market are these MSP providers being the first line for many, many medium and small businesses that are outsourcing their IT services. And those providers are moving to cloud-based email security providers. And we see a very strong complement in the business model; win-win for the end customer, the partners and us, where they're able to -- where we're able to provide the Office 365 mailbox, attach to that mailbox differentiated 100% margin, higher-value IP that also provides the MSP reseller with higher overall margin so that if we get, at the high end, if we get that business model working with our partners, we'll be in really, really strong shape. And then at the lower end, it would reflect continuing the businesses, like the combined growth rates we were experiencing in the past.

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Operator [6]

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Our next question comes from Zack Turcotte from Dougherty.

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Zack Turcotte, Dougherty & Company LLC, Research Division - Anlayst [7]

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Zack on for Catharine Trebnick. So you talked quite a bit about the integrations with AppRiver toward the end of the call there. And I just wanted to see if you had any more detail on sort of the impact the acquisition is going to have on your go-to-market in general, specifically in relation to the partners. You had said at the time of the acquisition you expect the ZixSuite to be integrated with the Nautical cloud platform. Sorry if I missed. What's the timeline on that and in general on selling the bundles of ZixSuite plus the AppRiver Hosted Exchange and Office 365 offerings?

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David J. Wagner, Zix Corporation - President, CEO & Director [8]

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Great. So as I said on the call, we really perceive the go-to-market motions to be highly complementary. As proud as we are on the Zix side of Zix HSP we launched last April on the 100% MRR growth from September to December, we have 30 transacting partners as compared to 4,500 transacting partners on the AppRiver side. So integrating the MSP go-to-market into one program, there's a little work to do, but it's 30, it's 30. And so we would expect the existing Zix go-to-market motion to continue unabated, working to engage VAR partners and MSP partners, as appropriate, based on end customer demand. And similarly, with that lack of overlap, we expect the now 4,530 MSP partners that would be running on the AppRiver platform and plan, we expect them to be able to continue very effectively.

What then will drive cross-synergies and specific dates, as I said, we expect in early Q2 to be enabling the Zix go-to-market sales force to have secure Office 365 and Secure Hosted Exchange as SKUs and part numbers that can be ordered and deployed through partners to be able to access that cross-selling opportunity. And then more specifically, we will be integrating ZixEncrypt and ZixArchive into Nautical, where the existing advanced threat protection on the Nautical platform will remain intact, so that beginning in early Q3, MSP partners of AppRiver will be able to access the Zix encryption offer as well as the Zix archiving offer.

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Zack Turcotte, Dougherty & Company LLC, Research Division - Anlayst [9]

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Okay, perfect. And then one more, actually stepping away from the acquisition for a second. With the enhancements to ZixArchive that you announced in the quarter, just what's the initial reaction been like from customers or additional demand from customers or new customers for the unified archiving solutions?

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David J. Wagner, Zix Corporation - President, CEO & Director [10]

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Yes. It's a really positive customer response to that new product. It's a 100% cloud-based solution with really broad channel support and really strong supervisory capabilities. So we're getting good uptake. We've already had a couple sales since the launch that -- archiving attach takes longer because the customer -- migrating the data is a project. And so customers don't update their archive as often, for example, as they re-look at their advanced threat protection solution. But we're very pleased and excited about the additional attach we'll get this year with the enhanced ZixArchive.

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Operator [11]

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(Operator Instructions) Our next question comes from Tim Klasell from Northland Securities.

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Timothy Elmer Klasell, Northland Capital Markets, Research Division - MD & Senior Research Analyst [12]

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Congrats on the quarter. And then I just have some of my questions are around sort of the model as well. First, for Q4, you've laid out, obviously, ARR and your gross margins and I just wanted to get a feel for what sort of revenue synergies and gross margin synergy you see particularly on the AppRiver side. Will that include them doing some cross-selling? And will there be any products or gross margins improvements on their side by embedding some of the AppRiver tech -- excuse me -- the Zix technologies into the AppRiver offerings?

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David J. Wagner, Zix Corporation - President, CEO & Director [13]

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Yes. So at a high level, at the low end of the guidance would reflect continuing organic growth, which is strong in both businesses, that continuing. And then the higher end of the range begins to represent additional cross-selling opportunities. So depending on how long it takes to get us to meet these expected dates of early Q2 and early Q3, respectively, to introduce the products, we'll have, of course, the subscription revenue, which takes a little time to wind into the model fully. But at the high end would represent some pretty nice success in getting that cross-selling going beginning in Q2 and then Q3 with the AppRiver side.

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David E. Rockvam, Zix Corporation - VP, CFO & Treasurer [14]

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Yes. Like Dave said, it's a subscription model once it gets going, right? We've baked in a little bit more on the higher side of the model for orders with that kind of starting in late Q2 into Q3, but the subscription revenue taking time to come through, Q4 before maybe a little bit of meaningful uplift on the overall number. But taking that into Q1 of next year is where we'd start to see -- probably feel impact.

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Timothy Elmer Klasell, Northland Capital Markets, Research Division - MD & Senior Research Analyst [15]

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Okay, great. And then on the MSP side, obviously as you begin to sort of maybe migrate particularly over, like you mentioned, on the archiving side, will the MSPs be doing that themselves if they're migrating off of somebody else's archiving solution? And generally speaking, how long will that take? I'm assuming there will be a little bit of a lag effect before the bookings turn into revenues. Can you help us understand that process a little bit?

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David J. Wagner, Zix Corporation - President, CEO & Director [16]

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Yes. So what we're seeing so far is MSPs putting archiving on new mailboxes. We've been doing migrations in the VAR and direct channel. But the MSPs are focusing on new mailboxes and that's what we would expect going forward across both the platforms; that the ZixArchive beginning in, as I said, early Q3 will be the preferred offer for new customers off Nautical, but to existing customers we'll make those migration decisions over a longer period of time.

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Timothy Elmer Klasell, Northland Capital Markets, Research Division - MD & Senior Research Analyst [17]

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Okay, great. Great. And then one final one. You mentioned that the $8 million in cost synergies, you've pretty much got those nailed down. Do you think that $8 million may prove to be a little bit conservative? Or maybe you can give us a little bit of color around how you were able to do it so quickly and maybe where there's other opportunity.

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David J. Wagner, Zix Corporation - President, CEO & Director [18]

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Well, I would attribute the identification, execution of those cost savings on a strong collaborative culture between the leadership teams. And it's always really hard work to do that, but to be able to do that on Day 1 or by Day 1 of closing, I'm really proud of the team, the leadership teams on both sides to be able to do that. It never happens without any impact, but again, I think the professional management was able to identify the redundancies and professionally do that so that that puts us, as I said in the script, in a really strong position to begin collaborating, and things that we do positively together forward I think are going to drive customer value acceleration. And we're going to work to get focused on the revenue synergy side and additional growth. And then we'll, as we always do in our profitable growth model, we'll look at reinvestment in highest-growth opportunities and/or bringing some of those future opportunities to the bottom line month by month, quarter by quarter as we move ahead.

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Operator [19]

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At this time, this concludes our question-and-answer session. I'd now like to turn the call back over to Mr. Wagner for his closing remarks.

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David J. Wagner, Zix Corporation - President, CEO & Director [20]

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Well, I'd just like to thank everybody again for your time and for joining us today and we look forward to speaking with you again in April.

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Operator [21]

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Thank you for joining us today for Zix' Fourth Quarter and Full Year 2018 Earnings Call. You may now disconnect.