Zix (ZIXI) Q2 2021 Earnings Call Transcript | #emailsecurity | #phishing | #ransomware


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Zix (NASDAQ:ZIXI)
Q2 2021 Earnings Call
Aug 05, 2021, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to Zix’s second-quarter 2021 earnings conference call. My name is Carmen, and I will be your operator today. Joining us for today’s presentations are the company’s president and CEO, David Wagner; CFO, David Rockvam; and chief marketing officer, 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 begin. 

Geoff BibbyChief Marketing Officer

Thank you, operator. Good morning, everyone, and thank you for joining our second-quarter 2021 earnings conference call. On the call today, we have our CEO, Dave Wagner; and our CFO, Dave Rockvam. Before the market opened today, we issued a press release announcing our results for the second quarter ended June 30, 2021, a copy of which is available on the investor relations section of our website at zix.com.

Please note that during the course of this call, we will make forward-looking statements regarding future events and the future 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 also note 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 call.

The risk factors section in our most recent Form 10-K and 10-Q filings with the SEC provides examples of those risks. As more fully described in our annual report on the Form 10-K for the year ended December 31, 2020, the company has been actively monitoring the COVID-19, the Delta variant, and its impact on both the company and the world in which we operate. The impact of COVID-19 and the unprecedented measures to prevent its spread are affecting our business in various ways, causing volatility in demand for our products, changes in customer behavior, including their spending and payment patterns, disruption in the operation with our third-party suppliers, and business partners. The labor market competition resulting in increased employer turnover and limitations on our employees’ ability to work and travel.

These factors also make it more challenging for management to estimate the future performance of our business, particularly over the near term. During the call, we’ll 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 and non-GAAP measures is included in today’s press release, which can be found in the investor relations section of our site. Now, with that, I would like to turn the call over to Dave Wagner for his opening remarks. Dave? 

Dave WagnerChief Executive Officer

Thanks, Jeff. Good morning, and thank you, everyone, for joining us today. As you can see from our earnings release, we delivered strong results across the board in the second quarter, highlighted by 18% total revenue growth and 17% annual recurring revenue growth. Annual recurring revenue, or ARR, totaled a record $252.4 million at quarter end, providing us with visibility to a solid second half of the year.

Cloud ARR increased 24% year over year to $225.6 million or 89% of total ARR and reflects Zix’s transformation into a cloud-first company. Operationally, we migrated more than 1,900 encryption customers to our Secure Cloud platform in Q2. This accelerating Secure Cloud adoption is helping our partners and customers be more productive, secure, and compliant. In turn, we are deepening our partner and customer relationships and enhancing their experiences, which is enabling us to layer on additional services more effectively.

CloudAlly is continuing to perform exceedingly well, validating our M&A thesis and reflecting cloud backups’ increasingly critical role within a secure modern workplace. We continue to grow cloud backup ARR at approximately 50% year over year as we take advantage of the strong secular tailwinds of protecting increasingly valuable cloud data sets from ransomware and employee error. We launched Secure Cloud into German market this quarter, adding 16 new German partners in the short weeks since our launch. The encouraging acceptance we’ve seen in this new market is validation of our investment in Germany and in the international expansion more generally.

Before I go further, I will now turn the call over to our CFO, Dave Rockvam, to provide details on our financial results for Q2. Dave?

Dave RockvamChief Financial Officer

Thank you Dave, and good morning, everyone. The second quarter again demonstrated our ability to continue driving profitable growth. In addition to robust revenue and ARR performances and strong cash flow generation, we delivered meaningful gross margin dollar expansion in the period, highlighting our success in layering on organic, higher-margin products. Looking at the numbers in more detail.

At the end of Q2, our ARR totaled $252.4 million, up 17% from Q2 of last year. Our cloud-based ARR grew 24% over Q2 of last year and comprises 89% of our total ARR or a record $225.6 million. New customers added in the quarter totaled roughly 5,232. For the second quarter, our net dollar retention was 101.4%, which represents our renewals plus new sales into the installed base divided by the renewals that were available at the beginning of the quarter.

101.4% is the highest level we have seen since pre-COVID, and we are pleased to once again be above the 100% plus level. Revenue for the second quarter increased 18% to $62.8 million from $53.3 million in the same quarter last year. The $62.8 million of revenue exceeded our guidance range for the second quarter. In Q2, as in the past, we saw the majority of all new customers on board to the Zix Secure Cloud platform.

Given we are running over 95% and the only meaningful cohort of customers not coming on to Secure Cloud are mostly our single license desktop users, we won’t be highlighting this metric in the future. We are pleased that just one year past the launch of Secure Cloud, the adoption has been so strong. Secure Cloud has helped us move from 1.24 services per customer in the second quarter of last year to 1.32 services per customer at the end of Q2 2021. This additional attach is driving revenue and gross margin growth, and we feel as a trend that will continue to build as our customers and partners continue to gain more and more value from our solutions and platform.

Our adjusted gross profit for the quarter was $31.3 million or 50% of total revenue. This was $2.1 million or a 7% improvement from $29.2 million in Q2 of last year and an increase of $1.3 million over Q1 of 2021. This quarter’s gross margin dollar performance was our highest level of growth since the first full quarter after acquiring AppRiver. We feel confident in building on this trend as we go throughout the rest of the year.

Our ability to assist our MSP partners and direct customers as they move to the cloud continues to make us an even more valuable partner to them. The macro acceleration of the business cloud journey and increased focus on email security give us confidence we can continue to capture meaningful growth opportunities well into the future. Moreover, our current base of more than 5,600 partners and over 100,000 end customers provide us a built-in growth opportunity to attach Zix’s organic, higher-margin products. Our adjusted R&D expenses for the second quarter of 2021 were $5.7 million or 9% of total revenue.

This compares to $5.2 million or 10% of total revenue in Q2 of last year. The year-over-year dollar increase for the quarter was primarily amortization due to certain development projects we completed in the quarter. We anticipate R&D expenses to continue to increase during the year. We don’t expect this to be in current cash expense increases, but amortization of past projects that are being deployed on Secure Cloud.

While these expenses impact our net income and EPS, they are adjusted out of EBITDA. Our adjusted selling and marketing expenses for the quarter were $10.9 million or 17% of total revenue, compared to $10.1 million or 19% of total revenue in Q2 of last year. The higher selling and marketing expenses on a dollar basis reflect the pickup in travel and trade show activity by our sales and marketing teams and increased direct and partner commissions due to increased revenues. On the other hand, the decline in selling and marketing expenses as a percentage of total revenue reflects the benefits of our lower cost of customer acquisition from our high-velocity sales model and the success we are having winning new customers and wallet share gains from our active MSP partners.

We do expect to see increases in selling and marketing the rest of the year as we continue to lean into the growing opportunity we are seeing in the market. For the second quarter of 2021, our adjusted general and administrative expenses were $4.5 million or 7% of total revenue, which compares to $3.4 million or 6% of total revenue reported in Q2 of last year. On a GAAP basis, we recorded a net loss attributable to common shareholders of a loss of $5.3 million or a loss of $0.10 per fully diluted share. The $0.10 loss for the quarter compares to a net loss attributable to common shareholders of a loss of $4.1 million or a loss of $0.08 per fully diluted share in Q2 of last year.

The change in the quarter was primarily driven by higher stock-based compensation over the prior year. We did incur severance expenses as a result of the elimination of approximately a dozen positions from the organization. These changes were made predominantly better align our workforce for changes in work as a result of COVID work-from-home and hybrid work. Our second-quarter non-GAAP adjusted net income before deemed evident excluding deferred tax was $7.9 million or $0.14 per fully diluted share, which was in line with our guidance.

This compares to $8 million or $0.15 per fully diluted share that we reported in Q2 of last year. The slightly lower net income compared to last year is due to the increase in amortization of R&D projects that were completed during the past 12 months. These are non-cash impacting on the quarter, and the amortization is removed as part of our adjusted EBITDA calculation. And finally, our adjusted EBITDA for Q2 2021 totaled $13.3 million, an increase from $12.7 million we reported in Q2 of last year.

As a percentage of total revenue, adjusted EBITDA for Q2 2021 was 21%, which was in line with our guidance and compares to 24% in Q2 of last year. Cash flow from operations for the second quarter of 2021 was $14.7 million, an increase of 212% or $10 million over Q2 of last year. The increase in cash flow from operations was primarily driven by continued focus on the business operations and continued careful working capital management. Capex and other intangibles for the second quarter of 2021 were $3.7 million, which consisted primarily of normal business capital purchases and capitalized internal-use software development.

Billings for the second quarter of 2021 totaled $60 million, up 15% from $52.8 million in Q2 last year. Turning to our balance sheet. We ended the quarter with $33.9 million in cash, which was an increase of over $10 million from the first quarter of 2021. In addition to our strong cash position, we also have $25 million available for borrowing under our revolving credit facility.

In terms of our capital structure and debt metrics, we had $211.3 million of total debt on our balance sheet at the end of the quarter. Our trailing 12-month adjusted EBITDA of nearly $53.5 million reflects a leverage ratio of approximately 3.3 times adjusted EBITDA at the end of Q2, putting us below the maximum permitted leverage ratio of four and a half times for the quarter. Shifting gears to our financial guidance for the third quarter of 2021, which is based on current market conditions and expectations and doesn’t take into account potential market changes such as increased COVID-19 activity or the Delta variant. In Q3, we currently expect revenue to range between $64 million and $64.4 million.

Our revenue forecast for the third quarter of 2021 implies a 17% growth rate compared to Q3 of last year. We are forecasting a fully diluted GAAP loss per share attributable to common stockholders to be in the range of a loss of $0.09 and a loss of $0.08 and fully diluted non-GAAP adjusted earnings per share attributable to common stockholders before deemed dividends and excluding deferred tax benefits expense to be $0.15 for the third quarter of 2021. We are currently forecasting adjusted EBITDA to be approximately 22% of forecast revenue for Q3 2021. The per share guidance figures are based on approximate basic share count of 56.9 million for Q3 2021.

Based on our current visibility, we are increasing our revenue guidance for 2021 to be between $253.1 million and $253.9 million, representing an increase of between 16% and 16.2% compared to 2020. We also expect fully diluted GAAP loss per share attributable to common stockholders to range between a loss of $0.38 and a loss of $0.36 for the year. On a non-GAAP basis, adjusted earnings per share attributable to common stockholders is expected to range between $0.58 and $0.60. Adjusted EBITDA is forecasted to be approximately $56 million or approximately 22% of total revenue for 2021, and a year-over-year increase of approximately 10% compared to fiscal year 2020.

The per share figures are based on an approximate basic share count of 55.5 million for 2021. Based on our current outlook, we expect to generate continued strong operating cash flow in 2021. We are forecasting approximately $9 million in interest expense on our bank credit facility and other interest-bearing items for 2021. In summary, as we execute this strategy, we believe our 100% subscription model, favorable profitability profile and strong cash flow generation positions us well to meet our manageable debt obligations and achieve our adjusted EBITDA guidance of approximately $56 million.

This completes my financial summary. For a more detailed analysis of our financial results, please refer to today’s earnings release as well as our 10-Q, which we plan to file by August 9. Also, visit our investor relations website to view our most recent investor presentation. Dave? 

Dave WagnerChief Executive Officer

Thanks, Dave. As our financial performance reflects, we experienced reacceleration in our business in Q2, and we’re seeing a steady growth market ahead as businesses globally continue their journey to the cloud with an increased focus on email security, compliance, and resilience. As you’ve heard me talk about, our growth strategy is built on three key pillars: new partner and customer acquisition, partner and customer add-ons, and retention. I’ll take a few minutes to provide updates in each of these areas.

Starting first with new partner and customer acquisition. During Q2, we added 5,232 new customers. Our global partner expansion continues to gain traction, especially in the U. K.

and Germany. In fact, all five of our top new partner wins were international, with three in the U. K. and two in Germany.

Our U. K. MSP wins in the quarter included a highly accredited U. K.-based MSP who initially moved over the Microsoft users and more recently moved over more than 1,000 seats of email security to our advanced Email Threat Protection.

We are working with this partner to add additional seats and services, including cloud backup. Another nice U. K. win was a MSP who consolidated with us as one strategic partner, providing a range of offerings, including replacing their current backup solution with CloudAlly.

These wins contributed to a record new partner recruit quarter in EMEA with 39, 16 of which were in Germany. We remain enthusiastic about our opportunity in Germany because Secure Cloud is so well-positioned to help IT providers in that market transition their businesses from traditional break-fix-focused businesses to becoming higher value-add subscription billing MSPs. Our U. K.

and German expansion reflect the success of those strategic investments and our commitment to strengthening our partners, security, compliance, and resilience tools. Equally exciting are the examples we’re seeing of cloud backup, helping us capture new partners and new customers. Our U. K.

team secured a new partner that was dissatisfied with the level of service and support they were receiving from a competitive cloud backup and cybersecurity provider. When the partner heard the Zix story, they not only chose our cloud backup solution for 3,000 seats but also brought over the Microsoft licensing of 5,000 seats as well. This partner plans to add more than 1,000 seats of archive later this quarter. In North America, one of our partners learned of a situation where an end customer was dissatisfied with a competing backup offering.

When they learned of Zix’s sales force backup capabilities, they selected us for both their 650 salesforce backup seats as well as their 5,500 Microsoft backup seats as well. This new win gives us the opportunity to demonstrate our value and expand even further with more solutions over time. It’s these types of success stories that reflect the value of Secure Cloud, our phenomenal service, and the effectiveness of our account management capabilities. In terms of our top five new wins through our VAR and direct sales team, we had two in healthcare, two in consumer, and one in the government vertical; four of the top five wins included email encryption.

Our largest VAR direct win in the quarter was a six-figure encryption win with a large government defense contractor. We displaced an incumbent vendor and were selected in a competitive process for our superior end-user experience and support. Turning to our second-growth pillar, which is sales to existing partners and customers. In his portion, Dave mentioned our updated partner and customer numbers.

When we include CloudAlly’s partners, we are up to more than 5,600 transacting partners and more than 100,000 end customers. This space and the white space in it is the key source of growth for us going forward. In the second quarter, sales to existing customers through MSPs accounted for 51% of the MRR increase in the quarter, which compares to 44% in Q1. We see this largely as the reversal of the COVID trend of reducing users to reflect the increase in SMB hiring we saw in North America, especially in March and April.

In terms of our top five add-ons through our VAR and direct sales team, four were in healthcare and one was in construction. The largest add-on was with a healthcare organization who wanted to consolidate encryption, data loss prevention, and Microsoft licenses with one vendor who provides phenomenal support. Our top five add-on customers in Q2 had an average of more than three solutions per account as we continue to successfully attach more solutions to existing accounts. We’re also doing a great job of introducing Zix’s cloud backup capability to our existing partners and customers.

We already had more than 100 and 60 direct customers signed on with a cloud backup offering. This adoption has us well on track to meet or exceed our attached goals for cloud backup in 2021. Moving to our third growth pillar, increasing retention. Total company net dollar retention increased from 98% in Q1 to over 101% this quarter.

Gross retention at the company level remained over 90%, which is in line with historical trends. We anticipate our retention rates to remain strong as we attach more services to our base. Over the past five years, we’ve successfully transitioned Zix from an email encryption provider to a cloud-first provider with a broad range of solutions based on our Secure Cloud platform. As much we have accomplished and as proud as we are of Zix today, we are still in transition.

Our growth strategy in 2021 remains centered around transformation in addition to driving predictable and profitable growth, our focus is on improving partner and customer experiences, by consolidating more of our services onto our Secure Cloud platform. The migration of our encryption customers to Secure Cloud is going phenomenally well. In fact, nearly all new customers have been onboarded to Secure Cloud this year, and we’ve migrated more than 2,000 existing encryption customers to Secure Cloud year to date. The integration of CloudAlly cloud backup into our Secure Cloud platform will be completed this quarter, which will further unify the platform and allow our partners and customers to protect business-critical data within today’s modern SaaS applications like Microsoft 365, Salesforce, Google Workplace, Dropbox, and Box.

Looking ahead, Zix remains well-positioned to capitalize on secular market trends and cloud adoption, ensuring that hybrid work environment’s productive, secure, compliant, and resilient. Our building cloud momentum has us on track to realize our financial goals for 2021, while also setting us up for even greater success down the road. This includes long-term growth with a goal of achieving $500 million in annual recurring revenue by 2025. That concludes our prepared remarks.

Operator, we’re ready to open the call for questions. Operator?

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Chad Bennett with Craig-Hallum. 

Chad BennettCraig-Hallum Capital Group — Analyst

Great. Thanks for taking my questions. Congrats, guys. Re-acceleration was really impressive, especially on the secondary metric.

So I’m just curious on the mailbox numbers, I mean they — you know, you saw like huge step function growth there from last quarter? And then from a new-customer standpoint, just I guess, I know, you know, based on Microsoft results, we saw some acceleration in mailboxes in their numbers or Office 365, I should say, in their growth rate numbers. And I know NFIB has ticked up nicely. Just other than those kind of macro, but highly correlated metrics, what really happened? I mean, it’s a pretty dramatic uptick in those two figures. 

Dave WagnerChief Executive Officer

Yes, so thank you for the question, Chad. We do feel much better about those macro items that you mentioned, and those are absolutely key drivers. You know, Dave and I, the whole leadership team are really proud of the execution, which I think is improving as we don’t always execute well, but the team really came together this quarter, and what does feel good about the way they’re driving and executing right now.

Chad BennettCraig-Hallum Capital Group — Analyst

And then just in terms of the attach rate or services per Secure Cloud, you know, again, do we have — I mean, I love the examples you gave, David, of all the displacements and add-ons with various partners and customers in the quarter. If we look a year from now or exiting this year, can 1.32 go to 1.36? Or how do we think about that attach rate? And should we expect some acceleration from what it’s been in the last couple of quarters?

Dave RockvamChief Financial Officer

Yeah. I think you’re right. We’ve seen really good attach, especially since Secure Cloud launched in April of last year and 1.32 services per customer now. That’s been coming up one point to two points every quarter.

We think with — as long as things continue on the recovery that we’ve seen and, you know, that we can continue to see that grow, Secure Cloud, we know we’re going to get customers over on to Secure Cloud, it makes it easier for them to trial the products, makes them easier to buy and implement the products. So, we do expect that we can continue to drive that number, and that’s what drives our long-term model going forward.

Dave WagnerChief Executive Officer

And Chad, the other thing I think you heard in my commentary there is that how pleased we are with cloud backup. You know, the product we have is really good. The market for cloud backup is really strong. And that’s one of the things that’s helping the acceleration is that new product that’s in our area of high market demand right now. 

Chad BennettCraig-Hallum Capital Group — Analyst

Right. Well, just one last one for me. I assume CloudAlly, cloud backup is the highest success rate from attach standpoint right now. What would be kind of two and three from a service-product standpoint in your mind?

Dave WagnerChief Executive Officer

Well, our No. 1 attach product by seats is that advanced threat product. It’s the natural second layer of defense that we believe every one of our customers should have. And then the cloud backup, we also believe every cloud data set — key data set should be backed up.

So, irrespective of compliance posture, regulatory demands on the organization, we believe those are the two additional layers that every business mailbox has. So, those are the two highest attached opportunity products we have.

Chad BennettCraig-Hallum Capital Group — Analyst

Got it. Thanks. Nice job, again.

Operator

So, our next question comes from Andrew King with Colliers Securities.

Andrew KingColliers Securities — Analyst

Hey, guys. thanks for taking my question. Sorry, if you already addressed this. I got pulled off the call a couple of times, but you obviously saw some nice new partner adds in EMEA.

Can you give us a little color into the U. S. new partner adds? And specifically, how do you see that ramping to pre-pandemic levels given the return of in-person MSP events?

Dave WagnerChief Executive Officer

Yeah, that’s a great question, Andrew. So, it was — new partner adds actually they have been steady in North America during COVID. And this quarter, I think we let folks know, May was our first in-person partner event. That’s an area that we’re leaning into as North America’s new partner accrue.

Obviously, we’re all watching the Delta variant closely, but we do have a team out doing in-person events and are getting a lot more focused on new partner accrued here in North America. But that, like I said was kind of steadier during COVID, we’re looking for that to pick up here in the second half.

Dave RockvamChief Financial Officer

YeAH. And you saw in my comments, I mentioned your selling and marketing continue to invest, see investment in the second half of the year. We really want to lean into the opportunity. We’re seeing the seat license counts come up that we saw in Q2.

We think that there’s opportunity there in Q3 and Q4. And the leaning on the selling and marketing side is going to be to support that effort for North America and international partner adds, along with our direct as well, but mainly focusing on, as Dave said, is that accrued function.

Andrew KingColliers Securities — Analyst

Great. And then just double-clicking on international investments. Can you give us a little bit more color as to where you’re at in those initiatives specifically regarding hiring and where you’re at with the German markets there? Have you completed the hiring there? Are you still building that out and what functions?

Dave WagnerChief Executive Officer

Yeah. That’s right, Andrew. Yeah. So, we’re really pleased with the first hires where the salespeople in region, they’re doing a great job, as you can see from those numbers.

We had a nice small team already, in Germany, we’re adding support and implementation, people in the German market. It’s not — there’s not dozens of people, but by a handful of folks to make sure we have the resources in the region doing first call, doing the implementations that, obviously, the partner relationship work. It’s largely staffed in all functions in geography at this time, and we expect to continue to invest there as we bring our new partners and customers.

Andrew KingColliers Securities — Analyst

Great. Thank you for taking my questions, and congrats on the quarter.

Operator

Thank you. And our next question is from Nehal Chokshi with Northland Capital.

Nehal ChokshiNorthland Capital — Analyst

Thanks. Great results. So, you had $9 million of 2Q ARR growth this quarter. Did you break that up between AppRiver and the higher-margin services?

Dave RockvamChief Financial Officer

Yeah. I would say we’re running probably 65%, 70%, probably coming from the productivity in Microsoft and 35% coming from the IP, that balance as you probably write in on that 50% gross margin that we’re seeing today.

Nehal ChokshiNorthland Capital — Analyst

Great. OK. And I love that you pointed out that you had the highest amount of gross profit dollars sequential increase since the closing of the AppRiver acquisition, and that’s really great to see. There are lots of elements going on in terms of the gross profit trajectory.

In the past, you’ve cited a headwind of Hosted Exchange. And then there’s also just simply revenue growth. And then there’s also the tailwind of what you guys talked about ZIXI organic services to the AppRiver customers. Can you help break out these three elements in terms of that $1.2 million Q-to-Q increase there?

Dave WagnerChief Executive Officer

Yeah. As you do point out that, of course, the Hosted Exchange is one that over time Microsoft is encouraging, and actually, we’re encouraging other partners and customers to move off Hosted Exchange onto the newer cloud offers to empower more as customers with the Teams and additional functionalities. So that headwind remains, but we are pretty careful in pointing out in the Q1 call that that kind of excess churn we saw early in the year, that has leveled out and stabilized, which is one of the things that helped drive a stronger Q2 gross margin. I talked about the execution of the team generally when Chad asked his question.

And that’s really what they’re focused on, it’s the attached services, the addition of the cloud backup capability that we pointed out, the really strong success we’re seeing there, at least relative to the plans that we had at acquisition, which now seems quite modest. But those are the things that are helping drive that attach. And of course, the biggest tailwind, and we’re — it was a premise from the beginning of AppRiver, the biggest tailwind is that rotation to the cloud of the Office 365. And that’s what we really saw in the quarter, as we pointed out in one of my lines that as we “suffered the contraction of mailboxes” remember when COVID hit, we didn’t lose customers, we lost mailboxes of existing customers, and we saw that move back again, as we said in that call, at Q2, March and April, really strong months for existing customers to add back employee mailboxes, which was good for us.

Nehal ChokshiNorthland Capital — Analyst

Great. Awesome. And then Dave, last quarter, you gave us a little bit of a color as far as what we should expect for gross profit dollars trajectory in the June quarter, which was super helpful. Can you help out again with that for the September quarter?

Dave RockvamChief Financial Officer

Yeah. We — as I said in the script, we expect gross margin dollars to continue to increase. This $1.3 million increase this quarter, really got a little bit of a rubber band, which was good from March through June. So that really helped drive the number significantly in Q2, coming off of a disappointing Q1 for us on that metric.

So we do see it coming up, $1.3 million, maybe a high bar for next quarter as far as gross margin dollar increase. But we do continue to see that from here, the next couple of quarters, nice increases, but the $1.3 million is a really strong number this quarter.

Nehal ChokshiNorthland Capital — Analyst

Great. Thank you very much.

Operator

And our next question is from Brian Colley with Stephens.

Brian ColleyStephens Inc. — Analyst

So, really impressive cash flow in the quarter. I’m curious — I mean, I’m curious, specifically, what drove that strength and how sustainable you think that is? Because I mean, 17.5% free cash flow margin is pretty impressive.

Dave RockvamChief Financial Officer

Yeah. No, we think that cash flow is really important to us. We’ve been focused on it the last, I’d say, four quarters. And we’ve been able to — our operating cash flow numbers have continued to come up.

I think we’ve got three of our four best quarters probably in company history, and we’ll continue to keep that focus. I think that — I don’t know that we’ll — like last quarter, we were $10 million. This is $14.7 million. I don’t know that we’ll be at the $14.7 million level again.

You know, we stayed very focused, as we always do, but on making sure that all of our working capital, things are all in line. And I think we’ll continue to do that and build on that. Earnings continue to increase. So as we do that, we’ll be able to continue to grow that.

And, you know, our guidance is a 65% to 70% conversion of EBITDA dollars to cash flow. And so, we’ll keep focused in on that. This quarter was nicely ahead of that, and we’ll keep pushing through there.

Brian ColleyStephens Inc. — Analyst

Got it. Well, that’s really encouraging. I mean, especially if there’s nothing abnormal in there, I mean, that’s a much higher cash flow profile than I had kind of thought historically so and congrats.

Dave RockvamChief Financial Officer

Yeah. I think we pushed a little high this quarter. Like I said, I wouldn’t call it for that number every quarter, but, you know, it’s a strong focus. And that’s been our premise all along is that we can drive good gross margin dollar growth.

We can drive it to the bottom line through our EBITDA, adjusted EBITDA, and we can drive it to cash.

Brian ColleyStephens Inc. — Analyst

Absolutely. Understood. So just looking at the guidance based on the 18% growth you posted this quarter. I mean, the guidance for 4Q implies a bit of a slowdown.

I mean, is there anything specific happening in 4Q that would drive that? Or should we just kind of interpret that outlook as you guys being prudent with on the guidance?

Dave RockvamChief Financial Officer

I’d say being prudent on the guidance. So, you know, there is a little bit of inorganic when you look at bringing in CloudAlly, we’ll head up against that in Q4. In Q4, it will be about 1 point delta. So we’ll almost be back together on our organic versus inorganic.

And right now, it runs a couple of points. So still good, strong growth. But I think that just to be a little bit conservative, there’s — we don’t know exactly what’s going to happen as COVID — that picks its head back up and the Delta variant and stuff. So we’ll be pushing hard for the second half of the year as always, but I think we just wanted to be prudent as we continue to move the numbers up.

We started the year at 12% to 14% revenue growth. So, we’re pleased to be in a position to be at 18% this quarter and ended up a full-year guide just over 16% now that we got through the second quarter. 

Brian ColleyStephens Inc. — Analyst

Yeah, absolutely. I agree with that approach. So, I’m curious, on the services per customer metric, just as it relates to gross margins, just driving higher attach rates and seeing a stabilization in margins, I completely understand the strategies to drive the gross profit dollar growth. But I am curious, is there — what’s kind of the number as you run the math, what level of services per Secure Cloud customer — like what level does that need to get to in order for margins to kind of stabilize, like from a gross margin perspective?

Dave WagnerChief Executive Officer

Yeah. I don’t know Brian, there’s a number that stabilized that the Microsoft pricing value that they have puts that into $100 a mailbox today and growing. I’m really enthusiastic about the Microsoft opportunity, one, that they have; and two, we have as their partner to drive more and more value for us to make more and more margin for us, working and supporting their suite. So, I actually am really, really bullish on the Microsoft opportunity as it continues to lead the market, we continue to draft their growth in the market, we just see lots of opportunity to continue working with them.

So, the margin percentage, I understand in the transformation that Zix is in, the challenge that puts on some analysts and investors thinking about the pure software company that we once were to what we are now, which is really a tightly integrated solution set that our partners and customers enjoy. And we’re going to exploit both opportunities till their maximum, they’re just — they just — they work so well together from a partner and customer perspective, consolidating the services went under one tight integration, simplicity, flexibility extensibilities you could use. These are the value propositions that we’re bringing to the market. And it’s not going to — I don’t think it’s going to be a number of attaches that drives gross profit back to 80%.

Those days are gone. I think those days for most software companies are gone, as we continue to leverage the cloud and aren’t running on our own appreciated hardware. So, we really are focused on this gross profit dollar growth. And I think the margin percentage is something that we really are trying to encourage investors and analysts to not pay as close attention to.

I don’t think it’s a good metric for us.

Brian ColleyStephens Inc. — Analyst

Understood. Well, if you keep putting up cash flow like you are, then I don’t think people will care. So one last question here. You’ve given the 2025 ARR target for $500 million.

I mean, how should we think about maybe an EBITDA margin range for that time frame? Is 20% to 25% a decent range or any type of ballpark there you could give? 

Dave WagnerChief Executive Officer

So, two things when you’re processing through that, so that the ARR objective is a December 31 objective. So the revenue in 2025, I have the math on a spreadsheet, but you’d have to kind of back down the revenue, which would be in the mid to high mid or 100s, and then put an EBITDA percentage on it. You know, there’s been some compression to EBITDA percentage line, is at the gross margin line, but we would be thinking in terms of 20% EBITDA in that kind of time frame. There’s no other ways we would think of it, we are not putting out a strict guide as I said, because how the next five years or four years unfurl themselves in terms of the mix is going to have a really big difference on that.

But we in terms of some compression from EBITDA percentage, but really very strong at the EBITDA line as well.

Brian ColleyStephens Inc. — Analyst

Got it. Well, that’s super helpful. I appreciate you guys answering all the questions. And congrats, again.

Operator

Thank you. Our next question, a follow-up from Nehal Chokshi with Northland Capital.

Nehal ChokshiNorthland Capital — Analyst

Thank you. I want to double-click on the strong free cash flow here. It looks like there were two main elements on the strong free cash flow. One was that you had a good increase in accounts payable, and then also a good increase in deferred revenue.

Can you discuss why you had nice sequential upticks in both of these balance sheet items?

Dave RockvamChief Financial Officer

Yeah. On the accounts payable side, it was just being conservative on our payables down at the end. There’s a few things, of course, that will clean themselves up in the third quarter and year-end, which like I said, we’ll put a little bit of pressure on those. There’s certain bills that sit out there a little longer with different types of services people you’re working with and stuff.

So that’s why I said I wouldn’t — the $14.7 million is a really good number, and we can continue to put up good cash flow numbers and operating cash flow numbers, it might not hit that number every quarter. 

Dave WagnerChief Executive Officer

Yeah. One thing just to, hold it, to remind you, and you’ve been around long enough that the Zix’s annual billings that they are a good, strong quarter in Q2. So, that’s the deferred revenue does move a little more than the ARR number, which is really consistent, steady upward moving. We do have some timing of billings, obviously still with our annual contracts that contribute to the volatility.

And then I’m really pleased with Dave and the whole team on the working capital management, but payables were at a kind of a high watermark as Dave alluded to the other question. But I think that longer term, thinking about it as that 65% to 70% grower in terms of EBITDA to cash flow over time, we’ve had quarters we’ve been off that and we’ve gotten pressure. Now, we’re way ahead of it, but we do expect that to be more stable over time. 

Nehal ChokshiNorthland Capital — Analyst

If I look at the days payables, relative to pre-pandemic levels, it’s still below that. So, do you think that you still have room for extending your days payables or those are just different days?

Dave RockvamChief Financial Officer

Yes. Those are different days.

Nehal ChokshiNorthland Capital — Analyst

OK. All right. And two other nitpicky things. It looks like you’re guiding to a $2 million Q-over-Q increase in shares outstanding, why is that?

Dave RockvamChief Financial Officer

It’s how the balance works coming through. It’s all based on averages. And so we do our grants in the second quarter mainly in the first quarter and last year, they also came through in the second quarter. So it’s just the timing of grants and how that works its way through.

So, it’s just — it was lower in Q1 and Q2 than we expected, but it is pulling through on the average coming up in Q3 and Q4. 

Nehal ChokshiNorthland Capital — Analyst

Got it. OK. And then your G&A did increase $0.4 million Q to Q and $1.1 million year over year. What’s the narrative behind that?

Dave RockvamChief Financial Officer

Yeah. A lot of it has to do with expenses coming back up related to — Q2 of last year we really pulled back everything with COVID hitting, so not a lot of travel, but travel coming back in, variable compensation coming back in, you can read our Q or K from last year, our proxy, variable compensation was in 60% range. We’re accruing now toward a better — higher number. So those are kind of things that go into that number that have pushed it up.

Nehal ChokshiNorthland Capital — Analyst

Great. Thanks very much. And again, congrats on a strong quarter. Thanks, again.

Operator

And thank you. And at this time, this concludes our Q&A session. I would like to turn the call back to Mr. Wagner for his closing remarks. 

Dave WagnerChief Executive Officer

Well, I would just add. Thank you, everybody, for joining us early this morning in a pre-market earnings release. We look forward to meeting with you all again in about 90 days. And then, I’m going to talk through our Q3 results.

I thank you all, and have a great day.

Operator

[Operator signoff]

Duration: 50 minutes

Call participants:

Geoff BibbyChief Marketing Officer

Dave WagnerChief Executive Officer

Dave RockvamChief Financial Officer

Chad BennettCraig-Hallum Capital Group — Analyst

Andrew KingColliers Securities — Analyst

Nehal ChokshiNorthland Capital — Analyst

Brian ColleyStephens Inc. — Analyst

More ZIXI analysis

All earnings call transcripts

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