Monday, April 28, 2014

Zix ( Nasdaq - ZIXI ) -- Building a Secure Future

Zix (ZIXI $3.35) is a leading provider of e-mail encryption that protects sensitive information during transit.  The company sells its technology on a recurring revenue basis.  Customers who send encrypted messages pay the company approximately $20 a year per user for unlimited messaging.  Recipients can receive encrypted e-mails without charge by registering in the company's directory.  Any code can be broken if sufficient computer horsepower is applied.  From a practical standpoint, though, Zix's technology is safe from hacking.  Healthcare and financial institutions represented 72% of revenue in the latest quarter (March).  Renewals represent about 90% of revenue.  The renewal rate is approximately 100%.  New seats at existing customers offset losses.  Organic growth is 10%-15% a year.

A re-seller agreement with Google has caused performance to slow.  The huge search engine provider also sells an anti-spam and virus protection service to corporate clients.  It licenses Zix's email encryption technology to include in the bundle.  Google reorganized that service early in 2013.  A variety of back-end issues arose, causing sales of Zix's products to decline from 20% of Zix's annual sales to less than 10% in the latest quarter.  The infrastructure appears to have been reestablished.  But Google still is handling new orders by hand, for select large accounts, rather than through automation.  The system is ready to be turned on again.  But it remains to be seen when the Google channel will resume full speed.

A high potential new product remains in an early stage of development.  Last fall Zix launched a cloud based "bring your own device" (BYOD) security package.  The software allows employees to use their personal phones to send and receive company email, without any of it actually being stored on the phone itself.  That way if the phone is lost no proprietary information is jeopardized.  Several alternative technologies already are on the market.  Those are software packages that reside on the phone.  Besides creating privacy issues, pricing is higher because different software has to be written for hundreds of phone models.  Zix's is a single platform that operates in a cloud computing format.

Only 68 companies have been signed up to date.  Most still are in the testing stage.  Pricing is similar to email encryption, around $20 per user per year.  Zix boosted its sales force by 40% last year to get the new "ZixOne" line rolling.  A large number of evaluations are underway.  If the technology gains general acceptance the user population could jump into the millions, similar to encryption.  Margins could widen on the incremental volume, moreover, leading to superior earnings gains.

For now, the Google problem combined with the uncertain "ZixOne" rollout has exerted pressure on results.  Earnings probably will decline modestly in 2014 due to the greater sales effort.  Even if new business is generated Zix's recurring revenue model will spread those payments out into the future.  Revenue is recorded as earned, month by month.  Success could lay the groundwork for superior growth in future years.  If the new line pans out and Google gets back in gear, sales could attain $75-$100 million in 2-3 years to provide fully taxed earnings of $.20-$.30 a share.  Our advice is to wait for a lower entry price or more clear cut proof that "ZixOne" will realize its potential.

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