ANASTASIA SUTJAHJO

JEEWHAN SHIN

TING-YING (ERICA) WU

November 1, 2012

1

AGENDA

Introduction and Current Holding

Macroeconomic Review

Stock Market Overview

Industry Review

Company Assessment

Financial Analysis

Financial Projection

Methodology and Application

Recommendation

2

CURRENT HOLDING

April 17, 2012

• Acquired 2,000 shares @ $2.89/share• Cost basis = $5,780

October 31, 2012

• Current holdings 2,000 shares @ 2.90/share• Market value = $5,800• Annualized HPR = 0.642%• 1.67 % of total portfolio

MACROECONOMIC REVIEW Unemployment Rate

• U.S. unemployment rate fell to 7.8 percent in September, which was the lowest since January 2009

GDP Growth

• Slow recovery from recession

Source : http://finance.yahoo.com/news/us-jobless-rate-falls-7-123110416.html http://www.bea.gov/national/index.htm

4

STOCK MARKET

5

Source : Capital IQ

INDUSTRY OVERVIEW

The global application software market

• Total industry revenue of $76 billion in 2010• Representing a 4.7% growth from 2006 to 2010• The performance of the market is forecasted to accelerate• Anticipated to grow 7.8% during 2010 to 2015 • The value of the market is expected to be $110.9 billion by

the end of 2015

6Source: Market Line – Global Application Software Industry Report (http://advantage.marketline.com/Product?pid=MLIP0318-0001)

Global application software market value: $ billion, 2006–10

INDUSTRY OVERVIEW

7Source: Market Line – Global Application Software Industry Report (http://advantage.marketline.com/Product?pid=MLIP0318-0001)

Global application software market value forecast: $ billion, 2010–15

8Source: Market Line – Global Application Software Industry Report (http://advantage.marketline.com/Product?pid=MLIP0318-0001)

9

Forces driving competition in the global application software market, 2010

9Source: Market Line – Global Application Software Industry Report (http://advantage.marketline.com/Product?pid=MLIP0318-0001)

COMPANY HISTORY

1988 Incorporated in Texas, named as Amtech Corporation

1999 Changed name to ZixIt Corporation and entered encrypted

email market

2002 Became Zix Corporation as current name

2003 Entered the e-prescribing

2009 December 8, announced plan to exit from e-prescribing market

2011 Introduced ZixAccess, a new decryption service for inbound

email delivery

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Source: ZIXI Company Website (http://www.zixcorp.com/resources/), accessed October 31, 2012

BUSINESS DISCONTINUED OPERATIONS

E-prescribing

• Started in July, 2003• e-Prescribing consists of a single product line named

PocketScriptR, which is an electronic prescribing service that allows physicians to use a handheld device to prescribe drugs and transmit the prescription electronically to virtually any pharmacy

• Business going downward• December 8, 2009: Worked with Strategic View (Allen &

Company LLC)• Announced it would wind down the e-Prescribing business and

exit the business by December 31, 2010

Source : ZIXI 10-K FY2011 (http://www.sec.gov/Archives/edgar/data/855612/000119312512106508/d279168d10k.htm)

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BUSINESS CONTINUING OPERATIONS

Email encryption: Software-as-Service (“Saas”)

• ZixDirectory: largest email encryption information utility with more than 33 million members per week

• Transparent Email Encryption: easy to use and encrypted without any extra steps. Completely transparent to the sender and receiver, not utilizing decrypted password

•  Zix Mobility: penetration to mobile support email encryption as a respond of technology trend

12Source : ZIXI 10-K FY2011 (http://www.sec.gov/Archives/edgar/data/855612/000119312512106508/d279168d10k.htm)

ZIX’S COMPETITIVE ADVANTAGE

Competitors:•Product based approach’ which is depends on each company’s own system•Directory of each user identities is not shared•Less desirable since different companies encrypted email systems are not interoperable

ZIX Corp.:•Saas architecture enable transparent email delivery through ZixDirectory•Enable company to have secured communication with external network

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Source: ZIXI Company Website (http://www.zixcorp.com/resources/), accessed October 31, 2012

BUSINESS MODEL

Go-to-market model:

•Multiple-year subscription contracts with the fees paid annually at the inception of each year of service.

•As a result, a high percentage of customers subscribe to the Email Encryption Service for a three-year term versus a one-year term

14Source : ZIXI 10-K FY2011 (http://www.sec.gov/Archives/edgar/data/855612/000119312512106508/d279168d10k.htm)

BUSINESSDISTRIBUTION CHANNEL

15

Source: ZIXI Company Website (http://www.zixcorp.com/resources/), accessed October 31, 2012

CUSTOMERS

• Five division of US Treasury, all FFIEC U.S Federal Banking Regulators, SEC and FINRA, 22 U.S State Banking Regulators

• 1,800 Financial Institution, 20% all bank in U.S.• 1,500 U.S. Hospital, 20% U.S Hospital, 32 Blue Cross Blue Shield

Organizations

16

Source: ZIXI Company Website (http://www.zixcorp.com/resources/), accessed October 31, 2012

BUSINESS RISKS

• Decrease in demand

• Unfavorable economic/political conditions

• Rapid technology change

• Lack of infrastructure

• Significant investment with no guarantee of revenue

• Fierce competition

• Weak position in the supply chain

• Market penetration failure

• Low quality of services (reputation, potential legal liability)

17Source : ZIXI 10-K FY2011 (http://www.sec.gov/Archives/edgar/data/855612/000119312512106508/d279168d10k.htm)

POTENTIAL CONTROLS

Lobbying Activities

• $20,000 in 2005 by hiring Health Policy Group lobbying firm

High Operating Costs

• SG&A (5yr avg.): 57.4% of total sales • R&D Expenses (5yr avg.): 15% of total sales

Significant Cash Holdings

• Cash & ST Investment (5yr avg.): 86% of current assets

Might mitigate some business risks

18Source : ZIXI 10-K FY2011 (http://www.sec.gov/Archives/edgar/data/855612/000119312512106508/d279168d10k.htm)

HOW COMPANY GENERATES MONEYRevenue Drivers

• Email Encryption Contracts: • New First Year Order (“NFYO”): New Subscription

• Multiyear contract which is irrevocable and nonrefundable• Price is manufactured to induce long term contract• Upfront payment and revenue will be recognized ratably throughout

subscription year• Retention of subscription: Renewal Subscription

• 90% retention rate• Account for 95% revenue

• Regulatory Driver• Significant increase in demand in healthcare sector led by April 2005 HIPAA

(Health Insurance Portability and Accountability Act)• HITECH ACT: Increase penalty while expanding the scope of HIPPA• Current trend: Law, and regulation across the country have enhanced security

awareness. Governments have focused on encryption.

• Licensing (potential)• Potential large number of future NYFO

• Signed extended 3 year contract with Blue Cross Blue Shield, Pen Publishing Interactive, Austin Bank xDefenders, Berkshire Bank in 2011

19Source : ZIXI 10-K FY2011 (http://www.sec.gov/Archives/edgar/data/855612/000119312512106508/d279168d10k.htm)

HOW COMPANY GENERATES MONEYRevenue Breakdown

• Price * Quantity• Price: Constant, even allowance due to high competition• Matter of Quantity, Maximizing volume of contracts

• Backlog: Contractually bound agreements expected to be recognized as services are performed (Deferred Revenue)

• Approximately 60% to be recognized during the next 12 month

• Order: New First Year Order (NFYO) and Renewals

• As of June 2012: Backlog is $55.5M and Total Order is $22.6MSource: ZIXI 10-K and 10-Q FY2007 – 2012 (http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0000855612&type=10&dateb=&owner=exclude&count=40)

2007 2008 2009 2010 2011 GraphBacklog 31.8 37.4 44.3 49.9 53.7

Billed and Paid 16.1 17.4 17.3 16.8 17.4

Billed yet Unpaid 3.3 3.2 4.7 5.2 4.6

Unbilled Contract 12.4 16.8 22.3 28.0 31.7

Order 24.2 29.2 35.2 40.8 42.3

New First Year Order 5.5 5.5 6.5 8.7 7.1

Renewals & Multiple-year Contract 18.6 23.8 28.7 32.1 35.2

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FINANCIAL ANALYSISQuarterly Revenue Growth

• Average Growth of 16.74%

Source: ZIXI 10-Q FY2002 – 2012 (http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0000855612&type=10-q&dateb=&owner=exclude&count=40)

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FINANCIAL ANALYSISKey Observations

• Great Gross Profit Margin: Approx. Above 80%• Stable Operating Expenses

• Improving EBIT

• Huge Tax Refund in 2010 and 2011

Operating Expenses 2007 2008 2009 2010 2011 GraphSelling General & Admin Exp. 17.961 14.237 15.927 16.363 15.128

R & D Exp. 5.322 2.677 3.619 5.089 5.229

2007 2008 2009 2010 2011 GraphEBIT 1.585 2.285 5.146 10.577 10.944

Margin % 7.01% 8.65% 15.56% 27.73% 27.30%

2007 2008 2009 2010 2011 GraphIncome Tax Expense 0.181 0.042 0.067 (35.500) (11.889)

Source: Capital IQ (ZIXI Financial Statements from 2007 to 2011)

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FINANCIAL ANALYSISKey Observations

• Significant Cash Holdings and Deferred Tax Assets

• PP&E and Depreciation

• 99% Equity Financing: No public debt • Deferred Revenue is 88% of Current Liabilities and 87% of Total

Liabilities• Negative Retained Earnings

2007 2008 2009 2010 2011 GraphTotal Cash & ST Investments 12.258 13.245 13.312 24.619 20.680

Deferred Tax Assets, LT 0.064 - 0.063 34.304 48.806

2007 2008 2009 2010 2011 GraphGross Property, Plant & Equipment 32.088 31.226 29.807 30.438 30.409

Accumulated Depreciation (29.791) (28.990) (27.670) (28.229) (28.181)

Net Property, Plant & Equipment 2.297 2.236 2.137 2.209 2.228

2007 2008 2009 2010 2011 GraphRetained Earnings (318.618) (324.060) (328.495) (287.282) (264.728)

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Source: Capital IQ (ZIXI Financial Statements from 2007 to 2011)

FINANCIAL PROJECTIONS

Sales are Increasing

•Industry growth trend

•Economy recovery

•Increase of contracts sourced from the regulatory drivers and new product initiatives

•Increasing backlog to be recognized

Cost of Goods Sold is Increasing with Revenue

SG&A is Decreasing

•Declining percentage of the revenue comes from the direct sales distribution, which may lead the company to reduce marketing expense

•Discontinuation at E-Prescription business

R&D is Increasing

•Rapid technology change

•Development of new products such as ZixMobility

•Increase quality of products (reputation, potential legal liability)

Assumption 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016ESales -6.36% 16.82% 25.22% 15.36% 12.00% 16.00% 17.00% 19.00% 19.00%COGS (%Revenue) 18.18% 17.34% 19.57% 18.90% 19.00% 19.00% 19.00% 19.00% 19.00%SG&A 62.98% 60.31% 49.49% 39.66% 33.00% 32.00% 32.00% 32.00% 32.00%R&D 11.84% 13.70% 15.39% 13.71% 15.00% 17.00% 17.00% 18.00% 18.00%D&A(%PPE) 40.12% 47.59% 57.99% 61.62% 60.00% 60.00% 60.00% 60.00% 60.00%CapEX(%Revenue) 5.48% 0.00% 4.51% 3.86% 4.00% 4.20% 4.20% 4.30% 4.30%

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DISCOUNTED CASH FLOW

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CAPM

CAPM (50%) 6.50%

ROE (50%) 16.60%

Discount Rate 11.55%

Enterprise Value $160.60 Market Capitalization 181.28Share Price 2.94Terminal Growth Rate 3.50%

COMPARABLE ANALYSIS

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Company TickerMarket Capitalization

Enterprise Value Sales

Gross Profit EBITDAEBIT

Net Income

Total Assets Cash

Zix Corp. ZIXI 177.6 154.5 41.6 34.1 11.7 10.3 22 77.6 20.68EdgeWave, Inc. EWVE 1.7 8.7 17.5 12.4 -3.4 -3.8 -4.2 17.6 2.61IceWEB Inc. IWEB 15.1 16.7 2.7 0.6 -3.4 -3.7 -8.6 2.8 0.004Proofpoint, Inc. PFPT 426.2 349.7 93.7 62 -11.4 -19.8 -21 68 9.77

Mean 155.15 132.4 38.875 27.275 -1.625 -4.25 -2.95 41.5 8.266Median 96.35 85.6 29.55 23.25 -3.4 -3.75 -6.4 42.8 6.19

Low Medium HighEnterprise Value $ 155.26 $ 192.34 $ 399.07 Market Capitalization 178.49 215.57 422.30 Share Price 2.93 3.49 6.84

VALUATION SUMMARY

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RECOMMENDATION

† High growth potential

† Competitive advantage through ZixDirectory

† Growing stage

− Negative retained earnings

− Smaller size compared to diversified competitors

28

HOLD