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Q3 2020 Earnings Call
Nov 09, 2020, 5:00 p.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good afternoon, and welcome to Zix's third-quarter 2020 earnings conference call. My name is Christian, and I will be your operator today. Joining us for today's presentation are the company's president and CEO, David Wagner, CFO, David Rockvam; and vice president of marketing, Geoff Bibby. Following the remarks, we will open up the call for your questions.

[Operator instructions.] Now I will turn the call over to Geoff Bibby. Sir, please proceed.

Geoff Bibby -- Vice President of Marketing

Thank you, Christian. Good afternoon, everyone, and thank you for joining our Q3 2020 earnings conference call. On the call today, we have our CEO, Dave Wagner, our CFO, Dave Rockvam. After the market closed today, we issued a press release announcing our results for the third quarter ended September 30, 2020, 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 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 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 with the SEC provide examples of those risks. As more fully described in our quarterly report on Form 10-Q for the quarter ended September 30, 2020. The company has been actively monitoring the COVID-19 situation and its impact on both the company and the world in which we operate. The impact of COVID-19 and the unprecedented measures prevented spread are affecting our business in various ways, causing volatility and demand for our products change in customer behavior, including their spending payment patterns, disruptions in the operations of suppliers and partners and our employees' ability to work and travel.

We expect the ultimate significance of the impact will be dictated by the length of time that these circumstances continue, which will depend on the currently unknowable extend and duration of COVID-19 pandemic. 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 today, 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 to non-GAAP measures is included in today's press release, which can be found on the Investor Relations section of our site. Now with that, I'd like to turn the call over to Dave Wagner for his opening remarks. Dave?

Dave Wagner -- Chief Executive Officer

Thanks, Geoff. Good afternoon, and thank you, everyone, for joining us today. Our solid results for the third quarter demonstrate our team's continued commitment to driving profitable growth, as well as our partners and end customers' adoption of our Secure Cloud platform. Delivering 15% revenue growth, coupled with 25% adjusted EBITDA margins in the quarter demonstrates the growing value Zix is providing our partners through our Secure Cloud platform.

Secure Cloud delivers comprehensive digital productivity, security and compliance solutions for businesses of all sizes. Today, I'm also pleased to announce that we're taking our commitment a step further through our acquisition of CloudAlly, an industry leader in Cloud-based data backup and recovery. Founded in 2011, CloudAlly offers a robust suite of award winning, ISO 27001 certified and GDPR, HIPAA compliant solutions for Microsoft Office 365, Google Workspace, SharePoint, OneDrive, Salesforce, Box and Dropbox. If you haven't gone through the related press release we issued this afternoon announcing the acquisition, I would encourage you to do so for further transaction specifics and commentary.

At a high level, CloudAlly expands our product suite into Microsoft Office 365 backup and recovery. Filling a growing demand from AppRiver's MSP channel as well as Zix's value-added reseller and direct sales channels. Like Zix, CloudAlly is a channel first provider serving more than 5000 customers and 250,000 unique users globally, collectively served by 600 MSP partners. Our two companies have highly complementary and synergistic go-to-market motions and end markets with virtually no overlap in our MSP partner base.

Most importantly, our combination with CloudAlly will enable us to directly address and capitalize on the growing Cloud backup and recovery market, which is expected to reach more than $3 billion annually by 2025 according to industry analysts. Zix's transformation continues to achieve new heights, and we believe this acquisition will enable us to accelerate our growth even further. Now I will turn our call over to our CFO, Dave Rockvam, to provide details on our financial results for the quarter. After his remarks, I will return to discuss our core growth drivers, Cloud Ally and our new chief product officer.


Dave Rockvam -- Chief Financial Officer

Thank you, Dave, and good afternoon, everyone. At a high level, in the third quarter, we again delivered on our commitment to drive incremental ARR, revenue and adjusted EBITDA dollar growth. We also produced strong cash flow from operations, generating $15.1 million, bringing the total amount of cash flow from operations to $24.2 million on a year-to-date basis. Looking at our numbers for the quarter in more detail.

At the end of Q3, our ARR totaled $222.3 million, up 11% from Q3 of last year. Our continued and sustained ARR growth is being driven by our customers' move to secure modern workplace, which puts significant emphasis on Cloud adoption. We are pleased that our Cloud-based ARR grew by 19% over Q3 of last year and now comprised 86% of total ARR of $190.3 million. New customers in the quarter totaled over 4500; up 22% from Q3 of last year.

For the third quarter, we had just over 99% net dollar retention, which represents our renewals plus new sales into the installed base divided by the renewals that were available at the beginning of the quarter. We continue to be pleased that in this unprecedented environment, we were able to grow our ARR at a double-digit rate and maintain good retention rates with our customers. Which we believe demonstrates the mission-critical role that our solutions fill with our customers. Dave will provide more color on our net dollar retention in the context of our growth drivers shortly.

Revenue for the third quarter increased 15% to $54.8 million from $47.8 million in the same quarter last year. The $54.8 million of revenue exceeds our guidance range for the third quarter. In Q3, we continued to see the momentum from the Q2 launch of Secure Cloud with nearly all new customers on the MSP side of the business on-boarding onto the new platform, while on the ZixDirect and partner side, we saw 88% of all new customers onboard onto Secure Cloud. October continued that momentum with Secure Cloud on-boarding on the Zix side at 97%.

Secure Cloud customers now consume 1.29 services per mailbox; which is up from 1.26 in Q2 2020. In total, our customers averaged 1.1 services per customer. So we know when we get them on to Secure Cloud, they consume more services. We think this bodes well for our strategy of providing a strong user-friendly platform that makes it easy to add more Zix solutions; ultimately making us more valuable and stickier to our partners and customers.

Shifting back to the P&L. Our adjusted gross profit for the quarter was $29.5 million or 53.8% of total revenue, which was an improvement on a dollar basis from $28.5 million or 59.6% of total revenue in the third quarter of last year. On a quarter-over-quarter percentage basis, this is down from 54.7% last quarter due to the continued strong growth of Office 365 products, which carry lower margin than most of our Zix IP-based products. Our adjusted R&D expenses for the third quarter of 2020 were $5.2 million or 9.5% of total revenue compared to $4.8 million or 10% of total revenue in Q3 of last year.

The year-over-year dollar increase for the quarter was primarily due to certain development projects, which we completed in 2020, and we are now beginning to amortize into expenses. Because the majority of our solutions are now Cloud-based, we continue to capitalize a meaningful portion of our development effort. As we move -- as we see more of these projects going to production, we will continue to see increases in our amortization. This growth in amortization will not impact our EBITDA, but it will have an impact on overall R&D expense and net income.

In the near-term, we don't expect to be increasing R&D headcount, but would expect to see R&D increase on an expense dollar basis compared to a cash spend basis. Our adjusted selling and marketing expenses for the quarter were $9.7 million or 17.6% of total revenue compared to $9.5 million or 19.9% of total revenue in Q3 of last year. The lower 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 more than 4450 active MSP partners. For the third quarter of 2020, our adjusted general and administrative expenses were $3.4 million or 6.2% of total revenue, which was down from $4.6 million or 9.6% of total revenue reported in Q3 of last year.

Much of this decrease was associated with the cost actions we took in April of this year and the continued vigilance on expense management. On a GAAP basis, we reported a net loss of $725,000 versus a loss of $1.6 million in Q3 of last year. On a GAAP basis, we reported a net loss attributable to common shareholders of a loss of $3 million or a loss of $0.05 per fully diluted share. The $0.05 loss for the quarter compares to a net loss attributable to common shareholders of a loss of $3.7 million or a loss of $0.07 per fully diluted share in Q3 of last year.

Our third quarter non-GAAP adjusted net income before deemed dividends and acquisition-related expenses and excluding deferred tax was $9.2 million or $0.17 per fully diluted share, which is $0.01 above our guidance. This compares to $6.7 million or $0.13 per fully diluted share we reported in Q3 of last year. And finally, our adjusted EBITDA for Q3 2020 totaled $13.8 million; an increase of 19.9% from the $11.5 million we reported in Q3 of last year. As a percentage of total revenue, adjusted EBITDA for Q3 2020 was 25.1% compared to 24% in Q4 of last year, Q3 of last year.

We had a really strong cash flow generation quarter. In Q3 2020, we generated $15.1 million of cash flow from operations, which was up 128% or $8.5 million over Q3 last year. For the nine-month period, we generated $24.2 million of cash flow from operations; an increase of 205% or $16.3 million over the same period last year. Capex and other intangibles for the third quarter of 2020 were $4.7 million, which consisted primarily of normal business capital purchases and capitalized internal use software development.

We expect capex and other intangibles to be approximately $18 million to $19 million for the full year 2020. We also expect adjusted depreciation and amortization to be approximately $9.2 million for the full year 2020. Billings, another measure of the health and growth of our business totaled $54.6 million for the third quarter of 2020; up 18% from $46.2 million in Q3 of last year. Turning to our balance sheet.

We ended the quarter with $23.7 million in cash, an increase of 68% or $9.6 million from $14.1 million at the end of the prior sequential quarter. In addition to our strong cash position, we also currently have $25 million available for borrowing through our revolving credit facility. This year, we have reacquired or canceled approximately $2.7 million of our own shares as part of our employee equity awards program, which does consume our cash but helps to limit dilution. Switching gears to the acquisition of CloudAlly, which we announced earlier today.

In addition to the market opportunity, which Dave will touch on momentarily, we expect CloudAlly to be highly accretive from a financial perspective. It's 100% subscription business and favorable profitability profile provide us with a predictable adjusted EBITDA and cash flow to augment our already robust financial base. For the fiscal year ending December 31, 2020, CloudAlly is projected to generate a stand-alone basis approximately $8 million in ARR. And at the end of 2021, we expect them to be on a quarterly EBITDA run rate of $500,000 per quarter.

In connection with the acquisition, we modified our existing senior secured term loan by adding additional borrowings of $35 million, bringing the total outstanding debt under our credit facility to $212.2 million. The maturity date remains February 20, 2024, and carries the same interest rate; currently LIBOR plus 3.25%, which is subject to future step-downs as leverage reduces. Additionally, we used a portion of the additional term loan borrowing to repay all existing draws under the revolving credit facility, which will leave us with $25 million of capacity under the revolver. On a pro forma basis, taking into effect the CloudAlly acquisition as of December 31, 2020, we expect to have more than $20 million of cash and cash equivalents and total debt under the credit facility of $212.1 million at the end of 2020.

Longer term, our strong unlevered free cash flow generating capabilities, aided by CloudAlly, will reliably allow us to service our debt obligations and execute our growth strategy. Now turning to our financial guidance, which is based on current market conditions and expectations and is subject to various important cautionary factors, including risks and uncertainties associated with COVID-19 pandemic. For the fourth quarter of 2020, which includes partial contribution from CloudAlly, we currently expect revenue to range between $56.4 million and $57.4 million, which includes approximately $1 million of contribution from our acquisition of CloudAlly on November 5, 2020, and takes into account the GAAP required deferred revenue discount. Our revenue forecast for the fourth quarter 2020 implies a 12% to 14% growth rate compared to Q4 of last year.

We are forecasting fully diluted GAAP earnings per share attributable to common stockholders to be in a 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 acquisition-related expenses and excluding deferred tax benefits or expense to be in the range of $0.16 to $0.17 for the fourth quarter of 2020. We are currently forecasting adjusted EBITDA to be approximately 25% of forecasted revenue for Q4 2020. The per share guidance figures are based on an approximate basic share count of 55.3 million shares for Q4 2020. Based on our current visibility, we have increased our revenue range for the full fiscal year 2020.

We are currently forecasting revenue to range between $217 million and $218 million, representing an increase of between 25% and 26% compared to 2019. We also expect fully diluted GAAP loss per share attributable to common stockholders to range between a loss of $0.28 and a loss of $0.27 for the year. On a non-GAAP basis, adjusted earnings per share attributable to common stockholders is expected to range between $0.60 and $0.61. Adjusted EBITDA is forecasted to be in the range of $51.2 million and $51.8 million or approximately 24% of total revenue for 2020 and a year-over-year increase of between 29% and 32% compared to fiscal year 2019.

The midpoint of this range is down $500,000 from prior guidance, mainly due to slightly higher variable count compensation due to higher revenue performance than the company had been forecasting for most of the year. Our adjusted EBITDA guidance of $51.2 to $51.8 million implies a leverage ratio of approximately 3.7 at the end of Q4, putting us comfortably below our maximum permitted leverage ratio of 4.75 for year-end 2020. The per share figures noted earlier are based on approximate basic share count of 54 million shares for 2020. Based on our current outlook, we expect to generate continued strong free cash flow in Q4 2020.

We are forecasting approximately $2.2 million in interest expense on our bank credit facility in Q4. Looking ahead into 2021, we also like to provide some early modeling information. First, the revenue related to the acquisition of CloudAlly will add approximately $1.5 million of revenue in Q1 2021. This takes into account the deferred revenue discount on CloudAlly's revenue, which will improve throughout the year as we build those customers and can recognize the full value of their ARR.

On the cost side, remember that the first quarter normally includes a slight decline in profitability and cash flow for the company as our first quarter includes increases in costs associated with payroll taxes, sales and marketing investments for the year and the timing of payments of our annual bonus program, as well as retention bonuses associated with our acquisitions. Also on the cost side, as I mentioned earlier, R&D expense will increase due to the amortization of capitalized software development costs on Secure Cloud and other Cloud-based development projects from 2020. These additional costs will impact 2021 EPS but will not impact EBITDA growth. This completes my financial summary.

And for a more detailed analysis of our financial results, please refer to today's earnings release as well as our 10-Q, which we filed today. Also visit our investor relations website to view our most recent investor presentation. Dave?

Dave Wagner -- Chief Executive Officer

Thanks, Dave. I will now review our execution of strategy in the context of our three primary growth drivers, after which I will continue my discussion of why CloudAlly was the perfect acquisition for us and what it means for our business going forward. So starting with our first growth driver, which is new customer acquisition. We had some noteworthy wins in the quarter on both the Zix and AppRiver sides of the business.

First, on the Direct bar side, our top five wins in the quarter were in our traditional industries, including two in healthcare, two in finance and one in government. All five wins included email encryption and all five wins involve displacing a competitive solution. Our largest new customer win in Q3 was a six-figure deal in the finance vertical. This customer selected Zix, stating that they determined us to be best of breed compared to our most notable competitors.

We averaged two products per new customer and our top five new customer wins in the quarter and 88% of all new logo wins in the quarter were deployed on Secure Cloud. On the MSP partner side, we added 54 net new transacting partners in Q3, which compares to the 60 we added in Q2, bringing our total to 4507 at the end of the quarter. In Q3, we added approximately 170 net new customers per week, bringing our total customer count on the AppRiver side of the business to more than 75,000. Our sales momentum on both the direct and indirect side of our business picked up from Q2 levels into Q3 and continued into the current quarter as well.

As we shared on our last call, we achieved more than 4300 trials. Our second highest monthly total in July just behind June. Total October trials were just short of July levels. Zix IP trials for Q3 accounted for 27% of the total trials in the quarter, and we achieved a new record for IP trials in October.

In terms of our second growth driver, which is sales to existing customers. In Q3, our top five add-ons through our VAR and direct sales team included two in healthcare, one in banking, one in education and one in construction. We also had a broad mix of solutions represented in the top five, including two in encryption and two Office 365 add-ons. On the MSP side, sales to existing customers accounted for 47% of the monthly recurring revenue or MRR increases in the quarter, which compares to 22% in the prior quarter and 41% in Q3 of last year.

Moving on to our third growth driver, increasing retention. Our top five renewing customers by ARR in Q3 were all Cloud customers and 50% of our total renewing customers in the quarter were in the healthcare space. We also had a strong government renewal quarter that included renewals from six long-standing government customers, including one that first became a customer in 2002. As Dave mentioned, our total company net dollar retention was 99% in Q3, which was up from 96% in Q2 and just shy of our historical 100% plus level.

It's worth pointing out that our net dollar retention was impacted slightly in the quarter due to a $300,000 decline related to the planned end-of-life of our ZixOne product. Absent this change, we would have been at the 100% level. We have approximately $650,000 of ARR remaining from this product, which is scheduled to taper off through next year. Since the end of the quarter, we've seen our net dollar retention remain near the 100% threshold.

Today, Secure Cloud is a leading solution, enabling partners and end customers to achieve a secure modern workplace. Secure Cloud provides small and mid-market enterprises with unparalleled productivity, security and compliance; all from a single platform. The increase of remote work is making uninterrupted access to an organization's Cloud data vital for employee productivity. Remote work is also creating larger tax services, enabling more attacks, bigger breaches and a greater need for data restoration following a breach; which brings me to the strategic nature of the CloudAlly acquisition we announced earlier today.

I would like to take a few minutes to share with you why I am so excited to add CloudAlly and Cloud backup and recovery to our solution set and ultimately aim to Secure Cloud. There are three main reasons I really like this acquisition. Number one, it fills the number one partner request of what they want to buy next from Zix AppRiver. Number two, Cloud backup is an exciting and fast-growing market, which is highly complementary and is a natural extension of our current solutions.

And number three, in CloudAlly, we have added an extraordinary team of talented, Cloud-first, partner first, technology developers and professionals who share our vision of building superior products that are highly effective, easy to use and deploy and backed by phenomenal customer service. Over the summer, we did a comprehensive survey of our partner community. Of the 229 respondents, 59% had a current incumbent Office 365 backup vendor and 41% have yet to select a backup provider for their customers. Of the respondents, 55% indicated that they would be likely to resell Cloud backup from Zix.

And 34% said that they were 80% or more likely to resell Office 365 backup from Zix within two years. As you can see from the survey data, we expect to create a lot of shareholder value from Cloud backup as we work to double our Cloud backup ARR over the next three years. Beyond Office 365, and perhaps even more exciting, is our entry into the Cloud backup space more generally. The total backup market is estimated by Gartner to be $6.3 billion, growing at 2.5% annually.

Today, the Cloud backup segment represents about 20% of the total, or $1.3 billion; growing 25%, with Office 365 backup representing nearly half of that Cloud backup market at $600 million. We are focused on the large and growing Office 365 market, and we are excited that CloudAlly has solutions today for Google markets, Salesforce, Box and Dropbox. Each of these Cloud applications represent meaningful additional growth opportunities for Zix and our partners. When you step back and think about it, the rapid adoption of Cloud-based applications and the increasing value of the data sets in those applications, you can see a lot of room for future growth.

Which bridges me to my final point. We are really impressed with CloudAlly's born in the Cloud architecture. They've assembled a world-class technology team that has built products based on scalability, channel first, ease of use and data residency; all attributes that integrate very well with our strategy for Secure Cloud. Cloud backup and recovery is a critical component of a secure modern workplace.

And adding Cloud backup and recovery, will further improve our position with our partners as we work with them to capitalize on the digital transformation, our joint end customers require in our increasingly work from anywhere world. We are really excited to add the CloudAlly team to the Zix Corporate family. Speaking of new team members, I'm also pleased to announce our new Chief Product Officer, Ryan Allphin. As we think about our long-term growth, we see our Secure Cloud delivering value to partners and customers at the platform level, at the application level and through intelligence and data gathered from the vast amounts of information we will be processing.

Achieving this vision will require a product leader that can bring together product development and product management into a seamless organization with a shared technology strategy and product strategy. Ryan's most applicable experiences come from his 14 years at McAfee. At McAfee, Ryan held engineering leadership positions across a wide range of security products before progressing to become the General Manager of McAfee's Security Management Business Unit. Under Ryan's leadership, McAfee achieved the top Gartner Magic Quadrant rating for their endpoint security business.

He led several acquisition integrations, earned experienced building Cloud platforms and big data analytics projects. All experiences we expect to leverage as we continue to grow and scale our business at Zix. Digital transformation initiatives are continuing to proliferate, and we are well positioned to capitalize on a new work from anywhere world. With CloudAlly, Zix is even better positioned for profitable growth, higher attach rates and the opportunity to capture an even greater share of the multibillion-dollar business communications market.

That concludes our prepared remarks. Operator, we're ready to open the call for questions.

Questions & Answers:


[Operator instructions.] Now our first question will come from Chad Bennett from Craig-Hallum. Your line is open.

Chad Bennett -- Craig-Hallum Capital Group -- Analyst

Great. Thanks for taking my questions. Nice job on the quarter, guys. So I was just hopping between calls and I looked at the M&A press release, and I didn't see an actual purchase price associated with CloudAlly.

Did you offer that up on the call?

Dave Rockvam -- Chief Financial Officer

No. It's approximately $30 million on the purchase price.

Chad Bennett -- Craig-Hallum Capital Group -- Analyst

OK. And just, I guess, in terms of thinking about that business, guys, I mean the -- you're correct. The Cloud backup market is a very exciting market. And for sure, complementary to what you do.

And you indicated that based on your survey results, you believe some demand -- or significant demand is there just in the base. But I guess it's also just my experience there. It's a pretty competitive space. And I think you guys are somewhat used to that.

But just can you talk about the competitive landscape there real quick that at least you're familiar with today?

Dave Wagner -- Chief Executive Officer

Yes. So I think you're right. It is competitive. Of course, there are vendors who have been around a long time and have the good part of having the on-prem side of backup, which creates challenges on the Cloud backup.

So we're really, really pleased that we were very intentional about Cloud-to-Cloud backup. This is a pure, born in the Cloud, always in the Cloud backup platform. So we think that we're really, really well positioned, as we said in the press release, to handle Cloud-based workloads. That's where the growth is.

And we think by zeroing in on an asset that was focused on the Cloud backup, that's really going to help us out a lot. The second thing, if you remember, back to the strategy around the AppRiver acquisition just under two years ago, we recognize that the move to Cloud starts with Office 365 and grabbing those customers, the partners as they lead end customers from on-prem to the Cloud. That's the point at which that resiliency message, the importance of being secure and compliant. That's where that method resonates.

And so we think that we really are going to differentiate with where we sit in the partner ecosystem, as the productivity provider of choice is one of the largest CSP's in the country increasingly in the world. We think that's going to be a really nice competitive positioning as well. And then we love the idea of, as you pointed out, it's not just Office 365. Office 365 is about half the Cloud backup market today.

But these data sets in Salesforce in Box and Dropbox are increasingly getting high-value employee data in those workloads and being able to restore that data back to [court's] point in time. Makes an organization much more secure, much more productive, and we really think it's a great new customer and attach opportunity for us.

Chad Bennett -- Craig-Hallum Capital Group -- Analyst

Great. No, great color. And then maybe one follow-up for me. Just on Secure Cloud.

I mean the attach rates or kind of penetration rates continue to be very strong, even on the Zix core business are going up quite a bit sequentially. I guess when will we -- I know it's an interesting times and difficult environment. But when do we think that, that kind of moves the needle on net retention or net expansion, so to speak, because obviously, the product attach rates, you gave the metrics go up when you can get someone on Secure Cloud. Do you think we're close to being able to talk about, again, in a somewhat normalized environment, net retention kind of north of 100%?

Dave Wagner -- Chief Executive Officer

Yes. That's certainly the goal. And we think we will get back there as the economy recovers as our attach opportunities improve, I did give the October number, which is just a very small hair under 100 at this point. So things have remained really strong and steady since June for us, and we do expect things to expand as the economy expands, hopefully, in next year.

Great. Nice job on the quarter guys.


[Operator instructions.] The next question is from Andrew King from Colliers Securities.

Andrew King -- Colliers Securities -- Analyst

So if you could just give us a little bit more color into the linearity of the quarter. And if you've seen any of the customers that originally took seats away from their deployment due to weighing staff offices onset of COVID. Have you seen any of them come back either start to add services back or add more seats as they start to add back personnel?

Dave Wagner -- Chief Executive Officer

Yes. That's a great question. And we were really clear about that between Q2, I guess, in early Q3. And that's what we saw that brought us from 96% back to the over 99% in Q3, and those metrics, and that pace have stayed really, really steady through October.

So we're seeing a really steady, good environment, not like the environment we were in Q4 last year, but we see a real steady environment. Of course, that's on our monthly renewal customers. On the annual renewal customers, the COVID impacts we're still doing renewals on annual renewal customers who may have smaller workforces now than they did at their last renewal, and those will continue to work their way through the cycle between now and the March/April timeframe. That's a little less than 40% of our ARR.

So we feel that we're seeing the recovery in the monthly billing customers really consistently balanced by the annual renewal customers, who are still adjusting a little bit as we work them through the ARR renewal process.

Andrew King -- Colliers Securities -- Analyst

Great. And then just looking at the acquisition, can you give us an idea of the breakout of their revenues? How much of that's derived from Microsoft O365 versus other platforms and how that's broken out geography wise?

Dave Wagner -- Chief Executive Officer

Yes, they've done a really nice job, of course, getting into the Cloud backup market between really early and early and have done a nice job of covering the core applications. And Office 365 has been the lion's share of their backup market. They have nice customers and nice amounts of customers on each of those platforms I discussed, but I'd say it's almost 80% Office 365 in their partner customer base.

Dave Rockvam -- Chief Financial Officer

And then on a geography basis, they're not quite 50% U.S. and then over 50% rest of world. So they have a nice international component as well.


[Operator instructions.] Our next question is from Nehal Chokshi from Northland. Please proceed.

Nehal Chokshi -- Northcoast Securities Inc. -- Analyst

Yes. Thanks and congrats on a strong quarter, especially the free cash flow, well above our estimate. So for the December quarter, excluding the $1 million from CloudAlly, the midpoint revenue guidance is up 2% Q2, which is stronger than the guidance that you provided for September quarter of up 1% Q2. Dave Wagner, I think you've already alluded to this, but I just want to verify that.

Does this mean that you guys are seeing an improving environment? And if so, what are the indicators are giving you this incremental confidence relative to a quarter ago?

Dave Rockvam -- Chief Financial Officer

Yes. I'll also going to piggyback on Andrew's question about linearity, right? We talked about in -- on the July or the June quarter earnings call that we had a very strong record trials in June and a strong July, which was our second highest. So we were able to tell you on the call that we felt good about things, right, in 4Q, Q3, because of those trials, we saw that revenue come in or start to come in, in July, then having that strong July, made a good August. So we continued to see strength in the quarter, right? So when we see that -- saw that building, August would have been a little -- wouldn't have been as high as high of a month of trials because of vacations across Europe and the U.S., specifically.

But then September came back nicely, and that will change into revenue in October. So as far as the quarter goes, we saw good momentum and traction throughout Q3, which allowed us to a little bit stronger guidance and feel for Q4. And then adding on top, the $1 million from CloudAlly pushes us over-the-top end of what we said. So I think we were at $2.10 to $2.17 in April when we guided and brought that up just a little last quarter and then this quarter, with the results we saw in Q3, able to bring it up the rest of the way to get to the top end of that revenue range.

Nehal Chokshi -- Northcoast Securities Inc. -- Analyst

OK. Great. And then I want to drill a little bit more into these trials, especially the AppRiver customers that are trialing the Zix Security IP. What's the typical characteristics of the companies that are trialing the Zix Security IP that are already an approval customer?

Dave Wagner -- Chief Executive Officer

Yes. So the average customer size is right around 25 mailboxes. So these, on average, are smaller customers. Of course, the IP set, especially encryption archive, tend to work better at the larger end customer size.

So when you get into the Zix IP, they tend to be slightly larger. But we're still talking, Nehal, on the AppRiver platform averages in the 20% to 30% range and not larger customers. I mean, AppRiver does have some large customers. We have partners who work up into the thousands of users, but a lot of small businesses, over 75,000 small businesses, all over the country and increasingly in the U.K.

are that customer base that tend to be on the smaller side.

Nehal Chokshi -- Northcoast Securities Inc. -- Analyst

And these customers that are on the smaller side, did they already have an existing secure email gateway provider?

Dave Wagner -- Chief Executive Officer

So we're garnering end customers, lots of different ways. A lot of times, we recruit a new partner, the new partner, that will be a great opportunity for us to make sure that they're positioning additional security and compliance products as they come across. And so we collect customers there. We gather new customers from the exchange to Office 365 motion, and so we attach there as well.

The attach rates, we would like to be higher, so that we're still, as Dave said, we're in the 1.1 total, probably 1.2 in on the AppRiver Secure Cloud side. So we need those to grow higher, and we're getting them higher literally every month, but they're inching higher as opposed to racing higher, and I'm really happy with the trend and the trajectory, and we're staying on it, particularly being successful with the newer customers and the newer partners coming on to the ecosystem.

Nehal Chokshi -- Northcoast Securities Inc. -- Analyst

All right. Thank you.


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

Dave Wagner -- Chief Executive Officer

Well, thank you all very much for taking the time to join us for our Q3 earnings call and a very exciting announcement of the extension of the company into Cloud backup and recover with CloudAlly. We look forward to speaking with you all early in 2021.


[Operator signoff]

Duration: 46 minutes

Call participants:

Geoff Bibby -- Vice President of Marketing

Dave Wagner -- Chief Executive Officer

Dave Rockvam -- Chief Financial Officer

Chad Bennett -- Craig-Hallum Capital Group -- Analyst

Andrew King -- Colliers Securities -- Analyst

Nehal Chokshi -- Northcoast Securities Inc. -- Analyst

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