Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
ZIXI > SEC Filings for ZIXI > Form 10-K on 13-Mar-2013All Recent SEC Filings

Show all filings for ZIX CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-K for ZIX CORP


13-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The following discussion and analysis contains forward-looking statements about trends, uncertainties and our plans and expectations of what may happen in the future. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from the events or results described in the forward-looking statements, including risks and uncertainties described above in "Item 1A. Risk Factors." Readers are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements are based upon information available to us on the date of this report. We undertake no obligation to publicly update or revise any forward-looking statements.

Overview

We are a leader in providing secure email encryption in a SaaS model. Our email encryption service delivers information in a secure manner, enabling the use of Internet-based email for the safe delivery of sensitive information, especially for customers in the healthcare, finance, insurance, and government sectors. A core competency is our ability to deliver this complex service offering with a high level of availability, reliability, integrity and security.

We are encouraged by 2012 results and attribute our success to continuing efforts to build a solid and predictable business based on our successful recurring revenue subscription business model. Additionally, our results indicate that we are transitioning to become a part of mainstream demand for email encryption as data security and integrity issues continue to make headline news. We are also benefiting from a trend toward the use of powerful cloud-based offerings along with the growing need for regulatory compliance.

For 2012, we reported record revenue driven by continued growth in our Email Encryption business. The Company's operating income for 2012 was $8.9 million, a decrease of $1.6 million over prior year, resulting from 14% growth in revenue that was offset by increased SG&A spending and additional investments in R&D.


Table of Contents

Our net income in 2012 included a tax benefit of $2.3 million resulting from a decrease in the our deferred tax valuation allowance. The overall decrease to our valuation allowance was $5.2 million, of which $2.9 million was due to operations and offset current tax expense. The remaining $2.3 million was due to a partial reversal of the remaining valuation allowance and recorded as tax benefit. This compares to a decrease in our deferred tax asset valuation and resulting tax benefit of $11.8 million in 2011. Net income for 2012 and 2011 excluding the impact of this tax benefit was $8.7 million and $10.8 million, respectively.

Strategy and Focus Areas

The Company's email encryption subscription service continued to grow in 2012 by adding new customers while retaining a high percentage of existing customers. Our subscription model initially required large up-front investment to establish the service, but over time, the recurring subscription and transaction fees, and incremental costs to add new users are relatively low and have exceeded the fixed set-up costs.

Over the course of 2012 we continued to make investments to strengthen our Email Encryption services through the development of a number of significant portfolio upgrades. In addition to continuing to invest in growing the strength and efficiency of our core encryption technologies, we added two-factor authentication and message recall capabilities to our base ZixPort feature portfolio.

Operationally, our success is primarily dependent upon the following key metrics:

New subscriptions (termed "New First Year Orders" ("NFYO") for the Email Encryption Service;

Retention of subscribers to the Email Encryption Service;

Total orders (includes NFYO's, second and third years on multi-year orders and renewals), and;

Our ability to increase business volume with minimal cost increases.

Known trends regarding these key metrics and their implication on our current and future capital requirements are discussed throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A").

There are no assurances we will be successful in our efforts to achieve these key metrics. Our continued growth depends on the timely development and market acceptance of our products and services. See "Item 1A. Risk Factors" for more information on the risks relative to our operations and future prospects.

Discontinued Operations

On December 31, 2010, Zix Corporation completed the previously announced wind down of its e-Prescribing business and discontinued operating this line of business. This business had previously been reported as a segment. The wind down of this business entailed the fulfillment of existing contracts. Assets used by this segment, primarily business computer servers, were compatible with the remaining business, Email Encryption, and were therefore absorbed by our remaining business. As a result, no gain or loss on disposal of assets was incurred. Prior to the completion of the wind down, this business line had been a reportable segment. The following table summarizes the components of the Income from discontinued operations presented in our Statement of Operations for 2010. There was no activity relating to e-Prescribing in 2012 or 2011.

              (In thousands)                                  2010
              Revenues                                       $ 2,632
              Cost of revenues                                 1,266

              Gross margin                                     1,366
              Research and development expenses                  300
              Selling, general and administrative expenses       304

              Income before income taxes                     $   762

Unless specifically noted, the financial information contained and discussed in our MD&A is that of our continuing operations only.


Table of Contents

Revenue

Revenue increased by 14% in 2012 compared with 2011. Our revenue growth was driven by our successful subscription model that continues to yield steady additions to the subscriber base coupled with a high rate of renewing existing customers.

Operating Margins

For the year ended December 31, 2012, our gross profit of $35.7 million increased 16% compared to 2011. This increase was primarily driven by increased revenue. Our 2012 operating income of $8.9 million decreased $1.6 million over the prior year, primarily due to increased R&D and SG&A expenses. Net income for 2012 included a tax benefit of $2.3 million resulting from a decrease in our deferred tax asset valuation allowance. The overall decrease to our valuation allowance was $5.2 million, of which $2.9 million was due to 2012 operations and offset current tax expense. The remaining $2.3 million was due to a partial reversal of the remaining valuation allowance and recorded as a tax benefit in 2012. Net income for 2011 included an $11.8 million reduction to the Company's deferred tax asset valuation allowance, also recorded as a tax benefit in 2011. Net income for 2012 and 2011 excluding the impact of this tax benefit was $8.7 million and $10.8 million, respectively.

Other Financial Highlights

Backlog was $57.7 million at the end of 2012, compared with $53.7 million at the end of 2011

Total orders for 2012 were $48.2 million, an increase of 14% from the 2011 total orders of $42.3 million

Our deferred revenue at the end of 2012 was $18.4 million, compared with $17.4 million at the end of 2011

We generated cash flows from operations of $12.5 million during fiscal 2012. Our cash and cash equivalents were $23.0 million at the end of 2012, compared with $20.7 million at the end of 2011.

Our shared, cloud-based ZixDirectory now has approximately 35 million members including some of the most respected institutions in the country

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements, we make estimates, assumptions and judgments that can have a significant impact on revenue, income from operations and net income, as well as the value of certain assets and liabilities on our consolidated balance sheet. The application of our critical accounting policies requires an evaluation of a number of complex criteria and significant accounting judgments by us. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We evaluate our estimates on a regular basis and make changes accordingly. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Actual results may materially differ from these estimates under different assumptions or conditions. If actual results were to differ from these estimates materially, the resulting changes could have a material adverse effect on our consolidated financial statements.

We consider accounting policies to be critical when they require us to make assumptions about matters that are highly uncertain at the time the accounting estimate is made and when different estimates that our management reasonably has used have a material effect on the presentation of our financial condition, changes in financial condition or results of operations. Management believes the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of the consolidated financial statements.

Our critical accounting policies included the following:

Revenue recognition

Income taxes

Valuation of goodwill and other intangible assets

Stock-based compensation costs


Table of Contents

For additional discussion of the Company's significant accounting policies, refer to Note 2 to our consolidated financial statements.

Revenue Recognition

We develop, market, and support applications that connect, protect and deliver information in a secure manner. Our services can be placed into several key revenue categories where each category has similar revenue recognition traits:
Email Encryption subscription-based services, various transaction fees and related professional services. The majority of our revenues generated are through a combination of direct sales and a network of resellers and other distribution partners.

Under all product categories and distribution models, we recognize revenue after all of the following occur:

persuasive evidence of an arrangement exists,

delivery has occurred or services have been rendered,

the price is fixed and determinable, and

collectability is reasonably assured.

When we are engaged in a complex product deployment, customer acceptance may have to occur before the transaction is considered complete. In this situation, no revenue is recognized until the customer accepts the product. Discounts provided to customers are recorded as reductions in revenue.

Our Email Encryption Service is a subscription service. Providing this service includes delivering subscribed-for software and providing secure electronic communications and customer support throughout the subscription period. Our email subscribers generally execute multiple-year contracts that are irrevocable and non-refundable in nature and require annual, up-front payments. Subscription fees received from customers are initially recorded as deferred revenue and then recognized as revenue ratably over the subscription period. We do not offer stand alone services. Further, our services primarily include manufacturer provided warranty provisions. We recorded no warranty expense in any of the presented periods.

Income Taxes

Deferred tax assets are recognized if it is "more likely than not" that the benefit of the deferred tax asset will be realized on future federal or state income tax returns. At December 31, 2012, we provided a valuation allowance against a significant portion, $50.2 million, of our accumulated U.S. deferred tax assets. This significant valuation allowance reflects our historical losses and the uncertainty of future taxable income sufficient to utilize net operating loss carryforwards prior to their expiration. Our total deferred tax asset not subject to a valuation allowance is valued at $52.7 million, and consists of $43.9 million for federal net operating loss carryforwards, $5.6 million relating to temporary timing differences between GAAP and tax-related expense, $2.2 million relating to U.S. state income tax credits, and $1 million related to Alternative Minimum Tax credits. If U.S. taxable income increases from its current level in a future period or if the facts and circumstances on which our estimates and assumptions are based were to change, thereby impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied in determining the amount of valuation allowance no longer required. Reversal of all or a part of this valuation allowance could have a significant positive impact on operating results in the period that it becomes more likely than not that certain of the Company's deferred tax assets will be realized. Alternatively, should our future income decrease from current levels, a resulting increase to all or a part of this valuation allowance could also have a significant negative impact on our operating results.

The Company previously recorded a $327 thousand tax contingency liability related to tax year 2004, and that amount and the specifics therein have remained unchanged except for currency translation adjustments. As of December 31, 2010, the gross amount of our unrecognized tax benefits, inclusive of the $327 thousand tax liability and $50 thousand in other uncertain positions in 2008, was approximately $461 thousand. Because the statute of limitations expired on the returns associated with these uncertain positions, this contingency was reversed in 2011, creating a positive impact on our operating results.


Table of Contents

Valuation of Goodwill and Other Intangible Assets

We account for the valuation of goodwill and other intangible assets after classifying intangible assets into three categories: (1) intangible assets with finite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with finite lives, tests for impairment must be performed if conditions exist that indicate that the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually or more frequently if events or circumstances indicate that assets might be impaired.

Goodwill was $2.2 million, or 3% of total assets for the years ended December 31, 2011 and 2012, respectively.

Our goodwill is not being amortized, but we do evaluate the goodwill for impairment annually in the fourth quarter, or when there is reason to believe that the value has been diminished or impaired. Evaluations for possible impairment are based upon a comparison of the estimated fair value of the reporting unit to which the goodwill has been assigned to, versus the sum of the carrying value of the assets and liabilities of that unit including the assigned goodwill value. The fair values used in this evaluation are estimated based on the Company's market capitalization, which is based on the outstanding stock and market price of the stock. Impairment is deemed to exist if the net book value of the unit exceeds its estimated fair value. We have evaluated our goodwill and determined no impairment is required.

Stock-based Compensation

We have non-qualified stock options outstanding to employees, directors, and third parties under various stock option plans. The plans require the exercise price of options granted under these plans to equal or exceed the fair market value of the Company's common stock on the date of grant. The options, subject to termination of employment, generally expire ten years from the date of grant. Employee options typically vest pro-rata and quarterly over three years. Option grants to employees, officers and directors frequently contain accelerated vesting provisions upon the occurrence of a change of control, as defined in the applicable option agreements. We use the straight-line amortization method for recognizing stock option compensation costs. Our share-based awards include stock options, restricted stock and restricted stock units ("RSU's"). The weighted average grant-date fair value of awards of restricted stock and RSU's is based on quoted market price of the Company's common stock on the date of grant.

Full Year 2012 Summary of Operations

Financial

Revenue for 2012 was $43.4 million compared with $38.1 million in 2011 and $33.1 million in 2010.

Gross margin for 2012 was $35.7 million or 82% of revenues compared to $30.9 million or 81% of revenues in 2011 and $26.6 million or 80% of revenues in 2010.

Income from continuing operations for the year 2012 was $11.0 million compared with income from continuing operations of $22.6 million in 2011 and $40.7 million in 2010.

Net income for the year 2012 was $11.0 million compared with net income of $22.6 million in 2011 and net income of $41.2 million in 2010. Net income for 2012 included a tax benefit of $2.3 million resulting from a decrease in our deferred tax valuation allowance. The overall decrease to our valuation allowance was $5.2 million, of which $2.9 million was due to operations and offset current tax expense. The remaining $2.3 million was due to a partial reversal of the remaining valuation allowance and was recorded as a tax benefit. The tax benefit recorded on the reduction of our deferred tax valuation allowance in 2011 and 2010 was $11.8 million and $35.3 million, respectively.

Unrestricted cash was $23.0 million on December 31, 2012.


Table of Contents

Results of Operations

Revenue

The following table sets forth a year-over-year comparison of our total
revenues:



                                                                Variance                Variance
                         Year Ended December 31,             2012 vs. 2011           2011 vs. 2010
   (In thousands)     2012         2011         2010           $          %            $          %
   Revenues         $ 43,356     $ 38,145     $ 33,066     $   5,211       14 %    $   5,079       15 %

Our growth model seeks to continually add new users to the subscriber base, while at the same time retaining a high percentage of existing subscribers whose subscriptions are up for renewal. Across all periods presented, revenue increases were driven primarily by strong performances in our three core vertical sales markets: healthcare, finance and government and other non-core markets. Additionally, sales continued from a wide base of distributors - new first year orders derived from our value-added resellers, OEM and third party distribution channels for 2012 was 63% of the total NFYOs compared to 52% in 2011 and 53% in 2010. We measure additions to the subscriber base by NFYO, which is defined as the portion of new orders that are expected to be recognized into revenue in the first twelve months of the contract. NFYOs are summarized in the table below:

Year Ended December 31, (In thousands) 2012 2011 2010 New first year order value $ 8,993 $ 7,081 $ 8,670

Our go-to-market selling strategy seeks primarily 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. We expect this preference for a longer contract term by a high percentage of our customers to continue in 2013, as we have priced our services in a manner that encourages longer-term contractual commitments from customers.

Our list pricing has remained generally consistent during the periods shown above. We have continued to experience some market pricing pressure resulting in additional discount percentages off our list price during this period. There are no assurances that potential increased competition in this market or other factors will not result in future price erosion. Price erosion, should it occur, could have a dampening effect on the revenue derived from our new orders.

Revenue Outlook:

With our continued focus on sectors such as healthcare, financial services, insurance, government, and expansion into other non-core markets, along with the increased use of indirect OEM distribution and value-added reseller channels, we expect to increase our new first year orders in 2013 and fuel a continued increase in our year-over-year revenue.

Backlog and Orders

Backlog - Our order backlog was $57.7 million at December 31, 2012 compared to $53.7 million at the end of 2011. The backlog is comprised of contractually bound agreements that we expect to amortize into revenue. As of December 31, 2012, the backlog was comprised of the following elements: $18.4 million of deferred revenue that has been billed and paid, $5.7 million billed but unpaid, and approximately $33.6 million of unbilled contracts.

The backlog is recognized into revenue ratably as the services are performed. Approximately 57% of the total backlog is expected to be recognized as revenue during the next twelve months.

Orders - Total orders in 2012 were $48.2 million compared with $42.3 million in 2011. Total orders are comprised of contract renewals, NFYOs, and in the case of new multi-year contracts, the years beyond the first year of service.


Table of Contents

Cost of Revenues

The following table sets forth a year-over-year comparison of the cost of
revenues.



                                                               Variance                 Variance
                         Year Ended December 31,            2012 vs.  2011           2011 vs.  2010
  (In thousands)       2012        2011        2010           $            %          $            %
  Cost of revenues   $  7,609     $ 7,211     $ 6,468     $     398         6 %    $    743         11 %

Cost of revenues is comprised of costs related to operating and maintaining the ZixData Center, a field deployment team, customer service and support and the amortization of Company-owned, customer-based computer appliances. A significant portion of the total cost of revenues relates to the ZixData Center, which currently has excess capacity. Accordingly, cost of revenues is relatively fixed and is therefore expected to grow at a slower pace than revenue. The 6% increase in 2012 compared to 2011 resulted primarily from increases in average headcount.

The increase in 2011 of $743 thousand resulted primarily from shifting shared and fixed costs previously absorbed by the e-Prescribing product line. Personnel and other costs remained relatively flat year over year. During 2010, we wound down the operations of our e-Prescribing product line and transitioned a significant amount of shared resource costs from e-Prescribing to Email Encryption. Additionally, we shifted fixed costs that were previously absorbed by e-Prescribing to our Email Encryption business.

Research and Development Expenses

The following table sets forth a year-over-year comparison of our research and
development expenses from continuing operations:



                                                                                    Variance                Variance
                                              Year Ended December 31,            2012 vs. 2011           2011 vs.  2010
(In thousands)                              2012        2011        2010           $          %            $            %
Research and development expenses         $  7,419     $ 5,229     $ 5,089     $   2,190       42 %    $     140         3 %

Research and development expenses consist primarily of salary, benefits and stock-based compensation for our development staff, and other costs associated with improving our existing products and services and developing new products and services. The 42% increase in expenses in 2012 compared to 2011 resulted from additional headcount added in 2012 primarily related to new product development.

The increase in these expenses in 2011 compared to 2010 resulted primarily from approximately $300 thousand in costs associated with shifting resources from e-Prescribing to Email Encryption. These costs were partially offset by lower stock-based compensation expense of $115 thousand and other small reductions across various research and development expenses. During 2010 we wound down the e-Prescribing operation and shifted previously shared resources and the related expenses to the remaining business, Email Encryption. Additionally, we shifted fixed expenses previously absorbed by e-Prescribing to Email Encryption.

Selling and Marketing Expenses

The following table sets forth a year-over-year comparison of our selling and marketing expenses from continuing operations:

Variance Variance Year Ended December 31, 2012 vs. 2011 2011 vs. 2010 (In thousands) 2012 2011 2010 $ % $ % Selling and marketing expenses $ 10,984 $ 9,196 $ 9,925 $ 1,788 19 % $ (729 ) (7% )

Selling and marketing expenses consist primarily of salary, commissions, travel, stock-based compensation and employee benefits for selling and marketing personnel as well as costs associated with promotional activities and advertising. The 19% increase in 2012 compared to 2011 resulted primarily from higher sales commissions and bonuses resulting primarily from higher NFYOs and increase in average headcount ($1.0 million). We also acquired new sales and marketing tools and invested in marketing and advertising programs ($0.5 million). Stock-based compensation expense also increased by $0.2 million year-over-year. The remaining variance consisted of relatively minor increase across various selling and marketing activities none of which were significant.


Table of Contents

The decrease in 2011 compared to 2010 resulted primarily from lower commissions and bonuses on lower NFYOs ($1.2 million). This reduction was partially offset by the shift of shared and fixed costs in 2011 previously allocated the discontinued e-Prescribing product line.

General and Administrative Expenses

The following table sets forth a year-over-year comparison of our general and . . .

  Add ZIXI to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for ZIXI - All Recent SEC Filings
Sign Up for a Free Trial to the NEW EDGAR Online Pro
Detailed SEC, Financial, Ownership and Offering Data on over 12,000 U.S. Public Companies.
Actionable and easy-to-use with searching, alerting, downloading and more.
Request a Trial Sign Up Now


Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.