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ZIXI > SEC Filings for ZIXI > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for ZIX CORP

Form 10-Q for ZIX CORP


7-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS

Statements in this report which are not purely historical facts or which necessarily depend upon future events, including statements about trends, uncertainties, hopes, beliefs, anticipations, expectations, plans, intentions or strategies for the future, may be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. 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 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Any of these risk factors could have a material adverse effect on our business, financial condition or financial results and reduce the value of an investment in our securities. We may not succeed in addressing these and other risks associated with an investment in our securities, with our business and with our achieving any forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements. All forward-looking statements are based upon information available to us on the date the statements are made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.


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Overview

ZixCorp® offers email encryption, data loss prevention ("DLP"), and Bring-Your-Own-Device ("BYOD") security to meet business data protection and compliance needs. We primarily serve organizations in the healthcare, financial services, insurance and government sectors, including significant federal financial regulators-such as those on the Federal Financial Institutions Examination Council (FFIEC), divisions of the U.S. Treasury, the U.S. Securities and Exchange Commission (SEC), the Financial Industry Regulatory Agency (FINRA)-one in every five U.S. banks, more than 30 Blue Cross Blue Shield organizations and one in every five U.S. hospitals.

Zix® Email Encryption enables the secure exchange of email that includes sensitive information through a comprehensive secure messaging service, which allows an enterprise to use policy-driven rules to determine which email messages should be sent securely to comply with regulations or company-defined policies. It is a Software-as-a-Service ("SAAS") solution, for which customers pay an annual service subscription fee.

ZixCorp's main differentiation in the marketplace is our exceptional ease of use. The best example of this is our ability to provide transparent delivery of secure, encrypted email. Most email encryption solutions are focused on the sender. They typically introduce an added burden on receivers, often requiring additional user authentication with creation of a new user identity and password. We designed our solution to alleviate the receiver's burden by enabling the delivery of encrypted email automatically and transparently. ZixCorp enables transparent delivery by (1) ZixDirectory®, the world's largest email encryption community which is designed to share identities of our tens of millions of members (growing by approximately 100,000 members per week),
(2) ZixCorp's Best Method of Delivery®, which is designed to deliver email according to the sender's encryption policy, and (3) ZixGateway®, which is an enterprise gateway that automatically decrypts the message. The result is the industry's only transparent encrypted email, such that secure email can be exchanged without extra steps or passwords for both sender and receiver.

In March 2013 the Company launched ZixDLP®, an email-specific data loss prevention ("DLP") solution. By focusing strictly on email, ZixDLP addresses business's greatest source of data loss - corporate email. The straightforward DLP approach that decreases the complexity and cost often associated with other DLP solutions. ZixDLP is designed to reduce deployment time from months to hours and to minimize impact on customer resources and workflow. In addition, ZixDLP offers a convenient experience for both employees interacting with the solution and administrators managing the system.

Leveraging the Company's leadership and expertise in email encryption, ZixDLP uses ZixCorp's proven policy and content scanning capabilities with new quarantine functionality. The quarantine system and its intuitive interface allow administrators to (1) easily define policies and create custom lexicons for quarantining email messages, (2) conveniently manage quarantined messages using flexible searching and filtering options, (3) release or delete individual or multiple quarantined messages with one click, (4) review reports that monitor quarantine activities and trends and (5) automate custom notifications informing employees of quarantined messages.

ZixDLP is available as an add-on for existing ZixCorp customers or as a bundle with ZixCorp Email Encryption for new customers. ZixDLP is also available as a standalone solution that can easily integrate with most email systems and email encryption solutions.

In April 2014, we introduced a subset of our DLP solution, ZixDLP Insight, that provides visibility into the content of all outbound email and related attachments but does not block or quarantine any email. ZixDLP Insight gives customers a better understanding of what data is leaving their organization in their outbound email, and it enables customers to assess the data risks in their email and how quarantine capabilities could be implemented to mitigate these risks, prior to deploying the full DLP solution. ZixDLP Insight can be used as a standalone solution or as an ideal add-on for Zix Email Encryption customers who need increased visibility into the policies that are triggering encrypted email.

On September 3, 2013, ZixCorp launched ZixOne®, a unique mobile email app that solves the key IT challenge created by the BYOD trend in the workplace. BYOD describes the increasing trend of employees using their personal devices to conduct work. ZixOne provides access to corporate email while never allowing that data to be persistently stored on the device where it is vulnerable to loss or theft. If the device is lost or stolen, an administrator can simply disable access to corporate email from that device through ZixOne.

Unlike other BYOD solutions, ZixOne meets employee demands of convenience, control and privacy while giving companies the ability to secure corporate data and meet compliance needs. With seamless access to work email in a secure, simple-to-use environment, employees can stay productive while preserving device independence. A BYOD solution that is acceptable to employees and yet provides strong data protection for corporate data solves one of today's greatest IT management challenges.


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Our business operations and service offerings are supported by the ZixData Center™, a SysTrust/SOC3 certified, SOC2 accredited, PCI, DSS V2.0 certified facility. The operations of the ZixData Center are independently audited annually to maintain AICPA SysTrust/SOC3 certification in the areas of security, confidentiality, integrity and availability. Auditors also produce a SOC2 (formerly SAS70 Type II) report on the effectiveness of operational controls used over the audit period. The ZixData Center is staffed 24 hours a day with a track record that exceeds 99.99% availability.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in accordance with accounting principles generally accepted in the United States requires the Company's management to make estimates and assumptions that affect the amounts reported in the Company's condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of the Company's financial condition and results and require management's most subjective judgments.

We describe our significant accounting policies in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2013. We discuss our Critical Accounting Policies and Estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2013.

Results of Operations

Second Quarter 2014 Summary of Operations

Financial

• Revenue for the quarter ended June 30, 2014, was $12.6 million compared with $11.8 million for the same period in 2013, representing a 7% increase.

• Gross margin for the quarter ended June 30, 2014, was $10.6 million or 84% of revenues compared with $9.9 million or 84% of revenues for the comparable period in 2013.

• Net income for the quarter ended June 30, 2014, was $1.0 million compared with net income of $1.9 million in the comparable period in 2013.

• Ending cash and cash equivalents were $26.2 million on June 30, 2014, compared with $27.5 million on December 31, 2013.

Operations

• New first year orders ("NFYOs") for the quarter ended June 30, 2014, were $2.4 million. As of June 30, 2014, backlog was $68.4 million.

Revenues

Our Company provides subscription-based services. The following table sets forth
the quarter-over-quarter and six month comparisons of the Company's revenues:



                                                                                      3-month Variance                                                 6-month Variance
                                                Three Months Ended June 30,             2014 vs. 2013              Six Months Ended June 30,             2014 vs. 2013
(in thousands)                                   2014                 2013              $             %            2014                2013               $             %
Revenues                                    $       12,615       $       11,838     $     777           7 %    $      24,777       $      23,602     $     1,175         5 %

The increase in revenue was due to the growth inherent in a successful subscription model with steady additions to the subscriber base coupled with a high rate of existing customer renewals.

Revenue Indicators-Backlog, Orders and Deployments

Backlog-Our end-user order backlog is comprised of contractually bound agreements that we expect to amortize into revenue as the services are performed. The timing of revenue is affected by both the length of time required to deploy a service and the length of the service contract.


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As of June 30, 2014, total backlog was $68.4 million and we expect approximately 55% of the total backlog to be recognized as revenue during the next twelve months. As of June 30, 2014, the backlog was comprised of the following elements: $20.4 million of deferred revenue that has been billed and paid, $7.1 million billed but unpaid, and approximately $40.9 million of unbilled contracts. The second quarter ending backlog was an 8% increase over the $63.4 million backlog at the end of the second quarter 2013 and 4% above the ending backlog of $65.7 million at December 31, 2013.

Orders-Total orders were $15.7 million and $15.6 million for the three-month periods ended June 30, 2014 and 2013, respectively. Total orders include contract renewals, NFYOs, and in the case of new multi-year contracts, the years beyond the first year of service. NFYOs were $2.4 million and $2.4 million for the three-month period ended June 30, 2014 and 2013, respectively.

Cost of Revenues

The following table sets forth the quarter-over-quarter and six month
comparisons of the cost of revenues:



                                                                                 3-month Variance                                               6-month Variance
                                            Three Months Ended June 30,            2014 vs. 2013             Six Months Ended June 30,            2014 vs. 2013
(in thousands)                               2014                2013              $             %            2014               2013             $             %
Cost of revenues                         $       2,032       $       1,903     $     129           7 %    $      4,057       $      3,839     $     218           6 %

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 three and six month variances reflected in the table above resulted primarily from increases in average headcount and depreciation expense relating to investments in ZixOne networking equipment.

Research and Development Expenses

The following table sets forth the quarter-over-quarter and six month comparisons of our research and development expenses:

3-month Variance 6-month Variance Three Months Ended June 30, 2014 vs. 2013 Six Months Ended June 30, 2014 vs. 2013 (in thousands) 2014 2013 $ % 2014 2013 $ % Research and development expenses $ 2,218 $ 2,488 $ (270 ) (11 )% $ 4,419 $ 5,099 $ (680 ) (13 )%

Research and development expenses consist primarily of salary, benefits, and stock-based compensation for our development staff, independent development contractor expenses, and other direct and indirect costs associated with enhancing our existing products and services and developing new products and services. The three and six month decreases reflected in the table above resulted primarily from reduction in contractor headcount, partially offset by increases related to hiring research and development personnel.


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Selling and Marketing Expenses

The following table sets forth the quarter-over-quarter and six month
comparisons of our selling and marketing expenses:



                                                                                   3-month Variance                                               6-month Variance
                                              Three Months Ended June 30,            2014 vs. 2013             Six Months Ended June 30,            2014 vs. 2013
(in thousands)                                 2014                2013               $            %            2014               2013              $            %
Selling and marketing expenses             $       4,713       $       3,640     $     1,073        29 %    $      8,930       $      7,250     $     1,680        23 %

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 29% increase in the second quarter of 2014 compared to the same period in 2013 and the 23% six-month variance resulted primarily from an increase in average headcount and advertising and promotional expense.

General and Administrative Expenses

The following table sets forth the quarter-over-quarter and six month comparisons of our general and administrative expenses:

3-month Variance 6-month Variance Three Months Ended June 30, 2014 vs. 2013 Six Months Ended June 30, 2014 vs. 2013 (in thousands) 2014 2013 $ % 2014 2013 $ % General and administrative expenses $ 2,065 $ 1,892 $ 173 9 % $ 4,137 $ 4,898 $ (761 ) (16 )%

General and administrative expenses consist primarily of salary and bonuses, travel, stock-based compensation and benefits for administrative and executive personnel as well as fees for professional services and other general corporate activities. The 9% increase in the second quarter of 2014 compared to the same period in 2013 resulted primarily from a year-over-year increase in average headcount. The 16% decrease in the six month comparison resulted primarily from lower outside legal counsel fees associated with litigation partially offset by higher average headcount costs.

Provision for Income Taxes

The provision for income taxes was $622 thousand and $108 thousand for the three-month periods ended June 30, 2014 and 2013, respectively, and $1.3 million and $202 thousand for the three-month periods ended June 30, 2014 and 2013 . The operating losses incurred by the Company's U.S. operations in past years and the resulting net operating losses for U.S. Federal tax purposes are subject to a $46 million reserve because of the uncertainty of future taxable income levels sufficient to utilize our net operating losses and credits. Our June 30, 2014, provision of $1.3 million includes $1.1 million in deferred taxes, $104 thousand in state taxes currently payable based on gross revenues, $39 thousand related to the federal Alternative Minimum Tax, and $69 thousand in taxes related to our Canadian operations. Our June 30, 2013, provision of $202 thousand includes $56 thousand in state taxes currently payable based on gross revenues, $59 thousand related to deferred state taxes, $28 thousand related to the federal Alternative Minimum Tax, and $59 thousand in taxes related to our Canadian operations.

There were no penalty-related charges to selling, general and administrative expenses accrued or recognized for the three month periods ended June 30, 2014 and 2013. Additionally, we have not taken a tax position that would have a material effect on the financial statements or the effective tax rate for the three-month period ended June 30, 2014. We are currently subject to a three-year statute of limitations by major tax jurisdictions.

At June 30, 2014, the Company partially reserved its U.S. net deferred tax assets due to the uncertainty of future taxable income sufficient to utilize net loss carryforwards prior to their expiration. The Company did not reserve a portion, $53.0 million, of its U.S. net deferred tax assets. The majority of this unreserved portion related to $44.5 million in U.S. net operating losses ("NOLs") because we believe the Company will generate sufficient taxable income in future years to utilize these NOLs prior to their expiration. The remaining balance consists of $5.5 million relating to temporary differences between GAAP and tax-related expense, $1.9 million relating to U.S. state income tax credits and net operating loss carryovers, and $1.1 million related to Alternative Minimum Tax credits.


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At the end of 2013, the Company recorded a $1.4 million tax benefit by reducing the valuation allowance related to its deferred tax assets. This reduction was determined through an assessment of future deferred tax asset utilization following accounting guidance which relies largely on historical earnings. Using the same methodology, and updating the future taxable earnings estimates based on first and second quarter 2014 actual earnings, the Company believes its future U.S. federal taxable earnings estimate to be established at the end of 2014 may not exceed the estimate used at the end of 2013. For this reason, the Company has recognized its first quarter and second 2014 federal deferred tax provision in full. In contrast, in the first and second quarter 2013, the Company believed that its future U.S. federal taxable estimate established at the end of 2013 would exceed the prior year estimate. Accordingly, the Company offset its federal deferred tax provision by reducing its valuation allowance by an equal amount, thereby eliminating from its deferred tax provision federal taxes in excess of the estimated Alternative Minimum Tax from the Company's first and second quarter 2013 financial statements. The Company will continue to reevaluate the need for its valuation allowance each quarter, following the same assessment methodology described above. Adjusting our valuation allowance could have a significant impact on operating results for each period that it becomes more likely than not that an additional portion of our deferred tax assets will or will not be realized.

We have determined that utilization of existing net operating losses against future taxable income is not currently subject to limitation by Section 382 of the Internal Revenue Code. Future ownership changes, however, may limit the company's ability to fully utilize its existing net operating loss carryforwards against future taxable income.

As indicated earlier, the operating losses incurred by our U.S. operations and the resulting net operating losses for U.S. Federal tax purposes are subject to a partial reserve. Significant judgment is required in determining any reserve recorded against the deferred tax asset. In assessing the need for a reserve, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies.

Net Income

The net income for the three months ended June 30, 2014, of $1.0 million is a decrease of $0.9 million compared to the net income of $1.9 million for the same period last year. Our increased revenue and lower spending were offset primarily by higher selling and marketing and tax expense, as discussed above.

Liquidity and Capital Resources

Overview

Based on our performance over the last four quarters and current expectations, we believe our cash and cash equivalents and cash generated from operations, will satisfy our working capital needs, capital expenditures, investment requirements, contractual obligations, commitments, future customer financings, and other liquidity requirements associated with our operations through at least the next twelve months. We plan for and measure our liquidity and capital resources through an annual budgeting process. At June 30, 2014, our cash and cash equivalents totaled $26.2 million, a decrease of $1.4 million from the December 31, 2013 balance, and we had no debt.

Sources and Uses of Cash Summary



                                                        Six Months Ended June 30,
(In thousands)                                            2014                2013
Net cash provided by operations                       $       5,840         $  3,551
Net cash used in investing activities                 $        (857 )       $   (948 )
Net cash provided by (used in) financing activities   $      (6,341 )       $    717

Our primary source of liquidity from our operations is the collection of revenue in advance from our customers and accounts receivable from our customers, net of the timing of payments to our vendors and service providers.

Our investing activities consist primarily of computer and networking equipment purchases.

Cash used in financing activities in the first two quarters of 2014 include $6.2 million used in completion of the $15 million share repurchase program authorized by our board of directors, and $160 thousand used in the repurchase of common stock related to the tax impact of vesting restricted awards. These usages were partially offset by $62 thousand received from the exercise of stock options. Financing activities include the receipt of $717 thousand from the exercise of stock options in the first two quarters 2013.


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Options of ZixCorp Common Stock

We have significant options outstanding that are currently vested. There is no assurance that any of these options will be exercised; therefore, the extent of future cash inflow from additional option activity is not certain. The following table summarizes the options that were outstanding as of June 30, 2014. The vested shares are a subset of the outstanding shares. The value of the shares is the number of shares multiplied by the exercise price for each share.

                                            Summary of Outstanding Options
                                        Total Value of       Vested Options
                                          Outstanding         (included in       Total Value of
                       Outstanding          Options           outstanding        Vested Options
Exercise Price Range     Options        (In thousands)          options)         (In thousands)
$1.11 - $1.99               706,633     $         1,049              706,633     $         1,049
$2.00 - $3.49             1,884,424               5,134            1,363,515               3,714
$3.50 - $4.99             2,531,488              10,966            2,493,312              10,819
$5.00 - $5.99               286,500               1,433              286,500               1,433
$6.00 - $8.99               350,900               2,105              350,900               2,105

Total                     5,759,945     $        20,687            5,200,860     $        19,120

Off-Balance Sheet Arrangements

None.

Contractual Obligations, Contingent Liabilities and Commitments

A summary of our fixed contractual obligations and commitments at June 30, 2014, is as follows:

Payments Due by Period (In thousands) Total 1 Year Years 2 & 3 Beyond 3 Years Operating leases $ 11,234 $ 1,174 $ 2,335 $ 7,725

We have not entered into any material, non-cancelable purchase commitments at June 30, 2014.

We have severance agreements with certain employees which would require the Company to pay approximately $2.9 million if all such employees separated from employment with our Company following a change of control, as defined in the severance agreements.


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