(EDGAR Online via COMTEX) -- 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, 2018. 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.
Zix(R) is a leading provider of cloud email security, productivity and compliance solutions. Trusted by the nation's most influential institutions in healthcare, finance and government, Zix delivers a superior experience and easy-to-use solutions for email encryption and data loss prevention ("DLP"), advanced threat protection, archiving, and bring your own device ("BYOD") mobile security. Focusing on the protection of business communication, Zix enables its customers to better secure data and meet compliance needs. We serve organizations in many industries, with particular emphasis on the healthcare, financial services, insurance and government sectors, including U.S. federal financial regulators- such as members of the Federal Financial Institutions Examination Council, divisions of the U.S. Treasury, the U.S. Securities and Exchange Commission ("SEC"), more than 30% of U.S. banks, more than 30% of Blue Cross Blue Shield plans and more than 1,200 U.S. hospitals.
ZixEncryptSM (formerly ZixGateway(R) and ZixQuarantine(R)) bundles email encryption and DLP capabilities to enable the secure exchange of email that includes sensitive information. Through a comprehensive secure messaging service, ZixEncrypt allows an enterprise to use policy-driven rules to determine which email messages should be sent securely or quarantined for review to comply with regulations or company-defined policies.
The main differentiation for ZixEncrypt in the marketplace is our exceptional ease of use. The best example of this is our ability to provide transparent delivery of encrypted email. Most email encryption solutions are focused on the sender. They typically introduce an added burden on recipients, often requiring additional user authentication with creation of a new user identity and password. We designed our solution to alleviate the recipient's burden by enabling the delivery of encrypted email automatically and transparently. Zix enables transparent delivery by (1) ZixDirectory(R), the world's largest email encryption community which is designed to share identities of our tens of millions of members (growing by approximately 170,000 members per week),
ZixEncrypt also addresses business's greatest source of data loss - corporate email- with an easy, straightforward DLP approach. By focusing strictly on the risks of email, ZixEncrypt simplifies DLP in comparison to other DLP solutions by decreasing complexity and cost, reducing deployment time from months to hours and minimizing impact on customer resources and workflow. In addition, Zix offers a convenient experience for both employees interacting with our solution and administrators managing the system.
ZixEncrypt enables DLP capabilities for email by combining proven policy and content scanning capabilities with quarantine functionality. The quarantine system and its intuitive interface allow administrators to (1) easily define policies and create custom lexicons for quarantining email messages,
ZixEncrypt also provides greater visibility into an organization's data risks in email by capturing data in outbound emails and highlighting violations that trigger policy filters to encrypt or quarantine. Through our interactive, real-time interface, companies can monitor their greatest vulnerabilities, generate reports for business executives and train employees about the sensitivity of their company's data.
ZixEncrypt is available as a hosted solution, as a multi-tenant solution, or as a physical or virtual on-premises appliance.
In March 2017, Zix acquired Greenview Data, Inc. ("Greenview"), an email security company. Zix's acquisition of Greenview addresses increasing buyer demand for email security bundles by adding advanced threat protection, antivirus, anti-spam and archiving capabilities to its industry-leading email encryption. Greenview is a good fit for Zix's business based on its employees' expertise in email security and its emphasis on customer success, which align with Zix's reputation for delivering industry-leading solutions and a superior experience.
Through the acquisition of Greenview, Zix launched two new solutions in April 2017 - ZixProtectSM and ZixArchiveSM. ZixProtect defends organizations from zero-day malware, ransomware, phishing, CEO fraud, W-2 phishing attacks, spam and viruses in email with multi-layer filtering techniques. Accuracy in protecting organizations from email threats is increased further with automated traffic analysis, machine learning and real-time threat analysts.
ZixProtect is available as a cloud-based service in three bundles. ZixProtect Essentials includes email threat protection and business email continuity to enable access to emails during service disruption; ZixProtect Plus adds attachment assurance and time-of-click link defense to provide enhanced protection against sophisticated, targeted threats; and ZixProtect Premium delivers a comprehensive email security solution by including its leading email encryption and data loss prevention with its threat protection capabilities.
ZixArchive is a low-cost, cloud-based email retention solution that easily enables user retrieval, compliance and eDiscovery. Available as a standalone or add-on solution for ZixEncrypt or ZixProtect bundles, ZixArchive includes policy-based retention, automatic indexing and flexible search capabilities for audit and legal requirements. With on-demand access through the cloud, organizations can conveniently share messages with employees, auditors and outside consultants or legal counsel, as well as revoke access when needed.
In April 2018, Zix acquired Erado, a unified archiving company. Erado strengthened Zix's comprehensive archiving solutions with unified archiving, supervision, security, and messaging solutions for customers that demand bundled services. Erado's long standing focus on helping its customers comply with FINRA and SEC regulations helped further strengthen Zix's offerings for customers with compliance requirements. This acquisition also expanded Zix's cloud-based email archiving capabilities into more than 50 content channels, including social medial, instant message, mobile, web, audio and video.
ZixOne(R) is a unique mobile email app that solves the key IT challenge created by the BYOD trend in the workplace. BYOD describes employee's use of personal devices to conduct work. ZixOne provides mobile access to corporate email while never allowing that data to be persistently stored on an employee's 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.
ZixOne is available as a standalone solution and easily integrates with ZixEncrypt as an add-on solution. One feature of ZixOne is the ability to encrypt an email from your mobile device with the simple slide of an "Encrypt" button, ensuring that sensitive information is secured either by the user or through automatic policies of ZixEncrypt.
On March 5, 2019, we announced the availability of ZixSuite, a cloud-based business communications security and compliance solution that combines advanced threat protection, business email continuity, email encryption, email DLP and unified archiving, all managed from a centralized interface.
ZixSuite is designed to simplify security and regulatory compliance for small and medium size businesses that want an easier way to protect critical business communications while complying with industry or corporate regulations. It brings together three of the Company's industry-leading solutions: ZixProtect, ZixEncrypt and ZixArchive.
Integrated into a seamless management and reporting interface, the combination of these three services provides threat protection to reduce threats and spam, including protection from sophisticated zero-hour attacks; business email continuity to enable continued access to mail services during mail server outages; email encryption and DLP to automatically identify and protect sensitive data in email communication; and unified archiving for indefinite retention of business communications and easy access for compliance and eDiscovery. Unified archiving now supports over 50 data sources - from email and social media, to text messaging and more.
On February 20, 2019, we completed the acquisition of AppRiver, a leading provider of cloud-based cybersecurity solutions for SMB. The combined companies create one of the leading cloud based security solutions providers, particularly for the small and mid-size enterprise market. This acquisition further strengthens that alignment by bolstering our security offerings, expanding our go-to-market channels, and providing a stronger cloud platform to drive even more value for our customers and partners.
On May 7, 2019, we acquired DeliverySlip, expanding our portfolio with additional email encryption, e-signatures, and secure file sharing solutions.
Our business operations and service offerings are supported by the ZixData Center(TM), which is PCI DSS 3.2 certified for applicable services, SOC2 accredited and SOC 3 certified. The operations of the ZixData Center are independently audited annually to maintain AICPA SOC3 certification in the areas of security, confidentiality, integrity and availability. Auditors also produce a SOC2 report on the effectiveness of operational controls used over the audit period. The ZixData Center is staffed 24 hours a day and has 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, 2018. 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, 2018.
Results of Operations
Third Quarter 2019 Summary of Operations
Revenue for the quarter ended September 30, 2019, was $47.8 million, compared with $17.9 million for the same period in 2018, representing a 168% increase that was largely attributable to our AppRiver acquisition in February 2019.
Gross margin for the quarter ended September 30, 2019, was $26.4 million (or 55% of revenues), compared with $14.0 million (or 78% of revenues) for the comparable period in 2018. The period over period margin decline as a percentage of revenues is attributable to the effect of the higher cost of revenue associated with AppRiver's Microsoft Office365 and hosted exchange products.
Net (loss) for the quarter ended September 30, 2019, was $(1.6) million, compared with net income of $2.5 million in the comparable period in 2018. The net loss for the quarter ended September 30, 2019, was attributed to significant transaction and integration-related costs incurred to acquire AppRiver in February 2019 and Delivery Slip in May 2019.
Net (loss) attributable to common shareholders for the quarter ended September 30, 2019, was $(3.7) million, compared with net income attributable to common shareholders of $2.5 million in the comparable period in 2018. The Company's net loss attributable to common shareholders includes a deemed and accrued dividend of $2.1 million to preferred shareholders.
Net (loss) per diluted share was $(0.07) for the quarter ended September 30, 2019, compared with net income per diluted share of $0.05 in the comparable period in 2018.
Ending cash and cash equivalents were $10.1 million on September 30, 2019, compared with $24.0 million on September 30, 2018, and $27.1 million on December 31, 2018.
Total billings for the quarter ended September 30, 2019, were $46.2 million, compared with $21.3 million for the same period in 2018, representing a 117% increase. AppRiver contributed $27.6 million of third quarter 2019 billings.
The annual recurring revenue value of our customer subscriptions as of September 30, 2019, was $200.3 million, compared with $74.9 million for the same period in 2018, representing an increase of $125.4 million that was largely attributable to our AppRiver acquisition.
Net cash provided by operations in the nine months ended September 30, 2019, was $8.0 million, compared with $11.8 million provided by operations for the same period in 2018, representing a $3.8 million decrease.
As of September 30, 2019, backlog was $90.7 million, compared with $74.0 million as of September 30, 2018, representing a 23% increase.
Revenues Our Company provides subscription-based services. The following table sets forth the quarter-over-quarter comparison of the Company's revenues: 3-month Variance 9-month Variance Three Months Ended September 30, 2019 vs. 2018 Nine Months Ended September 30, 2019 vs. 2018 (in thousands) 2019 2018 $ % 2019 2018 $ % Revenues $ 47,833 $ 17,876 $ 29,957 168 % $ 123,049 $ 52,029 $ 71,020 137 %
The increase in revenue was primarily related to our AppRiver acquisition in February 2019, which contributed $28.7 million and $66.8 million in revenue to the three and nine months ended September 30, 2019, respectively. We additionally grew our revenue with continued success in our subscription-based business model with both steady additions to the subscriber base and a high rate of existing customer renewals and the realization of previously contracted revenue in our backlog. In the first nine months of 2019, excluding our AppRiver and Erado sales, we categorized our revenue in the following core industry verticals: 46% healthcare, 29% financial services, 7% government sector and 18% as other. In the first nine months of 2018, we categorized our revenue in the following core industry verticals: 49% healthcare, 29% financial services, 7% government sector, and 15% as other.
Revenue Indicator - Backlog
Backlog - Our end-user order backlog is comprised of contractually binding 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.
As of September 30, 2019, total backlog was $90.7 million, and we expect approximately 69% of the total backlog, or approximately $62.2 million, to be recognized as revenue during the next twelve months. As of September 30, 2019, the backlog was comprised of the following elements: $45.6 million of deferred revenue that has been billed and paid, $10.5 million billed but unpaid, and approximately $34.6 million of unbilled contracts. The backlog at September 30, 2019, was 23% higher than the $74.0 million backlog at the end of the third quarter 2018, and 24% higher than the ending backlog of $73.0 million at December 31, 2018. Our increase in backlog includes $13.8 million associated with AppRiver.
Cost of Revenues The following table sets forth the quarter-over-quarter comparison of the cost of revenues: 3-month Variance 9-month Variance Three Months Ended September 30, 2019 vs. 2018 Nine Months Ended September 30, 2019 vs. 2018 (in thousands) 2019 2018 $ % 2019 2018 $ % Cost of revenues $ 21,422 $ 3,870 $ 17,552 454 % $ 52,865 $ 11,189 $ 41,676 372 %
Cost of revenues is comprised of costs related to operating and maintaining the ZixData Center, a field deployment team, customer service and support, Microsoft fees associated with the resale of Microsoft Office365 and hosted exchange products and depreciation expense of computer equipment and amortization of acquired technology. The increases in 2019 compared to 2018 reflected in the table above resulted primarily from our acquisition of AppRiver in February 2019. As a reseller of Microsoft Office365 and hosted exchange products, which comprise over 50% of AppRiver revenue earned for the three and nine months ended September 30, 2019, we expect our costs of revenue to remain at higher levels than we have historically incurred. We additionally incurred increases in average headcount and other expenses to accommodate revenue growth. Our acquisition of DeliverySlip contributed to the cost reduction of email encryption service fees.
Research and Development Expenses The following table sets forth the quarter-over-quarter comparison of our research and development expenses: 3-month Variance 9-month Variance Three Months Ended September 30, 2019 vs. 2018 Nine Months Ended September 30, 2019 vs. 2018 (in thousands) 2019 2018 $ % 2019 2018 $ % Research and development expenses $ 5,590 $ 2,764 $ 2,826 102 % $ 15,048 $ 8,720 $ 6,328 73 %
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 increase in 2019 compared to 2018 reflected in the table above resulted primarily from increases in headcount and consulting attributable to our AppRiver acquisition in February 2019.
Selling and Marketing Expenses The following table sets forth the quarter-over-quarter comparison of our selling and marketing expenses: 3-month Variance 9-month Variance Three Months Ended September 30, 2019 vs. 2018 Nine Months Ended September 30, 2019 vs. 2018 (in thousands) 2019 2018 $ % 2019 2018 $ % Selling and marketing expenses $ 13,312 $ 5,223 $ 8,089 155 % $ 37,323 $ 15,054 $ 22,269 148 %
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 increase in the three months ended September 30, 2019, compared to the same period in 2018, was due primarily to our AppRiver acquisition in February 2019 as well as related integration activities. We additionally incurred increases in headcount expense and spending for marketing programs.
In addition to our AppRiver acquisition and the other items noted above, our nine month increase in spending is primarily attributable to increase in headcount expense, commission expense attributable to the amortization of previously capitalized commissions, integration costs including severance expenses to create synergy of the combined companies after our AppRiver acquisition in February 2019. We additionally incurred increases in stock based compensation expense and in spending for marketing programs.
General and Administrative Expenses The following table sets forth the quarter-over-quarter comparison of our general and administrative expenses: 3-month Variance 9-month Variance Three Months Ended September 30, 2019 vs. 2018 Nine Months Ended September 30, 2019 vs. 2018 (in thousands) 2019 2018 $ % 2019 2018 $ % General and administrative expenses $ 6,280 $ 2,802 $ 3,478 124 % $ 24,406 $ 9,085 $ 15,321 169 %
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 increase in the three months ended September 30, 2019 resulted primarily from acquisition and integration costs associated with AppRiver in February 2019. We additionally incurred increase in stock based compensation expense and advisory and audit fees.
The increase in the nine months ended September 30, 2019 resulted primarily from acquisition costs associated with AppRiver and DeliverySlip, acquired February 2019 and May 2019, respectively, and expenses associated with AppRiver operations. We additionally incurred increases in headcount, integration, audit and stock based compensation expenses offset by earnout expense incurred in the same period of 2018.
Other Income (Expense)
Our other income (expense) consists primarily of interest expense associated with our debt. In February 2019, we entered into a credit agreement with a syndicate of lenders and SunTrust Bank, borrowing $175 million to fund our AppRiver acquisition. In May 2019, we borrowed and additional $10 million to fund our DeliverySlip acquisition. During the three and nine months ended September 30, 2019, we recorded interest expense of $3.0 million and $7.4 million, respectively associated with this debt. At September 30, 2019, our outstanding debt balance was $178.3 million based on a weighted effective interest rate of 6.51%. See above Note 7 "Long-term Debt" for additional information regarding our debt.
Provision for Income Taxes
The provision for income taxes was a $133 thousand benefit and $945 thousand expense for the three month periods ended September 30, 2019 and 2018, respectively, and a $2.3 million benefit and a $2.5 million expense for each of the nine months ended September 30, 2019 and 2018, respectively. The operating losses incurred by the Company's U.S. operations in past years and the resulting net operating losses for U.S. Federal income tax purposes are subject to a $23.1 million reserve because of the uncertainty of future taxable income levels sufficient to utilize our net operating losses and credits. Our September 30, 2019, provision benefit of $2.3 million includes $2.1 million in deferred taxes, a $259 thousand benefit related to the return of federal Alternative Minimum Tax credits offset by a $87 thousand state income tax expense. Our September 30, 2018, income tax provision of $2.5 million includes $2.7 million in deferred taxes, $416 thousand in state taxes currently payable based on gross revenues, and $61 thousand in taxes related to our Canadian operations, all of which were offset by a $690 thousand benefit related to the return of federal Alternative Minimum Tax credits.
No tax penalty-related charges were accrued or recognized for the three month periods ended September 30, 2019 and 2018. Additionally, we have not taken a tax position that would have a material effect on our financial statements or our effective tax rate for the three month period ended September 30, 2019. We are currently subject to a three year statute of limitations by major tax jurisdictions.
At September 30, 2019, the Company partially reserved its U.S. net deferred tax . . .
Nov 06, 2019
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