NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying condensed consolidated financial statements of Zix Corporation (“Zix” the “Company,” “we,” “our,” or “us”) should be read in conjunction with the audited consolidated financial statements included in the Company’s 2017 Annual Report on Form 10-K. These financial statements are unaudited, but have been prepared in the ordinary course of business for the purpose of providing information with respect to the covered interim periods.
Effective January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASC 606”) using the modified retrospective transition method. The cumulative effect of applying the standard was a $4.6 million increase to shareholder’s equity as of January 1, 2018. The Company’s condensed consolidated statement of income for the three and six month period ended June 30, 2018, and the Company’s condensed consolidated balance sheet at June 30, 2018, are presented under ASC 606, while the Company’s condensed consolidated statement of income for the three and six month period ended June 30, 2017, and the Company’s condensed consolidated balance sheet at December 31, 2017, are presented under ASC 605, Revenue Recognition (“ASC 605”). See note 2 for disclosure of the impact of the adoption of ASC 606 on the Company’s condensed consolidated statement of income for the three and six month periods ended June 30, 2018, and the Company’s condensed consolidated balance sheet at June 30, 2018, and the effect of changes made to the Company’s consolidated balance sheet as of January 1, 2018.
Management of the Company believes that all adjustments necessary for a fair presentation for such periods have been included and are of a normal recurring nature. The results of operations for the three and six month periods ended June 30, 2018, are not necessarily indicative of the results to be expected for any future periods or for the full fiscal year.
2. Recent Accounting Standards and Pronouncements
Revenue Recognition
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASC 606, which supersedes most prior revenue recognition guidance under U.S. Generally Accepted Accounting Principles (“GAAP”). The core principle of ASC 606 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASC 606 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.
The standard became effective for us beginning in 2018. Our Company provides primarily email encryption and advanced threat protection security solutions as subscription services in which we recognize revenue as our services are rendered. We determined our revenue was not materially impacted by the new guidance. However, the guidance did require us to increase the amortization period of our sales commission expense. We applied the guidance to commissions earned on all contracts that were not complete as of January 1, 2018. Prior period amounts have not been adjusted and continue to be reported in accordance with the previous guidance. Our Company elected to use a portfolio approach, applying 8 year, 4 year, and 18 month amortization periods to our new, add-on, and renewal sales commission expenses, respectively. Determination of the amortization period and the subsequent assessment for impairment of the deferred cost asset requires significant judgement.
We applied a modified retrospective approach to our implementation of ASC 606 in which we recognized a $4.6 million cumulative effect adjustment to our 2018 retained earnings opening balance related to our increased amortization period. This adjustment includes a $1.6 million impact to our deferred tax asset. The table below presents the cumulative effect of the changes made to our condensed consolidated balance sheet due to the adoption of ASC 606:
(In thousands)
|
|
January 1, 2018
|
|
|
|
Beginning
Balance
|
|
|
Cumulative
Effect
Adjustment
|
|
|
Beginning
Balance, as
Adjusted
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid and other current assets
|
|
$
|
3,222
|
|
|
$
|
(415
|
)
|
|
$
|
2,807
|
|
Other assets and deferred costs
|
|
|
—
|
|
|
|
6,595
|
|
|
|
6,595
|
|
Deferred tax assets
|
|
|
25,647
|
|
|
|
(1,616
|
)
|
|
|
24,031
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit
|
|
$
|
(236,372
|
)
|
|
$
|
4,564
|
|
|
$
|
(231,808
|
)
|
7
Financial statement results as reported under the new revenue standard as compared to the previous standard for the three and six months ended and as of June 30, 2018, are as follows:
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
(In thousands, except per share data)
|
|
Under
ASC 605
|
|
|
Under
ASC 606
|
|
|
Variance
(1)
|
|
|
Under
ASC 605
|
|
|
Under
ASC 606
|
|
|
Variance
|
|
|
Revenues
|
|
$
|
17,500
|
|
|
$
|
17,500
|
|
|
$
|
—
|
|
|
$
|
34,153
|
|
|
$
|
34,153
|
|
|
$
|
—
|
|
|
Cost of revenues
|
|
|
3,806
|
|
|
|
3,806
|
|
|
|
—
|
|
|
|
7,319
|
|
|
|
7,319
|
|
|
|
—
|
|
|
Gross margin
|
|
|
13,694
|
|
|
|
13,694
|
|
|
|
—
|
|
|
|
26,834
|
|
|
|
26,834
|
|
|
|
—
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
2,978
|
|
|
|
2,978
|
|
|
|
—
|
|
|
|
5,956
|
|
|
|
5,956
|
|
|
|
—
|
|
|
Selling, general and administrative
|
|
|
9,298
|
|
|
|
8,562
|
|
|
|
(736
|
)
|
|
|
17,389
|
|
|
|
16,115
|
|
|
|
(1,274
|
)
|
|
Total operating expenses
|
|
|
12,276
|
|
|
|
11,540
|
|
|
|
(736
|
)
|
|
|
23,345
|
|
|
|
22,071
|
|
|
|
(1,274
|
)
|
|
Operating income
|
|
|
1,418
|
|
|
|
2,154
|
|
|
|
736
|
|
|
|
3,489
|
|
|
|
4,763
|
|
|
|
1,274
|
|
|
Other income, net
|
|
|
360
|
|
|
|
360
|
|
|
|
—
|
|
|
|
479
|
|
|
|
479
|
|
|
|
—
|
|
|
Income before income taxes
|
|
|
1,778
|
|
|
|
2,514
|
|
|
|
736
|
|
|
|
3,968
|
|
|
|
5,242
|
|
|
|
1,274
|
|
|
Income tax expense
|
|
|
(519
|
)
|
|
|
(674
|
)
|
|
|
(155
|
)
|
|
|
(1,242
|
)
|
|
|
(1,510
|
)
|
|
|
(268
|
)
|
|
Net income
|
|
$
|
1,259
|
|
|
$
|
1,840
|
|
|
$
|
581
|
|
|
$
|
2,726
|
|
|
$
|
3,732
|
|
|
$
|
1,006
|
|
|
Basic income per common share
|
|
$
|
0.02
|
|
|
$
|
0.04
|
|
|
$
|
0.01
|
|
|
$
|
0.05
|
|
|
$
|
0.07
|
|
|
$
|
0.02
|
|
|
Diluted income per common share
|
|
$
|
0.02
|
|
|
$
|
0.03
|
|
|
$
|
0.01
|
|
|
$
|
0.05
|
|
|
$
|
0.07
|
|
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Per share variance may not foot due to rounding.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
June 30, 2018
|
|
|
|
Under
ASC 605
|
|
|
Under
ASC 606
|
|
|
Variance
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid and other current assets
|
|
$
|
3,444
|
|
|
$
|
2,978
|
|
|
$
|
(466
|
)
|
Other assets and deferred costs
|
|
|
—
|
|
|
|
7,920
|
|
|
|
7,920
|
|
Deferred tax assets
|
|
|
23,956
|
|
|
|
22,340
|
|
|
|
(1,616
|
)
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit
|
|
$
|
(233,646
|
)
|
|
$
|
(228,076
|
)
|
|
$
|
5,570
|
|
Cash Flow Statement
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), which amends guidance on the classification of certain cash receipts and payments in the statement of cash flows. This ASU was issued with the intent to reduce diversity in practice with respect to eight types of cash flows. The new guidance addressed debt prepayment or extinguishment of costs, settlement of zero-coupon bonds, contingent consideration made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies and bank-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle.
The standard became effective for us beginning 2018. We applied the new guidance within our condensed consolidated statements of cash flows classification to an $800 thousand earn-out payment associated with our Greenview Data acquisition. Because this consideration payment was not made soon after the consummation date, as required by the guidance, we classified $605 thousand of the payment as a financing activity. This reflects the portion of the payment recognized a contingent liability as of the acquisition date. The $195 thousand balance of the payment was in excess of the original contingent consideration liability and was classified as an operating activity. The standard had no other impact to our condensed consolidated financial statements.
Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which introduces a lessee model that brings most leases on the balance sheet. The new ASU eliminates the requirement in U.S. GAAP that entities use bright-line tests in determining
8
lease classifications and requires lessors to provide additional transparency into their exposure to the
changes in value of their residual assets and how they manage that exposure.
The standard is effective for us beginning 2019. We expect the valuation of right to use assets and lease liabilities to be the present value of our forecasted future lease commitments and are assessing the discount rate to be applied in these valuations. We are currently evaluating the potential impact of this new guidance on our consolidated financial statements.
3. Stock- Based Awards and Stock-Based Employee Compensation Expense
Our stock-based awards include (i) stock options, (ii) restricted stock awards, some of which are subject to time-based vesting (“Restricted Stock”) and some of which are subject to performance-based vesting (“Performance Stock”), and (iii) restricted stock units, some of which are subject to time-based vesting (“RSUs”) and some of which are subject to performance-based vesting (“Performance RSUs”). As of June 30, 2018 the Company had 987,234 stock options outstanding, 1,503,855 non-vested Restricted Stock awards; 211,182 non-vested Performance Stock awards; 72,168 non-vested RSUs; 12,499 non-vested Performance RSUs and 5,850,004 shares of common stock available for grant.
Stock Option Activity
The following is a summary of all stock option transactions during the three months ended June 30, 2018:
|
|
Options
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted Average
Remaining
Contractual Term
(Yrs)
|
|
Outstanding at March 31, 2018
|
|
|
1,014,314
|
|
|
$
|
3.10
|
|
|
|
|
|
Granted at market price
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Cancelled or expired
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Exercised
|
|
|
(27,080
|
)
|
|
|
1.22
|
|
|
|
|
|
Outstanding at June 30, 2018
|
|
|
987,234
|
|
|
$
|
3.16
|
|
|
|
5.06
|
|
Options exercisable at June 30, 2018
|
|
|
843,484
|
|
|
$
|
3.06
|
|
|
|
4.59
|
|
At June 30, 2018, all 987,234 stock options outstanding and all 843,484 stock options exercisable had an exercise price lower than the market price of the Company’s common stock on that date. The aggregate intrinsic value of these stock options were $2.2 million and $2.0 million, respectively.
Restricted Stock Activity
The following is a summary of Restricted Stock activity during the three months ended June 30, 2018:
|
|
Restricted
Shares
|
|
|
Weighted
Average
Fair Value
|
|
Non-vested restricted stock at March 31, 2018
|
|
|
1,162,143
|
|
|
$
|
4.33
|
|
Granted at market price
|
|
|
405,000
|
|
|
|
5.10
|
|
Vested
|
|
|
(60,288
|
)
|
|
|
4.20
|
|
Cancelled
|
|
|
(3,000
|
)
|
|
|
4.04
|
|
Non-vested restricted stock at June 30, 2018
|
|
|
1,503,855
|
|
|
$
|
4.54
|
|
9
Restricted Stock Unit Activity
The following is a summary of all RSU activity during the three months ended June 30, 2018:
|
|
Restricted
Stock Units
|
|
|
Weighted
Average
Fair Value
|
|
Non-vested restricted stock units at March 31, 2018
|
|
|
52,168
|
|
|
$
|
4.42
|
|
Granted at market price
|
|
|
20,000
|
|
|
|
5.01
|
|
Vested
|
|
|
—
|
|
|
|
—
|
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
Non-vested restricted stock units at June 30, 2018
|
|
|
72,168
|
|
|
$
|
4.59
|
|
Performance RSU Activity
The following is a summary of all Performance RSU activity during the three months ended June 30, 2018:
|
|
Performance
RSUs
|
|
|
Weighted
Average
Fair Value
|
|
Non-vested performance RSUs at March 31, 2018
|
|
|
12,499
|
|
|
$
|
4.20
|
|
Granted at market price
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
Non-vested performance RSUs at June 30, 2018
|
|
|
12,499
|
|
|
$
|
4.20
|
|
Performance Stock Activity
The following is a summary of all Performance Stock activity during the three months ended June 30, 2018:
|
|
Performance
Stock
|
|
|
Weighted
Average
Fair Value
|
|
Non-vested performance stock at March 31, 2018
|
|
|
211,182
|
|
|
$
|
4.25
|
|
Granted at market price
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
Non-vested performance stock at June 30, 2018
|
|
|
211,182
|
|
|
$
|
4.25
|
|
The weighted average grant-date fair value of awards of Restricted Stock, RSUs, Performance RSUs and Performance Stock is based on the quoted market price of the Company’s common stock on the date of grant.
Stock-Based Compensation Expense
For the three month period ended June 30, 2018, the total stock-based employee compensation expense resulting from stock options, Restricted Stock, RSUs, Performance RSUs and Performance Stock was recorded to the following line items of the Company’s condensed consolidated statements of income:
(In thousands)
|
|
Three Months
Ended June 30,
2018
|
|
|
Six Months
Ended June 30,
2018
|
|
Cost of revenues
|
|
$
|
80
|
|
|
$
|
148
|
|
Research and development
|
|
|
112
|
|
|
|
202
|
|
Selling, general and administrative
|
|
|
653
|
|
|
|
1,122
|
|
Stock-based compensation expense
|
|
$
|
845
|
|
|
$
|
1,472
|
|
A deferred tax asset totaling $293 thousand and $374 thousand, resulting from stock-based compensation expense associated with awards relating to the Company’s U.S. operations, was recorded for the six month periods ended June 30, 2018 and 2017, respectively. As of June 30, 2018, there was $7.2 million of total unrecognized stock-based compensation expense related to non-
10
vested stock-based compensation awards granted under the incentive plans. This expense is expected to be recognized over a weighted average period of 1.62 years.
For additional information regarding the Company’s Equity Awards and Stock-based Employee Compensation, see Note 3 to the consolidated financial statements contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.
4. Supplemental Cash Flow Information
Supplemental cash flow information relating to taxes and non-cash activities:
|
|
Six Months Ended June 30,
|
|
(In thousands)
|
|
2018
|
|
|
2017
|
|
Cash income tax payments
|
|
$
|
556
|
|
|
$
|
349
|
|
5. Receivables, net
(In thousands)
|
|
June 30,
2018
|
|
|
December 31,
2017
|
|
Gross accounts receivables
|
|
$
|
15,400
|
|
|
$
|
9,307
|
|
Allowance for returns and doubtful accounts
|
|
|
(279
|
)
|
|
|
(270
|
)
|
Unpaid portion of deferred revenue
|
|
|
(12,825
|
)
|
|
|
(7,648
|
)
|
Note receivable
|
|
|
458
|
|
|
|
458
|
|
Allowance for note receivable
|
|
|
(458
|
)
|
|
|
(458
|
)
|
Receivables, net
|
|
$
|
2,296
|
|
|
$
|
1,389
|
|
The allowance for doubtful accounts includes all specific accounts receivable which we believe are likely not collectible based on known information. In addition, we record 2.5% of all accounts receivable greater than 90 days past due, net of those accounts specifically reserved, as a general allowance against accounts that could potentially become uncollectible.
The reduction for the unpaid portion of deferred revenue represents future customer service or maintenance obligations which have been billed to customers, but remain unpaid as of the respective balance sheet dates. Deferred revenue on our consolidated balance sheets represents future customer service or maintenance obligations which have been billed and collected as of the respective balance sheet dates.
The note receivable represents the remaining outstanding balance of an original note related to the sale of a product line in 2005 in the amount of $540 thousand. This was fully reserved at the time of the sale as the note’s collectability was not assured. The note receivable is fully reserved at June 30, 2018.
6. Revenue from Contracts with Customers
Accounting policies
Our
Company provides message security solutions as subscription services in which we recognize revenue as our services are rendered. Our contracts are typically one to three year contracts billed annually. We exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by our company from a customer (e.g., sales, use, value added, and some excise taxes).
Disaggregation of Revenue
In the three months ended June 30, 2018, we recorded revenue for our services in the following core industry verticals: 49% healthcare, 29% financial services, 7% government sector, and 15% as other. In the six months ended June 30, 2018, we recorded revenue for our services in the following core industry verticals: 50% healthcare, 28% financial services, 7% government sector, and 15% as other.
We operate as a single operating segment. Revenue generated from our email protection services represented 100% of our revenues in the three and six months ended June 30, 2018 and 2017. Further, we sell our solutions as a bundle, applying significant judgement to allocate transaction prices of our services based on the standalone selling price of our component services.
11
Contract balances
Our contract assets include our accounts receivables, discussed in Footnote 5 above, and the deferred cost associated with commissions earned by our sales team on securing new, add-on, and renewal contract orders. Upon our adoption of ASU 606 we recorded a cumulative effect adjustment, establishing a $6.6 million noncurrent deferred contract asset in recognition of the lengthened amortization period required by the new guidance, The Company simultaneously released the previously existing current deferred commission asset balance of $415 thousand. During the three and six months ended June 30, 2018, we increased our noncurrent deferred contract asset $1.3 million and $ 2.3 million, respectively, resulting from commissions earned by our sales team during the three and six months ended June 30, 2018. We also amortized $510 thousand and $954 thousand of deferred cost, respectively, as a selling and marketing expense in the related periods. Our deferred cost asset is assessed for impairment on a periodic basis. There were no impairment losses recognized on deferred contract cost assets for the three or six months ended June 30, 2018.
Our contract liabilities consist of
deferred revenue representing future customer services which have been billed and collected. The $1.4 million decrease to our net deferred revenue in the six months ended June 30, 2018, is related to the timing of orders and payments.
Performance obligations
As of June 30, 2018, the aggregate amount of the transaction prices allocated to remaining service performance obligations, which represents the transaction price of firm orders less inception to date revenue, is $73.2 million. We expect to recognize approximately $27.9 million of revenue related to this backlog during the remainder of 2018, $27.2 million in 2019, and $18.1 million in periods thereafter.
Approximately $15.0 million of our $17.5 million revenue recognized in the three months ended June 30, 2018, was included in our performance obligation balance at the beginning of the period. Approximately $28.2 million of our $34.2 million revenue recognized in the six months ended June 30, 2018, was included in our performance obligation balance at the beginning of the period.
7. Earnings Per Share and Potential Dilution
Basic earnings per share are computed using the weighted average number of common shares outstanding for the applicable period. The dilutive effect of potential common shares outstanding is included in diluted earnings per share. The computations for basic and diluted earnings per share for the three and six months ended June 30, 2018 and 2017, are as follows:
|
|
Three Months ended June 30,
|
|
|
Six Months ended June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Basic weighted average common shares
|
|
|
52,467,904
|
|
|
|
53,573,431
|
|
|
|
52,670,540
|
|
|
|
53,268,005
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee and director stock options
|
|
|
356,061
|
|
|
|
457,714
|
|
|
|
309,909
|
|
|
|
418,470
|
|
Restricted stock
|
|
|
306,909
|
|
|
|
313,577
|
|
|
|
272,549
|
|
|
|
270,569
|
|
RSUs
|
|
|
13,044
|
|
|
|
42,283
|
|
|
|
20,114
|
|
|
|
51,154
|
|
Performance RSUs
|
|
|
4,207
|
|
|
|
29,054
|
|
|
|
11,700
|
|
|
|
22,169
|
|
Performance Stock
|
|
|
68,975
|
|
|
|
63,904
|
|
|
|
63,164
|
|
|
|
44,636
|
|
Dilutive weighted average common shares
|
|
|
53,217,100
|
|
|
|
54,479,963
|
|
|
|
53,347,976
|
|
|
|
54,075,003
|
|
During the three months ended June 30, 2018, weighted average shares related to 56,250 stock options, 74,986 shares of Restricted Stock were excluded from the calculation of diluted earnings per share as anti-dilutive. During the six months ended June 30, 2018, weighted average shares related to 124,750 stock options, 263,004 shares of Restricted Stock, 12,167 RSUs, 1,833 Performance RSUs, and 37,073 shares of Performance Stock were excluded from the calculation of diluted earnings per share because these awards were anti-dilutive.
8. Commitments and contingencies
A summary of our fixed contractual obligations and commitments at June 30, 2018, is as follows:
|
|
Payments Due by Period
|
|
(In thousands)
|
|
Total
|
|
|
1 Year
|
|
|
Years 2 & 3
|
|
|
Years 4 & 5
|
|
|
Beyond 5 Years
|
|
Operating leases
|
|
$
|
7,866
|
|
|
$
|
1,755
|
|
|
$
|
2,512
|
|
|
$
|
2,175
|
|
|
$
|
1,424
|
|
We have not entered into any material, non-cancelable purchase commitments at June 30, 2018.
12
Claims and Proceedings
We are from time to time involved in legal claims, litigation, and other legal proceedings. Although we may incur significant expenses in those matters, we expect no material adverse effect on our operations or financial results from current or concluded legal proceedings.
9. Fair Value Measurements
FASB guidance regarding fair value measurement establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets or liabilities; Level 2, defined as inputs other than quoted prices for similar assets and liabilities in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
For certain of the Company’s financial instruments, including cash and cash equivalents, trade receivables, and accounts payable, the fair values approximate the carrying values due to the short-term maturities of these instruments. The carrying values of other current assets and accrued expenses are also not recorded at fair value, but approximate fair values primarily due to their short-term nature.
The Company recorded a contingent liability for the estimated fair value of earn-out consideration payments in our Greenview (as defined herein) acquisition. The Company determined the fair value of this earn-out liability based on the probability of attainment of certain sales milestones. Any changes to the variables and assumptions could significantly impact the estimated fair values recorded for the liability, resulting in significant changes to the Condensed Consolidated Statements of Operations. The fair value measurements are based on significant inputs not observable in the market and thus represent Level 3 measurements, which reflect the Company’s own assumptions concerning the achievement of the sales milestones in measuring the fair value of the acquisition-related contingent earn-out liability.
The following table represents a reconciliation of our acquisition-related contingent earn-out liability measured at fair value on a recurring basis, using Level 3 inputs for the three month period ended June 30, 2018:
(In thousands)
|
|
Fair Value
Measurements
Using Significant
Unobservable
Inputs (Level 3)
|
|
Balance at December 31, 2017
|
|
$
|
1,488
|
|
Payments during the period
|
|
|
(800
|
)
|
Adjustments to fair value during the period recorded in General and Administrative expenses
|
|
|
406
|
|
Balance at June 30, 2018
|
|
$
|
1,094
|
|
10. Goodwill
The following is a summary of the changes in the carrying amount of goodwill for the six month periods ended June 30, 2018 and 2017:
|
|
Six Months ended June 30,
|
|
(In thousands)
|
|
2018
|
|
|
2017
|
|
Opening balance
|
|
$
|
8,469
|
|
|
$
|
2,161
|
|
Additions
|
|
|
5,926
|
|
|
|
4,327
|
|
Acquisition adjustments
|
|
|
(901
|
)
|
|
|
—
|
|
Goodwill
|
|
$
|
13,494
|
|
|
$
|
6,488
|
|
Our 2018 acquisition of Erado resulted in the addition to our goodwill in the six months ended June 30, 2018. Our acquisition adjustments to goodwill in the six month period ended June 30, 2018, reflect the appropriate reallocation of excess purchase price from goodwill to acquired assets and liabilities related to our 2017 Greenview and EMS purchases. Our 2017 acquisition of Greenview resulted in the increase to our goodwill in the six months ended June 30, 2017. We evaluate goodwill for impairment annually in the fourth quarter, or when there is a reason to believe that the value has been diminished or impaired. There were no impairments to goodwill during the periods presented above.
13
11. Common Stock Repurchase Program
On April 24, 2017, the Company’s board of directors approved a share repurchase program that enabled the Company to purchase up to $10 million of its shares of common stock . During the three months ended June 30, 2018, the Company repurchased 500,000 shares of our common stock under this program at an aggregate cost of $2.3 million. During the three months ended March 31, 2018, the Company repurchased 706,994 shares of our common stock under the same program at an aggregate cost of $3.1 million. The share repurchase program expired May 31, 2018.
No shares were repurchased during the three month and six month periods ended June 30, 2017.
12. Income Taxes
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 $30.8 million reserve. Any reduction to this $30.8 million valuation allowance is based on an assessment of future utilization following accounting guidance, which relies largely on historical earnings. Using this methodology, and updating the future taxable earnings estimates based on first and second quarter 2018 actual earnings, the Company believes the deferred tax asset allowance as of December 31, 2017, will remain unchanged at December 31, 2018. For this reason, the Company has recognized its first and second quarter 2018 federal deferred tax provision in full. If in prospective periods we conclude our future U.S. federal taxable estimate established at the end of the year will exceed the prior year estimate, the Company will offset its federal deferred tax provision by reducing its valuation allowance by an equal amount, thereby eliminating from its deferred tax provision federal taxes from the Company’s 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.
13. Acquisitions
Greenview Data, Inc.
On March 15, 2017, the Company acquired all of the outstanding capital stock of Greenview Data, Inc. (“Greenview”), a provider of antivirus, anti-spam, and archiving products, for a total purchase price of $7.7 million, including cash consideration of $6.7 million, subject to a customary post-closing adjustment for working capital. Our acquisition of Greenview addresses increasing buyer demand for email security bundles by adding these capabilities to our existing portfolio of encryption services. Of the cash consideration paid, $650 thousand was deposited into an escrow account for the satisfaction of certain indemnification claims of the Company, if any, during the two year period following the closing of the acquisition, after which the balance, if any, will be distributed to the selling shareholders. Because sales of Greenview products met certain sales milestones by December 31, 2017, the Company paid contractually required cash earn-out consideration of $800 thousand in the three month period ended March 31, 2018. The Company may be required to pay an additional $800 thousand of earn-out consideration in cash should sales of the Greenview products achieve a separate target by December 31, 2018. Contingent consideration is considered a Level 3 fair value measurement.
We accounted for the acquisition as the purchase of a business and recorded the excess purchase price as goodwill. The goodwill from this transaction is not deductible for tax purposes. The results of operations and the provisional fair values of the acquired assets and liabilities assumed have been included in the accompanying condensed consolidated financial statements since our March 15, 2017, acquisition date. Revenue from Greenview was $892 thousand and $1.7 million for the three and six months ended June 30, 2018, and due to the continued integration of the combined businesses, it was impracticable to determine the earnings.
14
The follo
wing table summarizes the estimated fair value of acquired assets and liabilities:
(In thousands)
|
|
Estimated Fair
Value
|
|
Assets:
|
|
|
|
|
Current assets
|
|
$
|
334
|
|
Property and equipment
|
|
|
249
|
|
Trademark /names
|
|
|
170
|
|
Technology
|
|
|
1,990
|
|
Customer relationships
|
|
|
2,880
|
|
Goodwill
|
|
|
4,343
|
|
Total assets
|
|
|
9,966
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Deferred revenue
|
|
$
|
537
|
|
Other current liabilities
|
|
|
124
|
|
Deferred tax liability
|
|
|
1,609
|
|
Total liabilities
|
|
|
2,270
|
|
|
|
|
|
|
Net assets recorded
|
|
$
|
7,696
|
|
Entelligence Messaging Server
On September 13, 2017, the Company acquired Entelligence Messaging Server (“EMS”) technology, an email encryption solution, and the related business from Entrust Datacard Corporation for a cash purchase price of $1.7 million. Our acquisition of EMS strengthens our email encryption suite by offering enterprise-centric capabilities, such as advanced message tracking, PDF statement delivery, high availability on-premises architecture and standards-based end-to-end encryption.
We accounted for the acquisition as the purchase of a business and recorded the excess purchase price as goodwill. The goodwill from this transaction is deductible for tax purposes. The results of operations and the provisional fair values of the acquired assets and liabilities assumed have been included in the accompanying condensed consolidated financial statements since our September 13, 2017, acquisition date. Revenue from EMS was not material for the three and six months ended June 30, 2018, and due to the continued integration of the combined businesses, it was impracticable to determine the earnings.
The following table summarizes the provisional fair value of acquired assets and liabilities:
(In thousands)
|
|
Provisional Fair
Value
|
|
Assets:
|
|
|
|
|
Trademark/names
|
|
$
|
140
|
|
Internally developed software
|
|
|
550
|
|
Customer relationships
|
|
|
230
|
|
Goodwill
|
|
|
1,063
|
|
Total assets
|
|
|
1,983
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Deferred revenue
|
|
$
|
333
|
|
Total liabilities
|
|
|
333
|
|
|
|
|
|
|
Net assets recorded
|
|
$
|
1,650
|
|
15
Erado
On April 2, 2018, the Company acquired all the outstanding capital stock of CM2.COM, Inc., d/b/a Erado (“Erado”) for a total purchase price of $14.4 million, including cash consideration of $11.8 million, net of cash acquired. The purchase of Erado strengthens 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 will help further strengthen Zix’s offering for customers with compliance requirements. This acquisition also expands Zix’s cloud-based email archiving capabilities into more than 50 content channels, including social medial, instant message, mobile, web, audio, and video.
The purchase price includes a holdback of $2.3 million for the satisfaction of certain indemnification claims by the Company, if any, during the two-year period following the closing of the acquisition. An amount equal to $1.1 million of the holdback amount, less any amounts paid or otherwise subject to an outstanding claim for indemnification, will be released to the selling shareholders upon the one year anniversary of the closing of the acquisition, and the balance of the holdback amount, if any, will be distributed to the Selling Shareholders following the two year anniversary of the closing of the acquisition. The Company is currently in the process of determining the fair value of the contingent consideration associated with the indemnification liability.
The Company incurred $56 thousand and $375 thousand in acquisition-related costs which were recorded within operating expenses during the three and six months ended June 30, 2018, respectively.
We accounted for the acquisition as the purchase of a business and have initially recorded the excess purchase price as goodwill. The goodwill from this transaction is deductible for tax purpose. The results of operations and the provisional fair values of the acquired assets and liabilities have been included in the accompanying condensed consolidated financial statements since our April 2, 2018 acquisition. Revenue from Erado was $642 thousand for the three months ended June 30, 2018, and due to the continued integration of the combined businesses, it was impracticable to determine the earnings.
The following table summarizes the provisional fair value of acquired assets and liabilities.
(In thousands)
|
|
Estimated Fair
Value
|
|
Assets:
|
|
|
|
|
Current assets
|
|
$
|
848
|
|
Property and equipment
|
|
|
458
|
|
Trademark /names
|
|
|
260
|
|
Technology
|
|
|
3,030
|
|
Customer relationships
|
|
|
4,760
|
|
Goodwill
|
|
|
5,926
|
|
Total assets
|
|
|
15,282
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
Deferred revenue
|
|
$
|
809
|
|
Other current liabilities
|
|
|
93
|
|
Total liabilities
|
|
|
902
|
|
|
|
|
|
|
Net assets recorded
|
|
$
|
14,380
|
|
16
Pro Forma Financial Information (Unaudited)
The following unaudited pro forma financial information presents the combined results of operations for the three and six month periods ending June 30, 2018 and 2017, as though the Greenview, EMS and Erado acquisitions that occurred during the reporting period had occurred as of the beginning of the period presented, with adjustments to give effect to pro forma events that are directly attributable to the acquisition, such as amortization expense of intangible assets and acquisition-related transaction costs. These unaudited pro forma results are presented for information purposes only and are not necessarily indicative of what the actual results of operations of the combined company would have been if the acquisition had occurred at the beginning of the period presented, nor are they indicative of future results of operations:
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
(In thousands, except per share data)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Revenues
|
|
$
|
17,731
|
|
|
$
|
17,241
|
|
|
$
|
35,191
|
|
|
$
|
34,436
|
|
Net income
|
|
|
2,320
|
|
|
|
1,684
|
|
|
|
5,013
|
|
|
|
3,989
|
|
Basic income per common share
|
|
$
|
0.04
|
|
|
$
|
0.03
|
|
|
$
|
0.10
|
|
|
$
|
0.07
|
|
Diluted income per common share
|
|
$
|
0.04
|
|
|
$
|
0.03
|
|
|
$
|
0.09
|
|
|
$
|
0.07
|
|
The Company is in the process of determining the valuation of certain Erado property, equipment, and intangible assets and liabilities, which may result in further refinement of the allocation of the purchase price for these acquisitions.
14. Subsequent Events
On July 31, 2018, we filed with the SEC a “shelf” registration statement on Form S-3 (the “Registration Statement”) to register 25 million shares of our common stock for offering and sale in one or more future offerings. Our goal is to position the Company to take advantage of favorable market conditions for raising equity capital that may be used to finance future acquisitions and for other general corporate purposes. The registration statement relating to these securities has been filed with the Securities and Exchange Commission but has not yet become effective. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. A written copy of the registration statement may be obtained from our website at
http://investor.zixcorp.com
.
17