Zix
Annual Report 2018

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2018 Annual Report Statements in this document that are not purely historical facts or that necessarily depend upon future events, including statements about forecasts of sales, revenue or earnings, or other statements about anticipations, beliefs, expectations, hopes, intentions or strategies for the future, may be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Readers are cautioned not to place undue reliance on forward-looking statements. All forward- looking statements are based upon information available to Zix on the date this document was printed. Zix undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Any 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 or uncertainties related to Zix’s ability to successfully acquire, finance and integrate other businesses, market acceptance of new and enhanced Zix data protection solutions and how privacy and data security laws may affect demand for Zix data protection solutions. Zix may not succeed in addressing these and other risks. Further information regarding factors that could affect Zix’s business and its financial and other results can be found in the risk factors section of the accompanying annual report on Form 10-K. April 26, 2019 Dear Shareholders, As we close the books on 2018, the word affirmation seems an appropriate description. We’ve charted a bold and ambitious course for Zix. The results we’ve reported throughout the year prove that our strategy is sound and that we are moving in a direction and at a pace that is consistent with the demands of our customers and channel partners. This gives us great confidence that we are well-positioned for continued growth and profitability in the years ahead. Our strategy was validated by the strong results we achieved in 2018. Our list of financial goals that we’ve either met or exceeded is, in our opinion, quite impressive. Our record revenue and new first- year orders reflects, in part, our success in bringing ZixProtect and an enhanced ZixArchive to market. As we predicted, these services have been appealing to our customers and partners. This has dramatically improved our ability to cross-sell to our existing customers who are more often looking to purchase multiple services from one vendor. We leveraged that success to further strengthen our archiving capabilities with the addition of the Erado acquisition in April 2018. This further expanded our addressable market and began to transition us from a company with a sole focus on email to one that is more broadly protecting all business communications. We also made significant enhancements to our cloud platform putting our product in a better position to address market trends and meet our customer's current and future needs. But it's not just a great product that made 2018 a very successful year for Zix. It was also the strong performance from our sales, marketing and channel partners that helped us reach record revenue, orders and annual recurring revenue. In fact, it is to the great credit of the entire team – at each location and in every functional area – that 2018 was another giant step forward. Our opportunity now is to build on last year’s success and use our momentum to help us reach the new, even more ambitious goals we have set for 2019. Our fundamental strategy remains the same but the context in which we will execute has changed substantially. Put simply, we are operating at a different level as a result of our organic growth and acquisitions. With these new capabilities and resources come higher expectations about what Zix will deliver for partners and customers going forward. Our financial performance is the most obvious and visible measure. We expect to end 2019 with between $164 million and $167 million in total revenue. By then, we also plan to reach between $200 million and $207 million in annual recurring revenue. In just three to five years, our goal is to hit between $275 and $350 million of annual recurring revenue. Once again, we have set targets that are very ambitious, but in our opinion, completely within reach if we manage our opportunities well. Beyond the financial measures, however, we have to consider carefully our new position in the market. Much depends on how well we operate, integrate, and then elevate the company going forward. As Zix makes the transition from best-of-breed solution to industry leader, our presence and prominence must also reflect that growth. All of our stakeholders rightfully expect that the ‘whole’ of Zix will now be much more than the sum of disparate pieces. The addressable market, and thus our audience, is considerably larger. Our voice is louder. And our ideas and actions will be viewed more closely. The challenge in front of us is to capitalize on this additional strength and ensure that the Zix brand represents both industry leadership and thought leadership. Toward those ends, you should expect to see and hear about Zix more often and from more outlets than ever before. Our vision is for the brand to be the new standard for business cybersecurity across multiple product types. Accomplishing all of these objectives is a tall order that will require deep commitment and constant focus from our leadership and team members. Experience has shown us, however, that with the right resources and direction, they can deliver outstanding results. Our strategy has proven sound thus far. Our plans for moving forward are coming into place. Our team is prepared to execute. As chairman, I am incredibly excited for the future and I thank you, our shareholders, for trusting us enough to take this journey with us. Sincerely, Robert C. Hausmann Chairman of the Board United States SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K (Mark One) (cid:95)(cid:95) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2018 (cid:134)(cid:134) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 0-17995 Zix Corporation (Exact Name of Registrant as Specified in its Charter) Texas (State or Other Jurisdiction of Incorporation or Organization) 75-2216818 (I.R.S. Employer Identification Number) 2711 N. Haskell Avenue, Suite 2200, LB 36, Dallas, Texas 75204-2960 (Address of Principal Executive Offff iceff s) (214) 370-2000 (Registrant’s Telephone Number, Including Area Code) Securities Registered Pursuant to Section 12(b) of the Act: Title of each class of stock Common Stock $0.01 Par Value Name of each exchange on which registered NASDAQ Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check markrr whethet Indicate by check markrr whethet Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange (or for such shorter period that the Registrant was required to file such reports) and (2) has been subju ect is a well-knownww seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:134) No (cid:95) is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes (cid:134) No (cid:95) r the Registratt ntaa r the Registratt ntaa Act of 1934 during the preceding 12 monthst to such filing requirements for the past 90 days. Yes (cid:95) No (cid:134) Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submu itted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 monthst submit and post such reports) Yes (cid:95) No (cid:134) (or for such shorter period that the registrant was required to Indicate by check mark if disclosure of delinquent filers pursuantaa to Item 405 of Regulation S-K (§229.405 of this chapta er) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:134) Indicateaa by check markrr whethett r the registratt ntaa is a largaa e accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reportirr ng company. See definitions of “large accelerateaa d filer”, “accelerated filer” and “smaller repor e tinrr g company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer Non-accelerated filer (cid:134) (cid:134) (Do not check if a smaller reporting company) (cid:95) Accelerated filer Smaller reporting company (cid:134) Emerging growth company (cid:134) If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial aa accounting standards provided pursuant to Section 13 (a) of the Exchange Act. (cid:134) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:134) No (cid:95) As of March 6, 2019, there were 54,089,273 shares of Zix Corporation $0.01 par value common stock outstanding. As of June 30, 2018, the aggregate market value of the shares of Zix Corporation common stock held by non-affiliates was $289,258,242. Portions of the Registrant’s 2019 Proxy Statement are incorporated by reference into Part III of this Form 10-K. DOCUMENTS INCORPORATRR ED BY REFERENCE TABLE OF CONTENTS Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. Item 5. Item 6. Item 7. Item 7A. Item 8. Item 9. Item 9A. Item 9B. Item 10. Item 11. Item 12. Item 13. Item 14. Item 15. Item 16. kk PART I Business................................................................................................................................................................................. Risk Factors ........................................................................................................................................................................... Unresolved Staff Comments .................................................................................................................................................. Properties ............................................................................................................................................................................... Legal Proceedings.................................................................................................................................................................. Mine Safety Disclosures ........................................................................................................................................................ PART II Market for Registrant’s Common Equity, Related Stockhold er Matters and Issuer Purchases of Equity Securities ............. Selected Financial Data ......................................................................................................................................................... Management’s Discussion and Analysis of Financial Condition and Results of Operations................................................. Quantitative and Qualitative Disclosures About Market Risk ............................................................................................... Financial Statements and Supplementary Data...................................................................................................................... Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................................. Controls and Procedures ........................................................................................................................................................ Other Information .................................................................................................................................................................. PART III Directors, Executive Offiff cers and Corporate Governance ..................................................................................................... ....................................................................................................................................................... Executive Compensation Security Owneww rshipi of Certain Beneficff ial Owneww rs and Manaaa gement andaa Relatedaa rs .......................................... Certain Relationships and Related Transactions, and Director Independence ....................................................................... rr Principal Accountant Fees and Servirr ces ................................................................................................................................ PART IV Exhibits and Financial Statement Schedules.......................................................................................................................... Form 10-K Summary ............................................................................................................................................................. Stockholder Mattett m 3 9 22 22 22 22 23 25 26 37 37 37 38 40 41 41 41 41 41 42 45 2 Item 1. Business Zix Corporation (“Zix®,” the “Company,” “we,” “our,” or “us”) is a leader in email security. Trusr ted by the nation’s most PART I influff ential institutions in healthcare, finance, and government, Zix delivers a superi encryption, 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 primarily serve organizations in the healthcare, financial services, insurance and government sectors, including U.S. federal financial regulators, such as members of the Federal Financial Institutions Examination Council (“FFIEC”), 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. or experience and easy-to-use solutions for email uu ZixEncryptyy SM (forff merly ZixGateway® and ZixQuarantine®) bundles email encryption and DLP capabilities to enable the secure exchange of email that includes sensitive information. Through a comprehensive secure messaging service, ZixEncryptyy 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. allows The main differff entiation for Zix Encrypt in the marketplt ace 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 typiyy cally introduce an added burden on recipients, ofteff n requiring additional user authentication with creation of 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®, the world’s largest email encryption community, which is designed to share identities of our tens of millions of members (growing by approximately 160,000 members per week), (2) Zix’s patented Best Method of Delivery®, which is designed to deliver email in the most secure, most convenient method possible for the recipient, and (3) ZixEncrypt,yy which automatically encrypts and decryptyy s messages with sensitive content. The result is secure, transparent encrypted email, such that secure email can be exchanged without any impacmm t to administrators or extra steps for both senders and recipients. Zix delivers more than 1.5 million encryprr are exchanged transparently between senders and recipients. business day. Of those, approximately 70% ted messages on a typical yy ZixEncryptyy also addresses a business’s greatest source of data loss – corporate email – with an easy straightforff ward DLP approach. By focusing strictly on the risks of email, ZixEncryptyy simplifies DLP in comparison to other DLP solutions by decreasing complexity and costs, reducing deployment time from months to hours and minimizing impact on customer resources and workfloff w. In addition, Zix offerff s a convenient experience for both emplmm oyees interacting with our solution and administrators managing the system. ZixEncryptyy enables DLP capabilities for email by combining proven policy and content scanning capabilities with quarantine functionality. The quarantine system and its intuitive interface allows 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 emplmm oyees of quarantined messages. ZixEncryptyy 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 emplmm oyees about the sensitivity of their company’s data. ZixEncryptyy is available as a hosted solution, as a multi-tenant cloud 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 employm expertise in email security and its emphmm asis on customer success, which align with Zix’s reputation for delivering industry-leading solutions and a supeuu rior experience. ees’ Through the acquisition of Greenview, Zix launched two new solutions in April 2017 – ZixProtect and ZixArchive. 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 automatedaa trafficff analysis, machine learning and real-time threat analysis. 3 ZixProtect is available as a cloud-based service in three bundles. ZixProtect Essentials includes email threat protection, nation defenff imperso mm se, 0-hour malware filtering, and business email continuity to enable access to emails during service disruprr ZixProtect Plus adds policy based Content Disarm and Reconstruction with on-demand sandbox ing, as well as time-of-click link se, to provide enhanced protection against sophisticated, targeted threats; and ZixProtect Premium delivers a comprehensive defenff email security solution by including our leading email encryption and data loss prevention with our threat protection capabilities. d tion; ZixArchive is a low-cost, cloud-based email retention solution that easily enables user retrieval, compliance and eDiscovery. or ZixProtect bundles, ZixArchive includes policy-based retention, Available as a standalone or add-on solution for ZixEncryptyy automatic indexing and flexible search capabilities for audit and legal requirements. With on-demand access through the cloud, organizations can conveniently share messages with emplomm yees, auditors and outside consultants or legal counsel, as well as revoke access when needed. In April 2018, Zix acquired CM2.COM, Inc., d/b/a Erado (“Erado”), a unifiedff archiving company. Erado strengthens Zix’s comprehensive archiving solutions with unifiedff bundled services. Erado’s long standing focus on helping its customers comply with FINRA and SEC regulations helps further strengthen Zix’s offeri ngs 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. ision, security, and messaging solutions for customers that demand archiving, superv u ff ZixOne® is a unique mobile email app that solves the key IT challenge created by the BYOD trend in the workplace. describes emplomm yee’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 emplomm yee’s device where it is vulnerable to loss or theft.ff stolen, an administrator can simply disabla e access to corporate email from that device through ZixOne. If the device is lost or kk BYOD ZixOne is available as a standalone solution and easily integrates with ZixEncryptyy is the ability to encryptyy inforff mation is secured either by the user or through automatic policies of ZixEncryptyy . an email from your mobile device with the simple slide of an “Encrypt”yy as an add-on solution. One feature of ZixOne button, ensuring that sensitive Unlike other BYOD solutions, ZixOne meets emplomm yee desire for 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, emplmm oyees can stay productive while preserving device independence. A BYOD solution that is acceptable to emplomm yees and yet provides strong data protection for corporate data solves one of today’s greatest IT management challenges. Our business operations and service offeff rings are suppouu rted by the ZixData CenterTM, which is PCI DSS 3.2 certifiedff for applicable services, SOC2 accredited, and SOC3 certifieff d. The operations of the ZixData Center are independently audited annually to maintain AICPA SOC3 certification in the areas of security, confideff report on the effecff track record that exceeds 99.99% availability. e a SOC2 tiveness of operational controls used over the audit period. The ZixData Center is staffed 24 hours a day and has a ntiality, integrity and availability. Auditors also producdd On Februar security and productivity services, offerff ry 20, 2019, Zix complmm eted its acquisition of AppRiver, LLC (“AppRiver”), a channel-first provider of cloud-based ing web protection, email encryption, secure archiving, and email continuity solutions. cybery AppRiver is a channel-first provider of cloud-based cybey r security and productivity services, offeff encryption, secure archiving, and email continuity solutions. AppRiver also provides Microsoft Officff e 365 and Secure Hosted Exchange services, which serve as an effect accelerate our offeff 60,000 worldwide customers using a network of 4,500 Managed Service Providers, this acquisition also helps us expand our customer base. ive lead generation tool for the company’s solutions. The acquisition of AppRiver can rings into the cloud at the point of initial cloud application purchase. Because AppRiver currently services over ring web protection, email ff ff Our company was incorporated in Texas in 1988. Originally named Amtech Corporation, we changed our name to ZixIt ® Corporation in 1999 when we entered the encrypted email market. In 2002, we became Zix Corporation, and in 2017, the Company rebranded to Zix. Our executive offices (214) 370-2000. are located at 2711 North Haskell Avenue, Suite 2200, LB 36, Dallas, Texas 75204-2960, ff Overview Email is a mission-critical means of communication for enterprises. However, if email leaves a secure network environment in redirection, manipulation or clear text, it can be intercepted along the path between a sender and a recipient, which permits theft,ff exposure to unauthorized parties. Failure to control and manage such risks can result in enforcement penalties for noncompliance under numerous regulations, in addition to damaged reputation, competitive disadvantage, a loss of intellectual property or other corporate assets, exposure to negligence or liability claims, and diversion of resources to repair such damage. For examplm e, healthcare organizations, business associates and sub-u contractors are subject to the Privacy, Security, and Enforcement Rules of the Healtht 4 Information Portability and Accountability Act (“HIPAA”) as amended by the Health Inforff mation Technology for Economic and Clinical Health Act (“HITECH Act”). Financial institutions are subju ect to data privacy laws including the Gramm-Leach-Bliley Act (“GLBA”). These federal laws help drive the use of encrypted email. In addition, individual states such as Massachusetts and Nevada have enacted privacy laws requiring the safeguard of personal data, and almost all states encourage email encryption by allowing exemptimm ons from data breach notification laws. rr Corporat ions require easy to use, cost-effect ff ive email protection that can be used on an enterprise-wide basis. They need it to be quickly deployed and regularly updated to evolve with innovative technology practices and meet changing regulatory standards. To satisfy these needs, our Email Encryption Service provides a comprehensive solution that analyzes and encrypts email communications. Our Email Encryption Service allows a user to send encrypted email to any email user anywhere and on any Internet-enabled device. Encrypted email is delivered through the patented Best Method of Delivery protocol which automatically determines the most direct and appropriate means of delivery, based on the sender’s and recipient’s communications environment and preferff ences. The protocol suppouu rts a number of encryptyy ed email delivery mechanisms, including S/MIME, Transport Layer Security (“TLS”), Open Pretty Good Privacy (“PGP”), “push” delivery and secure portal “pull” delivery. These last two mechanisms enable users to send messages securely to anyone with an email address, including those who do not have an encryption tool. Our Best Method of Delivery makes the technology simple for end users and provides flexibility and ease of implemm mentation for inforff mation technology professionals. We believe the ability to send messages through different our Email Encryption Service supuu erior to competitive offerff modes of delivery is one of many differen tiators that makes ings. ff ff The deployment of our Email Encryption Service at the periphery of the customer’s network means our Email Encryption Service encrypts outbound email for an enterpris desktopkk softwff rr are. Our technology solutions are easy to use, easy to deploy, and can be made operational quickly. e without the need to create, deploy or manage end user encryption keys or deploy Our service has an integrated policy management capability. This policy engine can inspect the contents of emails and apply policies matching specific industry criteria such as HIPAA, the HITECH Act and GLBA. Customers can also build their ownww custom policies. This policy driven email encryption for regulatory compliance means customers can reduce the training required of their staffff and significff antly reduce the risk of inadvertently sending sensitive content by controlling the method of delivery through preset policies. Email is the number one communication tool for businesses and it is also one of the top vectors for cybery attacks. Attacks can jeopardize a company through malware, phishing, ransomware, business email compromise, viruses and other threats. Our advanced against email-borne attacks. Our threat protection solution uses a multi-layer approach to accurately identify email threats and defendff threat filters first analyze IP addresses and URLs then examine content for targeted phrases, campaign patterns and both known and zero-hour malware attacks. Accuracy is increased further with real-time threat analysts, automated trafficff learning. analysis and machine To safeguard against increasingly targeted and sophisticated attacks, our advanced threat protection can also leverage inspection of emails to performff quarantine and environment. Testing tly handles evasive attacker techniques while fully examining files for suspicious and malicious activity. Time-of-click link se reduces the risk of users clicking links in emails and inadvertently visiting malicious or compromised websites. This feature attachment assurance and time-of-click link defense to provide enhan nced protection. Attachment assurance offersff sandbox d ff efficien defenff re-writes all full, shortened, or obfuscated links to safe versions and perforff ms time-of-click analysis on the destination address, including IP address and domain blacklists, domain age and reputation, and other checks. forensic analysis of attachments in our secure, cloud-based sandbox d By combining our email encryption and advanced threat protection solutions, Zix meets customers’ increasing desire for a bundled solution that protects inboun n d and outbound email with leading email security. Competition The most significant differentiators for Zix as compared with our competition is ease of use and exceptional support . The best example of our unequalled ease of use is transparent delivery of encrypted email messages. We are able to deliver transparent email encryption as a result of our ZixDirectory, Best Method of Delivery and ZixEncrypt. The most critical and highly differff entiated component of our solution is the ZixDirectory which provides the ability to share user identities for encryption, and in turn provides frictionless interoperability between users in a community of interest such as healthcare, finance or government. uu 5 Our capability to offerff interoperability is particularly importm ant when it is necessary to communicate with external networks, as is the case with the healthcare and financial services markets. Our customers become part of the ZixDirectory, a global “white pages” enabling transparent secure communications with other ZixEncryptyy customers using our centralized key management system and overall unique approach to implm ementing encryptyy ed email. We enable secure communications with other users via TLS, Open PGP, “push” delivery and secure portal “pull” delivery mechanisms. However, we believe our unique transparent delivery is the more ff preferred delivery model. Our exceptional suppuu ort allows customers to reach Zix via phone or email 24/7/365 to address any questions or concerns. With the increasing cost and sophistication of email attacks, convenient access to our threat analysts at any time of the day provides our customers with unmatched peace of mind. We view our primary competitors in the email security space to be Proofpoint Inc., Mimecast, and Barracuda Networks. advanced threat protection against email attacks and “send-to-anyone” encrypted email, we Technically, while these companies offerff believe that Zix offersff supeuu rior customer service and unparalleled benefitff s that come from access to the ZixDirectory, use of our Best Method of Delivery protocol, and the industry’s only transparent email encryption. Nevertheless, some of these competitors are large rr enterpri antial financial and technical resources that exceed those we possess. ses with substu Regulatory Drivers We have been successful in securing market penetration in our target vertical markets of healthcare, finance services and government primarily due to regulations that address the need for data privacy and security. In addition to the need to protect personal data and sensitive business communication, demand for email security in the healthcare sector, including business associates of healthcare providers, is augmented by regulatory requirements under HIPAA and HITECH Act. The Privacy and Security rules under those acts provide severe penalties for violations, include strict breach notification requirements, and allow states to pursue HIPAA violations. In the financial services industry, financial institutions and their service providers are subju ect to the GLBA, which is enforced by the U.S. Federal Trade Commission (“FTC”). The FTC has issued guidance saying that businesses that transmit sensitive data by email should be sure to encrypt the data. In choosing an email security provider, compamm nies are influenced by the solutions chosen by their regulators. Our customers include all of the federal regulators that comprise the FFIEC as well as the state banking regulators in more than twenty states. Our service is also a recommended solution of the Confereff isors, whose members regulate the more than 4,600 state-chartered banks in the U.S. nce of State Bank Superv uu Additionally, state data breach laws and privacy regulations, along with highly public u ized breaches, have enhanced security awareness in vertical markets outside of healthcare and financial services and have promptmm ed affeff cted organizations to consider adopting systems that ensure data security and privacy. Even where there are no specificff protection to adhere to evolving industry best practices for protecting sensitive information. regulations, businesses may require email Sales and Marketing We sell our Zix Email Encryption, ZixProtect, ZixArchive, Zix DLP, and ZixOne Services through a direct sales force that focuses on larger businesses and a telesales force that focuses on small to medium-sized accounts. We also use a network of resellers and other distribution partners, including other service providers seeking an email encryption offeff manufacturing (“OEM”)-like relationship. New first year orders (“NFYOs”), definff ed as the twelve-month value of orders received from both new customers and from our existing customers ordering additional products or features, derived from our value-added resellers, OEM and third party distribution channels for 2018 were 43% of the total new first year orders compamm red to 56% in 2017. The reduction in orders received from our OEM channels was due in part to a migration of customers from our Google relationship into a direct relationship with Zix. In both years, the balance of our NFYOs were originated by our telesales and direct sales forces. As of December 31, 2018, we had 157 value-added resellers and 97 managed security service providers across the U.S. ring in an original equipment Employees We had 265 emplomm yees as of December 31, 2018. The majoa rity of our emplomm yees are located in Dallas, Texas. We also have a uu sales officeff smaller offiff ces located in Renton, Washington, and in Ottawa, Ontario, Canada. in Burlington, Massachusetts; an officeff in Ann Arbor, Michigan supportin r g ZixProtect and ZixArchive services; and 6 Research and Development We incurred research and development (“R&D”) expenses of $11.3 million, $11.0 million, and $9.6 million for the twelve- month periods ended Decembem r 31, 2018, 2017, and 2016, respectively. Over the course of 2018 we continued to make investments toward strengthening and expanding our service portfoff lio while aligning with customer trends toward simplification of infrastructure management through the use of cloud technologies. A new cloud tructure run and managed by platforff m was delivered which allows Managed Service Providers to provision and handle trafficff Zix. The new services and infrastruct direct and alternative channels which include enhanced variants of core Threat Protection, Encryption, Continuity and Archiving Technologies. ure were also extended to become the foundation for new security and compliance bundles for on infrasff rr In delivering new security and compliance bundles, the R&D organization materially enhanced and integrated the subsu ystem platforms obtained by way of acquisitions in 2017 and 2018. Web technology implem mentations associated with Threat Protection/Continuin ty and Multimedia Archive/Compliance platforms, obtained by way of acquisitions of Greenview Data and Erado respectively, were restructured to align to a new unifiedff ience model as were legacy Encryption subsu ystems and associated reporting and management capabilities. Most related services were enhanced with technologies to enable automation of customer- for the encryption appliance driven provisioning. We also completed branding and mobile-first modernization of the web interfaceff softwff elivery framework, thus enabling on-premises message delivery portal options for our customers. t Datacard and are now in the process of binding it into our Encryption Best-Method-of-Dff are we acquired from Entrusr user experxx Intellectual Property We depend upon our ability to develop, maintain and protect our proprietary technology and our related intellectual property rights. We rely on a combination of patent, trademark, trade secret and copyriyy ght law and contractual restrictions to protect the proprietary aspects of our technology and related property rights and to defenff d against infringement and/or misappropriation claims from others. We ownww 25 U.S. patents with expiration dates ranging from 2019 through 2036, and 10 pending U.S. Applications. We foreign countries where have a program to file applications for and obtain patents and trademarks in the United States and in specificff we believe filing for such protection is appropriate. While intellectual property rights are generally importan t to our business, we do not believe that our business is dependent on any single item of intellectual property, or that any single item of intellectual property is material to the operation of our business. Rather, we believe that our intellectual property rights provide us with a competitive advantage, and from time to time we have taken steps to enforce our intellectual property rights as a means of protecting that competitive advantage. m Our Company and certain of our subsidiaries are the owners of trademarks and service marks registered with the United States Patent & Trademark Offiff ce. These marks are renewable indefinitely, contingent upon continued use and payment of applicable renewal fees. Additionally, our Compamm ny and certain of our subu sidiaries own several pending trademark applications with the United States Patent & Trademark Offiff ce as well as a numberm of United States common law trademarks and several service marks and trademarks and service marks registered in foreign countries. We consider our trademark and service marks as valuable assets of the Company due to their recognition by our customers. We are not aware of any valid claims of infring use any of our trademarks or service marks in the United States. ement or challenges to our right to ff Please see generally the risks that are more fully disclosed in “Item 1A. Risk Factors” for risks related to our intellectual property. Compliance with Environmental Regulations We have not incurred, and do not expect to incur, any material expenditures or obligations related to environmental compliance issues. Governmental Contracts We have contracts with many local, state and federal agencies and regulators, which in the aggregate contributed approximately 7% of our annual revenue in 2018. Significant Customers In each of 2018, 2017, and 2016, no single customer accounted for 10% or more of our total revenues. 7 Backlog Our backlog is comprised of contractual commitments that we expect to recognize as revenue in the future. Our backlog was $73.0 million at Decembem r 31, 2018, compamm red to $72.6 million at Decembem r 31, 2017. As of Decembem r 31, 2018, our backlog is comprmm ised of the following elements: $32.1 million of deferred revenue that has been billed and paid, $10.7 million billed but unpaid, n and approximately $30.2 million of unbilled contracts. The backlog is recognized into revenue ratably as the services are performff ed. Approximately 65% of our total backlog at Decembem r 31, 2018, is expected to be recognized as revenue during the next twelve months. Seasonality The Compamm ny typiyy cally experiences lower NFYO’s in the first quarter of the calendar year. Our budget anticipates fewer NFYO’s in the first quarter, but historically this has not resulted in a material impactm to our revenue or earnings on a seasonal basis. Geographic Inforff mation Our operations are primarily based in the U.S., with approximately 4% of our emplomm yees located in Canada. Except for a United Kingdom based data center, we did not operate in, or have dependencies on, any other foreign countries as of Decembem r 31, 2018. Our revenues and orders to-date are almost entirely sourced in the U.S. and all significaff located in the U.S. nt corporate assets at December 31, 2018, were Financial Inforff mation About Industry Segments We have one reportable segment consisting of email encryption and security solutions. We internally evaluate all of our product offeff rings and other sources of revenue as one industry segment, and, accordingly, do not report segment information. Available Information rr Our Internet address is www.zixcor p.com . Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available on our website, without charge, as soon as reasonably practicable after electronically file such material with, or furnish it to, the SEC. The information found on our website shall not be considered to be part of this or any other report filed with or furnished to the SEC. ff we ii In addition to our website, you may read and copy any materials we electronically file with the SEC through the SEC’s website at www.sec.gov. The SEC’s website contains reports, proxy and other inforff mation statements, and other information regarding issuers, including us, that file electronically with the SEC. NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS This document contains “forff ward-looking statements” (including the discussion appearing under the caption “Liquidity ll of Financial Condition and Resultsll of Operations,”) within the Summary” in “Item 7. Management’s Discussion and Analysis meaning of Section 27A of the Securities Act of 1933, as amended (the “Act”) and Section 21E of the Exchange Act. All statements other than statements of historical fact are “forff ward-looking statements” for purposes of federal and state securities laws, including, but not limited to: any projections of future business, market share, earnings, revenues, recognition of revenues from backlog, cash receipts, or other financial items; any statements of the plans, strategies, and objectives of management for future operations, future acquisitions or the integration thereof; any statements concerning proposed new products, services, or developments; any statements regarding future economic conditions or performff ance; any statements of belief; and any statements of assumptions underlying any of the foregoing. Forward-looking statements may, but need not, include words such as “may,” “will,” “predict,” “project,” “foff recast,” “plan,” “should,” “could,” “goal,” “estimate,” “intend,” “continue,” “believe,” “expect,” “outlook,” “anticipate,” “hope,” and other similar expressions. Any forward-looking statements involve risks and uncertainties that could cause actual events or results to differff materially from the events or results described in the forward-looking statements, including, butuu not limited to, the risks and uncertainties described in the “Item 1A. Risk Factors” section. Although we believe that expectations reflected in and the assumptions underlying our forward-looking statements are reasonable, actual results or assumptions made could differff materially from those projected or assumed in any of our forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subju ect to change and to inherent risks and uncertainties, including, but not limited to, those disclosed in this document. Forward-looking statements speak only as of the date on which they are made, and we do not intend, and undertake no obligation, to update any forward-looking statement. 8 Item 1A. Risk Factors The following is a cautionary discuii ssion of risks, uncertainties and assumptions that we believe are significant to our business, financial condition and financial results. In addition to the factors discussed elsewhere in thisii Annual Repor following are some of the important factors that,t individualdd froff m those described in any forward-looking statements. It is impossible to predict or identify all such factorsrr and,dd as a result, you the following factorsrr to be a complete discii ussion of risks, uncertainties and assumptions. should not considerdd ate, we believe could make our results differ t on Form 10-K,KK the i ly or in the aggreg gg e materially Risks Related to our Business Our business depends upon customers using email and certain social media platforms to exchange confidff ential information, and a significff ant shiftff of those messages to other communication channels could impair our growth prospects and negatively affeff ct our business, financial condition and financial results. Our customers deploy and use our products and services to easily, securely and confideff ntially send and receive electronic ntially depend on our current and potential customers using email and social media to exchange sensitive information messages, by way of internet communications channels including email and certain social media platforff ms. Our business and revenue substa u migration to alternative means of secure electronically. New technologies, products, or business models that could support communications could be disruptuu ive to our business. If prospective or current customers were to send and receive sensitive inforff mation using technology or communication channels other than email or the social media platforff ms that we suppuu ort, our growth prospects and our business, financial condition and financa ial results could be materially adversely affeff cted. uu Our business depends on market acceptance of our products and services, and our failure to achieve and maintain influential customers could negatively affecff t our business, financial condition and financial results. In order to continue to operate profitff ably and grow, we must achieve and maintain broad market acceptance of our products and services at a price that provides us with an acceptable rate of return relative to our costs. We have been successful in selling our Email Encryptyy ion products and services to high-profilff e customers in the healthcare, financial services and government segments of the market. The acceptance and use of our products and services by those significaff nt customers facilitates our sales to other potential customers, and an expanding base of users in the Zix Directory aids in our market penetration and expansion. The loss of an influential customer of our existing producd ts and services, or the failure to achieve suffici ZixProtect and ZixArchive, could impamm ir our ability to expand the market penetration of our products and services, or cause us to reduce or increase prices, which could reduce our revenues and net income and materially adversely affeff ct our business, financial condition and financial results. ent market adoption of new products including ff Our business relies on securing new customer subscriptions and subscription renewals from existing customers. The vast majoa rity of our revenue is derived from customer subscu riptions, and existing customers have no contractual obligations u iptions and purchasing additional solutions or services after to purchase beyond the initial subsu cription or contract period. Our ability to grow our business is dependent in part on customers renewing their existing subscr we maintain and analyze historical data with respect to rates of customer renewals, upgrades and expansions, those rates may not accurately predict future trends in renewal of certain producdd ts and services offeff red by us. If our customers cancel or amend their agreements with us during their term, do not renew their agreements, renew on less favorable terms or do not purchase additional solutions or products during renewal periods, our revenue may grow more slowly than expected or decline and our profitabil be harmed. the initial term of their agreement. Though ity may ff ff Additionally, we have experienced, and expect to continue to experience, some level of attrition with existing customers and we may not maintain historical subsu cription rates, and we may be unablea have historically retained approximately 90% of our recurring revenue on an annual basis, there has been some recent decline in such retention and our customers’ renewal rates may further decline or fluctuate as a result of a number of factors, including the level of their satisfacff services, customer merger or acquisition activity, customer budgets, the pricing of our products compared with those offerff ed by our competitors, technology trends, the prevailing regulatory regime and general market conditions. If new subscu ion renewals decline from their current levels, our revenue or revenue growthww may decline, and our business may sufferff which could have a materially adverse effeff ct on our financial performance. to accurately predict our customer renewal rates. Although we tion with our products and technical support riptions or subscript uu u 9 The security of our networks and data centers is critical to our business and an actual or perceived breach of security through a cyber-attack or otherwise could cause us to lose customers and could negatively affect condition and financial results. our reputation, business, financial ff We are dependent on our networks and data centers to provide our products and services. Due to the nature of the products and services we provide and the sensitive nature of the information we collect, process, store, use and transmit, we may face cybery data protection breaches, computer viruses and other similar disruptu ions from unauthorized tamperimm ng or human error that attempt to penetrate and could harm our networks and data centers. Our business depends on customers having and maintaining confidence that we provide effeff ctive network and security protection. To reduce the risk of a successful cybery implemm mented significaff nt physical and logical security measures to detect, identify and mitigate threats as well as to monitor for and respond to potential breaches and incidents. Despite these security measures, our networks and data centers may remain vulnerable. We may not be able to correct a security flaw or particular vulnerability promptly, or at all. Further effoff rts may be costly to implmm ement and may not be successful. If a cybey r- malicious third parties to disrupr attack or other breach of security occurs, or is perceived to have occurred, in our internal systems or at our data centers and networks, it could cause negative publu icity, interruption of our services, damage to our reputation, unauthorized disclosure of our customers’ confideff disclosure, modification or removal of our confidential ff secrets, loss of customers, lost revenue and increased expense (including potentially indemnificatio could have a material adverse effeff ct on our business, financial condition and financial results. n of our trade n or warranty costs), any of which ntial or proprietary information (including personally identifiabff or sensitive information, theftff or unauthorized use or publicatio le information), disclosure of our intellectual property,tt -attack or similar event, we have t or undermine our security effoff rts to limit the ability of u ff ff -attacks, Public key cryptography technology used in our businesses is subject to technology integrity risks that could reduce demand for our products and services and could negatively affect our business, financial condition and financial results. u c reports of successfulff Our business emplomm ys public key cryptography technology and other encryption technologies to encrypt and decrypt sensitive data. The security afforff ded by encryption depends on the integrity of the private key, which is predicated on the assumptm ion that it is very diffiff cult to mathematically derive the private key from the related public email, or publiu methods or technologies, such as quantum computing, make it easier to derive the private key from the related public y technology could be impairmm ed and our products and services could become less of encryption services using public key cryptographa marketable. That could require us to make significan t changes to our products and services, which could increase our costs, damage our reputation, or otherwise harm our business. Any of these events could reduce our revenues, increase our expenses and materially adversely affeff ct our business, financial condition and financial results. decryption, whether or not true, could reduce demand for our products and services. If new key. Successful decryptyy ion of intercepted encrypted key, the security u u u ff Our business depends substantially on our data center facilities and other systems and infrastructure provided by third parties, and their unreliability or unavailability for a significant period could cause us to lose customers and could negatively affeff ct our business, financial condition and financial results. -attacks, sabotage, vandalism, earthquakes, terrorist attacks, hostilities or war or other events. Computer Our business relies on third-party suppuu liers of computer, cloud and telecommunications infrastructure to provide our products and services through the global Internet and to provide network access between our data centers, our customers and end-users of our products and services. Much of the computer and communications hardware upon which our businesses depend is located in our data center facilities in North America and in the United Kingdom. Our data centers might be damaged or interruprr numerous factors, many of which are beyond our control, including fire, flood, power loss, mechanical failure, telecommunications failure, break-ins, cybery viruses, equipment failure, denial of service attacks, and similara disruprr ed by third parties or our systems might cause service interruptuu ions, delays and loss of critical data, and could prevent us from providing our services. Problems affeff cting our data center operations or the networks on which we rely, whether or not in our control, could result in loss of revenues, increased expenses, failure to achieve market acceptance, diversion of resources, injun ry to our reputation, liability and increased costs, and may cause our customers to terminate or elect not to renew their agreements. We do not carryrr sufficie nt insurance to compensate us for all losses that may occur as a result of any of these events. Though our products generally tolerate isolated supplie r outages or problems, could materially adversely affeff ct our business, financial condition and financial results. r failures, the occurrence of any of these events, including multiple supplie tions affeff cting the internet, infrastructure suppli ted as a result of uu uu uu ff Outages or problems with internet communication systems and infrastructure supplied by third parties could negatively affect our business, financial condition and financial results. ff Our business relies on third-party suppluu communications service suppliers uu users of our products and services. If those supplier systems, we may be unable to gain or retain customers. These suppliers as a result of internal system failures or external third-party actions. Though our products generally tolerate isolated suppli multiple suppuu lier outages or problems could materially adversely affeff ct our business, financial condition and financial results. periodically experience outages or other operational problems er failures, and the global internet to provide network access between our data centers, our customers and end- s do not enable us to provide our customers with reliable, real-time access to our iers of the telecommunications and internet infrastructure. We use various uu uu uu 10 The infrastructure supporting our business may sufferff lose customers, increase our operating costs and could negatively affecff capacity constraints and business interruptions that could cause us to t our business, financial condition and financial results. Our business depends on our providing our customers reliable, real-time access to our data centers and networks. Customers will not tolerate a service hampered by slow delivery times, unreliable service levels, service outages, or insufficient capacity. System capacity limits or constraints arising from unexpected increases in our volume of business or network trafficff outages or delays in our services, or deterioration in their performance, or could impairmm be able to accurately projeo ct the rate of increase in usage of our systems or to timely increase capacity to accommodate increased trafficff third parties, which could result in our losing customers and revenues, or incurring liabilities that could have a material adverse effecff on our business, financial condition and financial results. could cause interruptuu ions, our ability to process transactions. We may not ons may prevent us from effiff ciently providing services to our customers or other on our systems. System delays or interruptiuu t The growth of our business may require significaff achieve delayed, or lower than expected benefitff s, which could impair our profitab financial condition and financial results. nt investment in systems and infrastructure and these investments may t our business, ility and negatively affff ecff ff r an increasing numberm of customers enhanced rings, systems and infraff structure may require us to commit substa As our operations grow in size and scope, we continually need to improvmm rings, systems and infrastructure to offeff products, services, features and functionality, while maintaining the reliability and integrity of our systems and infrastructure and pursuing reduced costs per transaction. Expanding our technology offeff u assurance that the volume of our business will increase, which could reduce our net income, deplete our cash, and materially advedd rsely affeff ct our business, financial condition and financial results. Developing and launching new product offerff ings adjad cent to or outside of our core service offeff the same time, these new offeff execute a sales and marketing strategy that justifiesff initiatives could materially adversely affeff ct our business, financial condition and financial results. rings involve greater uncertainty concerning both market acceptance and our ability to successfulff our investments. Our failure to properly manage and execute new product rings can be particularly costly in terms of capital investments for both product development and marketing. At ntial financial, operational and technical resources, with no e and upgrade our technology offeff ly aa Because we recognize subscription revenue over the term of the applicable customer agreement, a decline in subscription renewals or new service agreements may not be reflected immediately in our operating results. y one We generally recognize revenue from customers ratably over the terms of their customer agreements, which are typicall year or two years. As a result, much of the revenue we report in each quarter is deferred revenue from customer agreements entered into during previous quarters. Consequently, a decline in new or renewed client agreements in any one quarter will not be fully reflected diffiff cult for us to rapidly increase our revenue through additional sales in any period, as revenue from new clients must be recognized over the applicable subscriptio in our revenue or our results of operations until future periods. Accordingly, this revenue recognition model also makes it n term. yy u ff Our failure to keep pace with rapid technology changes could have a negative impact on our business, financial condition and financial results. The markets for our products and services are characterized by rapid technological developments and frequent changes in customer requirements. We must continually improm ve the perforff mance, features and reliability of our products and services, particularly in response to competitive offerff services address evolving operating environments, devices, industry trends, certificatio required to expand our offeff rt a broader range of mobile rings for virtual computer environments and mobile environments to suppouu devices. We also may need to develop products that are compatible with new operating systems while remaining compatible with existing, popular operating systems. Our business could be harmed by our competitors announcing or introducing new products and services that could be perceived by customers as superio development, but our research and development resources are more limited than many of our competitors. ings, to keep pace with these developments. We must ensure that our producdd ts and r to oursuu . We spend considerable resources on technology research and ns and standards. For example, we have been uu ff In addition, we are also focused on addressing new and accelerating market trends, such as the continued decline of on premise email security and advance threat protection solution(s) and the continued transition towards cloud-based solutions, which requires us to continue to impromm ve our product and service offeff our effoff rts to address these challenges and higher than expected or unanticipated execution costs. Our failure to introduce new or enhanced products on a timely basis, to keep pace with rapid indusd try, technological or market changes or to gain customer acceptance for our new and existing producdd ts and services, such as mobile device data protection, could have a material adverse effeff ct on our business, financial condition and financial results. rings. We may experience delays in the anticipated timing of activities related to 11 We face strong competition, which could negatively affecff t our business, financial condition and financial results. The markets in which we compete are characterized by rapid change and converging technologies and are very competitive. red by companies such as Barracuda Networks, Inc., Proofpoin red by companies such as AirWatch/VMWare, Citrix (with XenMobile), Blackberry, IBM/Fiberlink (with ings to expand the With rising demand for private and secure email communications, there is strong competition for email encryptyy ion products and services. Our Email Encryption Threat Protection, Archive, and Data Loss Prevention business competes with products and services offeff products and services offeff MaaS360), and MobileIron. Strong competition requires us to develop new technology solutions and service offerff functionality and value that we offeff customers as equivalent to, or having advantages over, our products and services. Competitors could capture a significant share in our markets, causing our sales and revenue to decline or grow more slowly. Barriers to entry are relatively low, and new ventures are oftenff formed that create producdd ts competitive with our products. Competitive pressures could lead to price discounting or to increases in expenses such as advertising and marketing costs. Increased competition could also decrease demand for our products and services. Competition could reduce our revenues and net income and materially adversely affeff ct our business, financial condition and financaa results. r to our customers. Our competitors may develop producdd ts and services that are perceived by t, MIMECast, and Virtru. Our ZixOne business competes with ial ff Industry consolidation may lead to increased competition and may negatively affect our operating results. There has been a trend toward industry consolidation in our industry for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. For example, some of our current and potential competitors have made acquisitions, or announced new strategic alliances. Compamm nies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better abla e to compete as sole-source vendors for customers. This could have a material adverse effecff condition and financial results. t on our business, financial Some competitors have advantages that may allow them to compete more effectively business, financial condition and financial results. ff than us, which could negatively affect our Some of our competitors have longer operating histories, more extensive operations, greater name recognition, larger technical staffs, bigger product development and acquisition budgets, established relationships with more distributors and hardware vendors, and greater financial and marketing resources than we do. These advantages might enable them (independently or through alliances) to develop and expand functionality of producd ts and services faster than we can, to spend more money to market and distribute products r their products and services at prices lower than ours. These advantages could reduce our revenues and services than we can, or to offeff and net income and materially adversely affeff ct our business, financial condition and financial results. If we do not effectively expand and train our sales force, we may be unable to add new customers or increase sales to our existing customers and our business may be negatively affected. ff We continuenn u to be substan tially dependent on our sales force to obtain new customers and to sell additional solutions to our nt numbem rs of sales personnel to suppor existing customers. We believe that there is significff ant competition for sales personnel with the skills and technical knowledge that we require. Our ability to achieve significaff ting, training and retaining t training and, in most cases, take significff ant ff sufficie time beforff e they achieve full productivity. Our recent hires and planned hires may not become as productive as we expect, and we may be unable to hire or retain sufficie If we are unable to hire and train sufficff new clients or increasing sales to our existing client base, our business will be harmed. nt numbers of qualified individuals in the markets where we do business or plan to do business. in obtaining of effeff ctive sales personnel, or the sales personnel are not successfulff ient numbersm nt revenue growth will depend, in large part, on our success in recruirr t our growthww . New hires require significan uu ff ff If we do not successfully manage our strategic alliances, we may not realize the expected benefits from such alliances and we may experience increased competition or delays in product development. We have entered into several strategic alliances with other companies to offeff r complementary products and services. These arrangements are generally limited to specificff projects or series of projects, and their main goal is generally to facilitate product compamm tibility and adoption of industry standards. There can be no assurance that we will realize the expected benefits from these strategic alliances. If successful, these relationships may be mutually beneficia l and result in industry growth. However, alliances carry an element of risk because, in most cases, we must compete in some business areas with a company with which we have a strategic alliance and, at the same time, cooperate with that company in other business areas. Also, if these partner companies fail to performff delays in product development or other operational diffiff culties. or if these relationships fail to materialize as expected, we could sufferff ff 12 We enlist third-party distributors to market our products and services, and our failure to succeed in those relationships could negatively affect our business, financial condition and financial results. ff We distribute a significaff nt percentage of our products and services by entering into alliances with third parties who can offeff r our products and services along with their own or our competitors’ products and services. Increased reliance on third parties to market and distribute our producd ts and services exposes us to a variety of risks. For example, we have limited control over and visibility into the sales cycles of third-party distributors, which could increase the length of our sales cycle, cause our revenue to fluctuate unpred and make it difficff ult to accurately forecast our revenue. In addition, we may not succeed in developing or maintaining marketing alliances. Companies with which we have marketing alliances may in the future discontinue their relationships with us, form marketing alliances with our competitors, or develop and market their own products and services that compete with ours. If a significaff products and services and our revenues could decline. Our failure to develop, maintain and expand strategic distribution relationships could reduce our revenues and net income and materially adversely affeff ct our business, financial condition and financial results. nt distributor were to discontinue its relationship with us, we could experience an interruprr tion in the distribution of our ictably nn Our future growth and success may be affected by acquisitions. If we are not able to successfull and integrate acquisitions, our operating results and prospects could be negatively affect ed. ff ff y identify, negotiate, complete We have acquired and expect to continue to acquire new products and technology, as well as customers, through acquisitions. The success of our future acquisition strategy will depend on our ability to identify, negotiate, complete and integrate acquisitions. Acquisitions are inherently risky, and any acquisition we complete may not be successful. Acquisitions we pursue, including our recent AppRiver acquisition, involve numerous risks, including the following: (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) diffiff culties in integrating and managing the operations and technologies of the companies and assets we acquire; diversion of our management’s attention from normal daily operations of our business; our inability to maintain the customers, the key emplom yees, the key business relationships and the reputations of the businesses and producd ts we acquire; our inability to generate sufficff acquisitions; ient revenue from acquisitions to offsff et increased expenses generally associated with diffiff culties in predicting or achieving synergies and cost savings between our existing businesses and acquired businesses; our responsibility for the liabilities of the businesses we acquire, including liabilities arising out of their failure to operate correctly, maintain effeff ctive data security, data integrity, disaster recovery and privacy controls prior to acquisition, or their infringement or alleged infringement of third-party intellectual property, contract or data access rights prior to acquisition; diffiff culties in complying with new markets or regulatory standards to which we were not previously subju ect; diffiff culties or unanticipated expenses associated with development work that is necessary to achieve interoperability between our products and solutions and the products and solutions we acquire; difficulties or unanticipated expenses associated with migrating customers from producd ts and solutions developed by our acquisition targets to our own products and solutions; delays in our ability to implmm ement internal standards, controls, procedures and policies in the businesses we acquire; and adverse effect ff s of acquisition activity on the key performance indicators we use to monitor our performff ance as a busines Unanticipated events and circumstances occurring in future periods may affeff ct the realizability of intangible assets that we are required to record on our balance sheet as a result of acquisitions. These events and circumstances could include significff ant under- performff ance relative to projeo cted future operating results and significant changes in our overall business or product strategies. Such events and circumstances may cause us to revise our estimates and assumptions used in analyzing the value of our intangible assets, and any such revision could result in a non-cash impamm irment charge that could have a material impamm ct on our financial results. ff Unfavorab financial results. le economic environments, particularly in the U.S., could negatively affect ff our business, financial condition and Challenging economic conditions worldwide have from time to time contributed, and may contribute to future slowdowns in the technology and networking industries at large, as well as in the email/data security market and in specific geographic markets in which we operate. If economic growthww in those markets, particularly in the U.S., which accounts for a subsu tantial majoa rity of our revenue, slows, or credit is unavailable at a reasonable cost, curren purchases, including the deployment or expansion of our products and services. Additionally, as we continue along our path of t and potential customers may delay or reduce technology uu 13 exploring additional international markets, we may become more susceptible to unfavorable economic environments outside the U.S. and that could compound the negative effeff cts of unfavorable economic environments in markets in which we currently operate. This could result in reduced sales of our products and services, longer sales cycles, slower adoption of new technologies and increased s, price competition. In addition, adverse economic conditions could negatively affeff ct the cash flow of our customers and distributoruu which might result in failures or delays in payments to us. This could increase our credit risk exposure and delay our recognition of revenue. Specificff corporate information technology spending, could have a more direct impamm ct on our business. If these conditions persist, spread or deteriorate further, our business, financial condition and financial results could be materially adversely affeff cted. economic trends, such as declines in the demand for cloud computing services and computing devices, or softnff ess in If our products do not work properly or have security vulnerabilities, our reputation, business, financial condition and financial results could be negatively affected and we could experience negative publicity, declining sales and legal liability. The threats facing our customers are constantly evolving and the techniques used by experienced hackers to access or sabotage data change frequently, ofteff n are not recognized until launched against a target, and may originate from less regulated or remote areas around the world. As a result, we must constantly update our product solutions to respond to these threats. We produce complmm ex solutions that incorporate leading-edge technology, including both hardware and softwff are that must operate in a wide variety of technology environments. Softwff vulnerabilities that can lead to unauthorized use or data loss. There can be no assurance that our testing programs will be adequate to detect all defects prior to the product being introduced, which might decrease customer satisfaction with our products and services. The product reengineering cost to remedy a product defecff t or mitigate vulnerabilities could be material to our operating results. Our inability to cure a product defecff security breach, negative publiu expense, any of which could have a material adverse effect t could result in the temporaryrr or permanent withdrawal of a product or service from the market, a city, damage to our reputation, failure to achieve market acceptance, lost revenue and increased are may contain defeff cts or “bugs” that can interfere with expected operations or introduce security on our reputation, business, financial condition and financial results. ff Our transmission and storage of personally identifiable information, including the personal data of European data subjects and other confidential information, and the potential for inadvertent exposure of PII or CI, could cause us to violate data privacy laws or lose customers and could negatively affect our business, financial condition and financial results. We transmit and store large amounts of personally identifiable information (“PII”) about individuals, which may include healthcare or financial information, and other confidentia and enhance, security measures and controls to help protect against unauthorized disclosure of such PII and other CI, an inadvertent disclosure of,ff or unauthorized third-party access to, PII or CI, could disruptuu our operations, damage our reputation and subject us to claims or other liabilities. l information (“CI”). Although we have established, and continue to develop ff In addition, our processing and storage of certain typeyy s of data is subju ect to confideff ntiality agreements with our clients and handling PII is increasingly subject to a variety of changing privacy and data security regulations around the world. For examplemm , the collection and use of personal data in the European Union, previously governed by the provisions of the Data Protection Directive, were replaced with the General Data Protection Regulation, or GDPR, in May 2018. GDPR imposmm es several requirements relating to the collection, use, processing and transfer of personal data, such as requirements for using consent or other legal grounds to process personal data, providing inforff mation to individuals about how their personal data is used, maintaining adequate security and data protection measures, giving data breach notificaff tions, complying with individuals’ requests to access, correct or delete their personal data and using third-party processors of personal data. GDPR also maintains the European Union’s strict rules limiting the transfer of personal data out of the European Economic Area. Failure to comply with the requirements of GDPR and the applicable national data protection laws of the European Union Member States may result in fines and other administrative penalties. GDPR will introduce substa ntial potential fines for violations and increase our responsibility and liability in relation to personal data that we process. To u comply with the GDPR, we may be required to put in place additional technical and administrative measures and controls mechanisms. This may be onerous and adversely affect ff laws and regulations are subju ect to new and differing October 2015, the European Court of Justice invalidated the U.S.-EU Safe Harbor framework that had been in place since 2000, which allowed companies including us to meet certain European legal requirements for the transfer of personal data from the European Economic Area to the United States. In the wake of that decision, we decided to participate in the new EU-U.S. Privacy Shield framework established by the U.S. Department of Commerce and the European Commission and opened for participation on August 1, 2016. We applied for and were approved for certificati Privacy Shield self-cff ertification was finalized by the Department of Commerce and became effeff ctive as of November 9, 2016 and was renewed in Novembem r 2017. This allows us to transferff United States, in compliance with the Privacy Shield principles. While our Privacy Shield certificaff Model Clauses) to lawfulff these legal challenges may result in different personal data. Future changes in requirements under these regulations may be inconsistent with our existing data management practices. If so, we could be required to fundamentally change our business activities and practices or modify our software, which could have an adverse effeff ct on our business, including increased cost of compliance and limitations on data transfer for us and our customers. ly transfer such data remain in place, those mechanisms are also subju ect to pending legal challenges and ring standards for the transfer of our business, financial condition, results of operations and prospects. Such interpretations and may be inconsistent among jurisdictions. For examplmm e, in personal data of European data subju ects that we receive from customers to the on and are now an Active Participant in the Privacy Shield program. Ouru European data protection regulators applying diffeff tion and other mechanisms (such as ff ff ff 14 Any inability to adequately address privacy concerns, even if unfounff ded, or to comply with applicable privacy or data protection laws, regulations and policies, could result in additional costs and liability to us, damage our reputation, inhibit sales, and harm our business. Furthermore, any inadvertent disclosure of,ff or unauthorized access (including due to a cybey r-attack) to, PII or other CI or other failure by us to comply with data privacy requirements could subju ect us to significaff expenses, and damage our reputation, any of which could have a material adverse effect financial results. nt penalties, damages, remediation and other on our business, financial condition and ff Problems with protecting and enforcing our intellectual property rights could negatively affect condition and financial results. ff our business, financial We rely on a combination of contractual rights, trademarks, trade secrets, patents and copyriyy ghts to establish and protect intellectual property rights and other proprietary rights in ouruu products and services. These intellectual property rights or other proprietary rights might be challenged, invalidated or circumvented. The steps we have taken to protect our proprietary inforff mation may not prevent its misuse, theftff or misappa substu antially equivalent or supeuu rior to our products or that inappropriately incorporate our intellectual property rights or other proprietary technology into their products. Competitors may hire our former emplomm yees who may misappropriate our intellectual property rights or other proprietary technology. Some jurisdictions may not provide adequate legal protection of our intellectual property rights or other proprietary technology. ropriation. Competitors may independently develop technologies or products that are We may have to defend or assert our rights in intellectual property that we use in our products and services, and we could be found to infringe the intellectual property rights of others, which could be disruptive and expensive to our business. We may have to defenff d against claims that we or our customers are infriff nging the rights of third parties in patents, copyriyy ghts, trademarks and other intellectual property. If we acquire technology to include in our products and services from third parties, our gement actions may increase because we must rely upon these third parties to verify the origin and ownership of exposure to infrinff such technology. Also, we may be required to spend significant resources to monitor and protect our intellectual property rights, including initiating claims or litigation against third parties foff r infringement or misappropriation. Intellectual property litigation and controversies are disruptuu ive and expensive, whether or not resolved in our favor. Even unmeritorious claims brought against us or our customers may harm our reputation and customer relationships, may cause us to incur significaff may have to be settled for significff ant amounts. Infriff ngement claims against us could require us to develop non-infringing products and services or enter into expensive royalty or licensing arrangements. Our business, financial condition and finff ancial results could be materially adversely affeff cted if we are not able to develop non-infringing technology or license technology on commercially reasonable terms. nt legal and other fees to defenff d, and We may face risks from using “open source” software that could negatively affect our business, finff ancial condition and financial results. Like many other software companies, we use “open source” software in order to take advantage of common industry building blocks and to add functionality to our products quickly and inexpxx ensively. Open source software license terms could adversely affeff ct our intellectual property rights in our products that include open source software. Depending upon how the open source softwff deployed, we could be required to offeff modifications or derivative works. Any of these obligations could have an adverse impactm revenue from products incorporating the open source software. Using open source code could also cause us to inadvertently infringe third-party intellectual property rights or require us to public s in place that are designed to address these risks and concerns, but we cannot be sure that our process or controls will be suffici mitigate all risk in this regard. Open source software might also introducd e security vulnerabilities or defecff ts. source community may not always respond with adequate urgency to mitigate the impacmm ts of such defecff ly disclose proprietary information. We have processes and control are for no cost, or make available the source code for ff tive functionality. The open r products that use the open source softwff on our intellectual property rights and tt ent to are is u We rely on the availability of third-party intellectual property, which may not be accessible to us on reasonable terms or at all. Some of our products include third-party intellectual property, which may require licenses for our use. For examplmm e, a nt portion of the revenue generated by our Erado business is dependent on the licensing of certain electronic message API’s, nt significaff such as those made available by LinkedIn Corporation, SMS providers, Facebook, and othet portion of the revenue generated by our AppRiver business is dependent on the licensing of Microsoftff products such as Officeff Based on past experience and industry practice, we believe that such licenses can be obtained on reasonable terms; however, there can be no assurance that we will be able to obtain or maintain the necessary licenses for new or current products on acceptable terms or at all. Changes in the terms of such licenses may decrease our product margins and our failure to obtain or maintain such licenses may limit our ability to sell our products, either of which could have a material adverse effect financial results. r social media channels, and a significaff 365. on our business, financial condition and ff 15 We may fail to recruit and retain key personnel, which could impair our ability to meet key objectives. Our success depends on our ability to attract and retain highly-skilled technical, managerial, sales, and marketing personnel. Changes in key personnel may be disruptuu ive to our business. It could be diffiff cult, time consuming and expensive to replace key personnel. Integrating new key personnel may be difficu lt and costly. Volatility, lack of positive perforff mance in our stock price or changes to our overall compensation program including our stock incentive program may adversely affeff ct our ability to retain key emplomm yees, many of whom are compensated, in part, based on the perforff mance of our stock price. The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future or delays in hiring required personnel could make it our business, financial diffiff cult to meet key objectives. Any of these impamm irments related to our key personnel could negatively affect condition and financial results. ff ff Governmental restrictions on the sale of our products and services in non-U.S. markets could negatively affeff ct our business, financial condition and financial results. Exports of softwff are solutions and services using encryption technology such as ours are generally restricted by the U.S. restrictions on the impomm rtation and use of encryption solutions and services such as ours. The cost of compliance with U.S. and our products and services in non-U.S. markets, could affeff ct government. Although we have obtained U.S. government approval to export our service to almost all countries, the list of countries to which we (and our distributors) cannot export our producdd ts and services could be expanded in the future. In addition, some countries imposemm other export laws, or our failure to obtain governmental approvals to offerff our ability to sell our products and services and could impairmm compliance risks. If we or our distributors fail to comply with applicable law and regulations, we may become subu jeb ct to penalties, fines or restrictions that could materially adversely affeff ct our business, financial condition and financial results. ouruu international expansion. We face a variety of other legal and Our sales to government entities are subject to a number of challenges and risks. nt upfront time and expense without any assurance that these effoff Sales to U.S. federal, state and local governmental agency customers have accountenn d for a significaff in past periods, and we may in the future increase sales to government agencies. Sales to government entities are subju ect to a number of challenges and risks. Selling to government entities can be highly competitive, expensive and time consuming, ofteff n requiring significaff requirements ofteff n carry a high compliance risk. Government certification requirements for solutions like ours may change and in doing so restrict our ability to sell into the federal government sector until we have attained the revised certification. Government demand and payment for our solutions may be impacted reductions or delays adversely affeff cting public contractual or other legal rights to terminate contracts for convenience or due to a default, impactmm mm sector demand for our solutions. Government entities also may have statutory, sector budgetary cycles and funding authorizations, with funding rts will generate a sale. Government contractual and any such termination may adversely our future operating results. nt portion of our revenuen u by public u ff Risks Related to our Indebtedness, Capital Strutt cture and Ownershrr ip of our Common Stoctt k Our indebtedness could adversely affect we may be unable to generate suffiff cient cash flow to satisfyff our debt service obligations. our business and limit our ability to expand our business or respond to changes, and ff In February 2019, we entered into a credit agreement with the lenders party thereto under which we established (i) a senior secured term loan facility in an aggregate principal amount of $175 million, (ii) a senior secured delayed draw term loan facility in an aggregate principal amount of $10 million and (iii) a senior secureu d revolving credit facility in an aggregate principal amount of $25 million (collectively, the “Credit Facilities”). The Credit Facilities are guaranteed by certain wholly-owned subsidiarie s of Zix. The Credit Facilities are secured by substa ntially all assets of Zix and the guarantors, subju ect to certain customary exceptions. The Credit u Facilities will mature in February following: of 2024. The incurrence of this indebtedness could have adverse consequences, including the u r (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) reducing the availability of our cash flow for our operations, capital expenditures, future business opportunities, stock buybay cks and other purposes; limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; making it more difficuff market or industry conditions; lt to pay or refinff ance our debts as they become due during periods of adverse economic, financial limiting our ability to obtain additional financing for working capital, acquisitions or other purposes, particularly since substu antially all of our assets are subju ect to securituu y interests relating to existing indebtedness; requiring our debt to become due and payabla e upon a change in control; increasing our vulnerability to general adverse economic and industry conditions; and lengthening or otherwise adversely affeff cting our sales process as customers evaluate our financial viability. 16 Optional prepayments of borrowings under the Credit Facilities will be permitted at any time, without premium (other than customary LIBOR breakage costs). We must prepay the term loan facility in equal quarterly installments of $437,500 on the last day of each March, June, Septembem r and December (commencing on June 30, 2019) until maturity in February of 2024. In addition to other customary mandatory prepayment requirements, the term loan facility requires annual prepayments based on a percentage fof Zix’s excess cash flow, which percentage will reduce as Zix’s total net leverage ratio decreases. We depend on cash on hand and cash flows from operations to make scheduled debt payments. To a significan t extent, our ability to do so is subju ect to general economic, ff financial, competitive, legislative, regulatory and other factors that are beyond our control. If our business does not generate sufficie cash flow from operating activities or if future borrowings are not availabla e to us in amounts sufficie liquidity needs, our operating results, financial condition and ability to expand our business may be adversely affected nt to enable us to fund our ff ff ff . nt The interest rate borne by our Credit Facilities will float over time and is initially LIBOR plus 3.50%, with future step downs in the interest rate margin as our total net leverage reduces. The floating rate nature of this interest rate exposes us to interest rate risk. Changes in economic conditions outside of our control could result in higher interest rates, thereby increasing our interest expense even though the amount borrowed remains the same. Restrictive covenants in our credit agreement may adversely affect our financial and operational flexibility. The credit agreement governing our Credit Facilities contains certain financial, operational and legal covenants. The financial covenant requires Zix to maintain a maximum total net leverage ratio (as defined in the credit agreement) and is tested on a quarterly basis (commencing March 31, 2019), based on the rolling four-quarter period that ends on the last day of each fiscal quarter. The non- financial covenants restrict our ability and the ability of our restricted subsu idiaries to, among other things, incur indebtedness, incur liens, merge with or acquire other entities, make investments, dispose of assets, enter into sale and leaseback transactions, make dividends, distributions or stock repurchases, prepay junior indebtedness, enter into transactions with affiliates, agreements, and amend our organizational documents or the terms of junior indebtedness. enter into restrictive ff These restrictions may make it more diffiff cult or discourage a takeover of Zix, whether favored or opposed by our management and/or our Board of Directors. Our ability to comply with some of these restrictive covenants can be affected ff by events beyond our control, and we may be unabla e to do so. Failure to comply could require us to seek waivers or amendments of covenants or alternative sources of financing, or to reduce expenditures. We cannot guarantee that such waivers, amendments or alternative financing could be obtained or, if obtained, would be on terms acceptable to us. Upon the occurrence of a defauff lt, or if we are unable to make the representations and warranties in the credit agreement governing our Credit Facilities, we will not be able to borrow funds or issue letters of credit under our Credit Facilities. Upon the occurrence of an event of defauff immediately due and payabla e. If we are unable to repay that amount,nn our lenders could seize our assets securing the loans and our business and financial condition could be materially and adversely affeff cted. lt, our lenders could elect to declare all amounts outstanding under our Credit Facilities to be Our Series A Convertible Preferred Stock (the “Series A Preferred Stock”), Series B Convertible Preferred Stock (the “Series B Preferred Stock”) and investment agreement restrict our ability to incur certain indebtedness which limits our flexibility in operating our business. In February 2019, we issued Series A Preferred ff Designations”) and Series B Preferr which contain covenants that, among other things, require the consent of the holders of a majoa rity of each of the then-outstanding Stock beforff e we can incur indebtedness in excess of a specifieff d leverage shares of Series A Preferr ratio. ed Stock established by a Certificaff ed Stock and Series B Preferred Stock established by a Certificate of Designations (the “Series A Certificate of e of Designations”), te of Designations (the “Series B Certificat ff ff ff ff In January 2019, we entered into an investment agreement with an investment fund managed by Truer Wind Capita a l (the “Investor”), which contains customary covenants, including among others, that for so long as any shares of preferred stock issued pursuant to the investment agreement are outstanding, the consent of the Investor will be necessary for us to issue, subju ect to certain exceptions, any debt securities convertible into any of our capital stock. 17 We may need additional capital, and we cannot be certain that additional financing will be available. We may require additional financing in the future to operate or expand our business, acquire assets or repay or refinff ance our rts, business plans, existing debt. Our ability to obtain financing will depend, among other things, on our business development effoff operating performance and the condition of the capital markets at the time we seek financing, as well as other factors beyond our control. We cannot provide any assurance that additional financing will be availabla e to us on favorable terms when required, or at all. Additionally, under the terms of our credit agreement, preferred stock and investment agreement, respectively, we are restricted from incurring additional debt, subju ect to certain exceptions. If we raise additional funds through the issuance of equity, equity-linked or debt securities, those securities may have rights, preferences and our stockholders may experience dilution. or privileges senior to the rights of our common stock or preferff red stock, ff ff If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things: (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) develop or enhance our solutions; continue to expand our sales and marketing and research and development organizations; repay or refinff ance our existing debt; acquire complementary technologies, solutions or businesses; expand operations, in the United States or internationally; hire, train and retain emplomm yees; or respond to competitive pressure or unanticipated working capital requirements. Our failure to do any of these things could seriously impacm t our business, negatively affeff cting financial condition and operating results. We may be able to incur more debt and take other actions that could diminish our ability to make payments on our indebtedness when due, which could further exacerbate the risks associated with our current level of indebtedness. Despite our current indebtedness level, we may be able to incur more indebtedness in the future. We are not completely prohibited under the terms of the credit agreement, preferred indebtedness from incurring additional debt, securing existing or futff ure debt, recapitalizing our debt or taking a number of othet r actions, any of which could diminish our ability to make payments on our indebtedness when due and further exacerbat associated with our current level of indebtedness. If new debt is added to our or any of our existing and future subsiu debt, the related risks that we now face could intensify.ff stock, investment agreement or other agreements governing our currer nt r e the risks diaries' current ff Our preferred stockholders can exercise significant control over the Company, which could limit the ability of our common stockholders to influence the outcome of key transactions, including a change of control. The Investor holds approximately 16.6% of our outstanding voting capital stock based on the numberm of shares of common ff red Stock outstanding as of March 6, 2019, on an as-converted basis. If Stockholder Approval (as stock and convertible Series A Preferff definff ed in the investment agreement) is obtained, the Investor will have an aggregate voting power of at least 24.2% of our outstanding capital stock on the date of such Stockholder Approval, which amount may increase based on the accrued value of the Series B Preferre d Stock at conversion. In addition, the Investor’s aggregate voting power will increase further in connection with future accretion of the Series A Preferr Series A Preferre ff matters submu the ability to significaff Investor is entitled to act separately in its own respective interests with respect to its ownership interests in the Company and has the ability to subsu tantially influff ence the election of the members of our Board of Directors, thereby potentially controlling our management and affaff including the approval of significaff d Stock are entitled to vote their shares, on an as-converted basis, together with holders of our common stock on all itted to a vote of the holders of our common stock. As a result, the holders of shares of the Series A Preferred irs. In addition, the Investor has significant influence over all matters that require approval by our stockholders, itted for the vote of the holders of our common stock. The d Stock remains outstanding. The holders of our ntly influff ence the outcome of any matter submu ed Stock for as long as the Series A Preferre nt corporate transactions. Stock have ff ff ff Additionally, holders of a majoa rity of the then-outstanding shares of Series A Preferred ff Stock are required to approve certain matters as a class, voting separately from the common stock, such as (1) any amendment, alteration or repeal to our Restated Artirr cles of Incorporation (the “Articles of Incorporation”) or the Series A Certificate of Designations in a manner that would adversely affeff ct the rights, prefereff Incorporation or any other action to authorize or create, or increase the numberm of authorized or issued shares of,ff or any securities convertible into shares of,ff or reclassifyff any security into, or issue any parity stock or senior stock as to dividend or liquidation rights; (3) the issuance of shares of Series A Preferred Stock other than in connection with the conversion of Series B Preferred ed Stock; (2) any amendment or alteration to our Articles of nces, privileges or power of the Series A Preferr Stock that ff ff ff 18 was issued on the Issue Date; (4) any action that would cause us to cease to be treated as a domestic corporation for U.S. federal income tax purposes; or (5) the incurrence of indebtedness that would cause us to exceed a specified leverage ratio. Further, holders of a majoa rity of the then-outstanding shares of Series B Preferred ff as a class, voting separately from the common stock and the Series A Preferff to our Articles of Incorporation or the Series B Certificate of Designations in a manner that would adversely affeff ct the rights, prefeff rences, privileges or power of the Series B Preferr any other action to authorize or create, or increase the number of authorized or issued shares of,ff or any securities convertible into shares of,ff or reclassify any security into, or issue any parity stock or senior stock as to dividend or liquidation rights; (3) the issuance of any additional shares of Series B Preferred corporation for U.S. federal income tax purposes; or (5) the incurrence of indebtedness that would cause us to exceed a specified leverage ratio. ed Stock; (2) any amendment or alteration to our Articles of Incorporation or Stock; (4) any action that would cause us to cease to be treated as a domestic ff ff Stock, are required to approve certain matters red Stock, such as (1) any amendment, alteration or repeal Any issuance of common stock upon conversion of the Series A Preferred Stock and the issuance of Series A Preferred Stock upon automatic conversion of the Series B Preferred Stock in connection with the Stockholder Approval will cause dilution to existing stockholders and may depress the market price of our common stock. ff The Series A Preferred Stock has an initial stated value of $1,000 per share, which stated value will accrete at an annual rate of 8% per annum, compounded quarterly. Each share of Series A Preferff red Stock is convertible, at the option of the holders, into (i) the number of shares of common stock equal to the producd t of (A) the stated value per share as it has accreted as of such date multiplied by (B) the Conversion Rate as of the applicable conversion date divided by (C) 1,000 plus (ii) cash in lieu of fractional shares. The initial Conversion Rate is equal to 166.11 shares of our common stock and is subju ect to adjud stment from time to time upon the occurrence of certain customary events in accordance with the terms of the Series A Certificate of Designations. Each share of Series A Preferr ed Stock is entitled to participate in dividends paid in respect of the common stock on an as-converted basis. ff The issuance of common stock upon conversion of the Series A Preferred ff Stock (including any shares of Series A Preferred ff Stock issued upon automatic conversion of the Series B Prefeff rred Stock in connection with the Stockholder Approval) will result in immediate and substa connection with the future accretion of the Series A Prefeff rred Stock and the conversion of Series B Preferred Preferff ntial dilution to the interests of our common stock holders, and such dilution will increase over time in red Stock (assuming Stockholder Approval is obtained). Stock into Series A u ff Texas law and our Articles of Incorporation and bylaws contain certain provisions, including anti-takeover provisions, that limit the ability of stockholders to take certain actions and could delay or discourage takeover attempts that stockholders may consider favorable. The Texas Business Organizations Code, as amended (“TBOC”), and our Articles of Incorporation and second amended and restated bylaws contain provisions that could have the effecff deemed undesirable by our Board of Directors and thereforeff also make it difficff ult for stockholders to take certain actions, including electing directors who are not nominated by the current members of our Board of Directors or taking other corporate actions, including effeff cting changes in our management. Among other things, our certificate t of rendering more difficff ult, delaying, or preventing an acquisition depress the trading price of our common stock. These provisions could of incorporation and bylaws include provisions regarding: ff (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) the ability of our Board of Directors to issue shares of preferred determine the price and other terms of those shares, including preferences which could be used to significantly dilute the ownership of a hostile acquirer, and pursuant to which we have issued the Series A Preferre e and ed Stock, each of which are entitled to receive a liquidation preferenc certain amounts in connection with a change of control of the company and other similar extraordinary transactions; ff and voting rights, without stockhokk lder approval, stock, including “blank check” preferred ff d Stock and Series B Preferr stock, and to ff ff ff ff the limitation of the liability of,ff and the indemnificff ation of,ff our directors and offiff cers; the requirement that directors may only be removed from our Board of Directors by the affirff mative vote of a majoa rity of the issued and outstanding shares entitled to vote in the election of directors at a special meeting of the shareholders called for that purpose at which quorum is present; a prohibition on common stockhokk lder action by written consent, which forces common stockholder action to be taken at an annual or special meeting of stockholders and could delay the ability of stockholders to force consideration of a stockholder proposal or to take other action, including the removal of directors; the requirement that a special meeting of stockholders may be called only by the chairperson of our Board of Directors, our Board of Directors or a holder of at least 10% of all of the shares of the Company entitled to vote at the proposed special meeting, and must be called by our president or secretaryrr at the request in writing of a majoa rity of the members of 19 our Board of Directors, which could delay the ability of stockhokk lders to force consideration of a proposal or to take action, including the removal of directors; (cid:120) (cid:120) (cid:120) (cid:120) provisions enabling us to control the procedurd es for the conduct and scheduling of Board of Directors and stockholder meetings; the requirement for the affiff rmative vote of holders of at least a majoa rity of all issued and outstanding shares entitled to vote in the election of directors at a properly called and convened annual or special meeting of shareholders, to amend, alter, change or repeal any provision of our Articles of Incorporation or our bylaws, which could preclude stockholders from bringing matters before annual or special meetings of stockholders and delay changes in our Board of Directors and also may inhibit the ability of an acquirer to effeff ct such amendments to facilitate an unsolicited takeover attempt; the ability of our Board of Directors to amend our bylaws, which may allow our Board of Directors to take additional actions to prevent an unsolicited takeover and inhibit the ability of an acquirer to amend our bylaws to facilitate an unsolicited takeover attempt; and advance notice procedures with which stockholders must comply to nominate candidates to our Board of Directors or to propose matters to be acted upon at a stockholders’ meeting, which could preclude stockholders from bringing matters beforff e annual or special meetings of stockholders and delay changes in our Board of Directors and also may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attemptm ing to obtain control of our Company. These provisions, alone or together, could delay or prevent hostile takeovers and changes in control or changes in our Board of Directors or management. In addition, as a Texas corporation, we are subju ect to provisions of Texas law, including Section 21.606 of the TBOC, which may prohibit certain stockholders holding 20% or more of our outstanding capital stock from engaging in certain business combinations with us for a specifiedff period of time. Any provision of Texas law or our Articles of Incorporation or bylaws that has the effect of delaying or preventing a change in control could limit the opportuniu ty for our stockholders to receive a premium for their shares of our capital stock and could also affeff ct the price that some investors are willing to pay for our common stock. ff Othett r Riskskk Relatll edtt to our Series A Preferr ff ed Stock and Series B Preferred Stocktt Future resales of our common stock held by our significant stockholders or of the shares of common stock issuable upon conversation of the Series A Preferred Stock may cause the market price of our common stock to drop significaff ntly. We are obligated to register the resale of the common stock issuable upon conversion of,ff or issued as dividends upon, the Series A Preferred Stock, and to take certain actions to facilitate the transfer and sale of such shares. Upon such registration, shares of ff common stock into which the Series A Preferff conversion may represent overhang that may also adversely affeff ct the market price of our common stock. Overhang occurs when there is a greater suppluu company’s stock will decrease, and any additional shares which stockholders attempt to sell in the market, or the perception that such sales might occur, will only further decrease the share price. If the share volume of our common stock cannot absorb converted shares sold by the holders of the Series A Preferred y of a company’s stock in the market than there is demand for that stock. When this happa red Stock are converted would be freely tradable. The common stock issuable upon Stock, then the value of our common stock will likely decrease. ens, the price of the ff Any sale of large amounts of our common stock on the open market or in privately negotiated transactions could have the effeff ct of increasing the volatility in the price of our common stock or putting significaff stock. nt downward pressure on the price of our common Our Series A Preferred Stock and Series B Preferred Stock have rights, preferences and privileges that are not held by, and are preferential to, the rights of our common stockholders, which could adversely affect and may result in the interests of the holders of our Series A Preferred Stock and Series B Preferred Stock differin those of our common stockholders. our liquidity and financial condition, g from ff ff In the event of our liquidation, dissolution or the winding up of our affaff irs, the holders of our Series A Preferr ff ed Stock have the right to receive a liquidation preferff ence entitling them to be paid out of our assets generally available for distribution to our equity holders, together with holders of our Series B Preferr series of capital stock (including our common stock), in an amountuu ed Stock and beforff e any payment may be made to holders of any other class or equal to the greater of (i) $1,000 plus all accreted but unpan id ff 20 dividends and (ii) the amount such holder would have been entitled to receive if the Series A Preferff common stock immediately prior to such liquidation. red Stock had converted into In the event of our liquidation, dissolution or the winding up of our affaiff rs, the holders of our Series B Preferred ff Stock have the right to receive a liquidation preferff ence entitling them to be paid out of our assets generally available for distribution to our equity holders, together with holders of our Series A Preferred series of capital stock (including our common stock), in an amount equal to $1,000 plus all accrued but unpaid Stock and before any payment may be made to holders of any other class or dividends. n ff In addition, the $1,000 stated value per share of our Series A Preferred ff Stock will accrete at a fixed rate of 8.0% per annum, ded quarterly. The holders Series A Preferff compounmm stock on an as-converted basis. The holders of our Series B Preferr cumulative basis payablea “Dividend Rate”), which rate will automatically increase by 1.0% every six months that the Series B Preferff outstanding and unconverted (subjeb ct to a cap of 12.0%). If cash dividends are not paid in respect of any dividend payment period, the liquidation prefereff ed Stock are entitled to receive dividends accruing daily on a quarterly in arrears in cash at a fixed rate of 10.0% per annum on the $1,000 stated value per share (the red Stock are also entitled to receive any dividends paid in respect of our common Stock will automatically increase at the Dividend Rate. nce of each outstanding share of Series B Preferred red Stock remains ff ff Further, the Series A Preferre ff d Stock is mandatorily redeemable upon a change of control (as defined in the Series A Certificaff te ff Stock in cash equal to the greater of (i) the Series A Change of Control Stock, immediately prior to such change of control, converted such shares of Series A Prefeff rred Stock into shares of of Designations), at a price per share of Series A Preferred Redemption Price (as definff ed below) and (ii) (A) the amount of cash such holder of Series A Preferred received plus (B) the fair market value of any other assets such holder would have received, in each case had such holder of the Series ff A Preferred common stock. The “Series A Change of Control Redemption Price” per share of Series A Preferred accreted value of such share as of the date of determination multiplied by (1) 1.30 (if the change of control occurs beforff e the first anniversary of the date of issuance); (2) 1.35 (if the change of control occurs on or after but before the second anniversary of the date of issuance); (3) 1.40 (if the change of control occurs on or afteff of the date of issuance but before the third anniversary of the date of issuance); (4) 1.45 (if the change of control occurs on or after ff third anniversary of the date of issuance but before the fourth anniversary of the date of issuance); and (5) 1.50 (if the change of control occurs on or after r the second anniversary the the fourth anniversary of the date of issuance). the first anniversary of the date of issuance Stock is the product of the Stock would have ff ff ff ff ff Stock also have redemption rights upon the occurrence of certain events. red Stock to be redeemed as of the applicable redemptmm ion date multiplied by 1.50. The Stock is also mandatorily redeemable upon a change of control (as defined in the Series B Certificate fof d Stock is mandatorily redeemable, upon the holder’s election and after 90 days prior notice, any d Stock equal to the liquidation y, the Series B Preferre the seventh anniversary of the date of issuance at na amount per share of Series B Preferre per share of the Series B Preferff ff Further, the holders of our Series B Preferred ff Specificall ff time after ff preference ff Series B Preferred Designations), at a price per share of Series B Preferr Redemption Price (as definff ed below) and (ii) (A) the amount of cash such holder of Series B Preferred Stock would have received plus (B) the fair market value of any other assets in each case had such holder of Series B Prefeff rred Stock, immediately prior to such change of control, converted such shares of Series B Preferre Change of Control Redemption Price” per share of Series B Preferff as of the date of determination multiplied by (1) 1.30 (if the change of control occurs beforff e the first anniversary of the date fof issuance); (2) 1.35 (if the change of control occurs on or after the first anniversary of the date of issuance but before the second anniversary of the date of issuance); (3) 1.40 (if the change of control occurs on or after the third anniversary fof bbut before the third anniversary of the date of issuance); (4) 1.45 (if the change of control occurs on or after the date of issuance but before the fourth anniversary of the date of issuance); and (5) 1.50 (if the change of control occurs on or afteff the fourth anniversary of the date of issuanc )e . ed Stock in cash equal to the greater of (i) the Series B Change of Control red Stock is the producd t of the liquidation prefereff the second anniversary of the date of issuance d Stock into shares of Series A Preferred Stock. The “Series B nce of such share ff ff ff ff ff r ff the fourth anniversary of the date of issuance of the Series A Preferre ff d Stock, we have the right to redeem Stock for cash at a redemptmm ion price equal to the accreted value per share of Series A Preferred ff Stock to be Finally, any time after ff ff the Series A Preferred redeemed multiplied by 1.50. Likewise, at any time afteff we have the right to redeem the shares of the Series B Preferff prefereff nce per share of the Series B Prefeff rred Stock to be redeemed multiplied by 1.50. r the fourth anniversary of the date of issuance of the Series B Preferr Stock for cash at a redemptmm ion price equal to the liquidation redrr ff ed Stock, These dividend and redemptmm ion payment obligations could significantly impacm t our liquidity and reduce the amount of our cash flows that are available for working capital, capital expenditures, growth opportuniu ties, acquisitions, and other general corporate purposes. Our obligations to the holders of Series A Preferre additional financing or increase our borrowing costs, which could have an adverse effeff ct on our financial condition. The preferff ential rights described above could also result in divergent interests between the holders of shares of Series A Preferred Stock and/or Series ff B Preferre d Stock and the holders of our common stock. d Stock could also limit our ability to obtain d Stock and Series B Preferre ff ff ff 21 Item 1B. Unresolved Staff Comments None. Item 2. Properties r We leased properties during 2018 that are considered significff ant to the operations of the business in the following locations: Michigan; Renton, Washington; Ottawa, Ontario, Canada; the United Kingdom; and Dallas and development for our ZixArchive product line, which we acquired with our purchase of Erado. Our Ottawa emplmm oyees Burlington, Massachusetts; Ann Arbor, and Austin, Texas. Our Burlington emplmm oyees perform sales and marketing activities. Our Ann Arbor uu the support and development of our ZixProtect product line, which we acquired with our purchase of Greenview. Our Renton emplm oyees perforff m support uu perforff m both client services and sales suppouu customers. The Dallas offiff ce is our headquarters, which includes research and development, marketing, sales and all general administrative services, and the ZixData Center. Our Austin location is used primarily for fail-over and business continuity services and is used to some extent to suppouu rt normal ongoing operations. Our facilities are suitable for our current needs and are considered adequate to suppor rt activities. The United Kingdom facility provides data center suppor t expected near-term growth. r emplmm oyees performff t for our European uu uu Item 3. Legal e sgg Proceedingii We are subju ect to legal proceedings, claims, and litigation involving our business. While the outcome of these matters is currently not determinabla e, and the costs and expenses of resolving these matters may be significant, we currently do not expect that the ultimate costs to resolve these matters will have a material adverse effeff ct on our consolidated financial condition or operating results. Item 4. Mine Safety Disclosures Not applicable. 22 Item 5. Market for Registrant’s’ Common Equity, ii Relatll edtt Stockholder Matters and Issuer Purchases of Equity Securitiestt Our common stock trades on The Nasdaq Stock Market under the symbol ZIXI. The table below shows the high and low sales prices by quarter for fiscal 2018 and 2017. PART II Quarter Ended March 31 June 30 September 30 December 31 2018 2017 High Low High Low $ $ $ $ 4.75 5.62 5.93 7.09 $ $ $ $ 3.82 4.25 4.91 4.66 $ $ $ $ 5.41 6.67 6.04 5.40 $ $ $ $ 4.60 4.75 4.55 4.16 At March 6, 2019, there were 54,089,273 shares of common stock outstanding held by 397 shareholders of record. On that date, the last reported sales price of the common stock was $7.17. We have not paid any cash dividends on our common stock and do not anticipate doing so in the foreseeable future. For information regarding options and stock-based compensation awards outstanding and available for future grants, see “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” Perfor rmance Graph The following graph compares the cumulative total return of an investment in our common stock over the five-year period ended December 31, 2018, as compamm red with the cumulative total return of an investment in (i) the Center for Research in Securities Prices (“CRSP”) Total Return Index for Nasdaq Stock Market (U.S. companies) and (ii) the CRSP Total Return Index for Nasdaq Computer and Data Processing Stocks. The compamm rison assumes $100 was invested on December 31, 2013, in our common stock and in each of the two indices and assumes reinvestment of all dividends, if any. The stock price perforff mance on the following graph is not necessarily indicative of futff ure stock price perfoff rmance. A listing of the companies comprising each of the CRSP- NASDAQ indices used in the following graph is available, without charge, upon written request. Comparison of 5 Year Cumulative Total Return Assumes Initial Investment of $100 December 2018 250.00 200.00 150.00 100.00 50.00 0.00 2013 2014 2015 2016 2017 2018 Zix Corporation NASDAQ Stock Market (US Companies) NASDAQ Computer and Data Processing Index 23 Sale of Unregistered Securities None. Purchases of Equitytt Securities by the Issuer Period October 1, 2018 to October 31, 2018 November 1, 2018 to November 30, 2018 Decembem r 1, 2018 to Decembem r 31, 2018 Total Total Number of Shares Purchased(1) Average Price Paid per Share —— 6.67 —— 6.67 —— $ 914 $ —— $ 914 $ Total Number of Shares Purchased as part of Publicly Announced Plans or Programs Maximum Number (or Appropriate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs —— $ —— $ —— $ —— $ —— —— —— —— 1 Of the total numberm of shares repurchased for the one month period ended Novembem r 30, 2018, 914 shares of Restricted Stock were withheld by us upon the vesting of outstanding Restricted Stock. These shares were withheld by us to satisfy the minimum statutory tax withholding for the emplomm yees for whom Restricted Stock vested during the applicable period, which is required once the Restricted Stock is vested. 24 Item 6. Selected Finaii ncial Data The following selected financial data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and notes thereto. No cash dividends were declared in any of the five years shown below: tement of Operations Data: Revenues Cost of revenue Gross margin Research and development expenses Selling, general and administrative expenses Income tax expense (benefit)(1) Net income (loss) Basic income (loss) per common share Diluted income (loss) per common share Shares used in computing basic income per common share Shares used in computing diluted income per common share Statements of Cash Flows Data: Net cash flows provided by (used for): Operating activities Investing activities Financing activities Balance Sheet Data: Cash, Cash Equivalents and Marketable Securities Working capita a Total assets Stockholders’ equity l(2) 2018 2017 Year Ended December 31, 2015 2016 (In thousands, except per share data) 2014 $ $ $ $ $ $ $ $ $ $ 70,478 15,186 55,292 11,323 33,999 (4,720) 15,444 0.29 0.29 52,592 53,481 16,671 (15,952) (6,593) 27,109 (7,665) 104,640 60,947 $ $ $ $ $ $ 65,663 12,602 53,061 10,980 31,871 18,606 (8,057) (0.15) $ (0.15) $ 53,430 60,144 10,533 49,611 9,553 30,742 3,692 5,837 0.11 0.11 53,820 53,430 54,395 $ $ 18,204 (11,285) (367) 33,009 2,104 81,308 43,520 15,251 (2,136) (15,322) 26,457 2 82,358 49,070 $ $ $ $ $ 54,713 9,593 45,120 8,317 28,887 3,144 5,016 0.09 0.09 56,422 57,476 15,617 (1,951) (6,687) 28,664 3,821 87,286 56,772 50,347 8,324 42,023 9,051 26,222 2,830 4,103 0.07 0.07 57,949 58,967 13,317 (3,402) (15,748) 21,685 2,249 83,724 56,270 (1) The $4.7 million income tax benefitff in 2018 resulted from the release of a portion of our deferred tax asset valuation allowance. Based on analysis of both projected and current earnings, we have estimated our deferred tax asset as likely to be utilized prior to expiration, thus triggering this release. On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act of 2017 (thett Act”) which significantly changed U.S. tax law. The Tax Act lowered the Company’s statutory federal income tax rate from 34% to 21% effeff ctive January 1, 2018. At December 31, 2017, the Company adjud sted its deferred tax balances to reflecff tax rate that resulted in income tax expense of $12.5 million in that year. See “Income Taxes” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” “Tax t the new (2) Working capital includes deferff red revenue totaling $30.6 million, $28.4 million, $25.8 million, $23.2 million and $21.6 million, as of Decembem r 31, 2018, 2017, 2016, 2015, and 2014, respectively. 25 Item 7. Managema ent’s’ Discuii ssion and Analysll is of Financial Condition and Resultsll of Operations The following discussion and analysis contains forward-looking statements about trends, uncertainties and our plans and en in the future. Forward-looking statements involve risks and uncertainties that could cause actual r materially from the events or results described in the forward-looking statements, including risks and expectations of what may happa events or results to diffeff uncertainties described above in “Item 1A. Risk Factors.” Readers are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements in this report are based upon inforff mation available to us on the date of this report. We undertake no obligation to publicl STATEMENTS AND RISK FACTORS” in “Item 1. Business.” y update or revise any forward-looking statements. See “NOTE ON FORWAR RD-LOOKING u The following discussion should be read in conjunction with the consolidated financial statements and related notes beginning on page F-1. Overview We are a leader in providing email security. We provide email encryption, DLP, advanced threat protection, archiving, and BYOD solutions to meet the data protection and compliance needs of organizations primarily in the healthcare, finance, and government sectors. A core competency is our ability to deliver this complex service offeff reliabia lity, integrity and security. ring with a high level of availability, Our 2018 results included record revenues. We attribute our success to on-going effoff rts to build a solid and predictable business based on our successful recurring revenue subsu cription business model. For 2018, we continuen d to benefit from growing concerns about data security and integrity issues, which continue to make headline news, as well as the growing acceptance of cloud-based offeff rings along with the growing regulatory compliance burdens on many businesses. For 2018, we reported revenue of $70.5 million, an increase of $4.8 million over the prior year, driven by both continued growthww u in our subscriber base and new sales attributable to our Erado and Greenview acquisitions. For the year ended Decembem r 31, 2018, our gross profitff of $55.3 million increased 4% compamm red to 2017. This increase was primarily driven by increased revenue. Our 2018 operating income of $10.0 million decreased $240 thousand over the prior year, as the gross profitff acquisition related costs. increase was offsff et primarily by increased general and administrative expense, related to additional headcount and Our $15.4 of million net income in 2018 is an increase of $23.5 million compared to our $8.1 million net loss in 2017. Our 2018 net income includes a $7.8 million tax benefit resulting from a decrease to our deferff expected future profitabff to enactment of the Tax Act, which required us to reduce the valuation of our deferff red tax asset. ility and ability to use net operating losses. This compares to a $12.5 million tax expense incurred in 2017 due red tax asset valuation allowance based on Other Financial Highlig htgg stt i (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Backlog was $73.0 million at the end of 2018, compared with $72.6 million at the end of 2017. Total orders for 2018 were $73.3 million, an increase of 24% from 2017 total orders of $58.9 million. Our deferff red revenue at the end of 2018 was $32.1 million, compared with $29.4 million at the end of 2017. We generated cash flows from operations of $16.7 million during fiscal 2018. Our cash and cash equivalents were $27.1 million at the end of 2018, compared with $33.0 million at the end of 2017. Our shared, cloud-based ZixDirectoryrr now has approximately 60 million members including from some of the most respected institutions in the country. Our services are sold on a subsu cription basis with contract terms generally ranging from one to five years. At the end of the contract term we attempt to renew the subsu cription for the originally contracted period. Our customers pay us annually at the start of the subscrip u on a monthly basis over the term of the subsu cription once service commences. tion term and each succeeding year on the anniversary of the commencement of the service. We recognize revenue ratabla y We attempt to grow the business by signing new customers to subscripti u on services and/or selling new or higher volume services to existing customers (i.e., “upsuu ell”) while retaining existing customers through renewal of their subsu criptions for successive periods. 26 Our total orders consist of orders from new customers, sale of additional products or features to existing customers, plus renewal orders. Total orders may vary from quarter to quarter due to the timing of renewal orders, which will fluctuate in amount due to timing and length of expiring subscr iption terms. Similarly, total new orders and upsell orders will fluctuate in amount due to term length. u To better understand new orders, management tracks the first year value of new orders as well as the total order value for the n term because total order value will exceed the first year value on multi-year orders. By segregating the first year value of subscriptio u new orders, we eliminate the fluctuation in total order amount caused by the dollar impactmm metric as New First Year Orders (“NFYOs”). of multi-year contracts. We referff to this Our backlog consists of the total order value of contracted business that has not yet been recognized into revenue. Backlog is calculated by adding to the existing contracted order value the total value of all orders booked in the period (e.g., quarterly) less the value of revenue recognized for that period. Although orders are non-cancellable, occasionally we adjud st backlog for customer bankrukk ptcuu the value of total orders added in a period exceeds the value of revenue recognized in that period. Conversely, the backlog amount will decline if revenue recognized exceeds the total order value added for the period. A decline in backlog may result from fluctuations in total orders caused by timing of renewal orders described above as well as the shortening of the average term of our contracts. y or change of term, but these instances are rare and do not materially impactmm the backlog amount. The backlog will grow if ed by the 2017 merger and acquisition activity of three health care customers, as well as by loss due to customer As of Decembem r 31, 2018, we retained approximately 87% of our recurring revenue on an annual basis. We calculate this percentage by identifying the current period revenue less revenue associated with orders for new services received in the prior twelve month period and comparing this amount to the total revenue in the corresponding prior year period. Our recurring revenue retention has been impactm ts to either shiftff migration to Officeff those remaining customers still using their hardware-based platforff m to the Zix cloud platform, or to secure long term commitments from those customers who instead wish to retain their existing hardware-based solutions. Based on these continued efforff our recurring revenue retention to return to the 90% range going forward. Deferr ed revenue is the value of contracted business that has been paid but has not been recognized as revenue. See description of the components of the backlog following in “Backlog and Orders In this “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 365 from their on-premise-based hardware encryption solution. The Company has focused efforff ts, we expect ff Our revenue growthww is dependent on our ability to sell subscu ription services to new customers, sell additional products or features or increase volume with existing customers and retain existing customers by renewing their subscription u if annual NFYOs exceed the annual value of discontinued or non-renewed subscriptions, growthww may fluctuate due to timing of deployment of new services and subscu ription cancellations. For example, a new order reported in NFYOs in one quarter may not be deployed to the customer until the following quarter and therefoff re delay commencement of revenue recognition. Similarly, a cancellation of a contract with an expiration in the first month of a quarter will have a higher negative impactm impactmm comparisons more indicative of revenue growth than sequential quarterly revenuen of these quarter to quarter fluctuations tends to diminish over annual periods making year over year quarterly revenue on revenue in the quarter than a contract of the same amount with an expiration in the last month of a quarter. The revenue should grow. However, revenue services. Generally, comparisons. u Our operations and future prospects are further discussed throughout this “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” There are no assurances we will be successfulff in our effoff rts to achieve continued growth. Our continued growthww depends on the timely development and market acceptance of our products and services. See “Item 1A. Risk Factors” for more inforff mation on the risks relative to our operations and future prospects. Revenue Revenue increased by 7% in 2018 compamm red with 2017. Our revenue growth was driven by new sales attributable to our Erado and Greenview acquisitions, a successfulff rate of renewing existing customers supported uu u subscriptio n model that continues to yield steady additions to the subscu riber base, and a high by our migration of customers to our cloud platform. Critical Accounting Policies and Estimates In preparing our consolidated financial statements, we make estimates, assumptions and judgments that can have a significant impacmm t 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 significff ant accounting judgements by us. Management bases its estimates on historical experience and on various other assumptm ions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements 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 differff from these estimates, the resulting changes could have a material adverse effecff from these estimates under different assumptmm ions or conditions. If actual results were to materially differff t on our consolidated financial statements. 27 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 effeff ct 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 assumptm ions used in the preparation of our consolidated financial statements. Our critical accounting policies included the following: (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Revenue recognition Commission amortization Income taxes Valuation of goodwill and other intangible assets Stock-based compensation costs For additional discussion of the Company’s significaff nt accounting policies, referff to Note 2 to our consolidated financial statements. Revenue Recognition In May 2014, The Financial Accounting Standards Board (“FASB”) issued ASC 606 which requires revenue recognition when ed to customers in an amount that reflects the consideration to which an entity expects to be to our revenue promised goods or services are transferr entitled to those goods and services. The standard became effeff ctive for us in 2018, but did not have a material impactm recognition process. For additional inforff mation regarding our adoption of ASC 606 please see “New Accounting Standards.” ff We earn our revenue from subsu cription fees for rights related to the use of our softwff ance obligations that are highly interdependent and consist of software at the customer’s site, ongoing customer suppouu of message security offeff performff cloud-based access to the hosted Zix encryption network. As our Company has expanded its portfolio recent years, we have increased our revenue obtained from hosted service solutions. Approximately 38% of our revenue in 2018 was derived from hosted email protection solutions. ff are. Our revenue contracts include multiple rt, and rings in u Our subscript ion terms typicyy ally range from one to five years. Revenue is recognized by applying the following steps: (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Step 1: Identify the contract(s) with a customer, Step 2: Identify the perforff mance obligations in the contract, Step 3: Determine the transaction price Step 4: Allocate the transaction price to the perforff mance obligations in the contract, and Step 5: Recognize revenue when (or as) the perforff mance obligation is satisfiedff . Step 1: Identify the contract(s) with a customer: We consider the terms and conditions of the contract and our customary business practice in identifying our contracts. We determine we have a contract with a customer when (i) the contract is approved, (ii) we can identify each party’s rights regarding the services and products transferr commercial subsu tance, and (v) it is probabla e we will be paid. ed, (iii) we can identify the payment terms for the services and products, (iv) the contract has ff (cid:120) Step 2: Identifying the performff ance obligations: ASC 606 requires identificff ation and disclosure of performance obligations within a revenue contract. A good or service is considered distinct if the customer can both benefitff available to the customer, and the promise to transferff from the good or service on its own or with other resources that are readily the good or service is separately identifiable from other promises in the contract. 28 As of December 31, 2018, revenue from our email protection services represented 100% of our revenue, of which approximately 88% was specific to email encryption. To provide this service, our softwff to create a private encryptyy ion key that works in conjunction with the publu ic encryption key provided via cloud-based access to our hosted Zix encryption network. Both keys are required to enable our asymmetrical encryption service. In our assessment of the factors listed in ASC 606-10-25-21, we have determined that because our software at the customer’s site and the access to our hosted Zix encryption network are highly interrelated, these items are not regarded as distinct components. Based on this assessment, these elements are combined as a single perforff mance obligation. are at the customer site includes functionality (cid:120) Step 3: Determine the transaction price: The transaction price is determined based on the consideration we expect to be entitled to receive in exchange for transferring goods and services to the customer. We include variablea future reduction of cumulative revenue under the contract will not occur. consideration in the transaction price if we view it probable that a significant (cid:120) Step 4: Allocate the transaction price to the perforff mance obligations in the contract: We allocate transaction prices to each perforff mance obligation based on the stand-alone selling price of our component services. (cid:120) Step 5: Recognize revenue when (or as) the perforff mance obligation is satisfiedff : We recognize revenue when the customer obtains control of the product or services, at the amount allocated to the satisfieff d performff ance obligation. Our perforff mance obligations are generally satisfied over time. While some contracts include one or more perforff mance obligations (including the combined elements noted above along with additional ongoing customer suppor d by the separate allocations of these obligations because the services are generally satisfieff d over the same period of time and revenue is recognized over the contract period. Discounts provided to customers are recorded as reductions in revenue. recognition pattern generally is not impacte t and other hosted services), the revenuen mm uu Commission Amortization We amortize ouruu commission costs to expens x e on a systemic basis over the period of expexx cted benefitff to the customer. Determination of the amortization period requires significant judgement.nn We apply the practical expedx accountnn for ouruu commission costs and related amortirr zations at thet earned upon contract renewal as compared to initial commissions paid and determined that because commissions paid were not reasonably proportional to their respective contract initial commissions paid. values, our renewal commissions could not be considered commensurauu te with the io level. Additionally, the Company has evaluated commissions ient noted in ASC 606-10-104 to portfrr olff tt We considered ouruu average contrnn act term lengtht and historical customer retention rates to determine an average length of ouruu customer relationships. We also concluded ouruu add-on sales generally occur halfway into ouruu customer relationships, and evaluated ouruu average customer renewal terms. Based on these factors we have determined that 8 years, 4 years and 18 months area amortization periods to ouruu new, add-on, and renewal sales commission expexx nses, respectively. We also perforff m subsu equeqq nt assessmentsnn for impamm irment of the related deferred cost asset when indicators present. the appropriateaa Income Taxes ff red tax assets. This significaff nt valuation allowance reflect nt to utilize net operating loss carryforff wards prior to their expiration. Our total deferff Deferred tax assets are recognized if it is “more likely than not” that our benefit of the deferred tax assets will be realized on future federal or state income tax returns. At Decembem r 31, 2018, we provided a valuation allowance against a significff ant portion, s our historical losses and the $22.7 million, of our accumulated U.S. deferff uncertainty of future taxabla e income sufficie red tax assets not subju ect to a valuation allowance are valued at $28.8 million, and consist of $27.0 million for federal net operating loss carryforwards, $2.1 million relating to U.S. state income tax credits, and $678 thousand related to Alternative Minimum Tax credits, and $114 thousand related to foreign tax credits. These credits are offsff et by ($1.2) million relating to temporary timing differences between U.S. Generally Accepted Accounting Principles (“GAAP”) and tax-related expense. If our U.S. taxabla e income increases from its current level in a future period or if the facts and circumstances on which our estimates and assumptmm ions are based were to change, thereby impactmm ning the amount of valuation allowance no longer required. Reversal of all or a part of this valuation allowance could have a significff antnn positive impacmm t on operating results in the period that it becomes more likely than not that certain of the Company’s deferff 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 have a significant negative impactmm ing the likelihood of realizing our deferred tax assets, judgment would have to be applied in determi on our operating results. ff r red tax assets 29 Valuation of Goodwidd ll and Other tt 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 subju ect to amortization; (2) intangible assets with indefinite lives not subju ect to amortization; and (3) goodwill. For intangible assets with finite lives, tests for impamm irment must be perforff med if conditions exist that indicate that the carrying value may not be recoverable. For intangible assets with indefinff ite lives and goodwill, tests for impairmm perforff med at least annuan lly or more frequently if events or circumstances indicate that assets might be impaired ment must be . mm ff Goodwill was $13.8 million, or 13%, and $8.5 million, or 10% of total assets, in each of the years ended Decembem r 31, 2018 and 2017, respectively. We evaluate goodwill for impamm irment annuan lly in the fourth quarter, or when there is reason to believe that the value has been mm . Evaluations for possible impairmm diminished or impaired unit to which the goodwill has been assigned, versus the sum of the carrying value of the assets and liabilities of that unit including the assigned goodwill value. We include our entire Company as the reporting unit. The fair values used in this evaluation are estimated based on the Company’s market capitalization, which is based on the Company’s outstanding common stock and market price of the stock. Impamm irment is deemed to exist if the net book value of the unit exceeds its estimated fair value. We evaluated our goodwill in ment adjud stment is required. the fourth quarter of 2018 and determined no impairm ment are based upon a comparison of the estimated fair value of the reporting Our intangible assets with finite lives are amortized using a straight-line basis over their economic useful lives. Stock-bkk ased Compensation Our share-based awards include stock options, restricted stock awards and restricted stock units. We have non-qualified stock options outstanding to emplomm yees and directors 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, subju ect to termination of emplmm oyment, generally expire ten years from the date of grant. Emplmm oyee stock options typiyy cally vest pro-rata and quarterly over three or four years. Restricted stock is issued to the emplomm yee at grant but is subju ect to vesting and transfer restrictions and vesting restrictions. Stock is issued in exchange for restricted stock units when vesting conditions are met. The transferff lly vest pro-rata annually over three or conditions may be time- or perforff mance-based. Restricted stock and restricted stock units typica four years. We use the straight-line amortization method for recognizing stock-based compensation costs. The weighted average grant- date fair value of awards of restricted stock, and restricted stock units is based on the quoted market price of the Company’s common stock on the date of grant. Option, restricted stock and restricted stock unit grants to emplmm oyees, officer s and directors frequeq ntly contain accelerated vesting provisions upon the occurrence of a change of control, as defined in the applicable grant agreements. yy ff Full Year 2018 Summary of Operations Financial (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Revenue for 2018 was $70.5 million compared with $65.7 million in 2017 and $60.1 million in 2016. Gross margin for 2018 was $55.3 million or 78% of revenues compared with $53.1 million or 81% of revenues in 2017 and with $49.6 million or 82% of revenues in 2016. Our 2018 decrease in gross margin is related to our Erado acquisition. We expect the Erado gross margins to improvmm recognize the value of revenue earned on post-acquisition sales. e as we complete recognition of our acquired deferred revenue and Net income (loss) for 2018 was $15.4 million compared with $(8.1) million in 2017 and $5.8 million in 2016. Our 2018 net income includes a $7.8 million tax benefit resulting from a decrease to our deferff based on our expected future profitabilit expense incurred in 2017 due to enactment of the Tax Act, which required us to reduce the valuation of our deferred tax asset red tax asset valuation allowance y and ability to use net operating losses. This compares to a $12.5 million tax ff Net income (loss) per diluted share was $0.29 for 2018 compmm ared with $(0.15) for 2017 and $0.11 for 2016. Unrestricted cash was $27.1 million on December 31, 2018. 30 Results of Operations Revenue The following table sets forth a year-over-year comparison of our total revenues: (In thousands) Revenues $ Year Ended December 31, 2017 65,663 $ $ 2018 70,478 Variance 2018 vs. 2017 Variance 2017 vs. 2016 2016 60,144 $ $ 4,815 % 7% $ $ 5,519 % 9% u Our growth model seeks to continually add new users to the subscribe r base, while at the same time retaining a high percentage whose subsu criptions are up for renewal. In the year ended Decembem r 31, 2018, we categorized our revenue in of existing subscribers the following core verticals: 49% healthcare, 29% financial services, 7% government sector, and 15% as other. In the year ended December 31, 2017, we categorized our revenue in the following core verticals: 49% healthcare, 28% financial services, 7% government sector, and 16% as other. The disaggregation of revenue by industry verticals does not include our revenue from Greenview and Erado. u Additionally, sales continued from a wide base of distributors –NFYO’s derived from our value-added resellers, OEM and other third party distribution channels for 2018 were 43% of total NFYOs compared to 56% in 2017 and 57% in 2016. The 2018 reduction in orders received from our OEM channels was due in part to a migration of customers from our Google relationship into a direct relationship with Zix. We measure additions to the subsu criber base by NFYOs, which is definff ed 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: (In thousands) New firff st year order value 2018 Year Ended December 31, 2017 2016 $ 11,282 $ 9,340 $ 9,524 While we introduced bundled email security pricing during 2017 and have continued to add new bundled price offeff rings to our product portfolio, our list pricing has remained generally consistent during the periods shown above. However, there are no assurances that potential increased competition in this market or other factors, including inflation, will not result in future price erosion. Price erosion, should it occur, could have a dampening effeff ct on order growthww and the revenuen derived from our new orders. Revenue Outlook: We expect continued growth in our core Email Encryption offerff ing and in our new producd ts, along with increased sales from our managed security service providers and value-added reseller channels to increase our NFYOs in 2019 and increase our year-over- year revenue. Backlogll and Orderdd srr Backlog — Our backlog was $73.0 million at December 31, 2018 compared with $72.6 million at Decembem r 31, 2017. The backlog is comprised of contractual commitments that we expect to amortize into revenue. As of December 31, 2018, the backlog was , comprmm ised of the following elements: $32.1 million of deferred revenue that has been billed and paid, $10.7 million billed but unpaid and approximately $30.2 million of unbilled contracts. n n The backlog is recognized into revenue ratably as the services are performff ed. Approximately 65% of the total backlog is expected to be recognized as revenue during the next twelve months. Orders — Total orders in 2018 were $73.3 million compared with $58.9 million in 2017. 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. Cost of Revenue The following table sets forth a year-over-year compamm rison of the cost of revenue. (In thousands) Cost of revenue $ Year Ended December 31, 2017 12,602 $ $ 2018 15,186 Variance 2018 vs. 2017 Variance 2017 vs. 2016 2016 10,533 $ $ 2,584 % 21% $ $ 2,069 % 20% 31 Cost of revenue is comprmm ised of expenses related to operating and maintaining the ZixData Center, a field deployment team, rt and the amortization of Company-owned, customer-based computer appliances. The 21% increase in customer service and suppouu cost of revenue in 2018 compamm red with 2017 reflected which include additional ZixArchive suppor the Greenview acquisition in March 2017. We are also incurring additional costs associated with leased equipment suppuu Advanced Threat Protection, and we are amortizing expense resulting from the acquisition of technology. Additional increases relate to standard software maintenance and license suppuu ort, and depreciation and other expense relating to investments in networking equipment. in the table above resulted primarily from increases in average headcount, t gained in the Erado acquisition in April 2018 and the ZixProtect support team gained in orting uu uu ff The 20% increase in cost of revenue in 2017 compamm red with 2016 refleff cted in the table above resulted primarily from increases in average headcount expense, including our ZixProtect support incurred additional costs associated with leased equipment supportin resulting from the acquisition of Greenview’s internally developed softwff uu uu are. team gained in the Greenview acquisition in March 2017. We also g Greenview customers and we began amortizing expense Research and Developmo ent Expenses The following table sets forth a year-over-year comparison of our research and development expenses: (In thousands) Research and development expenses Year Ended December 31, 2017 2016 2018 Variance 2018 vs. 2017 $ % Variance 2017 vs. 2016 $ % $ 11,323 $ 10,980 $ 9,553 $ 343 3% $ 1,427 15% Research and development expenses consist primarily of salary, benefits and stock-based compensation for our development staff,ff independent contractor expense, and other direct and indirect costs associated with enhancing our existing products and services and developing new products and services. The 3% increase in research and development expense in 2018 compamm red with 2017 reflect ff ed in the table above resulted primarily from an increase in travel and average headcount, including the ZixProtect and additional ZixArchive R&D emplmm oyees gained in the Greenview acquisition and Erado acquisition in March 2017 and April 2018, respectively, partially offseff t by $1.5 million of costs related to development of new features and functionality for our hosting service arrangements which we began capia talizing in 2018. The 15% increase in research and development expense in 2017 compamm red with 2016 reflected in the table above resulted primarily from additional headcount expense, including ZixProtect R&D emplmm oyees gained in the Greenview acquisition in March 2017. Selling and Marketing Expenses The following table sets forth a year-over-year comparison of our selling and marketing expenses: (In thousands) Selling and marketing expenses $ Year Ended December 31, 2017 20,472 2018 20,380 $ $ Variance 2018 vs. 2017 $ % $ (92) (0)% $ Variance 2017 vs. 2016 $ 1,457 % 8% 2016 19,015 Selling and marketing expenses consist primarily of salary, commissions, travel, stock-based compensation and emplomm yee benefits for selling and marketing personnel as well as costs associated with promotional activities and advertising. The $92 thousand decrease in selling and marketing expense in 2018 compamm red with 2017 resulted from lower commission and bonus expenses driven by our implemm mentation of GAAP accounting rule ASC 606, which became effeff ctive for our Company on January 1, 2018, and lower advertising and marketing costs. This decrease was offsff et by additional headcount expenses, including the emplomm yees gained in the April 2018 Erado acquisition and the expansio n of our business development lead qualifications team, stock based compensation, travel, and the amortization of acquisition related intangible assets. xx The $1.5 million increase in selling and marketing expense in 2017 compamm red with 2016 resulted from the addition of sales leadership, sales executives, and the buildout of our Customer Success team. Additional amortization expense resulting from Greenview’s customer base and brand were offseff t by decreased advertising as compamm red to our 2016 branding initiative. 32 General and Administrative tt Expenses The following table sets forth a year-over-year comparison of our general and administrative expenses: (In thousands) General and administrative expenses Year Ended December 31, 2017 2016 2018 Variance 2018 vs. 2017 $ % Variance 2017 vs. 2016 $ % $ 13,619 $ 11,399 $ 11,727 $ 2,220 19% $ (328) (3%) 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 profess million increase in general and administrative expense from 2018 compared with 2017 resulted from an increase in acquisition-related costs, consulting fees, stock-based compensation expense, the addition of our Erado offiff ce, and amortization expense of internal use softwff are, as well as other general and administrative costs due to increase of headcount. ional services and other general corporate activities. The $2.2 ff The $0.3 million decrease in general and administrative expense from 2017 compared with 2016 resulted from a $2.6 million reduction in legal fees specific to intellectual property litigation, offsff et by increased headcount and stock-based compensation expenses, revaluation of earn-out costs associated with our Greenview acquisition, the addition of the Greenview officeff investment in an ERP solution. , and Income Taxeaa s Our Company or one of our subsidi u aries files income tax returns in the U.S. federal jurisdiction and various states and in the Canadian federal and provincial jurisdictions. We recognize and measure uncertain tax positions using a two-step approach. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. Our Company incurred a tax benefitff of $4.7 million, and incurred tax expense of $18.6 million, and $3.7 million for 2018, 2017, ff and 2016, respectively. Our 2018 tax benefitff expected future profitability . On December 22, 2017, the U.S. enacted the Tax Act which significaff Act lowered the Company’s statutory tax rate from 34% to 21% effeff ctive January 1, 2018. At Decembem r 31, 2017, the Company adjusted its deferff expense represented defeff rred tax expense, refundff U.S. taxes payabla e related to the operations of the Company’s Canadian subsid red tax balances to refleff ct the new tax rate that resulted in tax expense of $12.5 million. For all years presented, tax able U.S. Alternative Minimum Tax, U.S. research and development credits, non- iary established in late 2002, and state income taxes. includes a $7.8 million release to our deferff red tax asset valuation allowance based on ntly changed U.S. tax law. The Tax u Significant judgement is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider available evidence, including past earnings, estimates of future taxable income, and the feasibility of tax planning strategies. At Decembem r 31, 2018, the Compamm ny partially reserved its U.S. net deferr uncertainty of future taxabla e income sufficie defeff rred tax asset not reserved was $28.8 million. The majoa rity of this unreserved portion related to $27.0 million U.S. net operating ient taxabla e income in future years to utilize these NOLs prior losses (“NOLs”) because we believe the Company will generate sufficff to their expiration. The remaining balance consists of $2.1 million relating to U.S. state tax income credits, $678 thousand related to Alternative Minimum Tax credits, and $114 thousand related to foreign tax credits. These items are offsff et by ($1.2) million relating to temporary timing differeff ed tax assets due to the nt to utilize net loss carryforff wards prior to their expiration. The portion of the Company’s nces between GAAP and tax-related expense. ff ff We have determined that utilization of existing NOLs against future taxable income is not limited 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 any future taxabla e income. If we begin to generate additional U.S. taxabla e income in a futureuu period or if the facts and circumstances on which our current estimates and assumptmm ions are based were to change, thereby impacti ng the likelihood of realizing a greater or lesser amount of our deferred tax assets, judgement would have to be applied in determining the amount of valuation allowance required. Adjud sting ouruu valuation allowance could have a significff ant impacm t on operating results in the period that it becomes more likely than not that an additional portion of our deferff red tax assets will or will not be realized. mm 33 ff Our provision for income taxes is subju ect to volatility and could be adversely impacted by earnings being lower or higher than of nondeductible compensation; or by changes in tax laws, regulations, or accounting principles, including anticipated; by tax effects accounting for uncertain tax positions or interpretations. Significan measurement applicable to all income tax positions. This includes the potential recovery of previously paid taxes, which if settled unfavorably could adversely affeff ct our provision for income taxes or additional paid-in capital. In addition, our income tax returns are subju ect to examination by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income. t judgment is required to determine the recognition and m ff Net Income (Loss) Net Income (Loss)s – The Company generated net income of $15.4 million compared with a net loss of $8.1 million in 2017 and net income of $5.8 million in 2016. The increase in our net income is primarily due to revenue growth and a 2018 tax benefit resulting from the decrease to our deferff legislation, as discussed above. red tax asset valuation allowance as compared to the tax expense incurred following 2017 tax-reforff m Liquidity and Capital Resources Overview Based on our 2018 financial results and current expectations, we believe our cash and cash equivalents, cash generated from al expenditures, investment requirements, contractual obligations, commitments, , and other operations, and availability under our $25 million revolving credit facility and $10 million delayed draw term loan facilities, will satisfyff our working capital needs, capita 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 annuan l budgeting process. During 2018, our cash flow from operations was $16.7 million, a decrease of $1.5 million from the $18.2 million cash flow from operations during 2017. At December 31, 2018, our cash and cash equivalents totaled $27.1 million, a decrease of $5.9 million from the December 31, 2017 balance, and we had no bank debt. The $5.9 million decrease in our cash position indicated our expenditure of $11.8 million, net of cash acquired, related to our Erado purchase in April 2018 and $6.0 million related to our share repurchase activity, as discussed elsewhere herein. As disclosed elsewhere in this Annual Report on Form 10-K, on February 20, 2019, we obtained a $25 million revolving credit facility and a $10 million delayed draw term loan facility from a syndicate of banks, which can be used to manage our future liquidity needs. For the year ended December 31, 2018, we achieved 7% growth in revenuen , 78% gross margin and strong cash collections. While future results cannot be guaranteed, we expect these trends to continue in the foreseeable future, and believe a significff ant portion of our spending is discretionary and flexible and that we have the ability to adjud st overall cash spending and raise additional funds in order to react, as needed, to any shortfalff ls in projected cash. Sources and Uses of Cash (In thousands) Net cash provided by operations Net cash used in investing activities Net cash used in financing activities 2018 Years Ended December 31, 2017 2016 $ $ $ 16,671 $ (15,952) $ (6,593) $ $ 18,204 (11,285) $ (367) $ 15,251 (2,136) (15,322) Our primary source of liquidity from operations was the collection of revenue in advance from our customers, accounts receivable from our customers, and the management of the timing of payments to our vendors and service providers. Investing activities in 2018 consist of $11.8 million, net of cash acquired, used in the acquisition of Erado and $4.2 million for l use softwff capia tal expenditures, which include $2.1 million for computer and networking equipment, $1.5 million in internal research and development costs of hosting arrangement for our customers, and $500 thousand for other activities including the acquisition of other internar ucture are to modernize our business processes and product offeff acquisition of Greenview and Entelligence Messaging Server technology. We additionally purchased $2.2 million of computer and networking equipment, and invested $802 thousand in new systems to modernize our business processes. rings. Cash used in our investing activities for 2017 consisted of $8.2 million, net of cash acquired, used in the are. These investments in new equipment and cloud hosting infrastr ff Financing activities in 2018 relate primarily to $5.4 million used in a $10 million share repurchase program authorized by our Board of Directors on April 24, 2017, and $656 thousand used in the repurchase of common stock related to the tax impamm ct of vesting restricted stock awards, and a $605 thousand earn-out payment associated with our acquisition of Greenview. Financing activities in 2017 include $3.8 million used in the same share repurchase program and $762 thousand used in the repurchase of common stock related to the tax impamm ct of vesting restricted awards offseff t by the receipt of $4.2 million from the exercise of stock options. 34 Options of Zix 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 and related dilution from additional option activity is not certain. The following table summarizes the options that were outstanding as of December 31, 2018. The vested options are a subsu et of the outstanding options. The value of the options is the number of options exercisable into shares multiplied by the exercise price for each share. Exercise Price Range $2.00 - $3.49 $3.50 - $4.99 Total Liquidity Summary Summary of Outstanding Options Total Value fof Outstanding Options (In thousands) Vested Options (included in outstanding options) Outstanding Options 431,813 492,010 923,823 $ 1,112 1,871 2,983 431,813 385,760 817,573 Total Value fof Vested Options (In thousands) 1,112 1,473 2,585 $ Based on our current 2019 budget plans, we believe we have adequate resources and liquidity to sustain operations or raise capia tal as needed for at least the next twelve months. Off-Balanc ff e Sheet Arrangements None. Contractual Obligations and Contingent Liabilities and Commitments We have total contractual obligations of $1.6 million over the next year and $3.9 million over the next three years primarily consisting of various operating officeff lease agreements. The lease of our headquarters facility in Dallas expires in 2024. A summary of our fixed contractual obligations and commitments at December 31, 2018, is as follows: (In thousands) Operating leases Total 1 Year Payments Due by Period 2-3 Years 4-5 Years > 5 Years $ 6,983 $ 1,625 $ 2,292 $ 2,205 $ 861 As of December 31, 2018, we had severance agreements with certain emplom yees which would require us to pay up to approximately $5.8 million if all such emplomm yees were terminated from emplom yment with our Company following a triggering event (e.g., change of control) as defined in the severance agreements. New Accounting Standards Revenue Recognition In May 2014, the FASB issued ASC 606, which supers u edes 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 red to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or are transferff services. ASC 606 definff es 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 were required under prior U.S. GAAP. The standardaa beginning in 2018. Ouruu Company provides primarily email encryption and advanced threahh services in which we recognize revenue as ouruu services are rendered. We determined ouruu revenue was not materially impamm cted by the new guidance. However, the guidance did requiqq re us to increase the amortization period of ouruu sales commission expex nse. We applied the guidance to commissions earned on all contratt cts that were not complete as of January 1, 2018. Prior period amountsnn have not been adjusted and continuenn years, 4 years and 18 montht amortization periods for ouruu to ouruu new, add-on, and renewal sales commission expens Determination of the amortization period and subsu equent assessmentsnn for impaimm rment of the related deferred cost asset requires significant judgement. to be reporterr d in accordance with the previous guidance. Ouruu Company elected a portfrr olff xx io approach, applying 8 es, respectively. t protection securiuu ty solutions as subsu cription became effeff ctive for us 35 We applied a modified retrott spective approach to ouruu implmm ementann tion of ASC 606 in which we recognized a $4.6 million cumulmm ative effeff ct adjustmentnn to ouruu 2018 retained earnings opening balance related to ouruu increased amortization period. This adjud stment includes a $1.6 million impamm ct to ouruu deferred tax asset. The tabla e below presents the cumulative effeff ct of the changes made to ouruu consolidated balance sheet due to the adoption of ASC 606: (InII aa thousands ) Assets: Prepaid and other current assets Other assets and deferff red costs ff Deferr ed tax assets Stockholders’ equity: ff Accumulated deficit January 1, 2018 Cumulative Effeff ct Adjustment Beginning Balance, as Adjusted Beginning Balance $ $ 3,222 —— 25,647 (415) $ 6,595 (1,616) 2,807 6,595 24,031 $ (236,372) $ 4,564 $ (231,808) Financial statement results as reported under the new revenue standard as compared to the previous standarda for the twelve months ended and as of December 31, 2018, are as follows: thousands, except per share data) (InII Revenues Cost of revenues Gross margin Operating expenses: arch and development Selling, general and administrative Total operating expenses Operating income Other income, net Income beforff e income taxes Income tax expense Net income Basic income per common share Diluted income per common share (1) Per share variance may not foot due to rounding (InII thousands) Assets: Prepaid and other current assets Other assets and deferff red costs ff Deferr ed tax assets Stockholders’ equity: ff Accumulated deficit Twelve Months Ended December 31, 2018 Under Under ASC 606 ASC 605 Variance $ $ $ $ 70,478 15,186 55,292 11,323 36,554 47,877 7,415 754 8,169 5,257 13,426 0.26 0.25 $ $ $ $ $ $ 70,478 15,186 55,292 11,323 33,999 45,322 9,970 754 10,724 4,720 15,444 0.29 0.29 —— —— —— —— (2,555) (2,555) 2,555 —— 2,555 (537) 2,018 0.04 0.04 Under ASC 605 December 31, 2018 Under ASC 606 Variance $ $ 3,760 —— 30,401 $ 3,176 9,424 28,785 (584) 9,424 (1,616) $ (222,946) $ (216,364) $ 6,582 36 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 typesyy of cash flows. The new guidance addressed debt prepayment or extinguishment of costs, settlement of zero-coupouu insurance claims, proceeds from the settlement of corporate-owned lifeff distributions received from equity method investees, beneficff flows and application of the predominance principle. ff insurance policies and bank-owned life insurance policies, n bonds, contingent consideration made after ial interests in securitization transactions, and separately identifiable cash a business combination, proceeds from the settlement of The standard became effeff ctive for us beginning in 2018. We applied the new guidance within our consolidated statements of cash flows classification to an $800 thousand earn-out payment associated with our Greenview acquisition. Because this consideration $605 thousand of the payment as the consummation date, as required by the guidance, we classifiedff payment was not made soon after a financing activity. This refleff cts 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 classifiedff as an operating activity. The standard had no other impactmm on our consolidated financial statements. ff Leases In Februar ry 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Topic 842 requires companies to generally recognize on assets. The new lease standard becomes the balance sheet operating and financing lease liabilities and corresponding right-of-use effeff ctive for us beginning 2019. We expect to adopt Topic 842 using the effeff ctive date as the date of our initial application of the standard. Consequently, financial inforff mation for the comparative periods will not be updated. We currently expect that most of our operating lease commitments will be subju ect to the new standard and recognized as operating lease liabilities and right-of-uff se assets upon our adoption of Topic 842. We are evaluating the potential impamm ct of this new guidance on our consolidated financial statements, and currently estimate the recognition of our outstanding lease obligations as of December 31, 2018, will result in recording right-to- use-assets and lease liabili ties of $4.5 million to $6.5 million. a ff Item 7A. Quantitative and Qualitative Disclosures About Market Risk We do not believe that we face exposure to material market risk with respect to our cash, cash equivalents and restricted cash investments, which totaled $27.1 and $33.0 million at December 31, 2018 and 2017, respectively. We held no marketable securities and no debt as of Decembem r 31, 2018 and 2017. ii Item 8. Financial Statements and Supplementary Data The information required by this Item 8 begins on page F-1 of this Annual Report on Form 10-K. Item 9. Changes in and Disagreem a ents with Accountants on Accounting and Financial Disclosure None. 37 Item 9A. Controlsll and Procedures Effectiv ff eness of Disclosure Controls and Procedure In accordance with Rule 13a-15(b) of the Exchange Act, as of the end of the period covered by this Annual Report on Form 10- K, management evaluated, with the participation of our principal executive offiff cer and principal financial offiff cer, the effecff tiveness of the design and operation of the Company’s disclosure controls and procedurdd es (as defined in Rule 13a-15(e) under the Exchange Act). Based on their evaluation of these disclosure controls and procedures, they have concluded that our disclosure controls and procedures were effect ive as of the date of such evaluation. ff ff Certificati ons of our principal executive offiff cer and our principal accounting officer 13a- 14 of the Exchange Act, are attached as exhibits to this Annual Report. This “Effecti Procedures” section includes the inforff mation concerning controls evaluation referred conjunction with the certifications for a more complete understanding of the topics presented. ff , which are required in accordance with Rule veness of Disclosure Controls and ff ff to in the certifications, and it should be read in Management’s Annual Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is l control over financial reporting may not prevent definff ed in Exchange Act Rule 13a-15(f). Because of its inherent limitations, internar or detect misstatements. Also, projeo ctions of any evaluation of effeff ctiveness to future periods are subju ect to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate. Management assessed the effecff tiveness of our internal control over financial reporting as of Decembem r 31, 2018. In making this assessment, management used the criteria set forth in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission in “Inte Decembem r 31, 2018, our internal control over financial reporting was effeff ctive based on those criteria. rated Framework”. Based on this assessment, our management concluded that, as of rnal Control—Integ— “ On April 2, 2018, we completed our acquisition of CM2.COM, Inc., d/b/a Erado (“Erado”). We are in the process of evaluating the existing controls and procedures of Erado and integrating Erado into our internal control over financial reporting. In accordance with SEC Staff guidance permitting a company to exclude an acquired business from management’s assessment of the effectiv internal control over financial reporting for the year in which the acquisition is completed, we have excluded the business that we acquired in the Erado Combination from our assessment of the effecff Decembem r 31, 2018. The business we acquired in the Erado Combination represented approximately 9% of the Company’s total assets at Decembem r 31, 2018 and 3% of the Company’s revenues for the year ended Decembem r 31, 2018. The scope of management’s assessment of the effeff ctiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2018, includes all of the Company’s consolidated operations except for those disclosure controls and procedures of Erado that are subsu umed by internal control over financial reporting. tiveness of internal control over financial reporting as of eness of ff The effeff ctiveness of our internal control over financial reporting as of December 31, 2018, has been audited by Whitley Penn LLP, an independent registered public u accounting firm, as stated in their report which is included herein. Changes in Internal Controls over Financial Reporting During the three months ended Decembem r 31, 2018, there have been no changes in our internal control over financial reporting identified in connection with the evaluation described above that have materially affeff cted or are reasonably likely to materially affeff ct internal control over financial reporting. 38 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockhokk lders Zix Corporation Opinion on Internal Control Over Financial Reporting We have audited Zix Corporation and subsiu 2018, based on criteria established in 2013 Internal Control—Integ— Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effecti internal control over financial reporting as of December 31, 2018, based on criteria established in 2013 IntII ernal Control—In Frameworkrr issued by COSO. diaries’ (the “Compamm ny”) internal control over financial reporting as of December 31, rated Frameworkrr issued by the Committee of Sponsoring ll ff ve tegrated We also have audited, in accordance with the standards of the Public u (“PCAOB”), the consolidated balance sheets of the Company, as of December 31, 2018 and 2017, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and our report dated March 8, 2019 expressed an unqualifiedff Company Accounting Oversight Board (United States) opinion on those consolidated financial statements. Basis for Opinion The Compamm ny’s management is responsible for maintaining effeff ctive internal control over financial reporting, and for its assessment of the effeff ctiveness of internal control over financial reporting, included in the accompamm nying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the entity’s internal control over financial reporting based on our audit. We are a publu ic accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicabla e rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perforff m the audit to obtain reasonable assurance about whether effeff ctive internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weaknekk ss exists, and testing and evaluating the design and operating effecff tiveness of internal control based on the assessed risk. Our audit also included perforff ming such other procedurd es as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. As indicated in the accompanying Management’s Annual Report on Internal Controls over Financial Reporting, management’s assessment of and conclusion on the effeff ctiveness of internal control over financial reporting did not include the internal controls of the business that the Company acquired in the acquisition of CM2.COM, Inc., d/b/a/ Erado (“Erado”), which is included in the 2018 consolidated financial statements of the Company and constituted approximately 9% of the total assets as of December 31, 2018, and approximately 3% of revenues for the year then ended. Our audit of the internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Erado. Definitio ff n and Limitations of Internal Control Over Financial Reporting An entity’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. An entity’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the assets of the entity; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effeff ct on the financial statements. the transactions and dispositions of ff Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projeo ctions of any evaluation of effecff conditions, or that the degree of compliance with the policies or procedures may deteriorate. tiveness to future periods are subju ect to the risk that controls may become inadequate because of changes in /s/ WHITLEY PENN LLP Plano, Texas March 8, 2019 39 Item 9B. Other Informatiott n None. 40 PART III Item 10. Directortt s,rr Executive Officers and Corporate Governance Certain information required by this Item 10 is incorporated by reference from our Proxy Statement related to our 2019 Annual Meeting of Shareholders under the sections “OTHER INFORMATION YOU NEED TO MAKE AN INFORMED DECISION — ff Directors, Executive Offiff cers and Significaff al Ownership Reporting Compliance,” and nt Emplomm yees” and “Section 16(a) Benefici rate Governance Committee, Selection of Director NCAA E — Code of Ethics,” and “Nominating and Corporr “CORPORATE GOVERNARR Nominees,” and “Audit Committee.” Our Board of Directors has adopted a Code of Conduct and Code of Ethics that applies to all directors, offiff cers and emplmm oyees of the Company. A copy of this document is available on our website at www.zixcorp.com under “Corporate Governance.” Any waiver or amendment of the Code of Ethics with respect to ouruu chief executive officff er and senior financial offiff cers will be publu icly disclosed as required by applicable law and regulation, including by posting the waiver on our website. Item 11. Executive Compem nsation The information required by this Item 11, including certain information pertaining to Company securities authorized for issuance under equity compensation plans, is incorporated by referff ence from our Proxy Statement related to our 2019 Annual Meeting of Shareholders under the section “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS.” Item 12. Security Ownershrr ip of Certainii Beneficial e Owners and Management and Related Stockholder ll Matters The information required by this Item 12 is incorporated by reference from our Proxy Statement related to our 2019 Annual Meeting of Shareholders under the sections “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAAA Information.” GEMENT” and “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS — Equity Compensation Plan Item 13. Certainii Relatll iontt ships and Related Transactions, and Directortt Independence dd The information required by this Item 13 is incorporated by referff ence from our Proxy Statement related to our 2019 Annual Meeting of Shareholders under the sections “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS — Certain Relationships and Related Transactions” and “CORPORATE GOVERNANCE — Corporate Governance Requirements and Board Member Independence.” Item 14. Princip ii al Accountant Fees and Services The information required by this Item 14 is incorporated by reference from our Proxy Statement related to our 2019 Annual Meeting of Shareholders under the section “INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS.” 41 PART IV Item 15. Exhibitstt and Finanii cial Statemtt ent Schedules (a)(1) Financial Statements See Index to Consolidated Financial Statements on page F-1 hereof. FF (a)(2) Financi al Statement Scheduldd es All schedules for which provision is made in the applicable accounting regulations of the SEC have been omitted because of the absence of the conditions under which they are required or becauseaa statements or notes thereto. the information required is included in the consolidated financial 42 (a)(3) Exhibits Exhibit Number 2.1 Description — Stock Purchase Agreement, dated as of April 2, 2018, by and among Craig Brauff,ff tee of the Alexandra Brauffff Gift Trusr Richardson, as Trusr Courtney Brauff Gift Trusrr Zix Corporation. Filed as Exhibit 2.1 to Zix Corporation’s Current Report on Form 8-K, filed on April 2, 2018, and incorporated herein by reference. t U/A 12/21/12, Shari Wood-Richardson, as Trusrr tee of the Julie Lomax Giftff Trusr t U/A 12/21/12, Julie A. Lomax, as Trusr Julie Lomax Brauff,ff Shari Wood- tee of the t U/A 12/21/12, and 2.2* — Securities Purchase Agreement, dated as of January 14, 2019, by and among Zix Corporation, AR Topco, LLC, AppRiver Marlin Blocker Corp., AppRiver Holdings, LLC, AppRiver Marlin Topco, L.P., AppRiver Management Holding, LLC, Marlin Equity IV, L.P. and Marlin Topco GP, LLC, as the sellers’ representative. 3.1 — Restated Articles of Incorporation of Zix Corporatio rr n, as filed with the Texas Secretary of State on November 10, 2005. Filed as Exhibit 3.1 to Zix Corporation’s Annual Report on Form 10-K for the year ended Decembem r 31, 2005, and incorporated herein by reference. 3.2 — Second Amended and Restated Bylaws of Zix Corpora rr tion dated November 1, 2016. Filed as Exhibit 3.2 to Zix ration’s Quarterly Report on Form 10-Q for the quarterly period ended Septemberm 30, 2016, and incorporated Corporr herein by reference. 3.3 — Certificate of Designations of Series A Convertible Preferr ff ed Stock, as filed with the Texas Secretary of State on February 15, 2019. Filed as Exhibit 3.1 to Zix Corporation’s Current Report on Form 8-K, filed on February 22, 2019, and incorporated herein by reference. 3.4 — Certificaff te of Designations of Series B Convertible Preferred February 15, 2019. Filed as Exhibit 3.1 to Zix Corpor and incorporated herein by reference. rr ff Stock, as filed with the Texas Secretary of State on ation’s Current Report on Form 8-K, filed on February 22, 2019, 10.1† — Zix Corporation 2004 Stock Option Plan (Amended and Restated as of June 7, 2007). Filed as Exhibit 10.3 to Zix Corporation’s Current Report on Form 8-K, filed on June 12, 2007, and incorporated herein by referff ence. 10.2† — Zix Corporation 2006 Directors’ Stock Option Plan (Amended and Restated as of June 7, 2007). Filed as Exhibit 10.1 to Zix Corporation’s Current Report on Form 8-K, filed on June 12, 2007, and incorporated herein by reference. 10.3† — Form of Stock Option Agreement (with no “change in contrott l” provision) for Zix Corporation Stock Option Plans. Filed as Exhibit 10.2 to Zix Corporation’s Registration Statement on Form S-8 (Registration No. 333-126576), dated July 13, 2005, and incorporated herein by referff ence. 10.4† — Form of Stock Option Agreement (with “change in control” provision) for Zix Corporation Stock Option Plans. Filed as Exhibit 10.3 to Zix Corporr 2005, and incorporated herein by reference. ration’s Registration Statement on Form S-8 (Registration No. 333-126576), dated July 13, 10.5† — Form of Stock Option Agreement (with “acceleration event” provision) for Zix Corporation Stock Option Plans and applicable to option agreements held by the Company’s chief executive offiff cer and direct reports. Filed as Exhibit 10.17 to Zix Corpora rr reference. tion’s Annual Report on Form 10-K for the year ended December 31, 2007, and incorporated herein by 10.6 — Zix Corporation 401(k) Retirement Plan. Filed as Exhibit 10.10 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference. 10.7 — Adoption Agreement relating to Zix Corporation 401(k) Retirement Plan. Filed as Exhibit 10.11 to Zix Corporat r Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by referff ence. ion’s 43 Exhibit Number Description 10.8† — Form of Zix Corporation Outside Director Stock Option Agreement Filed as Exhibit 10.3 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004, and incorporated herein by referff ence. 10.9† — Zix Corporation Outside Director Stock Option Agreement. Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010, and incorporated herein by reference. 10.10† — Form of Zix Corporation Emplmm oyee Stock Option Agreement. Filed as Exhibit 10.2 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010, and incorporated herein by referff ence. 10.11† — Form of Director Indemnificat ff ion Agreement. Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10- Q for the quarterly period ended Septemberm 30, 2016, and incorporated herein by referff ence. 10.12 — Form of Amended and Restated Termination Benefits Agreement. Filed as Exhibit 10.1 to Zix Corporr ration’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2015, and incorporated herein by reference. 10.13† — Zix Corporation Amended and Restated 2012 Incentive Plan. Filed as Appendix A of Schedule 14A on May 13, 2015, and incorporated herein by reference. 10.14† — Amendment No. One to Zix Corpor rr ation Amended and Restated 2012 Incentive Plan. Filed as Exhibit 10.27 to Zix Corporation’s Annual Report on Form 10-K for the year ended Decembem r 31, 2015, and incorporated herein by reference. 10.15† — Zix Corporation 2018 Omnimm bus Incentive Plan. Filed as Appendix A of Schedule 14A on April 27, 2018, and incorporated herein by reference. 10.16† — Form of Executive Restricted Stock Agreement. Filed as Exhibit 10.22 to Zix Corporation’s Annual Report on Form 10-K for the year ended Decembem r 31, 2017, and incorporated herein by referff ence. 10.17† — Form of Executive Restricted Stock Agreement (Qualifieff d Perforff mance Based Award). Filed as Exhibit 10.23 to Zix Corporation’s Annual Report on Form 10-K for the year ended Decembem r 31, 2017, and incorporated herein by reference. 10.18† — Form of Executive Restricted Stock Unit Agreement. Filed as Exhibit 10.24 to Zix Corpor rr ation’s Annual Report on Form 10-K for the year ended December 31, 2017, and incorporated herein by referff ence. 10.19† — Form of Executive Restricted Stock Unit Agreement (Qualifiedff Performff ance Based Award). Filed as Exhibit 10.25 to Zix Corporr reference. ration’s Annual Report on Form 10-K for the year ended December 31, 2017, and incorporated herein by 10.20† — Form of Non-Emplmm oyee Director Restricted Stock Agreement. Filed as Exhibit 10.26 to Zix Corporation’s Annual Report on Form 10-K for the year ended Decembem r 31, 2017, and incorporated herein by reference 10.21† — Form of Non-Emplmm oyee Director Deferred Stock Unit Agreement. Filed as Exhibit 10.27 to Zix Corporr ration’s Annual Report on Form 10-K for the year ended Decembem r 31, 2017, and incorporated herein by reference. t 10.22* — Debt Commitment Letter, dated as of January 14, 2019, by and among SunTrust Robinson Humphmm rey, Inc., SunTrusrr Bank, KeyBanc Capital Markets Inc., KeyBank National Association and Zix Corporation. 10.23* — Credit Agreement, dated as of February 20, 2019, by and among Zix Corporation, the lenders party thereto, and SunTrusrr t Bank, as administrative agent. 10.24 — Investment Agreement, dated as of January 14, 2019, by and between Zix Corporation and the investor named therein. Filed as Exhibit 10.1 to Zix Corporation’s Current Report on Form 8-K, filed on January 17, 2019, and incorporated herein by reference. 10.25 — Registration Rights Agreement, dated as of February 20, 2019, by and among Zix Corporation and Truer Wind Capital, L.P. Filed as Exhibit 10.1 to Zix Corporation’s Current Report on Form 8-K, filed on February 22, 2019, and incorporated herein by reference. 21.1* — Subsidiari u es of Zix Corporation. 44 Exhibit Number Description 23.1* — Consent of Independent Registered Publu ic Accounting Firm (Whitley Penn LLP). 31.1* — Certification of David J. Wagner, President and Chief Executive Offiff cer of the Company, pursuant to Section 302 of the Sarbanr es-Oxley Act of 2002. 31.2* — Certification of David E. Rockvam, Chief Financial Office ff r (Principal Financial Offiff cer and Principal Accounting Officeff r) of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1** — Certification of David J. Wagner and David E. Rockvam, pursuu uant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 101.1* — 101. INS (XBRL Instance Document) 101. SCH (XBRL Taxonomy Extension Schema Document) 101. CAL (XBRL Calculation Linkbase Document) 101. LAB (XBRL Taxonomy Label 101. DEF (XBRL Taxonomy Linkbase Document) 101. PRE (XBRL Taxonomy Presentation Linkbase Document) Linkbase Document) a * ** † Filed herewith. Furnished herewith. Management contract or compensatory plan or arrangement. Item 16. Form 10-K Summary Not Applicable. 45 Pursuuu antnn to the requirements of Section 13 or 15(d) of the Securiuu ties Exchange Act of 1934, the Registratt nt has duly caused this reportrr to be signed on its behalf by the undersigned, thereuntonn duly authuu orized, in the city of Dallas, state of Texas, on March 8, 2019. SIGNATURES ZIX CORPORATION By: /s/ DAVID E. ROCKVAM David E. Rockvam Chief Financial Officer (Principal Financial Officff er and Principal Accounting Officer)r Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 8, 2019. Signature Title /s/ DAVID J. WAGNER (David J. Wagner) /s/ DAVID E. ROCKVAM (David E. Rockvam) /s/ MARK J. BONNEY (Mark J. Bonney) /s/ TAHER A. ELGAMAL (Taher A. Elgamal) /s/ JAMES H. GREENE, JR. (James H. Greene, Jr.) /s/ ROBERT C. HAUSMANN (Robert C. Hausmann) /s/ MARIBESS L. MILLER (Maribess L. Miller) /s/ RICHARD D. SPURR (Richard D. Spurr) /s/ BRANDON VANAA BUREN (Brandon Van Buren) Chief Executive Offiff cer, President and Director (Principal Executive Offiff cer) Chief Financial Offiff cer ff (Principal Financial Officer and Principal Accounting Offiff cer) Director Director Director Chairman, Director Director Director Director 46 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS u Accounting Firm Report of Independent Registered Public Consolidated Balance Sheets at Decembem r 31, 2018 and 2017 Consolidated Statements of Comprehensive Income for the years ended Decembem r 31, 2018, 2017, and 2016 Consolidated Statements of Stockhok lders’ Equity for the years ended December 31, 2018, 2017, and 2016 Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017, and 2016 Notes to Consolidated Financial Statements F-2 F-3 F-4 F-5 F-6 F-7 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockhokk Zix Corporation lders Opinion on the Financial Statements tion and subsidiaries (the “Compamm ny”), as of December We have audited the accompanying consolidated balance sheets of Zix Corpora 31, 2018 and 2017, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended Decembem r 31, 2018, and the related notes (collectively referred statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended Decembem r 31, 2018, in conforff mity with accounting principles generally accepted in the United States of America. to as the “finff ancial rr ff We also have audited, in accordance with the standards of the Public (“PCAOB”), the Company’s internar Internal Control—Integ— (“COSO”), and our report dated March 8, 2019, expressed an unqualified opinion. u l control over financial reporting as of December 31, 2018, based on criteria established in 2013 rated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission Company Accounting Oversight Board (United States) Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are a publu ic accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perfoff rm the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included perforff ming procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significaff nt estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company’s auditor since 2006. /s/ WHITLEY PENN LLP Plano, Texas March 8, 2019 F-2 December 31, 2018 2017 $ $ $ 27,109 3,188 3,176 33,473 3,924 9,424 15,251 13,783 28,785 104,640 769 9,747 30,622 41,138 1,539 1,016 2,555 43,693 33,009 1,389 3,222 37,620 4,048 — 5,524 8,469 25,647 81,308 1,053 6,101 28,362 35,516 1,087 1,185 2,272 37,788 — — 779 384,940 (108,392) (216,364) (16) 60,947 104,640 $ 778 381,457 (102,343) (236,372) — 43,520 81,308 $ $ $ $ ZIX CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share and par value data) ASSETS Current assets: Cash and cash equivalents Receivables, net Prepaid and other current assets Total current assets Property and equipment, net Other assets and deferff Intangible assets, net Goodwill ff Deferr red costs ed tax assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payabla e Accrued expenses Deferred revenue Total current liabilities Long-term liabilities: Deferred revenue Deferred rent Total long-term liabilities Total liabilities Commitments and contingencies (Note 15) Stockholders’ equity: ff Preferred stock, $1 par value, 10,000,000 shares authorized; none issued and outstanding Common stock, $0.01 para value, 175,000,000 shares authorized; 81,715,330 issued and 54,186,180 outstanding in 2018 and 80,709,970 issued and 54,542,612 outstanding in 2017 Additional paid-in capital Treasury stock, at cost; 27,529,150 common shares in 2018 and 26,167,358 common shares in 2017 Accumulated deficit Accumulated other comprehensive (loss) income ff Total stockholders’ equity Total liabilities and stockholders’ equity See notes to consolidated financial statements. F-3 ZIX CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands, except share and per share data) Revenues st of revenue Gross margin arch and development expenses Selling, general and administrative expenses Operating income er income (expense): Investment and other income Interest expense Total other income come beforff e income taxes come tax benefit (expense) Net income (loss) sic income (loss) per common share Diluted income (loss) per common share Weighted average shares outstanding Basic common shares outstanding Diluted common shares outstanding Other comprehensive income, net of tax: Foreign currency translation adjud stments Comprehensive income (loss) 2018 Year Ended December 31, 2017 2016 70,478 15,186 55,292 11,323 33,999 9,970 754 —— 754 10,724 4,720 15,444 0.29 0.29 $ $ $ $ $ 65,663 12,602 53,061 10,980 31,871 10,210 339 —— 339 10,549 (18,606) (8,057) $ (0.15) $ (0.15) $ 60,144 10,533 49,611 9,553 30,742 9,316 246 33 213 9,529 (3,692) 5,837 0.11 0.11 52,591,714 53,481,295 53,430,492 53,430,492 53,819,772 54,395,145 (16) 15,428 $ —— (8,057) $ —— 5,837 $ $ $ $ $ See notes to consolidated financial statements. F-4 ZIX CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (In thousands, except share data) Balance, December 31, 2015 uance of common stock upon exercise of stock options Issuance of common stock upon vesting of restricted stock units, net Issuance of common stock upon vesting of perforff mance stock units, net Issuance of restricted common stock, net Issuance of restricted perforff mance common stock, net Emplmm oyee stock-based compensation costs Treasury repurchase program Net income (loss) Balance, December 31, 2016 uance of common stock upon exercise of stock options Issuance of common stock upon vesting of restricted stock units, net Issuance of common stock upon vesting of perforff mance stock units, net Issuance of restricted common stock, net Issuance of restricted perforff mance common stock, net Emplmm oyee stock-based compensation costs Treasury repurchase program Net income (loss) Balance, December 31, 2017, as reported ulmm ative effeff ct adjud stment from changes in accounting standards (Note 2) Balance, January 1, 2018, as adjud sted uance of common stock upon exercise of stock options Issuance of common stock upon vesting of restricted stock units, net Issuance of common stock upon vesting of perforff mance stock units, net Issuance of restricted common stock, net Issuance of restricted perforff mance common stock, net Emplmm oyee stock-based compensation costs Treasury repurchase program Adjud stment from foreign currency translation Net income (loss) Balance, December 31, 2018 Stockhokk lders’ Equity Common Stock Shares 77,852,453 Amount $ 767 Additional Paid-In Capital $ 372,400 Treasury Stock Accumulated Deficit Accumulated Other Comprehensive Income (Loss) Total Stockhokk lders’ Equity $ (82,243) $ (234,152) $ —— $ 56,772 123,760 179,914 97,428 518,211 141,500 —— —— —— 78,913,266 932,303 126,167 20,999 645,623 71,612 —— —— —— 80,709,970 —— 80,709,970 90,011 50,751 32,665 735,987 95,946 —— —— 2 —— —— —— —— —— —— —— 769 9 —— —— —— —— —— —— —— 778 —— 778 1 —— —— —— —— —— —— 203 —— —— —— —— 1,783 —— —— 374,386 4,197 —— —— —— —— —— —— —— —— —— — — — — — (527) (15,000) —— (97,770) — — 5,837 (228,315) —— —— —— —— —— — — — — — 2,874 —— —— 381,457 (762) (3,811) —— (102,343) — — (8,057) (236,372) —— 381,457 —— (102,343) 4,564 (231,808) 165 —— —— —— —— —— —— —— —— —— 3,318 —— (656) (5,393) — — — — — — — —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— —— 81,715,330 $ —— —— 779 —— —— $ 384,940 —— —— — 15,444 $ (108,392) $ (216,364) $ (16) —— (16) $ See notes to consolidated financial statements. F-5 205 —— —— —— —— 1,256 (15,000) 5,837 49,070 4,206 —— —— —— —— 2,112 (3,811) (8,057) 43,520 4,564 48,084 166 —— —— —— —— 2,662 (5,393) (16) 15,444 60,947 ZIX CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Operating activities: Net income (loss) Non-cash items in net income (loss): Depreciation and amortization Emplomm yee stock-based compensation expense ed taxes Changes in deferr ff Changes in operating assets and liabilities: Receivables Prepaid and other assets Other assets and deferff Accounts payabla e Deferred revenue Earn-out payment Accrued and other liabilities red costs Net cash provided by operating activities vesting activities: Purchases of property, equipment and internal-use software Acquisition of business, net of cash acquired Net cash used in investing activities ed debt financing costs ancing activities: Proceeds from exercise of stock options ff Deferr Stock issuance costs Earn-out payment Treasury stock Net cash used in financing activities feff ct of exchange rate changes on cash crease (decrease) in cash and cash equivalents h and cash equivalents, beginning of year Cash and cash equivalents, end of year 2018 Year Ended December 31, 2017 2016 $ 15,444 $ (8,057) $ 3,706 3,318 (4,754) (1,376) 108 (3,139) (325) 1,892 (195) 1,992 16,671 (4,179) (11,773) (15,952) 166 (60) (45) (605) (6,049) (6,593) (26) (5,900) 33,009 27,109 $ 2,741 2,874 18,470 64 (386) — 645 1,370 — 483 18,204 (3,041) (8,244) (11,285) 4,206 — — — (4,573) (367) — 6,552 26,457 33,009 $ $ 5,837 2,303 1,783 3,186 (711) 79 —— (15) 3,200 —— (411) 15,251 (2,136) —— (2,136) 205 —— —— —— (15,527) (15,322) —— (2,207) 28,664 26,457 See notes to consolidated financial statements. F-6 ZIX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Company Overview Zix Corporation (“Zix,” the “Company,” “we,” “our,” “us”) provides email encryption, advanced threat protection, email archiving, data loss prevention (“DLP”) and Bring-Your-Own-Device (“BYOD”) solutions to meet the data protection and compliance needs of organizations primarily in the healthcare, financial services, and government sectors. 2. Summary of Significaff nt Accounting Policies Basis of Presentation — The accompanying consolidated financial statements include the accounts of all our wholly-owned iaries and are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. subsid u GAAP”). All inter-compamm ny accounts and transactions have been eliminated in consolidation. Use of Estimates — The preparation of consolidated financial statements in conforff mity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affeff ct the reported amount of assets and liabia lities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period. Our significant estimates include primarily those required in the valuation or impaimm rment analysis of goodwill and intangibles, property and equipment, revenue recognition, amortization period of our commission amortization, allowances for doubtfu deferred tax assets and tax accruals. Although we believe that adequate accruals have been made for unsettled issues, additional gains or losses could occur in future years from resolutions of outstanding matters. Actual results could differ materially from original estimates. accounts, stock-based compensation, litigation accruals, valuation allowances for ulff CashCC Equivalents — Cash investments with maturities of three months or less when purchased are considered cash equivalents. Fair Value of Financial Instruments —The Company does not measure the fair value of any financial instrument other than cash equivalents, options, and other equity awards. The carrying values of other financial instruments (receivables and accounts payabla e) are not recorded at fair value but approximate fair values primarily due to their short-term nature. 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. Valuation of Property and Equipment — The accounting policies and estimates relating to property and equipment are considered significff ant because of the potential impactm the Company’s operating results. that impamm irment, obsolescence, or change in an asset’s useful life could have on We record an impairmm ment charge on the assets to be held and used when we determine based upon certain triggering events that the carrying value of property and equipment may not be recoverable based on expected undiscounted cash flows attributable to such assets. The amount of a potential impairmm ment is determined by comparing the carrying amount of the asset to either the value determined from a projected discounted cash flow method, using a discount rate that is considered to be commensurate with the risk inherent in the Company’s current business model or the estimated fair market value. Assumptmm ions are made with respect to future net cash flows expected to be generated by the related asset. An impamm irment charge would be recorded for an amount by which the carryirr ng value of the asset exceeded the discounted projeo cted net cash flows or estimated faff ir market value. Also, even where a current impairmm ment charge is not necessary, the remaining usefulff presented. ment was recorded for any of the periods lives are evaluated. No impairmm Property and equipment are recorded at cost and depreciated or amortized using the straight-line method over their estimated ements — the shorter of five lives as follows: computer and offiff ce equipment and software — three years; leasehold improvmm usefulff years or the lease term; and furniture and fixtures — five years. We recorded a depreciation expenx se of $2.4 million for the year ended Decembem r 31, 2018. We allocated $1.7 million of the expense to cost of revenue, $426 thousand to research and development expense, and $314 thousand to selling, marketing, and general and administrative expenses. Goodwill and Other Intangi tt blell 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 subju ect to amortization; (2) intangible assets with ite lives not subju ect to amortization; and (3) goodwill. For intangible assets with finite lives, tests for impairmm indefinff performff ed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impamm irment must be perforff med at least annuan lly or more frequently if events or circumstances indicate that assets might be impamm ired. ment must be F-7 Goodwill was $13.8 million, or 13%, and $8.5 million, or 10%, of total assets as of December 31, 2018 and 2017, respectively. mm We evaluate the goodwill for impamm irment annually in the fourth quarter, or when there is reason to believe that the value has . Evaluations for possible impaimm rment are based upon a comparison of the estimated fair value of the been diminished or impaired reporting unit to which the goodwill has been assigned, versus the sum of the carrying value of the assets and liabila including the assigned goodwill value. We include our entire Company as the reporting unit. 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. Impairmm of the periods presented. ment is deemed to exist if the net book value of the unit exceeds its estimated fair value. No impairmm ment was recorded for any ities of that unit Our intangible assets with finite lives are amortized using a straight line basis over their economic usefulff lives. Deferred Taxaa Assetstt — Deferred tax assets are recognized if it is “more likely than not” that the benefitff of our deferff red tax t portion, $22.7 million, of our accumulated U.S. deferff ient to utilize net operating loss carryforff wards prior to their expiration. Our total deferff assets will be realized on future federal or state income tax returns. At December 31, 2018, we provided a valuation allowance against a significan red tax assets, reflecting our historical losses and the uncertainty of ff future taxabla e income sufficff subju ect to a valuation allowance are valued at $28.8 million, and consist of $27.0 million for federal net operating loss carryforwards , $2.1 million relating to U.S. state income tax credits, $678 thousand related to Alternative Minimum Tax credits and $114 thousand related to foreign tax credits. These credits are offsff et by ($1.2) million relating to temporary timing differeff nces between U.S. GAAP and tax-related expense. If our 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 impacti 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 significan t positive impacmm t on operating results in the period that it becomes more likely than not that certain of the Company’s deferr current levels, a resulting increase to all or a part of this valuation allowance could have a significaff results. ed tax assets will be realized. Alternatively, should our future income decrease from ng the likelihood of realizing our deferff nt negative impactmm red tax assets not on our operating red tax mm ff ff Uncertain Tax Positions — Our Company recognizes and measures uncertain tax positions using a two-step approach. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. Leases — A leased asset whose lease terms meet the criteria for capa italization is recorded as an asset and depreciated. If a lease as an operating lease and payments are recorded as rent expense. For 2018 does not meet the criteria for capitalization, it is classifiedff and 2017 we had no leases that qualified as capital leases. Lease renewal options which we are “reasonably assured” of using and the related payments are taken into account when initially classifying and recording the lease as a capital lease obligation or as straight- line rent if an operating lease. Funds provided by the lessor for leasehold improvmm amortized as a reduction of rent expense over the lease term. ements are recorded as a deferff red lease incentive and Revenue Recognition— In Mayaa 2014, The Financial Accounting Standards Board (“FASB”) issued ASC 606 which requires revenue recognition when promised goods or services are transferr which an entity expects to be entitled to those goods and services. The standard became effeff ctive for us in 2018, but did not have a material impacmm t to our revenue recognition process. For additional inforff mation regarding our adoption of ASC 606 please see “New Accounting Standards.” ed to customers in an amount that reflects the consideration to ff We earn our revenue from subsu cription fees for rights related to the use of our softwff ance obligations that are highly interdependent and consists of software at the customer’s site, ongoing customer support are. Our revenue contracts include multiple , and performff cloud-based access to the hosted Zix encryption network. As our Company has expanded its portfoff lio of message security offeff rings in recent years, we have increased our revenue obtained from hosted service solutions. Approximately 38% of our revenue in 2018 was derived from hosted email protection solutions. uu Our subscu ription terms typica yy lly range from one to five years. Revenue is recognized by applying the following steps: (cid:120) (cid:120) Step 1: Identify the contract(s) with a customer, Step 2: Identify the perforff mance obligations in the contract, F-8 (cid:120) (cid:120) (cid:120) (cid:120) Step 3: determine the transaction price Step 4: allocate the transaction price to the performff ance obligations in the contract, and Step 5: recognize revenue when (or as) the performance obligation is satisfied. Step 1: Identify the contract(s) with a customer: We consider the terms and conditions of the contract and our customary business practice in identifying our contracts. We determine we have a contract with a customer when the contract is approved, we can identify each party’s rights regarding the services and products transferred, we cana identify the payment terms for the services and products, the contract has commercial substa nce, and it is probable we will be paid. u (cid:120) Step 2: Identifying the performff ance obligations: ASC 606 requires identificaff tion and disclosure of perfoff rmance obligations within a revenue contract. A good or service is from the good or service on its own or with other resources that are readily considered distinct if the customer can both benefitff available to the customer, and the promise to transferff the good or service is separately identifiabff le from other promises in the contract. As of Decembem r 31, 2018, revenue from our email protection services represent 100% of our revenue, of which approximately to email encryption. To provide this service, our softwff 88% is specificff are at the customer site includes functionality to create a private encryption key provided via cloud-based access to our hosted Zix encryption encryption key that works in conjunction with the public network. Both keys are required to enable our asymmetrical encryption service. In our assessment of the factors listed in ASC 606-10- 25-21, we have determined that because our softwff are at the customer’s site and the access to our hosted Zix encryptyy ion network are highly interrelated, these items are not regarded as distinct components. Based on this assessment, these elements are combined as a single perforff mance obligation. u (cid:120) Step 3: Determine the transaction price: The transaction price is determined based on the consideration we expect to be entitled to receive in exchange for transferring goods and services to the customer. We include variable consideration in the transaction price if we view it as probable that a significant future reduction of cumulative revenue under the contract will not occur. (cid:120) Step 4: Allocate the transaction price to the perforff mance obligations in the contract: We allocate transaction prices to each perforff mance obligation based on the stand-alone selling price of our component services. (cid:120) Step 5: Recognize revenue when (or as) the perforff mance obligation is satisfiedff : We recognize revenue when the customer obtains control of the product or services, at the amount allocated to the satisfieff d performff ance obligation. Our perforff mance obligations are generally satisfied over time. While some contracts include one or more perforff mance obligations (including the combined elements noted above along with d by the additional ongoing customer suppuu ort and other hosted services), the revenue recognition pattern generally is not impacte separate allocations of these obligations because the services are generally satisfied over the same period of time and revenue is recognized over the contract period. Discounts provided to customers are recorded as reductions in revenuen . mm Commission Amortization — We amortize ouruu commission costs to expens ation period requiqq res significaff e on a systemic basis over the period of expexx cted nt judgement. We apply the practical expex dientnn noted benefit to the customer. Determination of the amortizrr in ASC 606-10-10-4 to account for ouruu commission costs and related amortizations at the portfolff io level. Additionally, the Company has evaluated commissions earned upon contratt ct renewal as compared to initial commissions paid and determined that because commissions paid were not reasonabla y proportional to their respective contract values, ouruu renewal commissions could not be considered commensurate with the initial commissions paid. xx We considered ouruu average contrnn act term length and historical customer retention rates to determine an average length of our customer relationships. We also concluded ouruu add-on sales generally occur halfway into ouruu customer relationships, and evaluated ouruu average customer renewal terms. Based on these factors we have determined that 8 years, 4 years and 18 months area amortization periods to ouruu new, add-on, and renewal sales commission expexx nses, respectively. We also perform subsu equentnn assessmentsnn for impamm irment of the related deferred cost asset when indicators present.nn ropriate the appaa F-9 Software Developmen o t Costs —Costs incurred in the development and testing of subscu ription softwff are products related to research, project planning, training, maintenance and general and administrative activities, and overhead costs are expensed as incurred. The costs of relatively minor upgrades and enhancements to the software are also expensed as incurred. Costs for the development of new software solutions and substu are solutions are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capa italized. Historically, we have not capitalized standard research and development costs because we believe that technological feasibility is established concurrent with general release to customers. antial enhancements to existing softwff Research and development costs associated with softwff are developed for internal use on behalf of our customers are capitalized. As we increasingly moved to a multi-tenant environment to keep up with the industry trend requiring transition to a cloud based solution for our existing services, certain research and development expenditures associated with hosting arrangements began to meet the accounting guidance requirement for capia talizing development costs under ASC 350-40, Internal-Use Softwff hosting arrangements. These capia talized costs are classified as intangible assets in our consolidated balance sheet. In 2018, we capitalized $1.5 million of research and development costs related to hosted softwff expects our capitalization of these research and development expenditures to increase in the future. are development for our customers. The Company are, as it applies to Advertis dd ing Expense — Advertising costs are expensed as incurred. Our operations include advertising expense of $1.3 million, $1.5 million, and $1.9 million in 2018, 2017, and 2016, respectively. Stock-Bkk ased Compensation — We currently use the straight-line amortization method for recognizing stock option and restricted stock compensation costs. The measurement and recognition of compensation expense for all share-based payment awards made to our emplmm oyees and directors are based on the estimated fair value of the awards on the grant dates. The grant date fair value is estimated using either an option-pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost is recognized over the period during which an emplmm oyee or director is required to provide service in exchange for the award, i.e., “the requisite service period” (which is usually the vesting period). We also estimate the numberm of instruments that tures as they occur. will ultimately be earned, rather than accounting for forfeiff Earnings Per Share (“EP“ S”PP )” — Basic EPS is based on the weighted average numberm of common shares outstanding during each period. Diluted EPS adjud sts Basic EPS for the effeff cts of dilutive common stock equivalents outstanding during each period using the treasury stock method. New Accounting Standards Revenue Recognition In May 2014, the FASB issued ASC 606, which supers uu edes 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 definff es 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 were required under prior U.S. GAAP. The standard became effeff ctive for us beginning in 2018. Ouruu Company provides primarily email encryption and advanced threat hh protection securiuu ty solutions as subsu cription services in which we recognize revenue as ouruu services are rendered. We determined ouruu revenue was not materially impam cted by the new guidance. However, the guidance did require us to increase the amortization period of ouruu commission expex nse. We applied the guidance to commissions earned on all contract Prior period amountsnn were not adjusted and continuen use a portfolio approach, applying 8 year, 4 year, and 18 month amortization periods for ouruu new, add-on, and renewal sales commission expexx nses, respectively. Determination of the amortirr zation period and the subsu equent assessmentsnn for impairmm ment of the related deferred cost asset requiqq res significff antnn judgement.nn s that were not complete as of January 1, 2018. to be reporterr d in accordance with the previous guidance. Ouruu Company elected to tt F-10 We applied a modified retrott spective approach to ouruu implmm ementann tion of ASC 606 in which we recognized a $4.6 million cumulmm ative effeff ct adjustmentnn to ouruu 2018 retained earnings opening balance related to ouruu increased amortization period. This adjud stment includes a $1.6 million impamm ct to ouruu deferred tax asset. The tabla e below presents the cumulative effeff ct of the changes made to ouruu consolidated balance sheet due to the adoption of ASC 606: (InI thousands) Assets: Prepaid and other current assets Other assets and deferff red costs ff Deferr ed tax assets Stockholders’ equity: ff Accumulated deficit January 1, 2018 Cumulative Effeff ct Adjustment Beginning Balance, as Adjusted Beginning Balance $ 3,222 $ —— 25,647 (415) $ 6,595 (1,616) 2,807 6,595 24,031 $ (236,372) $ 4,564 $ (231,808) Financial statement results as reported under the new revenue standard as compared to the previous standarda for the twelve months ended and as of December 31, 2018, are as follows: thousands, except per share data) (InII Revenues Cost of revenues Gross margin Operating expenses: arch and development Selling, general and administrative Total operating expenses Operating income Other income, net Income beforff e income taxes Income tax expense Net income Basic income per common share Diluted income per common share (1) Per share variance may not foot due to rounding (InII thousands) Assets: Prepaid and other current assets Other assets and deferff red costs ff Deferr ed tax assets Stockholders’ equity: ff Accumulated deficit Twelve Months Ended December 31, 2018 Under Under ASC 606 ASC 605 Variance $ $ $ $ 70,478 15,186 55,292 11,323 36,554 47,877 7,415 754 8,169 5,257 13,426 0.26 0.25 $ $ $ $ $ $ 70,478 15,186 55,292 11,323 33,999 45,322 9,970 754 10,724 4,720 15,444 0.29 0.29 —— —— —— —— (2,555) (2,555) 2,555 —— 2,555 (537) 2,018 0.04 0.04 Under ASC 605 December 31, 2018 Under ASC 606 Variance $ 3,760 $ —— 30,401 $ 3,176 9,424 28,785 (584) 9,424 (1,616) $ (222,946) $ (216,364) $ 6,582 F-11 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 typesyy of cash flows. The new guidance addressed debt prepayment or extinguishment of costs, settlement of zero-coupouu insurance claims, proceeds from the settlement of corporate-owned lifeff distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. ff insurance policies and bank-owned life insurance policies, a business combination, proceeds from the settlement of n bonds, contingent consideration made after The standard became effeff ctive for us beginning in 2018. We applied the new guidance within our consolidated statements of cash flows classification to an $800 thousand earn-out payment associated with our Greenview (as defined herein) acquisition. r the consummation date, as required by the guidance, we classifiedff Because this consideration payment was not made soon afteff 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 impacmm t on our consolidated financial statements. $605 Leases In Februar ry 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Topic 842 requires companies to generally recognize on assets. The new lease standard becomes the balance sheet operating and financing lease liabilities and corresponding right-of-use effeff ctive for us beginning 2019. We expect to adopt Topic 842 using the effeff ctive date as the date of our initial application of the standard. Consequently, financial inforff mation for the comparative periods will not be updated. We currently expect that most of our operating lease commitments will be subju ect to the new standard and recognized as operating lease liabilities and right-of-uff se assets upon our adoption of Topic 842. We are evaluating the potential impamm ct of this new guidance on our consolidated financial statements, and currently estimate the recognition of our outstanding lease obligations as of Decembem r 31, 2018, will result in the recognition of right-to-use-assets and lease liabilities of $4.5 million to $6.5 million. ff 3. Stock Options and Stock-Based Employee Compensation Below is a summary of common stock options outstanding at December 31, 2018: Employee and Director Stock Option Plans: Stock Option Plan 2006 Director’s Stock Option Plan 2012 Incentive Plan 2018 Omnimm bus Incentive Plan Total Authorized Shares Options Outstanding Options Vested Available for Grant 5,000,000 1,100,000 6,300,000 6,000,000 18,400,000 230,000 55,000 638,823 —— 923,823 230,000 55,000 532,573 —— 817,573 —— —— —— 5,875,000 5,875,000 Under all of our stock option plans, new shares are issued when options are exercised. Employee m and Director Stock- Based Plans We have non-qualified stock options outstanding to emplmm oyees and directors 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 Compamm ny’s common stock on the date of grant. The options, subju ect to termination of emplmm oyment, generally expire ten years from the date of grant. Historically, our emplomm yee options and equity awards typica lly vested pro-rata and quarterly over three years. Stock-based grants to emplmm oyees, offiff cers and directors frequently contain accelerated vesting provisions upon the occurrence of a change of control, as defined in the applicable option agreements. yy Under the terms of the 2018 Omnibus Incentive Plan approved by our shareholders during our annual meeting held on June 6, ally vest pro-rata and 2018, (the “2018 Plan”), 6,000,000 shares are available for issuance. Awards issued under the 2018 Plan typicyy quarterly over four years. F-12 Under the terms of the 2012 Incentive Plan adopted by our Board of Directors on April 13, 2012 (the “2012 Plan”), 2,700,000 shares are available for issuance, plus a numberm of additional shares (not to exceed 1,327,000) underlying options outstanding under certain of the Compamm ny’s prior equity plans that thereafter terminate or expire unexercised, or are cancelled, forfeited reason. Our shareholders approved an Amended and Restated 2012 Incentive Plan during our annual meeting held June 24, 2015, increasing the number of shares available for grant by 3,600,000. Awards issued under the 2012 Plan typical quarterly over four years. ly vest pro-rata and , or lapse for any yy ff Accounting Treatment We use the straight-line amortization method for recognizing stock option compensation costs. Our share-based awards include (i) stock options, (ii) restricted stock awards, some of which are subju ect to time-based vesting (“Restricted Stock”) and some of which are subju ect to perforff mance-based vesting (“Perforff mance Stock”), and (iii) restricted stock units, some of which are subju ect to time- based vesting (“RSUs”) and some of which are subju ect to perforff mance-based vesting (“Performance RSUs”). For the twelve months ended December 31, 2018, 2017, and 2016, respectively, the total stock-based compensation expense resulting from stock options, Restricted Stock, RSUs, Perforff mance RSUs, and Perforff mance Stock was recorded to the following line items of our consolidated statements of operations: (In thousands) Cost of revenue Research and development expenses Selling, general and administrative expenses Stock-based compensation expense Year Ended December 31, 2017 2016 2018 $ $ 327 469 2,522 3,318 $ $ 304 374 2,196 2,874 $ $ 186 246 1,351 1,783 Our stock-based compensation expense has increased yearly due to program expansion associated with our Company growthww . Our 2017 stock-based compensation expense includes $292 thousand related to accelerated vesting of awards associated with executive departures. Our 2016 stock-based compensation expense includes $280 thousand related to the accelerated vesting of awards related to our CFO transition. A deferff stock-based compensation expense associated with awards relating to the Company’s U.S. operations, was recorded for the twelve months ended December 31, 2018, 2017, and 2016, respectively. As of December 31, 2018, there was $5.2 million of total unrecognized stock-based compensation related to non-vested share-based compensation awards granted under the stock award plans. This cost is expected to be recognized over a weighted average period of 1.5 years. red tax asset of $673 thousand, $824 thousand, and $506 thousand, resulting from We use the Black-Scholes Option Pricing Model (“BSOPM”) to determine the fair value of option grants. The Company uses the “historical” method to calculate the estimated life of any options that may be granted. The expected stock price volatility is calculated by averaging the historical volatility of the Company’s common stock over a term equal to the expected lifeff of the options. We did not grant options in 2018. We granted 30,750 options in 2017 and 373,187 options in 2016. The following weighted average assumptm ions were applied in determining the fair value of options granted during the respective periods: Risk-free interest rate pected option life (years) Expected stock price volatility Expected dividend yield Fair value of options granted Year Ended December 31, 2017 2016 2018 —— —— —— —— —— $ 2.02% 5.7 42% —— 2.06 $ 1.21% 5.3 44% —— 1.51 $ The assumptions used in the BSOPM valuation are critical as a change in any given factor could have a material impacmm t on the financial results of the Company. The weighted average grant-date fair value of awards of restricted stock and restricted stock units is based on quoted market price of the Company’s common stock on the date of grant. F-13 Stock Option Activity The following is a summary of all stock option transactions for the three years ended Decembem r 31, 2018: Outstanding at January 1, 2016 Granted at market price Cancelled or expired Exercised Outstanding at Decembem r 31, 2016 Granted at market price Cancelled or expired Exercised Outstanding at Decembem r 31, 2017 Granted at market price Cancelled or expired Exercised Outstanding at Decembem r 31, 2018 Options exercisable at December 31, 2018 Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Yrs) 3.65 3.70 3.95 1.66 3.78 4.96 4.71 4.51 3.11 0.00 4.04 1.83 3.23 3.16 4.76 4.43 Shares $ 1,774,552 373,187 $ (63,700) $ (123,760) $ $ 1,960,279 30,750 $ (37,412) $ (932,303) $ $ 1,021,314 —— $ (7,480) $ (90,011) $ $ 923,823 817,573 $ At December 31, 2018, all 923,823 options outstanding and all 817,573 options exercisable had an exercise price lower than the market value of the Company’s common stock. The aggregate intrnn insic value of these options was $2.3 million and $2.1 million, respectively. At Decembem r 31, 2017, 983,564 options outstanding and 802,314 options exercisable had an exercise price lower than the market value of the Company’s common stock. The aggregate intrinsic value of these options was $1.3 million and $1.2 million, respectively. The total intrinsic value of options exercised during the years ended Decembem r 31, 2018 and 2017, was $334 thousand and $914 thousand , respectively. Summarized information about stock options outstanding at December 31, 2018, is as follows: Options Exercisable Number Exercisable 431,813 $ 385,760 $ 817,573 $ Weighted Average Exercise Price 2.58 3.82 3.16 Range of Exercise Prices $2.00 - $3.49 $3.50 - $4.99 Number Outstanding 431,813 492,010 923,823 Options Outstanding Weighted Average Remaining Contractual Lifeff Weighted Average Exercise Price 2.58 3.80 3.23 2.90 $ 6.40 $ 4.76 $ There were 832,376 and 1,685,732 exercisable options at December 31, 2017 and 2016, respectively. F-14 tt Restricte d Stock Activity The following is a summary of all Restricted Stock activity during the three years ended Decembem r 31, 2018: Non-vested restricted stock at January 1, 2016 Granted at market price Vested Cancelled Non-vested restricted stock at Decembem r 31, 2016 Granted at market price Vested Cancelled Non-vested restricted stock at Decembem r 31, 2017 Granted at market price Vested Cancelled Non-vested restricted stock at December 31, 2018 Restricted Shares 423,250 $ $ 573,461 (292,469) $ (15,000) $ 689,242 $ $ 665,623 (251,956) $ (20,000) $ 1,082,909 $ $ 842,546 (419,452) $ (151,003) $ $ 1,355,000 Weighted Average Fair Value 3.91 3.75 3.50 4.11 3.94 5.02 4.00 4.96 4.57 4.53 4.44 4.77 4.71 tt Restricted Stock Unit Activity t The following is a summary of all RSU activity during the three years ended December 31, 2018: Non-vested restricted stock units at January 1, 2016 Granted at market price Vested Cancelled Non-vested restricted stock units at December 31, 2016 Granted at market price Vested Cancelled Non-vested restricted stock units at December 31, 2017 Granted at market price Vested Cancelled Non-vested restricted stock units at December 31, 2018 Restricted Stock Units Weighted Average Fair Value $ 299,500 38,500 $ (179,914) $ —— $ $ 158,086 54,500 $ (126,167) $ —— $ $ 86,419 36,500 $ (50,751) $ —— $ $ 72,168 3.79 3.74 3.66 —— 3.92 4.96 4.07 —— 4.36 4.57 4.18 —— 4.59 F-15 Performance RSU Activity The following is a summary of all Perforff mance RSU activity during the three years ended December 31, 2018: Non-vested performff ance RSUs at January 1, 2016 Granted at market price Vested ff Forfeit ed Non-vested performff ance RSUs at Decembem r 31, 2016 Granted at market price Vested ff Forfeit ed Non-vested performff ance RSUs at Decemberm 31, 2017 Granted at market price Vested ff Forfeit ed Non-vested performff ance RSUs at Decembem r 31, 2018 Restricted Stock Units Weighted Average Fair Value 182,500 $ $ 22,500 (97,428) $ (16,741) $ 90,831 $ $ 11,500 (20,999) $ (41,668) $ 39,664 $ $ 5,500 (32,665) $ —— $ $ 12,499 3.88 3.61 3.88 3.88 3.81 4.96 4.08 3.83 3.98 4.04 3.91 0.00 4.20 Performance Stock Activityi The following is a summary of all Perforff mance Stock activity during the three years ended December 31, 2018: Non-vested performance stock at January 1, 2016 Granted at market price Vested ff Forfeit ed Non-vested performance stock at Decembem r 31, 2016 Granted at market price Vested ff Forfeit ed Non-vested performance stock at Decembem r 31, 2017 Granted at market price Vested ff Forfeit ed Non-vested performance stock at Decembem r 31, 2018 Restricted Stock Units Weighted Average Fair Value $ $ —— 141,500 $ (20,000) $ —— 121,500 112,112 —— (40,502) $ 193,110 $ $ 153,723 (77,874) $ (13,333) $ $ 255,626 —— 3.61 3.61 —— 3.61 4.96 —— 3.61 4.39 4.04 4.26 4.50 4.22 The weighted average grant-date fair value of awards of Restricted Stock, RSUs, Perforff mance RSU’s, and Perforff mance Stock is based on the quoted market price of the Company’s common stock on the date of grant. 4. Supplemental Cash Flow Information Suppuu lemental information relating to interest and taxes: (In thousands) Interest payments Income tax payments 2018 Year Ended December 31, 2017 2016 $ $ —— $ $ 1,115 —— $ $ 636 33 670 F-16 5. Receivables, net (In thousands) Gross accounts receivabla es Allowance for returns and doubu tfulff Unpaid red revenue Note receivabla e Allowance for note receivable portion of deferff n Receivables, net accounts December 31, 2018 2017 $ $ 14,135 (277) (10,670) 458 (458) 3,188 $ $ 9,307 (270) (7,648) 458 (458) 1,389 The allowance for doubtfu ulff accounts includes all specificff accounts receivable which we believe are likely not collectable based on known information. In addition, we record 2.5% of all accounts receivable greater than 90 days past due, net of those accounts ff specificall y reserved, as a general allowance against accounts that could potentially become uncollectible. The reduction for 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 receivabla e 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 December 31, 2018 and 2017. 6. Prepaid and other current assets (In thousands) Prepaid insurance, maintenance, softwff are licenses and other Deferre ff Tax-related d commissions Prepaid and other current assets 7. Property and Equipment (In thousands) Computer and office ff Leasehold improvmm Furnitureu and fixtures ements equipment and software Less accumulated depreciation Property and equipment, net December 31, 2018 2017 2,460 —— 716 3,176 $ $ 2,386 415 421 3,222 December 31, 2018 2017 26,762 6,834 2,181 35,777 (31,853) 3,924 $ $ 25,379 6,763 2,136 34,278 (30,230) 4,048 $ $ $ $ Our operations include depreciation expense related to property and equipment of $2.4 million, $2.4 million, and $2.3 million in 2018, 2017, and 2016, respectfully. 8. Other Assets and Deferred ff Costs As of December 31, 2018, our other assets and deferred costs balance primarily consists of $9.3 million in unamortized contract acquisition costs related to our adoption of ASC 606 as discussed above in Note 2 to the consolidated financial statements. F-17 9. Goodwill and Other Intangible Assets The changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2017, are as follows: (In thousands) Opening balance Additions Acquisition adjud stments Goodwill Year Ended December 31, 2017 2018 $ $ 8,469 6,215 (901) 13,783 $ $ 2,161 6,308 —— 8,469 Our 2018 acquisition of Erado (as definff ed herein) resulted in the addition to our goodwill the increase to our goodwill in 2018. Our acquisition adjud stments to goodwill reflect the appropriate reallocation of excess purchase price from goodwill to acquired assets ment annually and liabilities related to our 2017 Greenview and EMS (as defined herein) purchases. We evaluate goodwill for impairmm in the fourth quarter, or when there is reason to believe that the value has been diminished or impaired m indicators to the goodwill recorded as of Decembem r 31, 2018. . There were no impairm ent mm Our other intangible assets consist of the following: (In thousands) Internal use software ternally-developed hosting arrangement Trademarks and other Technology Customer relationships Intangible assets, net Gross Carrying Amount $ $ 1,189 1,520 691 7,604 7,870 18,874 December 31, 2018 Accumulated Amortization $ Net Carrying Amount (162) $ (77) (113) (2,678) (593) (3,623) $ 1,027 1,443 578 4,926 7,277 15,251 $ For the twelve months ended December 31, 2018, amortization of intangible assets was recorded to the following line items of our consolidated statements of operations: (In thousands) Cost of revenue Research and development expenses Selling, general and administrative expenses Amortization of intangible assets Year Ended December 31, 2018 $ $ 368 203 699 1,270 The following table summarizes our estimated future amortization expense: (In thousands) Amortization expense 2019 2020 2021 2022 2023 Thereafter Total $ 1,670 1,690 $ 1,690 $ 1,481 $ 1,310 $ 7,410 $ 15,251 10. Accrued Expenses ional fees (In thousands) Emplomm yee compensation and benefitff s Profess ff Taxes Other Total accrued expenses December 31, 2018 2017 $ $ 5,122 1,289 113 3,223 9,747 $ $ 4,452 356 154 1,139 6,101 F-18 11. Revenue from Contracts with Customers Accounting policies Our Company provides message security solutions as subu scription services in which we recognize revenue as our services are rendered. Our customer contracts are typiyy cally 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 producing transaction and collected by our Compamm ny from a customer (e.g., sales, use, value added, and some excise taxes). on and concurrent with a specificff revenue- mm Disaii ggregation of Revenue In 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. The disaggregation of revenue by industry verticals does not include our revenue from Greenview and Erado. We operate as a single operating segment. Revenue generated from our email protection services represented 100% of our revenue in 2018 and 2017. Further, we sell our solutions as a bundle, applying significaff our services based on the standalone selling price of our component services. nt judgement to allocate transaction prices of Contract balances Our contract assets include our accounts receivabla e, 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 ASC 606, we recorded a cumulative effeff ct adjud stment, 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 deferff red commission asset balance of $415 thousand. During the twelve months ended Decembem r 31, 2018, we increased our noncurrent deferred contract asset by $4.9 million, resulting from commissions earned by our sales team during the twelve months ended Decembem r 31, 2018. We also amortized $2.2 million of deferff Our deferred cost asset is assessed for impairmm ment on a periodic basis. There were no impaimm rment losses recognized on deferred contract cost assets for the twelve months ended Decembem r 31, 2018. red cost, as a selling and marketing expense in the related periods. Our contract liabilities consist of deferr The $2.7 million increase to our net deferff and payments as well as growth of revenue. ff ed revenue representing future customer services which have been billed and collected. red revenue in the twelve months ended December 31, 2018, is related to the timing of orders Performance obligations As of December 31, 2018, the aggregate amount of the transaction prices allocated to remaining service perforff mance obligations, which represents the transaction price of firm orders less inception to date revenue, was $73.0 million. We expect to recognize approximately $47.3 million of revenue related to this backlog in 2019, and $25.7 million in periods thereafter Approximately $45.1 million of our $70.5 million revenue recognized in the twelve months ended December 31, 2018, was included in our perforff mance obligation balance at the beginning of the period. ff . 12. Fair Value Measurements FASB guidance regarding fair value measurement establishes a three-tier fair value hierarchy, which prioritizes the inpun ts used in measuring fair value. These tiers include: Level 1, definff ed as observable inpun ts such as quoted prices in active markets for identical assets or liabilities; Level 2, definff ed as inputs other than quoted prices for similar assets and liabilities in active markets that are either directly or indirectly observable; and Level 3, definff ed as unobservablea requiring an entity to develop its own assumptm ions. inputs for which little or no market data exists, thereforff e For certain of the Company’s financial instruments, including cash and cash equivalents, trade receivables, and accounts payable, the fair values approximate the carrying value 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 value due to their short-term nature. The Compamm ny recorded a contingent liability for the estimated fair value of earn-out consideration payments in our Greenview acquisition. The Company determined the fair value of this earn-a milestones. Any changes to the variables and assumptm ions could significaff liability, resulting in significaff significaff assumptmm ions concerning the achievement of the sales milestones in measuring the fair value of the acquisition-related contingent earn- out lability. ntly impactmm nt changes to the Consolidated Statements of Operations. The fair value measurements are based on ts not observable in the market and thus represent Level 3 measurements, which reflect the Company’s own out liability based on the probability of attainment of certain sales the estimated fair values recorded for the nt inpun F-19 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 inpun ts for the year ended Decembem r 31, 2018: (In thousands) Balance at Decembem r 31, 2017 Additions during the period Payments during the period Adjud stments to fair value during the period recorded in General and Administrative expenses Balance at Decembem r 31, 2018 Fair Value Measurements Using Significff ant Unobservable Inputs (Level 3) 1,488 $ —— (800) $ 476 1,164 13. Earnings Per Share and Potential Dilution Basic earnings per share are computed using the weighted average number of common shares outstanding for the period under the Treasury Stock method. The dilutive effeff ct of potential common shares outstanding is included in diluted earnings per share. The compumm tations for basic and diluted earnings per share for the years ended December 31, 2018, 2017, and 2016, are as follows: Basic weighted average shares Effeff ct of dilutive securities: Emplmm oyee and director stock options Restricted Stock RSUs Perforff mance RSUs Perforff mance Stock Potential dilutive common shares 2018 52,591,714 Year Ended December 31, 2017 53,430,492 2016 53,819,772 347,167 409,871 24,369 9,367 98,807 53,481,295 —— —— —— —— —— 53,430,492 317,329 149,817 63,484 24,449 20,294 54,395,145 For the year ended December 31, 2018, weighted average shares related to 73,313 stock options; 131,774 shares of Restricted Stock, 6,084 RSUs, 917 Perforff mance RSUs, and 18,536 shares of Performff ance Stock were excluded from the calculation of diluted earnings per share because these awards were anti-dilutive. For the year ended Decembem r 31, 2017, potential common shares of all securities were excluded from the calculation of diluted earnings per share because the awards were anti- dilutive. For the year ended December 31, 2016, weighted average shares related to 1,079,474 stock options; 109,293 shares of Restricted Stock, 20,600 RSUs, 886 Performff per share because these awards were anti-dilutive. ance Stock, respectively were excluded from the calculation of diluted earnings ance RSUs, and 5,572 shares of Performff 14. Significant Customers In 2018, 2017, and 2016, no single customer accounted for 10% or more of our revenuen s. 15. Commitments and Contingencies Leases We lease offiff ce facilities under non-cancelable operating lease agreements. Our operations include rent expense for these operating leases of $1.6 million, $1.4 million, and $1.4 million in 2018, 2017, and 2016 respectively. The lease of our headquarters facility in Dallas expires in 2024. A summary of our fixed contractual obligations and commitments at December 31, 2018, is as follows: (In thousands) Operating leases 2019 2020 2021 2022 2023 Thereafter Total $ 1,625 $ 1,220 $ 1,072 $ 1,089 $ 1,116 $ 861 $ 6,983 F-20 Claimll s and Proceedings We are subju ect to legal proceedings, claims, and litigation against our business. While the outcome of these matters is currently not determinabla e and the costs and expenses of defenff ding these matters may be significaff ultimate costs to resolve these matters will have a material adverse effect ff on our consolidated financial statements. nt, we currently do not expect that the 16. Other Comprehensive Loss The assets and liabilities of international subsu idiaries are translated from the respective local currency to the U.S. dollar using exchange rates at the balance sheet date. Related translation adjud stments are recorded as a component of the accumulated other comprehensive loss. Our Consolidated Statement of Comprehensive Income of international subsidiaries currency to the U.S. dollar using average exchange rates for the period covered by the income statements. are translated from the local u We are exposed to fluctuations in the foreign currency exchange rates as a result of our net investments and operations in Canada. For fiscal 2018, movements in currency exchange rates and the related impacmm t on the translation of the balance sheets of our subsu idiary in Canada was the primary cause of our foreign currency translation loss of $16 thousand, net of $26 thousand in income taxes. 17. Income Taxes Components of the income taxes are as follows: (In thousands) Current: U.S. State Foreign Deferred Federal Foreign Income tax (benefitff ) expense 2018 2017 2016 $ $ (794) $ 725 71 183 (196) 156 (4,722) —— (4,720) $ 18,461 2 18,606 $ $ 100 329 75 3,185 3 3,692 On Decembem r 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) which significaff ntly changed U.S. tax law. The Tax Act, among other things, lowered the federal statutory corporate income tax rate from 34% to 21% effeff ctive January 1, 2018. The Company completed its assessment of the impam ct to 2018 noting no changes from what it disclosed in 2017. The Company’s income tax expense (benefit) for 2018, 2017 and 2016, respectively, reflect tax expense (benefit) based on statutory rates in 2018, 2017, and 2016. A reconciliation of the expected U.S. tax expense (benefitff ) to income taxes related to continuing operations is as follows: ff s (In thousands) Expected tax expense at U.S. statutory rate Change in corporate tax rate- deferred Increase (decrease) in valuations allowance Increase (decrease) in valuations allowance- other Nondeductible expense and nontaxable income State income taxes, net of federal benefits Foreign income taxes Other Income tax (benefitff ) expense 2018 2017 2016 $ $ $ 2,260 —— (7,841) —— 111 815 68 (133) (4,720) $ 3,587 12,473 —— 2,064 890 (129) 159 (438) 18,606 $ $ 3,250 —— —— —— 114 217 78 33 3,692 . $7.8 million of the valuation allowance was reversed in 2018 based on current and expected future profitability ff F-21 ff Deferred income taxes reflect the net tax effeff cts of temporary differen ces between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Components of our U.S. deferred income taxes as of Decembem r 31, 2018 and 2017 are as follows: ff forwards (In thousands) Deferred tax assets: Nondeductible U.S. net operating loss carryforff wards State net operating loss carryforff wards Tax credit carryrr Stock-based compensation Depreciable assets Other assets Total deferr ff Deferre Intangible assets Prepaid expenses ff Total deferr Less valuation allowance ff Net deferred d tax liabilities: ed tax assets ed tax assets tax assets ff 2018 2017 $ 113 46,826 71 5,703 976 822 938 55,449 112 48,769 321 6,450 750 851 1,039 58,292 (3,428) (572) 51,449 (22,667) 28,782 $ (1,342) (532) 56,418 (30,773) 25,645 $ $ The Company has partially reserved its U.S. net deferred tax assets in 2018 and 2017 due to the uncertainty of future taxable income. The Company has U.S. net operating loss carryforwff ards of approximately $223 million which begin to expire in 2021. The Company has state credits totaling $2.0 million which can be utilized through 2027 and state net operating losses that have various expiration dates. The Compamm ny also has tax credit carryforff wards of approximately $3.7 million consisting of business tax credits that began to expire in 2018 and alternative minimum tax credits which will be refunded through 2021 in accordance with the new tax law effeff ctive 2018. We have determined that utilization of existing net operating losses against future taxable income is not limited 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 carryforff wards against any future taxabla e income. The Company or one of our subsu idiaries files income tax returns in the U.S. federal jurisdiction and various states and in the Canadian federal and provincial jurisdictions. We have not taken a tax position that, if challenged, would have a material effecff t on the financial statements or the effeff ctive tax rate for the twelve-months ended December 31, 2018, or during the prior three years. We have determined it is not reasonably possible for the amounts of unrecognized tax benefits to significantly increase or decrease within the next twelve months. We are currently subju ect to a three-year statute of limitations by majoa r tax jurisdictions. 18. Employee Benefit Plan 401(k)(( Plan — We have a retirement savings plan structurt ed under Section 401(k) of the Internal Revenue Code covering subsu tantially all of our U.S. emplmm oyees. Under the plan, contributu ions are voluntarily made by emplmm oyees, and we may provide contributions based on the employees’ contributions. Our operating income includes $611 thousand, $512 thousand, and $448 thousand in 2018, 2017, and 2016, respectively, for net contributions from operations to this plan. 19. Zix Repurchase Program On April 24, 2017, the Company’s Board of Directors approved a share repurchase program that enables the Company to purchase up to $10 million of its shares of common stock. The shares repurchase program expired on May 31, 2018. During the year ended December 31, 2018, the Company repurchased 1,206,994 shares at an aggregate cost of $5.4 million. During the year ended December 31, 2017, the Company repurchased 750,000 shares at an aggregate cost of $3.8 million. F-22 20. 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, subju ect to a customary post-closing adjud stment 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 Company, if any, during the two year period following the closing of the acquisition, afteff distributed to the selling shareholders. Because sales of Greenview producd ts met certain sales milestones by December 31, 2017, the Company was contractually obligated to pay earn-out consideration in cash of $800 thousand in the first quarter 2018. The Company is also required to pay a further $800 thousand of earn-out consideration in cash in the first quarter of 2019 because sales of the Greenview products achieved a separate target by December 31, 2018. Contingent consideration is considered a Level 3 fair value measurement. r which the balance, if any, will be claims of the ff 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 intangible assets we acquired from Greenview consist of trademarks, internally developed softwff years, 10 years, and 15 years, respectively. The results of operations and the estimated fair values of the acquired assets and liabilities assumed have been included in the accompanying consolidated financial statements since our March 15, 2017, acquisition date. The Company incurred $476 thousand and $427 thousand in acquisition-related costs in which was recorded within operating expenses for the year ended Decembem r 31, 2018 and 2017, respectively. Revenue from Greenview was $3.4 million and $2.4 million for the year ended December 31, 2018 and 2017, respectively, and due to the continued integration of the combim ned businesses, it was mm impractic are, and customer relationships, which we are amortizing over an estimated usefulff able to determine the earnings. lifeff of 5 The following table summarizes the estimated fair value of acquired assets and liabilities: thousands) (InII Assets: Current assets Property and equipment Trademark/names Technology Customer relationships Goodwill Total assets Liabilities: Deferred revenue Other current liabilities ff Deferred Total liabilities tax liability Net assets recorded Estimated Fair Value $ $ $ 334 249 170 1,990 2,880 4,343 9,966 537 124 1,609 2,270 7,696 F-23 Enteltt lill gei nce Messagingii Server On September 13, 2017, the Compamm ny 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 encryptyy ion suite by offeff ring enterprise-centric capabilities, such as advanced message tracking, PDF statement delivery, high availability on-premises architecture and standards-based end-to-end encryption. The Company incurred $58 thousand and $59 thousand in acquisition-related costs which were recorded within operating expenses for the year ended Decembem r 31, 2018 and 2017, respectively. 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 estimated fair values of the acquired assets and liabilities assumed have been included in the accompanying consolidated financial statements since our September 13, 2017, acquisition date. Revenue from EMS was not material for the year ended Decembem r 31, 2018 and 2017, respectively, and due to the continued integration of the combined businesses, it was impract icable to determine the earnings. mm The following table summarizes the estimated fair value of acquired assets and liabilities: thousands) (InII Assets: Trademark/names Technology Customer relationships Goodwill Total assets Liabilities: Deferred revenue Total liabilities Net assets recorded Estimated Fair Value $ $ $ 140 550 230 1,063 1,983 333 333 1,650 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 unifieff d archiving, superv 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 offeff Zix’s cloud-based email archiving capabilities into more than 50 content channels, including social medial, instant message, mobile, web, audio, and video. ring for customers with compliance requirements. This acquisition also expands ision, security, and messaging solutions for uu The purchase price includes a holdback of $2.3 million for the satisfacff tion of certain indemnification claims by the Compamm ny, 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 subu jeb ct to an outstanding claim for indemnificatio 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. n, will be released to the selling shareholders upon ff The Compamm ny incurred $334 thousand in acquisition-related costs which were recorded within operating expenses during twelve months ended Decembem r 30, 2018. 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 purpose. The intangible assets we acquired from Erado consist of trademarks, internally developed softwff and 15 years, respectively. The results of operations and the estimated fair values of the acquired assets and liabilities have been included in the accompanying consolidated financial statements since our April 2, 2018, acquisition date. Revenue from Erado was $2.1 million for the twelve months ended December 31, 2018, since the acquisition date. Due to the continued integration of the combined businesses, it was impract are, and customer relationships, which we are amortizing over an estimated useful life of 5 years, 10 years, icable to determine the earnings. mm F-24 The following table summarizes the estimated fair value of acquired assets and liabilities: thousands) (InI Assets: Current assets Property and equipment Trademark/names Technology Customer relationships Goodwill Total assets Liabilities: Deferred revenue Other current liabilities Total liabilities Net assets recorded Estimated Fair Value $ $ $ 848 169 260 3,030 4,760 6,215 15,282 809 93 902 14,380 Pro Forma Financial Inforn marr tion (UnaUU uditdd ed) tt The following unaudited pro forma financial information presents the combined results of operations for the twelve month periods ending Decembem r 31, 2018, and 2017, respectively, as though the Erado, EMS and Greenview acquisitions that occurred during the reporting period had occurred as of the beginning of the earliest period presented, with adjud stments to give effeff ct 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 inforff mation 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 earliest period presented, nor are they indicative of future results of operations: thousands, except per share data) (InII Revenues Net income (loss) Basic income (loss) per common share Diluted income (loss) per common share Twelve Months Ended December 31, 2018 2017 $ $ $ 71,762 18,330 0.35 0.34 $ $ $ 69,587 (6,981) (0.13) (0.13) 21. Quarterly Results of Operations (Unaudited) The following is a summary of the quarterly results of operations for the years ended Decembem r 31, 2018 and 2017: (In thousands except per share data) 2018 nues Gross margin Net income (loss) Basic net income (loss) per common share* Diluted net income (loss) per common share* Comprehensive Income 2017 Revenues Gross margin Net income (loss) Basic net income (loss) per common share* Diluted net income (loss) per common share* Comprehensive Income March 31 June 30 September 30 December 31 Quarter Ended $ $ $ $ 16,654 13,140 1,892 0.04 0.04 —— 15,893 13,070 1,775 0.03 0.03 —— $ $ 17,500 13,694 1,840 0.04 0.03 —— 16,378 13,131 1,139 0.02 0.02 —— $ $ 17,876 14,006 2,455 0.05 0.05 —— 16,592 13,320 1,905 0.04 0.03 —— 18,448 14,451 9,240 0.18 0.17 9,224 16,800 13,540 (12,877) (0.24) (0.24) —— * Net income (loss) per share is calculated independently for each quarter. The sum of Net income (loss) per share for each quarter may not equal the total Net income (loss) per share for the year due to rounding differen ces. ff F-25 22. Subsequent Events Acquisitiontt pp of AppRiver Companies m On February 20, 2019, Zix acquired 100% of the equity interest of AR Topco, LLC and its subsu idiaries, including AppRiver LLC (“AppRiver” and collectively, the “AppRi AppRiver Companies retired at closing and certain accrued items and unpaid working capital adjustment. The Company is currently in the process of determining the fair value of the assets and liabilities acquired in the AppRiver purchase. ver Companies”). Zix paid $275 million in cash, less outstanding indebtedness of the transaction expenses, and subju ect to a customary A n Also on February 20, 2019, Zix entered into a credit agreement with a syndicate of lenders and SunTrusrr t Bank, as administrative agent, providing Zix with (1) a senior secured term loan facility in an aggregate principal amount of $175 million (the “Term Loan”), (2) a senior secured delayed draw term loan facility in an aggregate principal amount of $10 million, and (3) a senior secured revolving credit facility in an aggregate principal amount of $25 million, up to $5 million of which is available for letters of credit. On February 20, 2019, the Term Loan was borrowed in full to pay a portion of the purchase price in connection with the AppRiver acquisition. The AppRiver acquisition was further funded by the February 20, 2019 private placement of preferred stock with an investment d Stock, $1.00 par value per share, and its ff fund managed by Truer Wind Capital. Zix issued shares of its Series A Convertible Preferre Series B Convertible Preferr million. ff ed Stock, $1.00 par value per share, at a price of $1,000 per share for an aggregate purchase price of $100 AppRiver is a channel-firff st provider of cloud-based cybery security and producd tivity services, offeff ring web protection, email encryption, secure archiving, and email continuity solutions. AppRiver also provides Microsoft Offiff ce 365 and Secure Hosted Exchange services, which serve as an effeff ctive lead generation tool for the company’s solutions. The acquisition of AppRiver can accelerate our offeff rings into the cloud at the point of initial cloud application purchase. Because AppRiver currently services over 60,000 worldwide customers using a network of 4,500 Managed Service Providers, this acquisition can help us expand our customer base. F-26 Zix Corporation Corporate Information* Board of Directors Robert C. Hausmann Chairman of the Board, Zix Corporation Operating Partner, Thoma Bravo Mark J. Bonney Consultant Taher A. Elgamal Chief Technology Officer of Security, Salesforce.com Inc. James H. Greene, Jr. Founding Partner, True Wind Capital Management, L.P. Maribess L. Miller Consultant Richard D. Spurr Retired Chief Executive Officer, Zix Corporation Brandon Van Buren Principal, True Wind Capital Management, L.P. David J. Wagner Chief Executive Officer, Zix Corporation Executive Officers David J. Wagner Chief Executive Officer and President Kelly P. Haggerty Vice President, Product Management and Strategy David J. Robertson Vice President, Engineering David E. Rockvam Vice President and Chief Financial Officer Noah F. Webster Vice President, General Counsel and Corporate Secretary * Information current as of April 26, 2019. Corporate Headquarters Zix Corporation 2711 N. Haskell Avenue, Suite 2200, LB 36 Dallas, TX 75204-2960 Tel: (214) 370-2000 Fax: (214) 370-2070 Stock Listing The NASDAQ Global Market Symbol: ZIXI Investor Relations Zix Corporation 2711 N. Haskell Avenue, Suite 2200, LB 36 Dallas, TX 75204-2960 Tel: (214) 515-7357 Fax: (214) 370-2295 Email: invest@zixcorp.com Shareholder Services Visit our website, www.investor.zixcorp.com, where you may request an investor packet, listen to quarterly conference calls, access recent SEC filings, learn about upcoming investor events, and sign up for email alerts. Stock Transfer Agent and Registrar Computershare Trust Company, N.A. 462 South 4th Street, Suite 1600 Louisville, KY 40202 Tel: (877) 373-6374 Auditors Whitley Penn LLP Dallas, Texas Form 10-K Additional copies of the Company’s Annual Report on Form 10-K (including exhibits) to the Securities and Exchange Commission for the year ended December 31, 2018, are available without charge (i) at www.zixcorp.com/investors or (ii) upon written request by email to invest@zixcorp.com or by mail to Zix Investor Relations at 2711 N. Haskell Ave., Suite 2200, LB 36, Dallas, Texas 75204.

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