##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2008
 o
    
    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
    
    75-2216818(State of Incorporation)
    
    (I.R.S. Employer IdentificationNumber)
 2711 North Haskell Avenue
Suite 2200, LB 36
Dallas, Texas 75204-2960
(Address of Principal Executive Offices)
 (214) 370-2000
(Registrants Telephone Number, Including Area Code)
 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 Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
 Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer  o(Do not check if a smaller reporting company)
    
    Smaller Reporting Company o
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
 Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
 Class
    
    Outstanding at November 3, 2008Common Stock, par value $0.01 per share
    
    63,175,321




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##### 



INDEX
 PageNumberPART I  FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets at September 30, 2008 (unaudited) and December 31, 2007 (audited)
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008
and 2007
    
    
    4Condensed Consolidated Statement of Stockholders Deficit for the nine months ended September 30, 2008
    
    
    5Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    28PART II-OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    28Item 1A. Risk Factors
    
    
    28Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    29Item 3. Defaults Upon Senior Securities
    
    
    29Item 4. Submission of Matters to a Vote of Security Holders
    
    
    29Item 5. Other Information
    
    
    29Item 6. Exhibits
    
    
    30EX-10.1EX-10.2EX-31.1EX-31.2EX-32.1
  2




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##### Table of Contents



Part I. Financial Information
 
 Item 1. Financial Statements
 ZIX CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2008
    
    
    2007(unaudited)
    
    
    (audited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    13,140,000
    
    
    $
    10,524,000Marketable securities
    
    
    
    
    
    
    1,734,000Receivables, net
    
    
    539,000
    
    
    
    1,119,000Prepaid and other current assets
    
    
    1,126,000
    
    
    
    1,545,000Total current assets
    
    
    14,805,000
    
    
    
    14,922,000Restricted cash
    
    
    25,000
    
    
    
    25,000Property and equipment, net
    
    
    2,020,000
    
    
    
    2,297,000Goodwill
    
    
    2,161,000
    
    
    
    2,161,000Other assets
    
    
    32,000
    
    
    
    69,000Total assets
    
    $
    19,043,000
    
    
    $
    19,474,000LIABILITIES AND STOCKHOLDERS DEFICITCurrent liabilities:Accounts payable
    
    $
    402,000
    
    
    $
    231,000Accrued expenses
    
    
    2,766,000
    
    
    
    3,064,000Deferred revenue
    
    
    13,968,000
    
    
    
    12,606,000Total current liabilities
    
    
    17,136,000
    
    
    
    15,901,000Long-term liabilities:Deferred revenue
    
    
    2,891,000
    
    
    
    3,497,000Deferred rent
    
    
    330,000
    
    
    
    365,000Total long-term liabilities
    
    
    3,221,000
    
    
    
    3,862,000Total liabilities
    
    
    20,357,000
    
    
    
    19,763,000Commitments and contingencies (see Note 14)Stockholders deficit:Preferred stock, $1 par value, 10,000,000 shares authorized; none issued and outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 175,000,000 shares authorized; 65,474,428 issued and
63,147,247 outstanding in 2008 and 64,959,649 issued and 62,632,468 outstanding in 2007
    
    
    655,000
    
    
    
    650,000Additional paid-in capital
    
    
    332,719,000
    
    
    
    329,186,000Treasury stock, at cost; 2,327,181 common shares in 2008 and 2007
    
    
    (11,507,000
    )
    
    
    (11,507,000
    )Accumulated deficit
    
    
    (323,181,000
    )
    
    
    (318,618,000
    )Total stockholders deficit
    
    
    (1,314,000
    )
    
    
    (289,000
    )Total liabilities and stockholders deficit
    
    $
    19,043,000
    
    
    $
    19,474,000
  3




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ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Revenues
    
    $
    6,709,000
    
    
    $
    6,191,000
    
    
    $
    20,866,000
    
    
    $
    17,133,000Cost of revenues
    
    
    2,383,000
    
    
    
    2,662,000
    
    
    
    7,505,000
    
    
    
    8,162,000Gross margin
    
    
    4,326,000
    
    
    
    3,529,000
    
    
    
    13,361,000
    
    
    
    8,971,000Operating expenses:Research and development expenses
    
    
    1,590,000
    
    
    
    1,320,000
    
    
    
    4,516,000
    
    
    
    3,962,000Marketing expenses
    
    
    906,000
    
    
    
    814,000
    
    
    
    2,596,000
    
    
    
    2,671,000Sales expenses
    
    
    1,909,000
    
    
    
    2,214,000
    
    
    
    6,462,000
    
    
    
    6,749,000General and administrative expenses
    
    
    1,417,000
    
    
    
    1,208,000
    
    
    
    4,598,000
    
    
    
    4,265,000Customer deposit forfeiture
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,000,000
    )Loss on impairment of operating lease
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100,000Total operating expenses
    
    
    5,822,000
    
    
    
    5,556,000
    
    
    
    18,172,000
    
    
    
    15,747,000Operating loss
    
    
    (1,496,000
    )
    
    
    (2,027,000
    )
    
    
    (4,811,000
    )
    
    
    (6,776,000
    )Other (expense) income:Investment and other income
    
    
    97,000
    
    
    
    143,000
    
    
    
    435,000
    
    
    
    437,000Interest expense
    
    
    
    
    
    
    (35,000
    )
    
    
    
    
    
    
    (141,000
    )Loss on extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (178,000
    )Total other income
    
    
    97,000
    
    
    
    108,000
    
    
    
    435,000
    
    
    
    118,000Loss before income taxes
    
    
    (1,399,000
    )
    
    
    (1,919,000
    )
    
    
    (4,376,000
    )
    
    
    (6,658,000
    )Income taxes expense
    
    
    (110,000
    )
    
    
    (17,000
    )
    
    
    (187,000
    )
    
    
    (54,000
    )Net loss
    
    $
    (1,509,000
    )
    
    $
    (1,936,000
    )
    
    $
    (4,563,000
    )
    
    $
    (6,712,000
    )Basic and diluted loss per common share
    
    $
    (0.02
    )
    
    $
    (0.03
    )
    
    $
    (0.07
    )
    
    $
    (0.11
    )Basic and diluted weighted average
common shares outstanding
    
    
    63,072,191
    
    
    
    60,344,165
    
    
    
    62,893,809
    
    
    
    60,189,352
  4




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ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS DEFICIT
  Stockholders DeficitAdditional
    
    
    
    
    
    
    
    
    
    
    TotalCommon Stock
    
    
    Paid-In
    
    
    Treasury
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Capital
    
    
    Stock
    
    
    Deficit
    
    
    DeficitBalance, January 1, 2008
    
    
    64,959,649
    
    
    $
    650,000
    
    
    $
    329,186,000
    
    
    $
    (11,507,000
    )
    
    $
    (318,618,000
    )
    
    $
    (289,000
    )Issuance of common
stock upon exercise of
stock options
    
    
    67,342
    
    
    
    1,000
    
    
    
    163,000
    
    
    
    
    
    
    
    
    
    
    
    164,000Common stock issued to
employees as
compensation in lieu of
cash
    
    
    447,437
    
    
    
    4,000
    
    
    
    1,422,000
    
    
    
    
    
    
    
    
    
    
    
    1,426,000Employee share-based
compensation costs
    
    
    
    
    
    
    
    
    
    
    1,905,000
    
    
    
    
    
    
    
    
    
    
    
    1,905,000Non-employee
share-based
compensation
    
    
    
    
    
    
    
    
    
    
    43,000
    
    
    
    
    
    
    
    
    
    
    
    43,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,563,000
    )
    
    
    (4,563,000
    )Balance, September 30, 2008
    
    
    65,474,428
    
    
    $
    655,000
    
    
    $
    332,719,000
    
    
    $
    (11,507,000
    )
    
    $
    (323,181,000
    )
    
    $
    (1,314,000
    )
  5




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ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  Nine Months Ended September 30,2008
    
    
    2007Operating activities:Net loss
    
    $
    (4,563,000
    )
    
    $
    (6,712,000
    )Non-cash items in net loss:Depreciation and amortization
    
    
    961,000
    
    
    
    1,246,000Employee share-based compensation costs
    
    
    1,905,000
    
    
    
    740,000Non-employee share-based compensation costs
    
    
    43,000
    
    
    
    89,000Common stock
issued to employees in lieu of cash
    
    
    1,004,000
    
    
    
    Changes in deferred taxes
    
    
    37,000
    
    
    
    (106,000
    )Amortization of debt discount/premium, financing costs and other
    
    
    
    
    
    
    36,000Loss on extinguishment of debt
    
    
    
    
    
    
    178,000Loss on impairment of operating lease
    
    
    
    
    
    
    100,000Customer deposit forfeiture
    
    
    
    
    
    
    (2,000,000
    )Changes in operating assets and liabilities:Receivables
    
    
    580,000
    
    
    
    (90,000
    )Prepaid and other current assets
    
    
    435,000
    
    
    
    661,000Accounts payable
    
    
    166,000
    
    
    
    246,000Deferred revenue
    
    
    756,000
    
    
    
    5,214,000Accrued and other liabilities
    
    
    89,000
    
    
    
    148,000Net cash provided (used) by operating activities
    
    
    1,413,000
    
    
    
    (250,000
    )Investing activities:Purchases of property and equipment
    
    
    (695,000
    )
    
    
    (769,000
    )Restricted cash investments and marketable securities, net
    
    
    1,734,000
    
    
    
    (1,665,000
    )Net cash provided (used) by investing activities
    
    
    1,039,000
    
    
    
    (2,434,000
    )Financing activities:Proceeds from exercise of stock options
    
    
    164,000
    
    
    
    15,000Payment of short-term notes payable
    
    
    
    
    
    
    (229,000
    )Net cash provided (used) by financing activities
    
    
    164,000
    
    
    
    (214,000
    )Increase (decrease) in cash and cash equivalents
    
    
    2,616,000
    
    
    
    (2,898,000
    )Cash and cash equivalents, beginning of period
    
    
    10,524,000
    
    
    
    12,783,000Cash and cash equivalents, end of period
    
    $
    13,140,000
    
    
    $
    9,885,000
  6




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##### Table of Contents



ZIX CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  1. Basis of Presentation
  2. Recent Accounting Standards and Pronouncements
 Share-Based Payment.
 Business Combinations Non-controlling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51
 3. Company Overview and Liquidity
     7




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##### Table of Contents




    
    The key metrics upon which the operational success of the Company is primarily
dependent are set forth under the caption Overview, which appears on page 14 of this
form 10-Q.
    
    The Company will begin recruiting prescribers related to the new contracts signed
in the fourth quarter 2008 and continues to pursue additional payor sponsorship contracts
to deploy its e-Prescribing service to a significant number of new prescribers. There are
considerable upfront variable costs associated with establishing the service. The Company
has historically asked its health care payor sponsors to pay all (or most) of these
variable costs either before or as they are incurred. In the case of possible new
sponsorships being proposed, the Company would pay a substantial portion of these variable
costs upfront in exchange for cash and revenue streams that commence as payments are made
upon achievement of various utilization metrics or other milestones, as applicable. Our
business plan in these instances is designed such that future payments exceed our variable
costs and provides net contribution to our fixed costs and, with sufficient number of new
active prescribers, the business would become increasingly profitable. However, with
significant increases to the number of orders, and with the payor
sponsors not paying a substantial portion of the variable costs up
front, the Companys use of its cash resources
will increase accordingly.
    
    The Company may increase its research and development spending to develop new
functionality and services for one or both of its lines of business.
    
    Significant increases in the number of users of our two core lines of business may
require significant investments for new technology or infrastructure.
 4. Revenue and Significant Customers
 Software
Revenue Recognition, Modification of SOP 97-2, Software Revenue Recognition, With respect
to Certain Transactions, Revenue Arrangements with Multiple Deliverables, Revenue Recognition in
Financial Statements,
  8




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##### Table of Contents



5. Segment Information
   9




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##### Table of Contents



Three Months Ended September 30, 2008
    
    
    Three Months Ended September 30, 2007Email
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    EmailEncryption
    
    
    e-Prescribing
    
    
    Corporate
    
    
    Total
    
    
    Encryption
    
    
    e-Prescribing
    
    
    Corporate
    
    
    TotalRevenues
    
    $
    5,578,000
    
    
    $
    1,131,000
    
    
    $
    
    
    
    $
    6,709,000
    
    
    $
    4,631,000
    
    
    $
    1,560,000
    
    
    $
    
    
    
    $
    6,191,000Cost of revenues
    
    
    985,000
    
    
    
    1,398,000
    
    
    
    
    
    
    
    2,383,000
    
    
    
    1,029,000
    
    
    
    1,633,000
    
    
    
    
    
    
    
    2,662,000Gross margin (loss)
    
    
    4,593,000
    
    
    
    (267,000
    )
    
    
    
    
    
    
    4,326,000
    
    
    
    3,602,000
    
    
    
    (73,000
    )
    
    
    
    
    
    
    3,529,000Direct expenses
    
    
    2,643,000
    
    
    
    1,762,000
    
    
    
    
    
    
    
    4,405,000
    
    
    
    2,487,000
    
    
    
    1,725,000
    
    
    
    
    
    
    
    4,212,000Segment contribution (loss)
    
    
    1,950,000
    
    
    
    (2,029,000
    )
    
    
    
    
    
    
    (79,000
    )
    
    
    1,115,000
    
    
    
    (1,798,000
    )
    
    
    
    
    
    
    (683,000
    )Unallocated (expense) / incomeMarketing, general and administrative expense
    
    
    
    
    
    
    
    
    
    
    (1,417,000
    )
    
    
    (1,417,000
    )
    
    
    
    
    
    
    
    
    
    
    (1,344,000
    )
    
    
    (1,344,000
    )Loss on impairment of operating lease
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Investment and other income
    
    
    
    
    
    
    
    
    
    
    97,000
    
    
    
    97,000
    
    
    
    
    
    
    
    
    
    
    
    143,000
    
    
    
    143,000Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35,000
    )
    
    
    (35,000
    )Total
    
    
    
    
    
    
    
    
    
    
    (1,320,000
    )
    
    
    (1,320,000
    )
    
    
    
    
    
    
    
    
    
    
    (1,236,000
    )
    
    
    (1,236,000
    )Income (loss) before income taxes
    
    $
    1,950,000
    
    
    $
    (2,029,000
    )
    
    $
    (1,320,000
    )
    
    $
    (1,399,000
    )
    
    $
    1,115,000
    
    
    $
    (1,798,000
    )
    
    $
    (1,236,000
    )
    
    $
    (1,919,000
    )
 Nine Months Ended September 30, 2008
    
    
    Nine Months Ended September 30, 2007Email
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    EmailEncryption
    
    
    e-Prescribing
    
    
    Corporate
    
    
    Total
    
    
    Encryption
    
    
    e-Prescribing
    
    
    Corporate
    
    
    TotalRevenues
    
    $
    16,534,000
    
    
    $
    4,332,000
    
    
    $
    
    
    
    $
    20,866,000
    
    
    $
    12,685,000
    
    
    $
    4,448,000
    
    
    $
    
    
    
    $
    17,133,000Cost of revenues
    
    
    3,094,000
    
    
    
    4,411,000
    
    
    
    
    
    
    
    7,505,000
    
    
    
    3,255,000
    
    
    
    4,907,000
    
    
    
    
    
    
    
    8,162,000Gross margin (loss)
    
    
    13,440,000
    
    
    
    (79,000
    )
    
    
    
    
    
    
    13,361,000
    
    
    
    9,430,000
    
    
    
    (459,000
    )
    
    
    
    
    
    
    8,971,000Direct expenses
    
    
    8,266,000
    
    
    
    5,314,000
    
    
    
    
    
    
    
    13,580,000
    
    
    
    7,897,000
    
    
    
    5,344,000
    
    
    
    
    
    
    
    13,241,000Segment contribution (loss)
    
    
    5,174,000
    
    
    
    (5,393,000
    )
    
    
    
    
    
    
    (219,000
    )
    
    
    1,533,000
    
    
    
    (5,803,000
    )
    
    
    
    
    
    
    (4,270,000
    )Unallocated (expense) / incomeMarketing, general and administrative expense
    
    
    
    
    
    
    
    
    
    
    (4,592,000
    )
    
    
    (4,592,000
    )
    
    
    
    
    
    
    
    
    
    
    (4,406,000
    )
    
    
    (4,406,000
    )Loss on extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (178,000
    )
    
    
    (178,000
    )Loss on impairment of operating lease
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (100,000
    )
    
    
    (100,000
    )Customer deposit forfeiture
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,000,000
    
    
    
    2,000,000Investment and other income
    
    
    
    
    
    
    
    
    
    
    435,000
    
    
    
    435,000
    
    
    
    
    
    
    
    
    
    
    
    437,000
    
    
    
    437,000Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (141,000
    )
    
    
    (141,000
    )Total
    
    
    
    
    
    
    
    
    
    
    (4,157,000
    )
    
    
    (4,157,000
    )
    
    
    
    
    
    
    
    
    
    
    (2,388,000
    )
    
    
    (2,388,000
    )Income (loss) before income taxes
    
    $
    5,174,000
    
    
    $
    (5,393,000
    )
    
    $
    (4,157,000
    )
    
    $
    (4,376,000
    )
    
    $
    1,533,000
    
    
    $
    (5,803,000
    )
    
    $
    (2,388,000
    )
    
    $
    (6,658,000
    )
   September 30, 2008
    
    
    December 31, 2007Total assets:Email Encryption
    
    $
    3,392,000
    
    
    $
    3,730,000e-Prescribing
    
    
    644,000
    
    
    
    1,272,000Corporate
    
    
    15,007,000
    
    
    
    14,472,000Total assets
    
    $
    19,043,000
    
    
    $
    19,474,000
 6. Stock Options and Share-based Employee Compensation
  Three Months Ended
    
    
    Nine Months EndedSeptember 30, 2008
    
    
    September 30, 2008Cost of revenues
    
    $
    80,000
    
    
    $
    237,000Research and development expenses
    
    
    64,000
    
    
    
    195,000Selling, general and administrative expenses
    
    
    496,000
    
    
    
    1,473,000Share-based compensation expense
    
    $
    640,000
    
    
    $
    1,905,000
 10




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##### Table of Contents



Stock Option Activity
  Weighted AverageWeighted
    
    
    Remaining
    
    
    AggregateAverage
    
    
    Contractual Term
    
    
    IntrinsicShares
    
    
    Exercise Price
    
    
    (Yrs)
    
    
    ValueOutstanding at June 30, 2008
    
    
    9,567,891
    
    
    $
    4.94Granted at market price
    
    
    39,061
    
    
    $
    2.56Cancelled or expired
    
    
    (30,403
    )
    
    $
    3.96Exercised
    
    
    (4,583
    )
    
    $
    3.12Outstanding at September 30, 2008
    
    
    9,571,966
    
    
    $
    4.93
    
    
    
    6.54
    
    
    $
    1,555,000Options exercisable at September 30, 2008
    
    
    7,192,230
    
    
    $
    5.45
    
    
    
    5.86
    
    
    $
    926,000
  Common Stock Issued in Lieu of Cash
   7. Supplemental Cash Flow Information
  Nine Months Ended September 30,2008
    
    
    2007Cash paid for interest
    
    $
    
    
    
    $
    66,000Cash paid for income taxes
    
    $
    97,000
    
    
    $
    133,000Noncash investing and financing activities:Issuance of common stock and warrants related to the
restructure of the prior promissory note payable
    
    $
    
    
    
    $
    1,393,000Issuance of a replacement promissory note payable
    
    $
    
    
    
    $
    1,477,000Accrued expenses related to fixed asset purchases
    
    $
    5,000
    
    
    $
    102,000Assets sold to customers as part of their subscription service
    
    $
    16,000
    
    
    $
    Stock issued in lieu of accrued expenses
    
    $
    422,000
    
    
    $
    
 11




---



##### Table of Contents



8. Fair Value Measurements
    9. Receivables, net
 September 30,
    
    
    December 31,2008
    
    
    2007Gross trade accounts receivable
    
    $
    3,612,000
    
    
    $
    4,513,000Allowance for returns and doubtful accounts
    
    
    (50,000
    )
    
    
    (66,000
    )Unpaid portion of deferred revenue
    
    
    (3,023,000
    )
    
    
    (3,328,000
    )Trade receivables, net
    
    
    539,000
    
    
    
    1,119,000Note receivable
    
    
    488,000
    
    
    
    488,000Allowance for note receivable
    
    
    (488,000
    )
    
    
    (488,000
    )Note receivables, net
    
    
    
    
    
    
    Total receivables, net
    
    $
    539,000
    
    
    $
    1,119,000
    10. Prepaid and other current assets
 September 30,
    
    
    December 31,2008
    
    
    2007Inventory
    
    $
    87,000
    
    
    $
    218,000Deferred cost of revenues charges
    
    
    288,000
    
    
    
    301,000Prepaid insurance, maintenance and other
    
    
    742,000
    
    
    
    1,013,000Tax related
    
    
    9,000
    
    
    
    13,000Prepaid and other current assets
    
    $
    1,126,000
    
    
    $
    1,545,000
 Inventory
 12




---



##### Table of Contents



Deferred cost of revenues charges
  Prepaid insurance, maintenance and other
 11. Notes Payable
  12. Loss on Impairment of Operating Lease
  13. Earnings Per Share and Potential Dilution
  September 30,2008
    
    2007Stock options
    
    
    9,571,966
    
    
    
    9,479,846Warrants issued in relation to debt and equity arrangements
    
    
    10,434,804
    
    
    
    13,365,741Total antidilutive securities excluded from EPS calculation
    
    
    20,006,770
    
    
    
    22,845,587
  14. Commitments and contingencies
  13




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##### Table of Contents



Leases
  Payments Due by PeriodTotal
    
    1 Year
    
    Years 2 & 3
    
    Beyond 3 YearsOperating leases
    
    $
    5,864,000
    
    
    $
    1,208,000
    
    
    $
    1,968,000
    
    
    $
    2,688,000
  
 ITEM 2.
 MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Overview
      
    
    Rate of new subscriptions (termed new first year orders) for the Email Encryption
Service;
    
    Renewal rates for the Email Encryption Service;
    
    Additional payor sponsorship of the e-Prescribing service by new or existing
insurance payors;
    
    Successful adoption and usage of the e-Prescribing service by prescribers;
    
    Retention of the users (prescribers) of the e-Prescribing service as measured by
renewal rates;
    
    Transaction fees or incremental service fees for new or existing functionality
incorporated in our e-Prescribing service, such as disease management at the physician
point-of-care; and
 14




---



##### Table of Contents




    
    Our ability to increase business volume with reasonable cost increases.
   Critical Accounting Policies and Estimates
  Property and Equipment, Long-Lived and Other Intangible Assets, Depreciation and Amortization
   Deferred Tax Assets
 Revenue Recognition Software Revenue Recognition, Modification of SOP 97-2, Software Revenue
Recognition, With respect to Certain Transactions, Revenue Arrangements
with Multiple Deliverables, Revenue
 15




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##### Table of Contents



Recognition in Financial Statements,
 Deferred cost of revenues charges
  Share-based compensation Share-Based Payment Accounting for Stock Issued to Employees
 Share-Based Payment.
 Results of Operations
 Third Quarter 2008 Summary of Operations
 Financial Statement
 
    
    Company-wide revenue for the quarter ended September 30, 2008, was $6,709,000
compared with $6,191,000 for the same period in 2007, representing an 8% increase.
    
    Company-wide gross margin for the quarter ended September 30, 2008, was $4,326,000 or
64% of revenues compared to $3,529,000 or 57% of revenues for the comparable period in
2007.
    
    Email Encryption  gross margin for this segment for the quarter ended September 30,
2008, was $4,593,000 or 82% of revenues totaling $5,578,000 compared to $3,602,000 or 78%
of revenues totaling $4,631,000 for the comparable period in 2007.
    
    e-Prescribing  the gross margin incurred by this segment for the quarter ended
September 30, 2008, was a negative $267,000 or 24% of revenues totaling $1,131,000
compared to a negative gross margin of $73,000 or 5% of revenues totaling $1,560,000 for
the comparable period in 2007.
    
    Loss before income taxes for the quarter ended September 30, 2008, was $1,399,000
compared with a loss before income taxes of $1,919,000 for the same period in 2007.
 16




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##### Table of Contents




    
    The Companys ending cash balance at September 30, 2008, was $13,140,000 compared to
$9,885,000 at September 30, 2007.
    
    Net cash provided by operating activities for the first nine months of 2008 was
$1,413,000. Total cash and cash equivalent balances (including unrestricted, marketable
securities and restricted cash) increased by $882,000 in the first nine months of 2008.
 Operations
 
    
    The Company secured new first year orders in the quarter ended September 30, 2008,
totaling $1,170,000 for its Email Encryption services and achieved customer contract
renewals of 95% on a contract value basis for Email Encryption customers. The customer
contract renewal rate is expected to remain at or above 95% for 2008. See Revenues 
Email Encryption below for more information.
    
    The Company deployed approximately 140 new e-Prescribing devices to prescribers under
sponsorship arrangements with several insurance payor/sponsors.
    
    The Company achieved approximately 2,011,000 electronic prescriptions transacted in
the three months ended September 30, 2008, through the use of its e-Prescribing service
versus approximately 1,765,000 for the comparable period in 2007.
 Revenues
  Three Months Ended,
    
    
    3-month Variance
    
    
    
    
    
    
    
    
    
    
    9-month VarianceSeptember 30,
    
    
    2008 vs. 2007
    
    
    Nine Months Ended, September 30,
    
    
    2008 vs. 20072008
    
    
    2007
    
    
    $
    
    
    %
    
    
    2008
    
    
    2007
    
    
    $
    
    
    %Email Encryption
    
    $
    5,578,000
    
    
    $
    4,631,000
    
    
    $
    947,000
    
    
    
    20
    %
    
    $
    16,534,000
    
    
    $
    12,685,000
    
    
    $
    3,849,000
    
    
    
    30
    %e-Prescribing
    
    
    1,131,000
    
    
    
    1,560,000
    
    
    
    (429,000
    )
    
    
    (28
    %)
    
    
    4,332,000
    
    
    
    4,448,000
    
    
    
    (116,000
    )
    
    
    (3
    %)Total revenues
    
    $
    6,709,000
    
    
    $
    6,191,000
    
    
    $
    518,000
    
    
    
    8
    %
    
    $
    20,866,000
    
    
    $
    17,133,000
    
    
    $
    3,733,000
    
    
    
    22
    %
 Email Encryption 
  e-Prescribing 
 17




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##### Table of Contents



Revenue Outlook:
   Revenue Indicators  Backlog, Orders, and Deployments
 Company-wide backlog 
   Email Encryption Orders 
 18




---



##### Table of Contents



2008
    
    
    2007Three-month period ending:March 31
    
    $
    1,432,000
    
    
    $
    1,352,000June 30
    
    
    1,375,000
    
    
    
    1,397,000September 30
    
    
    1,170,000
    
    
    
    1,359,000December 31
    
    
    
    
    
    
    1,406,000Total new first year orders
    
    $
    3,977,000
    
    
    $
    5,514,000
    e-Prescribing 
    19




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##### Table of Contents



Cost of Revenues
  Three Months Ended,
    
    
    3-month Variance
    
    
    Nine Months Ended,
    
    
    9-month VarianceSeptember 30,
    
    
    2008 vs. 2007
    
    
    September 30,
    
    
    2008 vs. 20072008
    
    
    2007
    
    
    $
    
    
    %
    
    
    2008
    
    
    2007
    
    
    $
    
    
    %Email Encryption
    
    $
    985,000
    
    
    $
    1,029,000
    
    
    $
    (44,000
    )
    
    
    (4
    %)
    
    $
    3,094,000
    
    
    $
    3,255,000
    
    
    $
    (161,000
    )
    
    
    (5
    %)e-Prescribing
    
    
    1,398,000
    
    
    
    1,633,000
    
    
    
    (235,000
    )
    
    
    (14
    %)
    
    
    4,411,000
    
    
    
    4,907,000
    
    
    
    (496,000
    )
    
    
    (10
    %)Total cost of revenues
    
    $
    2,383,000
    
    
    $
    2,662,000
    
    
    $
    (279,000
    )
    
    
    (10
    %)
    
    $
    7,505,000
    
    
    $
    8,162,000
    
    
    $
    (657,000
    )
    
    
    (8
    %)
  20




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##### Table of Contents



Email Encryption 
 e-Prescribing 
 Research and Development Expenses
  3-month Variance
    
    
    
    
    
    
    
    
    
    9-month VarianceThree Months Ended, September 30,
    
    2008 vs. 2007
    
    Nine Months Ended, September 30,
    
    2008 vs. 20072008
    
    2007
    
    $
    
    %
    
    2008
    
    2007
    
    $
    
    %Research and
Development
expenses
    
    $
    1,590,000
    
    
    $
    1,320,000
    
    
    $
    270,000
    
    
    
    20
    %
    
    $
    4,516,000
    
    
    $
    3,962,000
    
    
    $
    554,000
    
    
    
    14
    %
  Selling, General and Administrative Expenses
   3-month Variance
    
    
    
    
    
    
    
    
    
    
    9-month VarianceThree Months Ended, September 30,
    
    
    2008 vs. 2007
    
    
    Nine Months Ended, September 30,
    
    
    2008 vs. 20072008
    
    
    2007
    
    
    $
    
    
    %
    
    
    2008
    
    
    2007
    
    
    $
    
    
    %Marketing expenses
    
    $
    906,000
    
    
    $
    814,000
    
    
    $
    92,000
    
    
    
    11
    %
    
    $
    2,596,000
    
    
    $
    2,671,000
    
    
    $
    (75,000
    )
    
    
    (3
    %)Sales expenses
    
    
    1,909,000
    
    
    
    2,214,000
    
    
    
    (305,000
    )
    
    
    (14
    %)
    
    
    6,462,000
    
    
    
    6,749,000
    
    
    
    (287,000
    )
    
    
    (4
    %)General and
administrative
expenses
    
    
    1,417,000
    
    
    
    1,208,000
    
    
    
    209,000
    
    
    
    17
    %
    
    
    4,598,000
    
    
    
    4,265,000
    
    
    
    333,000
    
    
    
    8
    %Total selling,
general and
administrative
expenses
    
    $
    4,232,000
    
    
    $
    4,236,000
    
    
    $
    (4,000
    )
    
    
    
    
    
    $
    13,656,000
    
    
    $
    13,685,000
    
    
    $
    (29,000
    )
    
    
    
 21




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##### Table of Contents



Customer Deposit Forfeiture
  Loss on impairment of operating lease
  Investment and Other Income
  Interest Expense
  Loss on extinguishment of debt
  Income Taxes
    22




---



##### Table of Contents



Net Loss
  Liquidity and Capital Resources
 Overview
   Email Encryption
 e-Prescribing
   23




---



##### Table of Contents



Sources and Uses of Cash Summary
   Nine Months Ended September 30,2008
    
    
    2007
    
    
    VarianceOperating cash receipts
    
    $
    24,010,000
    
    
    $
    23,699,000
    
    
    $
    311,000
    
    
    
    1
    %Net operating cash spending
    
    
    (22,597,000
    )
    
    
    (23,949,000
    )
    
    
    1,352,000
    
    
    
    6
    %Net cash provided (used) by operating activities
    
    $
    1,413,000
    
    
    $
    (250,000
    )
    
    $
    1,663,000
    
    
    
    
   24




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##### Table of Contents



Cash Sources
  
    
    Ending cash balance of $13,140,000;
    
    Contractual backlog;
    
    Email Encryption growth and retention;
    
    e-Prescribing growth and retention; and
    
    Transaction fees or incremental service fees for new or existing functionality
incorporated in our e-Prescribing service, such as, disease management at the physician
point-of-care
 Backlog
 Email Encryption growth and retention
 e-Prescribing growth and retention
 e-Prescribing performance-based, transaction and other incremental service fees
  25




---



##### Table of Contents



Cash Requirements
     Liquidity Summary
  26




---



##### Table of Contents




    
    The key metrics upon which the operational success of the Company is primarily
dependent are set forth under the caption Overview, which appears on page 14 of this
form 10-Q.
    
    The Company will begin recruiting prescribers related to the new contracts signed in
the fourth quarter 2008 and continues to pursue additional payor sponsorship contracts to
deploy its e-Prescribing service to a significant number of new prescribers. There are
considerable upfront variable costs associated with establishing the service. The Company
has historically asked its health care payor sponsors to pay all (or most) of these
variable costs either before or as they are incurred. In the case of possible new
sponsorships being proposed, the Company would pay a substantial portion of these variable
costs upfront in exchange for cash and revenue streams that commence or payments that are
made upon achievement of various utilization metrics or other milestones, as applicable.
Our business plan in these instances is designed such that future payments exceed our
variable costs and provide net contribution to our fixed costs and, with sufficient
number of active prescribers, the business would become increasingly profitable. However,
with significant increases to the number of orders, and with the
payor sponsors not paying a substantial portion of the variable costs
up front, the Companys use of its cash
resources will increase accordingly.
    
    The Company may increase its research and development spending to develop new
functionality and services for one or both of its lines of business.
    
    Significant increases in the number of users of our two core lines of business may
require significant investments for new technology or infrastructure.
 Options and Warrants of ZixCorp Common Stock
  Summary of Outstanding Options and WarrantsVested SharesTotal Value of
    
    
    (included in
    
    
    Total Value ofExercise Price Range
    
    Outstanding Shares
    
    
    Outstanding Shares
    
    
    Outstanding shares)
    
    
    Vested Shares$1.21  $1.99
    
    
    6,973,296
    
    
    $
    10,793,071
    
    
    
    6,152,351
    
    
    $
    9,549,381$2.00  $3.49
    
    
    4,971,807
    
    
    
    14,858,833
    
    
    
    4,679,346
    
    
    
    13,992,771$3.50  $4.99
    
    
    4,316,125
    
    
    
    19,254,334
    
    
    
    3,049,795
    
    
    
    13,284,752$5.00  $5.99
    
    
    600,354
    
    
    
    3,047,997
    
    
    
    600,354
    
    
    
    3,043,795$6.00  $8.99
    
    
    971,599
    
    
    
    6,203,082
    
    
    
    971,599
    
    
    
    6,199,862$9.00  $19.99
    
    
    1,116,570
    
    
    
    11,965,164
    
    
    
    1,116,570
    
    
    
    11,958,465$20.00  $57.60
    
    
    1,057,019
    
    
    
    57,590,935
    
    
    
    1,057,019
    
    
    
    57,590,233Total
    
    
    20,006,770
    
    
    $
    123,713,416
    
    
    
    17,627,034
    
    
    $
    115,619,259
 Off-Balance Sheet Arrangements
  Contractual Obligations, Contingent Liabilities and Commitments
  Payments Due by PeriodTotal
    
    1 Year
    
    Years 2 & 3
    
    Beyond 3 YearsOperating leases
    
    $
    5,864,000
    
    
    $
    1,208,000
    
    
    $
    1,968,000
    
    
    $
    2,688,000
   27




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
   
 PART II  OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
  
 ITEM 1A. Risk Factors
  NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
   
 28




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##### Table of Contents



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  29




---



##### Table of Contents



ITEM 6. EXHIBITS
 a. Exhibits
  Exhibit No.
    
    Description of Exhibits3.1
    
    Restated Articles of Incorporation of Zix Corporation, 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 December 31, 2005, and incorporated herein by reference.3.2
    
    Restated Bylaws of Zix Corporation, dated October 30, 2002. Filed as Exhibit 3.2 to Zix
Corporations Quarterly Report on Form 10-Q for the quarterly period ended September 30,
2002, and incorporated herein by reference.10.1*
    
    Stock Option Agreement between Zix Corporation and Susan K. Conner covering 130,000 shares
at $1.70 exercise price per share (grant date October 16, 2008).10.2*
    
    Separation Pay Agreement between Zix Corporation and Susan K. Conner, dated November 4, 2008.31.1*
    
    Certification of Richard D. Spurr, President and Chief Executive Officer of the Company,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of Susan K. Conner, Chief Financial Officer of the Company, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1**
    
    Certification of Richard D. Spurr, President and Chief Executive Officer of the Company, and
Susan K. Conner, Chief Financial Officer of the Company, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 *
    
    Filed herewith.**
    
    Furnished herewith. 30




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##### Table of Contents



SIGNATURES
  ZIX CORPORATIONBy:
    /s/ Susan K. ConnerSusan K. ConnerChief Financial Officer  Signature
    
    Title/s/ Richard D. Spurr

(Richard D. Spurr)
    
    Chairman, Chief Executive Officer, President and Director
(Principal Executive Officer)/s/ Susan K. Conner

(Susan K. Conner)
    
    Chief Financial Officer (Principal Financial and Accounting Officer)/s/ Robert C. Hausmann
(Robert C. Hausmann)
    
    Director/s/ Charles N. Kahn III
(Charles N. Kahn III)
    
    Director/s/ James S. Marston

(James S. Marston)
    
    Director/s/ Antonio R. Sanchez III

(Antonio R. Sanchez III)
    
    Director/s/ Paul E. Schlosberg

(Paul E. Schlosberg)
    
    Director
 31