##### 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 June 30, 2005
 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
(State of Incorporation)
    
    75-2216818
(I.R.S. Employer Identification Number)
 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 R No £
 Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act).
Yes R No £
 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 July 29, 2005Common Stock, par value $.01 per share
    
    32,424,929




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INDEX
  
 PART I-FINANCIAL INFORMATION
 PageNumberItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets at June 30, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2005 and 2004
    
    
    4Condensed Consolidated Statement of Stockholders Equity (Deficiency) for the six months ended June 30, 2005
    
    
    5Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    42Item 4. Controls and Procedures
    
    
    42PART II-OTHER INFORMATIONItem 4. Submission of Matters to a Vote of Security Holders
    
    
    42Item 6. Exhibits
    
    
    43Form of Amended and Restated Convertible NoteForm of Amended and Restated Common Stock Purchase WarrantForm of Amended and Restated Registration Rights AgreementSublease AgreementCertification of CEO Pursuant to Section 302Certification of VP, CFO and Treasurer Pursuant to Section 302Certification of Pursuant to Section 906
 2




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##### Table of Contents



ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
 ZIX CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
  June 30,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    7,673,000
    
    
    $
    3,856,000Marketable securities
    
    
    
    
    
    
    16,000,000Accounts receivable, net
    
    
    327,000
    
    
    
    561,000Note receivable, net
    
    
    971,000
    
    
    
    Prepaid and other current assets
    
    
    1,217,000
    
    
    
    1,950,000Total current assets
    
    
    10,188,000
    
    
    
    22,367,000Restricted cash
    
    
    10,412,000
    
    
    
    10,374,000Property and equipment, net
    
    
    4,686,000
    
    
    
    5,024,000Intangible assets, net
    
    
    1,601,000
    
    
    
    3,832,000Goodwill
    
    
    6,958,000
    
    
    
    9,119,000Deferred financing costs and other assets
    
    
    1,134,000
    
    
    
    1,526,000$
    34,979,000
    
    
    $
    52,242,000LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY)Current liabilities:Accounts payable
    
    $
    692,000
    
    
    $
    1,234,000Accrued expenses
    
    
    4,476,000
    
    
    
    4,709,000Deferred revenue
    
    
    6,988,000
    
    
    
    6,372,000Customer deposits
    
    
    1,008,000
    
    
    
    968,000Capital lease obligations
    
    
    249,000
    
    
    
    130,000Short-term note payable
    
    
    112,000
    
    
    
    193,000Convertible promissory notes payable
    
    
    7,357,000
    
    
    
    3,848,000Total current liabilities
    
    
    20,882,000
    
    
    
    17,454,000Long-term liabilities:Deferred revenue
    
    
    1,389,000
    
    
    
    1,731,000Customer deposit
    
    
    2,000,000
    
    
    
    3,000,000Convertible promissory notes payable
    
    
    9,351,000
    
    
    
    13,347,000Promissory note payable
    
    
    2,027,000
    
    
    
    1,840,000Capital lease obligations and other
    
    
    299,000
    
    
    
    105,000Total long-term liabilities
    
    
    15,066,000
    
    
    
    20,023,00035,948,000
    
    
    
    37,477,000Contingencies (Note 13)Stockholders equity (deficiency):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; 34,752,110 issued and
32,424,929 outstanding on June 30, 2005 and 34,584,406 issued and 32,257,225
outstanding on December 31, 2004
    
    
    348,000
    
    
    
    346,000Additional paid-in capital
    
    
    272,157,000
    
    
    
    269,406,000Treasury stock, at cost; 2,327,181 common shares in 2005 and 2004
    
    
    (11,507,000
    )
    
    
    (11,507,000
    )Accumulated deficit
    
    
    (261,967,000
    )
    
    
    (243,480,000
    )Total stockholders equity (deficiency)
    
    
    (969,000
    )
    
    
    14,765,000$
    34,979,000
    
    
    $
    52,242,000
  3




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ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
  Three Months Ended June 30,
    
    
    Six Months Ended June 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Services
    
    $
    3,199,000
    
    
    $
    2,786,000
    
    
    $
    6,497,000
    
    
    $
    5,273,000Hardware
    
    
    241,000
    
    
    
    293,000
    
    
    
    426,000
    
    
    
    322,000Software
    
    
    9,000
    
    
    
    442,000
    
    
    
    109,000
    
    
    
    769,000Total revenues
    
    
    3,449,000
    
    
    
    3,521,000
    
    
    
    7,032,000
    
    
    
    6,364,000Costs and expenses:Cost of revenues
    
    
    3,508,000
    
    
    
    3,704,000
    
    
    
    7,399,000
    
    
    
    6,878,000Research and development expenses
    
    
    1,535,000
    
    
    
    2,311,000
    
    
    
    3,510,000
    
    
    
    5,156,000Selling, general and administrative expenses
    
    
    6,559,000
    
    
    
    7,349,000
    
    
    
    14,061,000
    
    
    
    15,155,000Customer deposit forfeiture
    
    
    (960,000
    )
    
    
    
    
    
    
    (960,000
    )
    
    
    Gain of sale of product lines
    
    
    
    
    
    
    
    
    
    
    (950,000
    )
    
    
    Total costs and expenses
    
    
    10,642,000
    
    
    
    13,364,000
    
    
    
    23,060,000
    
    
    
    27,189,000Operating loss
    
    
    (7,193,000
    )
    
    
    (9,843,000
    )
    
    
    (16,028,000
    )
    
    
    (20,825,000
    )Other (expense) income:Investment and other income
    
    
    143,000
    
    
    
    79,000
    
    
    
    286,000
    
    
    
    137,000Interest expense
    
    
    (1,996,000
    )
    
    
    (85,000
    )
    
    
    (2,826,000
    )
    
    
    (140,000
    )Recovery of previously impaired investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70,000Total other (expense) income
    
    
    (1,853,000
    )
    
    
    (6,000
    )
    
    
    (2,540,000
    )
    
    
    67,000Loss before income taxes
    
    
    (9,046,000
    )
    
    
    (9,849,000
    )
    
    
    (18,568,000
    )
    
    
    (20,758,000
    )Income tax benefit (expense)
    
    
    131,000
    
    
    
    (27,000
    )
    
    
    81,000
    
    
    
    (56,000
    )Net loss
    
    $
    (8,915,000
    )
    
    $
    (9,876,000
    )
    
    $
    (18,487,000
    )
    
    $
    (20,814,000
    )Basic and diluted loss per common share
    
    $
    (0.28
    )
    
    $
    (0.31
    )
    
    $
    (0.57
    )
    
    $
    (0.67
    )Weighted average common shares outstanding
    
    
    32,391,777
    
    
    
    31,687,841
    
    
    
    32,343,737
    
    
    
    30,943,779
  4




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ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (DEFICIENCY)
  Stockholders' Equity (Deficiency)TotalCommon Stock
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    Stockholders'Paid-In
    
    
    Treasury
    
    
    Accumulated
    
    
    EquityShares
    
    
    Amount
    
    
    Capital
    
    
    Stock
    
    
    Deficit
    
    
    (Deficiency)Balance, January 1, 2005
    
    
    34,584,406
    
    
    $
    346,000
    
    
    $
    269,406,000
    
    
    $
    (11,507,000
    )
    
    $
    (243,480,000
    )
    
    $
    14,765,000Issuance of common stock upon exercise of stock
options
    
    
    833
    
    
    
    
    
    
    
    3,000
    
    
    
    
    
    
    
    
    
    
    
    3,000Employee stock compensation expense
    
    
    69,555
    
    
    
    1,000
    
    
    
    242,000
    
    
    
    
    
    
    
    
    
    
    
    243,000Non-employee stock-based compensation
    
    
    
    
    
    
    
    
    
    
    119,000
    
    
    
    
    
    
    
    
    
    
    
    119,000Issuance of common stock for payment of interest
on convertible promissory notes payable
    
    
    97,316
    
    
    
    1,000
    
    
    
    266,000
    
    
    
    
    
    
    
    
    
    
    
    267,000Revaluation of warrants resulting from
restructure of convertible promissory notes
payable (Note 11)
    
    
    
    
    
    
    
    
    
    
    (375,000
    )
    
    
    
    
    
    
    
    
    
    
    (375,000
    )Valuation of beneficial conversion feature
resulting from the restructure of convertible
promissory notes payable (Note 11)
    
    
    
    
    
    
    
    
    
    
    2,518,000
    
    
    
    
    
    
    
    
    
    
    
    2,518,000Other
    
    
    
    
    
    
    
    
    
    
    (22,000
    )
    
    
    
    
    
    
    
    
    
    
    (22,000
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18,487,000
    )
    
    
    (18,487,000
    )Balance, June 30, 2005
    
    
    34,752,110
    
    
    $
    348,000
    
    
    $
    272,157,000
    
    
    $
    (11,507,000
    )
    
    $
    (261,967,000
    )
    
    $
    (969,000
    )
  5




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ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  Six Months Ended June 30,2005
    
    
    2004Operating activities:Net loss
    
    $
    (18,487,000
    )
    
    $
    (20,814,000
    )Non-cash items in net loss:Depreciation and amortization
    
    
    2,195,000
    
    
    
    2,760,000Amortization of debt discount, financing costs and other
    
    
    2,198,000
    
    
    
    Employee stock compensation expense
    
    
    243,000
    
    
    
    1,075,000Common stock issued in lieu of cash compensation
    
    
    
    
    
    
    1,515,000Common stock issued in lieu of cash interest payment
    
    
    267,000
    
    
    
    Amortization of unearned stock-based compensation
    
    
    119,000
    
    
    
    30,000Recovery of investment in Maptuit Corporation
    
    
    
    
    
    
    (70,000
    )Customer deposit forfeiture
    
    
    (960,000
    )
    
    
    Gain on sale of product lines
    
    
    (950,000
    )
    
    
    Changes in operating assets and liabilities, excluding effects of acquisitions:Accounts receivable
    
    
    234,000
    
    
    
    (176,000
    )Other assets
    
    
    682,000
    
    
    
    147,000Accounts payable
    
    
    (542,000
    )
    
    
    920,000Deferred revenue
    
    
    1,820,000
    
    
    
    1,516,000Customer deposits received
    
    
    
    
    
    
    4,000,000Accrued and other liabilities
    
    
    8,000
    
    
    
    (415,000
    )Net cash used by operating activities
    
    
    (13,173,000
    )
    
    
    (9,512,000
    )Investing activities:Purchases of property and equipment
    
    
    (1,010,000
    )
    
    
    (1,909,000
    )Purchases of marketable securities
    
    
    
    
    
    
    (5,077,000
    )Sales and maturities of marketable securities
    
    
    16,000,000
    
    
    
    6,964,000Purchase of restricted cash investment
    
    
    (38,000
    )
    
    
    Proceeds from sale of product lines
    
    
    2,309,000
    
    
    
    Cash received from Maptuit Corporation
    
    
    
    
    
    
    70,000Net cash provided by investing activities
    
    
    17,261,000
    
    
    
    48,000Financing activities:Proceeds from exercise of stock options
    
    
    3,000
    
    
    
    15,338,000Proceeds from exercise of warrants
    
    
    
    
    
    
    5,338,000Payment of short term note payable
    
    
    (165,000
    )
    
    
    Payment of capital lease
    
    
    (87,000
    )
    
    
    Proceeds from promissory note payable
    
    
    
    
    
    
    3,000,000Other
    
    
    (22,000
    )
    
    
    Net cash (used) provided by financing activities
    
    
    (271,000
    )
    
    
    23,676,000Increase in cash and cash equivalents
    
    
    3,817,000
    
    
    
    14,212,000Cash and cash equivalents, beginning of period
    
    
    3,856,000
    
    
    
    6,599,000Cash and cash equivalents, end of period
    
    $
    7,673,000
    
    
    $
    20,811,000
  6




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ZIX CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  1. Basis of Presentation
  2. Operational Overview and Liquidity
        7




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3. 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



4. Stock-based Employee Compensation
 Accounting for Stock-Based Compensation, Accounting for Stock Issued to Employees
  Three Months Ended June 30
    
    
    Six Months Ended June 302005
    
    
    2004
    
    
    2005
    
    
    2004Net loss, as reported
    
    $
    (8,915,000
    )
    
    $
    (9,876,000
    )
    
    $
    (18,487,000
    )
    
    $
    (20,814,000
    )Add employee stock compensation expense
recorded under the intrinsic value
method
    
    
    
    
    
    
    133,000
    
    
    
    
    
    
    
    1,075,000Deduct pro forma stock compensation
expense computed under the fair value
method
    
    
    (1,601,000
    )
    
    
    (2,344,000
    )
    
    
    (3,362,000
    )
    
    
    (4,967,000
    )Pro forma net loss
    
    $
    (10,516,000
    )
    
    $
    (12,087,000
    )
    
    $
    (21,849,000
    )
    
    $
    (24,706,000
    )Basic and diluted loss per common share:As reported
    
    $
    (0.28
    )
    
    $
    (0.31
    )
    
    $
    (0.57
    )
    
    $
    (0.67
    )Pro forma
    
    $
    (0.32
    )
    
    $
    (0.38
    )
    
    $
    (0.68
    )
    
    $
    (0.80
    )
 9




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##### Table of Contents



5. Supplemental Cash Flow Information
  Six Months Ended June, 302005
    
    
    2004Cash paid for interest
    
    $
    298,000
    
    
    $
    Cash paid for income tax
    
    $
    294,000
    
    
    $
    151,000Noncash investing and financing activities:Assets acquired on capital lease
    
    $
    160,000
    
    
    $
    Issuance of note receivable relating to the sale of
Message Inspector and Web Inspector product lines (Note
6)
    
    $
    1,435,000
    
    
    $
    Revaluation of warrants resulting from restructure of
convertible promissory notes payable (Note 11)
    
    $
    (375,000
    )
    
    $
    Valuation of beneficial conversion feature resulting
from the restructure of convertible promissory notes
payable (Note 11)
    
    $
    2,518,000
    
    
    $
    Insurance premiums financed by short-term note payable
    
    $
    84,000
    
    
    $
    Common stock issued for purchase of MyDocOnline (Note 6)
    
    $
    
    
    
    $
    9,037,000
 6. Business Sales and Acquisitions
 Sale of Web Inspector and Message Inspector Product Lines
   Net assets sold:Equipment, net
    
    $
    15,000Prepaid expenses
    
    
    165,000Intangibles, net
    
    
    1,499,000Deferred revenue
    
    
    (1,546,000
    )Net assets
    
    
    133,000Goodwill
    
    
    2,161,000Net proceeds:Cash
    
    
    2,126,000Note receivable, net
    
    
    1,435,000Transaction fees
    
    
    (317,000
    )Net proceeds
    
    
    3,244,000Gain on sale
    
    $
    950,000
  10




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##### Table of Contents



Acquisition of MyDocOnline, Inc.
   Fair market value of 583,411 shares of the Companys common stock
    
    $
    9,037,000Transaction costs
    
    
    282,000Total acquisition cost
    
    $
    9,319,000
   Working capital items:Receivables and prepaid expenses
    
    $
    354,000Deferred revenue
    
    
    (140,000
    )Net working capital acquired
    
    
    214,000Property and equipment
    
    
    1,292,000Customer relationships
    
    
    658,000Developed technology
    
    
    2,051,000Goodwill
    
    
    4,798,000In-process research and development
    
    
    306,000$
    9,319,000
   7. Restricted Cash and Marketable Securities
   11




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##### Table of Contents



8. Accounts Receivable
 June 30,
    
    
    December 31,2005
    
    
    2004Gross accounts receivable
    
    $
    3,455,000
    
    
    $
    3,732,000Allowance for returns and doubtful accounts
    
    
    (95,000
    )
    
    
    (74,000
    )Unpaid portion of deferred revenue
    
    
    (3,033,000
    )
    
    
    (3,097,000
    )Receivables, net
    
    $
    327,000
    
    
    $
    561,000
  9. Intangible Assets and Goodwill
  June 30, 2005
    
    
    December 31, 2004Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedCost
    
    
    Amortization
    
    
    Net
    
    
    Cost
    
    
    Amortization
    
    
    NetDeveloped technology
    
    $
    2,598,000
    
    
    $
    1,382,000
    
    
    $
    1,216,000
    
    
    $
    3,541,000
    
    
    $
    1,347,000
    
    
    $
    2,194,000Customer contract and relationships
    
    
    658,000
    
    
    
    273,000
    
    
    
    385,000
    
    
    
    1,994,000
    
    
    
    596,000
    
    
    
    1,398,000Trademarks and trade names
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    432,000
    
    
    
    192,000
    
    
    
    240,000Total intangible assets
    
    $
    3,256,000
    
    
    $
    1,655,000
    
    
    $
    1,601,000
    
    
    $
    5,967,000
    
    
    $
    2,135,000
    
    
    $
    3,832,000
   AccumulatedCost
    
    
    AmortizationBeginning balance at January 1, 2005
    
    $
    5,967,000
    
    
    $
    2,135,000Amortization of intangibles
    
    
    
    
    
    
    732,000Sale of intangibles to CyberGuard
    
    
    (2,711,000
    )
    
    
    (1,212,000
    )Ending balance at June 30, 2005
    
    $
    3,256,000
    
    
    $
    1,655,000
  Six months ended December 31, 2005
    
    $
    575,0002006
    
    
    967,0002007
    
    
    59,000Total
    
    $
    1,601,000
  12




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##### Table of Contents



10. Customer Deposit
     11. Notes Payable
  December 31,
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    June 30,Stated
    
    
    Effective
    
    
    
    
    
    
    2004
    
    
    Additional
    
    
    Discount from
    
    
    
    
    
    
    Payment
    
    
    
    
    
    
    2005Interest
    
    
    Interest
    
    
    Note
    
    
    Net Book
    
    
    Debt
    
    
    Debt
    
    
    Discount
    
    
    Premium
    
    
    Payments
    
    
    Net BookRate
    
    
    Rate
    
    
    Expiration
    
    
    Value
    
    
    Incurred
    
    
    Amendments
    
    
    Amortization
    
    
    Accretion
    
    
    Made
    
    
    ValueConvertible promissory
notes payable
    
    
    6.4
    %
    
    
    30.3
    %
    
    Nov 2007
    
    $
    17,195,000
    
    
    $
    
    
    
    $
    (2,143,000
    )
    
    $
    1,479,000
    
    
    $
    177,000
    
    
    $
    
    
    
    $
    16,708,000Promissory note payable
    
    
    4.5
    %
    
    
    11.0
    %
    
    Mar 2007
    
    
    1,840,000
    
    
    
    
    
    
    
    
    
    
    
    187,000
    
    
    
    
    
    
    
    
    
    
    
    2,027,000Short-term promissory notes
    
    
    5.1
    %
    
    
    5.1
    %
    
    Oct 2005
    
    
    193,000
    
    
    
    84,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (165,000
    )
    
    
    112,000Total notes payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    19,228,000
    
    
    $
    84,000
    
    
    $
    (2,143,000
    )
    
    $
    1,666,000
    
    
    $
    177,000
    
    
    $
    (165,000
    )
    
    $
    18,847,000
 Convertible Promissory Notes Payable
 Original terms of Convertible Promissory Notes Payable
 
    
    The principal is payable in four equal annual installments of $5,000,000 beginning
November 2, 2005.
    
    If the Companys common stock closes above $6.00 per share for 15 of 20 days before any
annual payment date, the scheduled principal repayments may be made in common stock.
    
    The Company has the right to prepay the principal amount owing under the notes at any
time at 105% of the outstanding principal amount of the notes, plus accrued interest. In
addition, the Company must issue immediately exercisable warrants to
 13




---



##### Table of Contents



the Investors equaling 70% of the common stock that would be issued to the Investors to
retire the principal and interest assuming the notes and interest were converted to the
Companys common stock. The exercise price of these warrants, if issued, would be $6.00 a share.
    
    The notes stated interest rate is the six-month LIBOR plus 300 basis points and is reset
every six months (this rate was reset on April 29, 2005 to 6.41%).
    
    At the Companys option, interest on the notes is payable quarterly in cash or common
stock valued at a 10% discount to the volume weighted average price (VWAP) for the Companys
common stock for a specified number of trading days preceding the interest payment date.
    
    The Investors may convert the notes into the Companys common stock at $6.00 a share at
any time. However, the Company has the right to force the conversion of the notes at $6.00
if the Companys common stock closes above $11.00 per share for 15 of 20 days before the
annual payment date and if the following conditions are met:
 1.
    
    no event of default or repurchase event, as such terms are defined in the
convertible notes, under the notes has occurred,2.
    
    there is an effective registration statement on file with the SEC covering the shares of stock to be issued with respect to the payment of principal and the
registration statement has been effective during the 20 consecutive trading days
preceding the principal payment date and is reasonably expected to be effective for at
least 30 days following the issuance of the shares; and3.
    
    110% of the sum of the number of common stock shares to be issued to a particular
holder on the scheduled principal payment date, plus the number of common stock shares
previously issued to that holder, plus the number of common stock shares then issuable
upon conversion of the note held by that holder or exercise of the warrants held by that
holder is less than the portion of a maximum share amount allocated to such holder
(initially 3,407,801 shares for each original note holder).
 
    
    The notes have weighted average anti-dilution provisions that would cause an adjustment
to the conversion price and the number of shares issuable under the notes upon the
occurrence of issuances of equity securities or convertible equity securities at prices
below the then-effective conversion price or other specified dilutive events such as stock
splits, stock dividends, recapitalizations, certain repurchases by the Company of its shares, and certain dividends and distributions made by the Company.
    
    The Investors have the right to require the Company to repurchase the notes in cash upon
the occurrence of specified repurchase events, such as a change in control or events of
default while the notes are outstanding. Additionally, the notes contain restrictive
covenants, including covenants that prohibit the Company from incurring certain
indebtedness, establishing certain liens on the Companys assets or issuing any variable
priced securities.
    
    The Company was required to place certain proceeds from the notes into a restricted
collateral account. The amount of restricted cash collateral required to be maintained in
this account is 50% of the aggregate principal amount outstanding (initially $10,000,000).
The requirement for the Company to maintain the collateral account is removed if the Company
attains two consecutive quarters of net income, assuming the Company is otherwise in
compliance with its obligations under the convertible notes and related transaction
documents and no event of default or repurchase event, as such terms are defined in the
convertible notes, has occurred. Separately, the Company is required to maintain cash
(including the cash collateral held in the collateral account) and cash equivalents of
$10,000,000 through November 2, 2007, and $5,000,000 thereafter for so long as the notes are
outstanding.
 Amendments to the terms of Convertible Promissory Notes Payable
 
    
    The $5,000,000 principal payments due on November 2, 2005 and November 2, 2008 are now
due on October 31, 2005 and December 31, 2005, respectively (collectively, the 2005
Payments). Initially, under the terms of the amendments the November 2005 payment was
changed to July 31, 2005. However, the Investors subsequently agreed to delay the July 31,
2005 payment date to August 31, 2005. In addition, if the Company raises a minimum of
$7,500,000 in additional funding
 14




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##### Table of Contents



before August 31, 2005, that payment will be further delayed to October 31,
2005. The Company has raised the required funding (see Note 15) and therefore the November
2005 payment is now payable on October 31, 2005.
    
    The 2005 Payments will be redeemed at 105% of principal and can be redeemed in stock, in
whole at any time or in part from time-to-time on or before the revised payment dates. The
redemption value of the stock is based on the daily VWAP of the common stock less a 10%
discount for 15 trading days preceding the date of stock redemption. The amount of stock
redeemed during any 15 day redemption period is limited to 20% of the volume of the
Companys stock traded in the public market. The Company may declare more than one stock
redemption before the October 31 and December 31, 2005 payment dates as long as the stock
redemptions are at least 20 trading days apart. Any portion of the 2005 payments which are
not or cannot be redeemed in stock must be paid in cash at 105% of principle.
    
    The terms governing the $5,000,000 payments due November 2, 2006 and November 2, 2007,
remain unchanged. Under these terms, the
Company can choose to repay the 2006 and 2007 convertible notes upon maturity if the
holders have not elected conversion into common stock. Alternatively, the Company can
redeem the 2006 and 2007 convertible notes prior to maturity in cash at 105% of the
principal amount, plus accrued interest and the issuance of an immediately exercisable
supplemental warrant exercisable for 70% of the common stock that would be issuable to the
holders of the convertible notes upon conversion in respect to the principal amount thereof
if the convertible notes were to remain outstanding.
    
    If the Company pays all or a portion of the 2005 payments in
cash, the Company must issue
immediately exercisable warrants to the Investors equaling 70% of the common stock that
would be issued to the Investors to retire that portion of the principal paid in cash at
$6.00 per share. The exercise price of these warrants, if issued, would be $6.00 and the
warrants will expire equally on an annual basis beginning on November 2, 2006 and ending on
November 2, 2008. These warrants would thereafter be subject to potential weighted average
downward re-pricing triggered by future equity issuance by the Company at a price lower
than $6.00 per share.
    
    The warrants to purchase 1,000,000 shares of the Companys common stock at an exercise
price of $6.00 per share, were amended, such that the exercise price for a pro-rata portion
of the warrants is reduced to the price of the Companys common stock as and when the
convertible notes are redeemed in stock, if the redemption value per share of common stock
is lower than $6.00 per share.
    
    The Company was required to place certain proceeds from the notes into a restricted
collateral account. The amount of restricted cash collateral required to be maintained in
this account is 50% of the aggregate principal amount outstanding (initially $10,000,000).
The Company is required to maintain an overall cash balance of $10,000,000 (restricted and
non-restricted) through December 31, 2005 at which time the required cash balance will be
reduced $9,000,000. The required cash balance will further decrease to $5,000,000 in
November 2006.
    
    Under the terms of the Amendment Transaction Documents, the maximum number of shares of
common stock that the Company may issue to the Investors under the terms of the Amendment
Transaction Documents is subject to the limitation arising as a result of certain rules of
the Nasdaq National Market applicable to the Company. Because of this limitation, the
Company may not, without the approval of its shareholders, issue more than approximately
6.2 million shares of its common stock (or 19.99% of the Companys common stock
outstanding, measured as of the date of the Original Purchase Agreements) in connection
with:
 
    
    the 2005 Redemptions;
    
    any other payment or redemption of the principal amount of the convertible notes;
    
    the possible conversion by the Investors of the convertible notes at $6.00 per share;
    
    the possible exercise by the Investors of the warrants; and
    
    the payment of interest on the convertible notes.
 
    
    The Company expects to redeem the 2005 Payments in its common stock. The actual number
of shares of common stock issued to effect the 2005 Payments will depend on the market
price of the Companys common stock at the time of redemption.
    
    If the approximate 6.2 million shares of common stock is not enough to enable the
Company to complete the 2005 Payments, or if the Company is unable to complete the 2005
Payments for any other reason (e.g., insufficient trading volume), then the Company would
be required to (i) redeem for cash the principal balance of the convertible notes that
could not be redeemed in the 2005 Payments and (ii) if the Investors so elect after January
1, 2006, redeem for cash the remaining $10,000,000 principal balance of the convertible
notes. Further, if the number of shares is sufficient to complete the 2005 Payments, but at
 15




---



##### Table of Contents



any time after January 1, 2006 there are not enough shares left of the approximately 6.2
million shares to permit the Investors to convert the remaining outstanding principal amount
of the convertible notes to common stock at $6.00 per share (subject to adjustment as
provided in the convertible notes) and exercise the warrants, then, if the Investors so
elect, the Company would be required to redeem in cash any remaining principal balance of the
convertible notes for which there are not sufficient shares available to convert to common
stock at $6.00 per share (subject to adjustment). In each such case, the convertible notes
would be redeemed at 105% of principal and the Company would be required to issue a warrant
exercisable for 70% of the number of shares into which the redeemed convertible note would
have been convertible in the absence of the share limitation. Any reductions of the principal
amounts outstanding as a result of the cash redemptions described above would also reduce the
cash balances the Company is required to maintain under the covenants described above, such
that the cash balances would not exceed the principal amounts outstanding under the
convertible notes.
    
    The interest rates, interest payment dates and the ability to pay interest in the
Companys common stock remain unchanged from the original notes.
 Accounting treatment of the amended convertible promissory notes payable
 Accounting for Derivative Financial instruments Indexed to, and Potentially Settled in a
Companys Own Stock Accounting for Convertible Debt
and Debt Issued with Stock Purchase Warrants.
 Accounting for
Convertible Securities with Beneficial Conversion Features of Contingently Adjustable Conversion
Features Application of Issue No. 98-5 to Certain Convertible
Instruments
    16




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##### Table of Contents



Promissory Note Payable
   Short-term Note Payable
  12. Earnings Per Share and Potential Dilution
  Three Months ended June 30,
    
    
    Six Months ended June 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Stock options
    
    
    8,164,634
    
    
    
    6,470,000
    
    
    
    8,067,509
    
    
    
    6,225,000Warrants issued in relation to debt and equity arrangements
    
    
    3,691,317
    
    
    
    2,746,000
    
    
    
    3,632,594
    
    
    
    3,025,000Shares issuable for conversion of convertible promissory
notes payable (see Note 11)
    
    
    3,333,333
    
    
    
    
    
    
    
    3,333,333
    
    
    
    Total antidilutive securities excluded from earnings per
share calculation
    
    
    15,189,284
    
    
    
    9,216,000
    
    
    
    15,033,436
    
    
    
    9,250,000
   17




---



##### Table of Contents



13. Contingencies
       18




---



##### Table of Contents



14. Related Party Transactions
   15. Subsequent Events
      19




---



##### Table of Contents



ITEM
2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Summary
   
    
    Net revenue for the second quarter 2005 is $3,449,000.
    
    Net loss for the second quarter 2005 is $8,915,000.
    
    The effect of selling Message Inspector and Web Inspector product lines on March 11,
2005 decreased the Companys second quarter 2005 revenue and spending.
    
    The Company restructured the payment terms of the $20,000,000 of convertible promissory
notes payable.
    
    Overall revenue decreased $72,000 second quarter 2005 versus second quarter 2004.
However, when the impacts of the sale of the Message Inspector and Web Inspector product
lines are eliminated, revenue increased $1,006,000 (see table below).
    
    Spending cuts and increases in cash receipts improved the cash used by operations.
    
    Cash (restricted and unrestricted) and marketable securities decreased by $5,808,000.
    
    The Companys net loss was reduced by $960,000 related to the forfeiture by
Sanofi-Aventis of a portion of their $4,000,000 deposit for future services to be provided
by the Company.
    
    The Company signed a contract with Aetna for 1,000 pilot deployments of the PocketScript
e-Prescribing solution.
    
    Subsequent to the second quarter, the Company completed a private placement of its
common stock in which the Company received approximately $24,750,000
of net proceeds, of which $9,800,000 was placed in escrow subject to
shareholder approval.
  20




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##### Table of Contents



3-monthVarianceThree Months Ended June 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %Total revenue as reported
    
    $
    3,449,000
    
    
    $
    3,521,000
    
    
    $
    (72,000
    )
    
    
    (2%
    )Less: Revenue from Message
Inspector and Web Inspector
product lines
    
    
    (9,000
    )
    
    
    (1,087,000
    )
    
    
    (1,078,000
    )
    
    
    (99%
    )Revenue excluding impacts of
Message Inspector and Web
Inspector sale
    
    $
    3,440,000
    
    
    $
    2,434,000
    
    
    $
    1,006,000
    
    
    
    41%
    Overview
   21




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##### Table of Contents



Critical Accounting Policies and Estimates
  Long-Lived Assets
    22




---



##### Table of Contents



Deferred Tax Assets
 Accounting for Income Taxes,
  Revenue Recognition
 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,
  23




---



##### Table of Contents



24




---



##### Table of Contents



Results of Operations
 Revenues
    3-monthVariance
    
    
    
    
    
    
    
    
    
    
    6-monthVarianceThree Months Ended June 30,
    
    
    2005 vs. 2004
    
    
    Six Months Ended June 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %
    
    
    2005
    
    
    2004
    
    
    $
    
    
    %Services
    
    $
    3,199,000
    
    
    $
    2,786,000
    
    
    $
    413,000
    
    
    
    15
    %
    
    $
    6,497,000
    
    
    $
    5,273,000
    
    
    $
    1,224,000
    
    
    
    23
    %Hardware
    
    
    241,000
    
    
    
    293,000
    
    
    
    (52,000
    )
    
    
    (18
    %)
    
    
    426,000
    
    
    
    322,000
    
    
    
    104,000
    
    
    
    32
    %Software
    
    
    9,000
    
    
    
    442,000
    
    
    
    (433,000
    )
    
    
    (98
    %)
    
    
    109,000
    
    
    
    769,000
    
    
    
    (660,000
    )
    
    
    (86
    %)Total revenues
    
    $
    3,449,000
    
    
    $
    3,521,000
    
    
    $
    (72,000
    )
    
    
    (2
    %)
    
    $
    7,032,000
    
    
    $
    6,364,000
    
    
    $
    668,000
    
    
    
    10
    %
  3-monthVariance
    
    
    
    
    
    
    
    
    
    
    6-monthVarianceThree Months Ended June 30,
    
    
    2005 vs. 2004
    
    
    Six Months Ended June 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %
    
    
    2005
    
    
    2004
    
    
    $
    
    
    %eSecure
    
    $
    2,443,000
    
    
    $
    2,993,000
    
    
    $
    (550,000
    )
    
    
    (18
    %)
    
    $
    5,123,000
    
    
    $
    5,572,000
    
    
    $
    (449,000
    )
    
    
    (8
    %)eHealth
    
    
    1,006,000
    
    
    
    528,000
    
    
    
    478,000
    
    
    
    91
    %
    
    
    1,909,000
    
    
    
    792,000
    
    
    
    1,117,00
    
    
    
    141
    %Total revenues
    
    $
    3,449,000
    
    
    $
    3,521,000
    
    
    $
    (72,000
    )
    
    
    (2
    %)
    
    $
    7,032,000
    
    
    $
    6,364,000
    
    
    $
    668,000
    
    
    
    10
    %
    25




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##### Table of Contents



26




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##### Table of Contents



Cost of Revenues
  1.
    
    A decrease in costs due to the sale of Message Inspector and Web Inspector in the
first quarter of 2005 (see Note 6 to the condensed consolidated financial statements)..2.
    
    A decrease in costs resulting from the termination of the Connect service for
online doctor visits (see Note 6 to the condensed consolidated financial statements).3.
    
    Increase in costs relating to PocketScript services for investments required to
remain in the e-Prescribing market.
   3-monthVariance
    
    
    
    
    
    
    
    
    
    
    6-monthVarianceThree Months Ended June 30,
    
    
    2005 vs. 2004
    
    
    Six Months Ended June 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %
    
    
    2005
    
    
    2004
    
    
    $
    
    
    %Total cost of
revenues
    
    $
    3,508,000
    
    
    $
    3,704,000
    
    
    $
    (196,000
    )
    
    
    (5
    %)
    
    $
    7,399,000
    
    
    $
    6,878,000
    
    
    $
    521,000
    
    
    
    8
    %
  27




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##### Table of Contents



Research and Development Expenses
   3-monthVariance
    
    
    
    
    
    
    
    
    
    
    6-monthVarianceThree Months Ended June 30,
    
    
    2005 vs. 2004
    
    
    Six Months Ended June 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %
    
    
    2005
    
    
    2004
    
    
    $
    
    
    %Total research
and development
expenses
    
    $
    1,535,000
    
    
    $
    2,311,000
    
    
    $
    (776,000
    )
    
    
    (34
    %)
    
    $
    3,510,000
    
    
    $
    5,156,000
    
    
    $
    (1,646,000
    )
    
    
    (32
    %)
   Selling, General and Administrative Expenses
  28




---



##### Table of Contents



3-monthVariance
    
    
    
    
    
    
    
    
    
    
    6-monthVarianceThree Months Ended June 30,
    
    
    2005 vs. 2004
    
    
    Six Months Ended June 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %
    
    
    2005
    
    
    2004
    
    
    $
    
    
    %Total selling,
general and
administrative
expenses
    
    $
    6,559,000
    
    
    $
    7,349,000
    
    
    $
    (790,000
    )
    
    
    (11
    %)
    
    $
    14,061,000
    
    
    $
    15,155,000
    
    
    $
    (1,094,000
    )
    
    
    (7
    %)
   Customer Deposit Forfeiture
   Gain on Sale of Product Lines
  Investment and Other Income
  29




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##### Table of Contents



Interest Expense
   Stated
    
    
    
    
    
    
    
    
    
    
    Financing
    
    
    TotalInterest
    
    
    Discount
    
    
    Premium
    
    
    Cost
    
    
    Intereston Notes
    
    
    Amortization
    
    
    Accretion
    
    
    Amortization
    
    
    ExpenseConvertible promissory notes payable
    
    $
    570,000
    
    
    $
    1,479,000
    
    
    $
    177,000
    
    
    $
    392,000
    
    
    $
    2,618,000Promissory note payable
    
    
    
    
    
    
    187,000
    
    
    
    
    
    
    
    
    
    
    
    187,000Short-term promissory notes
    
    
    5,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,000Capital Leases
    
    
    16,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,000Total interest expense
    
    $
    591,000
    
    
    $
    1,666,000
    
    
    $
    177,000
    
    
    $
    392,000
    
    
    $
    2,826,000
     Recovery of Previously Impaired Investment
  Income Taxes
   30




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##### Table of Contents



Net Loss
  Liquidity and Capital Resources
 Overview
   Sources and Uses of Cash
    31




---



##### Table of Contents



Debt Instruments and Related Covenants
  1.
    
    $20,000,000 Convertible Promissory Notes Payable2.
    
    $2,700,000 Promissory Note Payable3.
    
    $277,000 Short-term Promissory Notes
 $20,000,000 Convertible Promissory Notes Payable
   32




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##### Table of Contents



$2,700,000
Promissory Note Payable
 $277,000 Short-term Promissory Notes
 Cash Requirements
  Cash Sources
  Backlog 
 Continued Growth of Secure Messaging Business 
 New e-Prescribing Payors 
  Cash Management
  33




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##### Table of Contents




    
    Saleof Web Inspector/Message Inspector (collectively the Inspector) Product Line In
mid-March, 2005, the Company sold the Inspector product line to CyberGuard for $3,309,000 in
cash and note receivable, net of transaction fees totaling $317,000 (see Note 6 to the
condensed consolidated financial statements). These products operated on a cash neutral
basis so their elimination will not impact the Companys on-going operating cash
requirements. CyberGuard paid $2,126,000 at closing and gave the Company a note payable for
three payments of $500,000 each due in the second, third and fourth quarters in 2005. The
second quarter installment was received on time by the Company.
    
    Workforce Reductions In the first half, the Company reduced its workforce by
approximately 17%. This was done selectively to avoid adversely impacting the core business
operations and sales momentum. The Company forecasts that the reduction will result in a net
improvement of $3,000,000 to $3,500,000 in cash expenditures during 2005. Additional
investments in e-Prescribing will offset approximately $1,000,000 of these savings for a net
benefit verses the $12,244,000 shortfall noted above of $2,000,000 to $2,500,000.
    
    Restructuring $20,000,000 Convertible Promissory Notes Payable On April 13, 2005, the
Company entered into amendments (the Purchase Agreement Amendments) to the Original
Purchase Agreements with the Investors (see Note 11 to the condensed consolidated financial
statements). The Purchase Agreement Amendments were closed on July 28, 2005. The new terms
allow the Company to repay the first and last $5,000,000 installments, which were scheduled
to be paid in cash in November 2005 and 2008, in stock during 2005. The first $5,000,000 is
now scheduled to be redeemed in stock before October 31, 2005 and the second $5,000,000 is
scheduled to be redeemed in stock prior to December 31, 2005. Should the Company be unable
to make the December 31, 2005 in full with stock redemptions, the balance would be paid in
cash.
 Private Placement of Common Stock
  Liquidity Summary
  Options and Warrants of ZixCorp Common Stock
  34




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##### Table of Contents



Summary of Outstanding Options and WarrantsVested SharesTotal Value
    
    
    (included in
    
    
    Total ValueOutstanding
    
    
    of Outstanding
    
    
    outstanding
    
    
    of VestedExercise Price Range
    
    Shares
    
    
    Shares
    
    
    shares)
    
    
    Shares$2.50 - $4.99
    
    
    4,208,014
    
    
    $
    16,340,000
    
    
    
    2,400,201
    
    
    $
    9,093,000$5.00 - $5.75
    
    
    1,794,468
    
    
    
    9,282,000
    
    
    
    1,410,024
    
    
    
    7,359,000$6.00 - $8.89
    
    
    2,970,414
    
    
    
    19,218,000
    
    
    
    2,087,183
    
    
    
    13,537,000$9.00 - $19.75
    
    
    1,830,104
    
    
    
    21,384,000
    
    
    
    1,259,971
    
    
    
    15,364,000$21.38 - $57.60
    
    
    1,163,695
    
    
    
    61,141,000
    
    
    
    1,163,695
    
    
    
    61,141,000Total
    
    
    11,966,695
    
    
    $
    127,365,000
    
    
    
    8,321,074
    
    
    $
    106,494,000
 Off-Balance Sheet Arrangements
  Contractual Obligations, Contingent Liabilities and Commitments
  Payments Due by PeriodTotal
    
    
    < 1 Year
    
    
    1-3 Year
    
    
    3-5 Years
    
    
    > 5 YearsLong-term debt
    
    $
    23,312,000
    
    
    $
    10,612,000
    
    
    $
    12,700,000
    
    
    $
    
    
    
    $
    Operating leases
    
    
    9,637,000
    
    
    
    1,459,000
    
    
    
    2,472,000
    
    
    
    1,936,000
    
    
    
    3,770,000Capital lease
    
    
    290,000
    
    
    
    249,000
    
    
    
    41,000
    
    
    
    
    
    
    
    Total cash obligations
    
    
    33,239,000
    
    
    
    12,320,000
    
    
    
    15,213,000
    
    
    
    1,936,000
    
    
    
    3,770,000Interest on obligations
    
    
    1,517,000
    
    
    
    875,000
    
    
    
    642,000
    
    
    
    
    
    
    
    Total
    
    $
    34,756,000
    
    
    $
    13,195,000
    
    
    $
    15,855,000
    
    
    $
    1,936,000
    
    
    $
    3,770,000
    Risks and Uncertainties
 (In these risk factors, we, us, our, and ZixCorp refer to Zix Corporation and its
wholly-owned subsidiaries.)
 An investment in our common stock involves a high degree of risk. You should carefully
consider the following risk factors in evaluating an investment in our common stock. The risks
described below are not the only ones that we face. Additional risks that we do not yet know of or
that we currently think are immaterial may also impair our business operations. If any of the
following risks actually occurs, our business, financial condition, or results of operations could
be materially and adversely affected. In such case, the trading price of our common stock could
decline, and you could lose all or part of your investment. You should also refer to the other
information set forth in this report, including our condensed consolidated financial statements and
the related notes.
 We continue to use significant amounts of cash for our business operations and for repaying
our debt which could result in our having insufficient cash to fund our operations under our
current business plan.
  35




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The market may not broadly accept our e-messaging and e-Prescribing products and services and
related applications and services, which would prevent us from operating profitably.
  Failure to enter into additional sponsorship agreements for our PocketScript e-Prescribing
services or maintain existing and generate other revenue opportunities from our PocketScript
e-Prescribing services could harm our business.
   If healthcare providers fail to adopt the PocketScript Solution, we will fail to achieve the
critical mass of physicians to build a successful business.
  Competition in our businesses is expected to increase, which could cause our business to fail.
   36




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##### Table of Contents



Our inability to successfully and timely develop and introduce new e-messaging, e-Prescribing
and e-transaction products and related applications and services and to implement technological
changes could harm our business.
   If the market for secure e-messaging, e-Prescribing and e-transaction products and related
applications and services does not continue to grow, demand for our products and services will be
adversely affected.
  If critical services and products that we source from third parties were to no longer be made available
to us or at a considerably higher price than we currently pay for them, and suitable alternatives could not be found, our business could be harmed.
 Future asset impairments could affect our financial results.
   37
    Table of Contents  Capacity limits on our technology and network hardware and software may be difficult to
project, and we may not be able to expand and upgrade our systems to meet increased use, which
would result in reduced revenues.
  Security interruptions to our data centers could disrupt our business, and any security
breaches could expose us to liability and negatively impact customer demand for our products and
services.
     Pending litigation could have a material impact on our operating results and financial
condition.
   38
    Table of Contents  We may have to defend our rights in intellectual property that we use in our services, which
could be disruptive and expensive to our business.
  Defects or errors in our services could harm our business.
  Public key cryptography technology is subject to risks.
  We depend on key personnel.
  We could be affected by government regulation.
  39
    Table of Contents  Our stock price may be volatile.
  Our directors and executive officers own a substantial percentage of our securities. Their
ownership could allow them to exercise significant control over corporate decisions and to
implement corporate acts that are not in the best interests of our shareholders as a group.
  One investor owns a large percentage of our outstanding stock and could significantly
influence the outcome of actions.
  We have a substantial amount of debt and may be unable to service or refinance this debt or
servicing this debt may restrict cash available for our business operations.
  
    
    result in our inability to comply with the financial and other restrictive covenants in
the notes, which, among other things, require us to maintain specified cash levels and limit
our ability to incur debt and sell assets, which could in turn result in an event of default
that, if not cured or waived, could have a material adverse effect on our operations;
    
    require us to dedicate a substantial portion of our cash flow from operations to make
scheduled principal payments on our debt or to meet required cash reserves, thereby reducing
the availability of our cash flow for working capital, capital investments and other
business activities;
    
    increase our vulnerability to adverse industry and general economic conditions;
    
    limit our ability to obtain additional financing to fund future working capital, capital
investments and other business activities;
    
    limit our ability to refinance our indebtedness on terms that are commercially reasonable or at all; and
    
    limit our flexibility to plan for, and react to, changes in our business and our industry.
 40
    Table of Contents  We have a significant amount of convertible securities outstanding, have recently issued a
significant amount of shares of common stock and related warrants in a private placement, and may
issue additional equity securities in the future. Conversion or redemption of the notes into our
common stock, the common stock issued in the private placement, exercise of the outstanding
warrants, and future issuances or conversion of other securities will dilute the ownership
interests of existing shareholders.
   We may have liability for indemnification claims arising from the sale of our Web Inspector
and Message Inspector product lines.
  We may encounter other unanticipated risks and uncertainties in the markets we serve or in
developing new products and services, and we cannot assure that we will be successful in responding
to any unanticipated risks or uncertainties.
  NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
  41
    Table of Contents  ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
  
 PART II  OTHER INFORMATION
 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  Nominee
    
    Shares For
    
    Shares WithheldMichael E. Keane
    
    
    25,906,392
    
    
    
    5,030,770James S. Marston
    
    
    25,908,650
    
    
    
    5,028,512John A. Ryan
    
    
    25,394,042
    
    
    
    5,543,120Antonio R. Sanchez III
    
    
    29,406,897
    
    
    
    1,530,265Richard D. Spurr
    
    
    29,600,314
    
    
    
    1,336,848Dr. Ben G. Streetman
    
    
    25,952,810
    
    
    
    4,984,352
  For
    
    
    9,106,419Against
    
    
    4,473,418Abstain
    
    
    170,972Broker NonVotes
    
    
    17,186,353
  For
    
    
    9,871,940Against
    
    
    3,756,354Abstain
    
    
    122,515Broker NonVotes
    
    
    17,186,353
 42
    Table of Contents  ITEM 6. EXHIBITS
 a. Exhibits
  Exhibit No.
    
    Description of Exhibits3.1
    
    
    
    
    Articles of Amendment to the Articles of Incorporation of Zix Corporation, as filed with the Texas
Secretary of State on August 1, 2002. Filed as Exhibit 3.1 to Zix Corporations Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2002, and incorporated herein by reference. Restated Articles
of Incorporation of Zix Corporation, as filed with the Texas Secretary of State on December 4, 2001. Filed
as Exhibit 3.1 to Zix Corporations Annual Report on Form 10-K for the year ended December 31, 2001, 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.4.1*
    
    
    
    
    Form of Amended and Restated Convertible Note Due 2005-2008 of Zix Corporation (including exhibits).4.2*
    
    
    
    
    Form of Amended and Restated Common Stock Purchase Warrant to purchase shares of Zix Corporation (excluding
exhibits).4.3*
    
    
    
    
    Form of Amended and Restated Registration Rights Agreement by and between Zix Corporation and the Investors
(excluding exhibits).4.4
    
    
    
    
    Securities Purchase Agreement,
dated as of August 9, 2005, by and between Zix Corporation and the
Purchasers listed on Schedule A thereto (including redacted
schedule and excluding appendices and exhibits). Filed as Exhibit 4.1 to the Companys Form 8-K, dated August 9,
2005, and incorporated herein by reference.4.5
    
    
    
    
    Form of Warrant to purchase shares
of Common Stock of Zix Corporation (including appendices). Filed as Exhibit 4.2 to the
Companys Form 8-K, dated August 9, 2005, and incorporated herein by reference.4.6
    
    
    
    
    Amendment No. 1 to Purchase Agreement, dated as of April 13, 2005, by and between Zix Corporation and
Omicron Master Trust (excluding schedules and exhibits). Filed as Exhibit 4.1 to the Companys Form 8-K,
dated April 14, 2005, and incorporated herein by reference.4.7
    
    
    
    
    Amendment No. 1 to Purchase Agreement, dated as of April 13, 2005, by and between Zix Corporation and
Amulet Limited (excluding schedules and exhibits). Filed as Exhibit 4.2 to the Companys Form 8-K, dated
April 14, 2005, and incorporated herein by reference.10.1*
    
    
    
    
    Sublease Agreement between ZixCorp Canada, Inc. and Intelligent Photonics Control Corp., dated May 20, 2005.10.2+
    
    
    
    
    Zix Corporation 2005 Stock Compensation Plan (Adopted Effective as of May 25, 2005). Filed as Exhibit 10.1
to the Companys Registration Statement on Form S-8 (Registration No. 333-126571), dated July 13, 2005, and
incorporated herein by reference.10.3+
    
    
    
    
    Zix Corporation 2004 Stock Option Plan (Amended and Restated as of May 25, 2005). Filed as Exhibit 10.1 to
the Companys Registration Statement on Form S-8 (Registration No. 333-126576), dated July 13, 2005, and
incorporated herein by reference.10.4+
    
    
    
    
    Form of Stock Option Agreement (with no change in control provision) for Zix Corporation 2004 Stock
Option Plan. Filed as Exhibit 10.2 to the Companys Registration Statement on Form S-8 (Registration No.
333-126576), dated July 13, 2005, and incorporated herein by reference.10.5+
    
    
    
    
    Form of Stock Option Agreement (with change in control provision) for Zix Corporation 2004 Stock Option
Plan. Filed as Exhibit 10.3 to the Companys Registration Statement on Form S-8 (Registration No.
333-126576), dated July 13, 2005, and incorporated herein by reference.10.6
    
    
    
    
    Escrow Agreement, dated as of
August 9, 2005, by and between Zix Corporation and JPMorgan Chase Bank, N.A.,
as escrow agent (excluding exhibits and schedules). Filed as Exhibit 10.1 to the Companys Form 8-K, dated August 9, 2005, and incorporated
herein by reference.
 43
    Table of Contents  Exhibit No.
    
    Description of Exhibits19.1
    
    
    
    
    Zix Corporations Annual Report on Form 10-K for the fiscal year ended December 31, 2004. Filed on March
30, 2005.31.1*
    
    
    
    
    Certification of Richard D. Spurr, Chief Executive Officer, President, and Chief Operating Officer of the
Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    
    
    
    Certification of Bradley C. Almond, Vice President, Chief Financial Officer, and Treasurer of the Company,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    
    
    
    Certification of Richard D. Spurr, Chief Executive Officer, President, and Chief Operating Officer of the
Company, and Bradley C. Almond, Vice President, Chief Financial Officer, and Treasurer of the Company,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Filed herewith.+
    
    Management contract or compensatory plan or arrangement. 44
    Table of Contents  SIGNATURE
  ZIX CORPORATION
(Registrant)Date: August 9, 2005
    /s/ Bradley C. AlmondBradley C. AlmondVice President, Chief Financial Officer, and
Treasurer
(Principal Financial Officer and
Duly Authorized Officer) 45