##### 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 March 31, 2006
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the transition period fromto
 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 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 þ No o
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or
a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):
 Large accelerated filer o Accelerated filer
þ Non-accelerated filer 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 May 1, 2006Common Stock, par value $.01 per share
    
    
    59,638,839




---



##### 



INDEX
 PART
 FINANCIAL INFORMATION
 PageNumberItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets at March 31, 2006 and December 31, 2005
    
    
    iiCondensed Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005
    
    
    iiiCondensed Consolidated Statement of Stockholders Equity for the three months ended March 31, 2006
    
    
    ivCondensed Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005
    
    
    vNotes to Condensed Consolidated Financial Statements
    
    
    1Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    37Item 4. Controls and Procedures
    
    
    37PART II-OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    37Item 1A. Risk Factors
    
    
    38Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    45Item 3. Defaults Upon Senior Securities
    
    
    45Item 4. Submission of Matters to a Vote of Security Holders
    
    
    45Item 5. Other Information
    
    
    45Item 6. Exhibits and Reports on Form 8-K
    
    
    45Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO and CFO Pursuant to Section 906
  i




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ZIX CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
  March 31,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    14,158,000
    
    
    $
    20,240,000Restricted cash
    
    
    5,102,000
    
    
    
    5,100,000Receivables, net
    
    
    413,000
    
    
    
    149,000Prepaid and other current assets
    
    
    1,654,000
    
    
    
    1,845,000Total current assets
    
    
    21,327,000
    
    
    
    27,334,000Restricted cash
    
    
    35,000
    
    
    
    35,000Property and equipment, net
    
    
    3,377,000
    
    
    
    3,652,000Intangible assets, net
    
    
    379,000
    
    
    
    559,000Goodwill
    
    
    2,161,000
    
    
    
    2,161,000Deferred financing costs and other assets
    
    
    325,000
    
    
    
    374,000$
    27,604,000
    
    
    $
    34,115,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,042,000
    
    
    $
    1,313,000Accrued expenses
    
    
    3,505,000
    
    
    
    3,749,000Deferred revenue
    
    
    7,824,000
    
    
    
    7,087,000Customer deposit
    
    
    2,020,000
    
    
    
    1,000,000Capital lease obligations
    
    
    103,000
    
    
    
    165,000Promissory note payable
    
    
    2,330,000
    
    
    
    Short-term note payable
    
    
    192,000
    
    
    
    268,000Convertible promissory note payable
    
    
    4,504,000
    
    
    
    4,404,000Total current liabilities
    
    
    21,520,000
    
    
    
    17,986,000Long-term liabilities:Deferred revenue
    
    
    1,325,000
    
    
    
    1,261,000Customer deposit
    
    
    
    
    
    
    2,000,000Promissory note payable
    
    
    
    
    
    
    2,226,000Deferred rent
    
    
    239,000
    
    
    
    245,000Total long-term liabilities
    
    
    1,564,000
    
    
    
    5,732,00023,084,000
    
    
    
    23,718,000Contingencies (Note 14)Stockholders equity: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; 52,027,281 issued and
49,700,100 outstanding in 2006 and 51,932,561 issued and
49,605,380 outstanding in 2005
    
    
    520,000
    
    
    
    519,000Additional paid-in capital
    
    
    309,457,000
    
    
    
    308,461,000Treasury stock, at cost; 2,327,181 common shares in 2006 and 2005
    
    
    (11,507,000
    )
    
    
    (11,507,000
    )Accumulated deficit
    
    
    (293,950,000
    )
    
    
    (287,076,000
    )Total stockholders equity
    
    
    4,520,000
    
    
    
    10,397,000$
    27,604,000
    
    
    $
    34,115,000
  ii




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##### Table of Contents



ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
  Three Months Ended March 31,2006
    
    
    2005Revenues:Services
    
    $
    3,895,000
    
    
    $
    3,298,000Hardware
    
    
    
    
    
    
    185,000Software
    
    
    
    
    
    
    100,000Total revenues
    
    
    3,895,000
    
    
    
    3,583,000Cost of revenues
    
    
    3,375,000
    
    
    
    3,891,000Gross margin (loss)
    
    
    520,000
    
    
    
    (308,000
    )Operating expenses:Research and development expenses
    
    
    1,595,000
    
    
    
    1,975,000Selling, general and administrative expenses
    
    
    6,592,000
    
    
    
    7,502,000Customer deposit forfeiture
    
    
    (1,000,000
    )
    
    
    Gain of sale of product lines
    
    
    
    
    
    
    (950,000
    )Total operating expenses
    
    
    7,187,000
    
    
    
    8,527,000Operating loss
    
    
    (6,667,000
    )
    
    
    (8,835,000
    )Other (expense) income:Investment and other income
    
    
    217,000
    
    
    
    143,000Interest expense
    
    
    (418,000
    )
    
    
    (830,000
    )Total other (expense) income
    
    
    (201,000
    )
    
    
    (687,000
    )Loss before income taxes
    
    
    (6,868,000
    )
    
    
    (9,522,000
    )Income taxes
    
    
    (6,000
    )
    
    
    (50,000
    )Net loss
    
    $
    (6,874,000
    )
    
    $
    (9,572,000
    )Basic and diluted loss per common share
    
    $
    (0.14
    )
    
    $
    (0.30
    )Basic and diluted weighted average common shares outstanding
    
    
    49,654,338
    
    
    
    32,295,162
  iii




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##### Table of Contents



ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
  Stockholders EquityAdditional
    
    
    
    
    
    
    
    
    
    
    TotalCommon Stock
    
    
    Paid-In
    
    
    Treasury
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Capital
    
    
    Stock
    
    
    Deficit
    
    
    EquityBalance, January 1, 2006
    
    
    51,932,561
    
    
    $
    519,000
    
    
    $
    308,461,000
    
    
    $
    (11,507,000
    )
    
    $
    (287,076,000
    )
    
    $
    10,397,000Common stock issued to employees for
compensation in lieu of cash
    
    
    82,196
    
    
    
    1,000
    
    
    
    156,000
    
    
    
    
    
    
    
    
    
    
    
    157,000Common stock issued in lieu of cash
for third-party services
    
    
    12,524
    
    
    
    
    
    
    
    20,000
    
    
    
    
    
    
    
    
    
    
    
    20,000Employee share-based compensation costs
    
    
    
    
    
    
    
    
    
    
    767,000
    
    
    
    
    
    
    
    
    
    
    
    767,000Value of additional warrants issued
    
    
    
    
    
    
    
    
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    50,000Non-employee stock-based compensation
    
    
    
    
    
    
    
    
    
    
    3,000
    
    
    
    
    
    
    
    
    
    
    
    3,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,874,000
    )
    
    
    (6,874,000
    )Balance, March 31, 2006
    
    
    52,027,281
    
    
    $
    520,000
    
    
    $
    309,457,000
    
    
    $
    (11,507,000
    )
    
    $
    (293,950,000
    )
    
    $
    4,520,000
  iv




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##### Table of Contents



ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  Three Months Ended March 31,2006
    
    
    2005Operating activities:Net loss
    
    $
    (6,874,000
    )
    
    $
    (9,572,000
    )Non-cash items in net loss:Depreciation and amortization
    
    
    779,000
    
    
    
    1,135,000Amortization of debt discount / premium, financing costs and other
    
    
    307,000
    
    
    
    552,000Value of additional warrants issued
    
    
    10,000
    
    
    
    Amortization of discount on notes receivable
    
    
    
    
    
    
    (5,000
    )Common stock issued to employees and non-employee in lieu of cash
    
    
    177,000
    
    
    
    243,000Employee share-based compensation costs
    
    
    767,000
    
    
    
    Non-employee share-based compensation
    
    
    3,000
    
    
    
    56,000Customer deposit forfeiture
    
    
    (1,000,000
    )
    
    
    Gain on sale of product lines
    
    
    
    
    
    
    (950,000
    )Changes in operating assets and liabilities, excluding effects of acquisitions:Accounts receivable
    
    
    (264,000
    )
    
    
    28,000Other assets
    
    
    175,000
    
    
    
    314,000Accounts payable
    
    
    (197,000
    )
    
    
    677,000Deferred revenue
    
    
    801,000
    
    
    
    460,000Customer deposits
    
    
    20,000
    
    
    
    Accrued and other liabilities
    
    
    (250,000
    )
    
    
    (324,000
    )Net cash used by operating activities
    
    
    (5,546,000
    )
    
    
    (7,386,000
    )Investing activities:Purchases of property and equipment
    
    
    (398,000
    )
    
    
    (685,000
    )Sales and maturities of marketable securities
    
    
    
    
    
    
    12,997,000Purchase of restricted cash investment
    
    
    
    
    
    
    (36,000
    )Proceeds from sale of product line
    
    
    
    
    
    
    1,840,000Net cash (used) provided by investing activities
    
    
    (398,000
    )
    
    
    14,116,000Financing activities:Proceeds from exercise of stock options
    
    
    
    
    
    
    3,000Payment of short-term notes payable, capital leases and other
    
    
    (138,000
    )
    
    
    (109,000
    )Net cash used by financing activities
    
    
    (138,000
    )
    
    
    (106,000
    )(Decrease) increase in cash and cash equivalents
    
    
    (6,082,000
    )
    
    
    6,624,000Cash and cash equivalents, beginning of period
    
    
    20,240,000
    
    
    
    3,856,000Cash and cash equivalents, end of period
    
    $
    14,158,000
    
    
    $
    10,480,000
  v




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##### Table of Contents



ZIX CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  1. Basis of Presentation
  2. Company Overview and Liquidity
 ®
  Company History
  
    
    ZixVPM® (Virtual Private Messenger): an e-messaging gateway service that provides
company-wide privacy protection for inbound and outbound email communications.
    
    ZixAuditor®: an assessment service used to analyze email traffic patterns and
monitor compliance with corporate and regulatory policies.
    
    ZixPort®: a secure Web-messaging portal.
    1




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##### Table of Contents















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,




2



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##### Table of Contents



4. Segment Information
   3




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##### Table of Contents



Three Months Ended March 31, 2006
    
    
    Three Months Ended March 31, 2005Email
    
    
    e-
    
    
    
    
    
    
    
    
    
    
    Email
    
    
    e-Encryption
    
    
    Prescribing
    
    
    Corporate
    
    
    Total
    
    
    Encryption
    
    
    Prescribing
    
    
    Corporate
    
    
    TotalRevenues
    
    $
    3,333,000
    
    
    $
    562,000
    
    
    $
    
    
    
    $
    3,895,000
    
    
    $
    2,044,000
    
    
    $
    832,000
    
    
    $
    707,000
    
    
    $
    3,583,000Cost of revenues
    
    
    1,466,000
    
    
    
    1,909,000
    
    
    
    
    
    
    
    3,375,000
    
    
    
    1,314,000
    
    
    
    1,800,000
    
    
    
    777,000
    
    
    
    3,891,000Gross margin (loss)
    
    
    1,867,000
    
    
    
    (1,347,000
    )
    
    
    
    
    
    
    520,000
    
    
    
    730,000
    
    
    
    (968,000
    )
    
    
    (70,000
    )
    
    
    (308,000
    )Direct expenses
    
    
    2,945,000
    
    
    
    2,604,000
    
    
    
    
    
    
    
    5,549,000
    
    
    
    3,056,000
    
    
    
    2,659,000
    
    
    
    711,000
    
    
    
    6,426,000Segment (loss)
    
    
    (1,078,000
    )
    
    
    (3,951,000
    )
    
    
    
    
    
    
    (5,029,000
    )
    
    
    (2,326,000
    )
    
    
    (3,627,000
    )
    
    
    (781,000
    )
    
    
    (6,734,000
    )Unallocated (expense)
/ incomeMarketing, general
and administrative
expense
    
    
    
    
    
    
    
    
    
    
    (2,638,000
    )
    
    
    (2,638,000
    )
    
    
    
    
    
    
    
    
    
    
    (3,051,000
    )
    
    
    (3,051,000
    )Gain of sales of
product line
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    950,000
    
    
    
    950,000Customer deposit
forfeiture
    
    
    
    
    
    
    
    
    
    
    1,000,000
    
    
    
    1,000,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Investment and
other income
    
    
    
    
    
    
    
    
    
    
    217,000
    
    
    
    217,000
    
    
    
    
    
    
    
    
    
    
    
    143,000
    
    
    
    143,000Interest Expense
    
    
    
    
    
    
    
    
    
    
    (418,000
    )
    
    
    (418,000
    )
    
    
    
    
    
    
    
    
    
    
    (830,000
    )
    
    
    (830,000
    )Total
    
    
    
    
    
    
    
    
    
    
    (1,839,000
    )
    
    
    (1,839,000
    )
    
    
    
    
    
    
    
    
    
    
    (2,788,000
    )
    
    
    (2,788,000
    )Loss before income
taxes
    
    $
    (1,078,000
    )
    
    $
    (3,951,000
    )
    
    $
    (1,839,000
    )
    
    $
    (6,868,000
    )
    
    $
    (2,326,000
    )
    
    $
    (3,627,000
    )
    
    $
    (3,569,000
    )
    
    $
    (9,522,000
    )
   March 31, 2006
    
    
    December 31, 2005Email
    
    
    e-
    
    
    
    
    
    
    
    
    
    
    Email
    
    
    e-Encryption
    
    
    Prescribing
    
    
    Corporate
    
    
    Total
    
    
    Encryption
    
    
    Prescribing
    
    
    Corporate
    
    
    TotalTotal assets
    
    $
    3,949,000
    
    
    $
    1,202,000
    
    
    $
    22,453,000
    
    
    $
    27,604,000
    
    
    $
    3,969,000
    
    
    $
    1,436,000
    
    
    $
    28,710,000
    
    
    $
    34,115,000
 4




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##### Table of Contents



5. Stock Options and Stock-based Employee Compensation
  Authorized
    
    Options
    
    Options
    
    AvailableShares
    
    Outstanding
    
    Vested
    
    for GrantEmployee and Director Stock Option Plans:1990 Stock Option Plan
    
    
    345,045
    
    
    
    2,500
    
    
    
    2,500
    
    
    
    1992 Stock Option Plan
    
    
    450,000
    
    
    
    65,666
    
    
    
    65,666
    
    
    
    1995 Long-term Incentive Plan
    
    
    1,825,000
    
    
    
    1,362,100
    
    
    
    913,766
    
    
    
    1996 Directors Stock Option Plan
    
    
    225,000
    
    
    
    62,500
    
    
    
    62,500
    
    
    
    1999 Directors Stock Option Plan
    
    
    975,000
    
    
    
    826,153
    
    
    
    770,625
    
    
    
    2001 Stock Option Plan
    
    
    2,525,000
    
    
    
    1,887,740
    
    
    
    787,225
    
    
    
    171,3502001 Employee Stock Option Plan
    
    
    300,000
    
    
    
    223,643
    
    
    
    166,516
    
    
    
    32,8102003 New Employee Stock Option Plan
    
    
    500,000
    
    
    
    481,400
    
    
    
    324,317
    
    
    
    18,6002004 Stock Option Plan
    
    
    3,200,000
    
    
    
    1,791,860
    
    
    
    463,515
    
    
    
    1,408,1402004 Directors Stock Option Plan
    
    
    300,000
    
    
    
    270,832
    
    
    
    126,250
    
    
    
    29,168Cook Employee Transferred Options
    
    
    807,127
    
    
    
    18,000
    
    
    
    18,000
    
    
    
    Total employee and director stock option
plans
    
    
    11,452,172
    
    
    
    6,992,394
    
    
    
    3,700,880
    
    
    
    1,660,068Executive Stock Option Agreements:John A. Ryan, former Chairman and CEO
    
    
    1,000,000
    
    
    
    1,000,000
    
    
    
    1,000,000
    
    
    
    Richard D. Spurr, Chairman, President and CEO
    
    
    650,000
    
    
    
    650,000
    
    
    
    472,727
    
    
    
    Other executive stock option agreements
    
    
    450,000
    
    
    
    158,665
    
    
    
    158,665
    
    
    
    Total executive stock option agreements
    
    
    2,100,000
    
    
    
    1,808,665
    
    
    
    1,631,392
    
    
    
    Other Stock Option Agreements
    
    
    70,000
    
    
    
    70,000
    
    
    
    70,000
    
    
    
    Total
    
    
    13,622,172
    
    
    
    8,871,059
    
    
    
    5,402,272
    
    
    
    1,660,068
  Employee and Director Stock Option Plans
  Cook Employee Transferred Options
 Executive Stock Option Agreements:
 John A. Ryan
 Richard D. Spurr
 Other Executive Stock Option Agreements
 Other Stock Option Agreements:
  5




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##### Table of Contents



Accounting Treatment
 Share-Based Payment
   Cost of revenues
    
    $
    33,000Research and development expenses
    
    
    32,000Selling, general and administrative expenses
    
    
    702,000Stock-based compensation expense
    
    $
    767,000
  Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards,
  Three Months EndedMarch 31, 2005Net loss, as reported
    
    $
    (9,572,000
    )Deduct pro forma stock compensation expense
computed under the fair value method
    
    
    (1,761,000
    )Pro forma net loss
    
    $
    (11,333,000
    )Basic and diluted loss per common share:As reported
    
    $
    (0.30
    )Pro forma
    
    $
    (0.35
    )
  6




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##### Table of Contents



Three Months Ended March 31,2006
    
    2005Risk-free interest rate
    
    
    4.58
    %
    
    
    3.10
    %Expected option life
    
    6 years
    
    3.6 yearsExpected stock price volatility
    
    
    97.5
    %
    
    
    98.0
    %Expected dividend yield
    
    
    
    
    
    
    Fair value of options granted
    
    $
    1.34
    
    
    $
    2.69
 Stock Option Activity
  WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicShares
    
    
    Price
    
    
    Term
    
    
    ValueOutstanding at January 1, 2006
    
    
    7,595,415
    
    
    $
    7.03Granted at market price
    
    
    15,000
    
    
    $
    1.93Granted above market price
    
    
    1,871,944
    
    
    $
    3.02Cancelled or expired
    
    
    (611,300
    )
    
    $
    7.24Exercised
    
    
    
    
    
    $
    Outstanding at March 31, 2006
    
    
    8,871,059
    
    
    $
    6.16
    
    
    
    7.00
    
    
    $
    Options exercisable at March 31, 2006
    
    
    5,402,272
    
    
    $
    7.47
    
    
    
    7.00
    
    
    $
    
   Common Stock Issued in Lieu of Cash
  Three Months Ended March 31,2006
    
    
    2005Common stock issued to employees for compensation in lieu of cash
    
    $
    157,000
    
    
    $
    243,000Stock granted to third parties
    
    
    20,000
    
    
    
    Total
    
    $
    177,000
    
    
    $
    243,000
 7




---



##### Table of Contents



6. Supplemental Cash Flow Information
  Three Months Ended March 31,2006
    
    
    2005Cash paid for interest
    
    $
    102,000
    
    
    $
    276,000Cash paid for income tax
    
    $
    
    
    
    $
    220,000Noncash investing and financing activities:Accrued expenses related to fixed asset purchases
    
    $
    74,000
    
    
    $
    Value of additional warrants issued
    
    $
    50,000
    
    
    $
    Insurance premiums financed by short-term note payable
    
    $
    
    
    
    $
    84,000
 7. Business Sales and Acquisitions
 Sale of Dr. Chart, a product of MyDocOnline
    Net assets sold (liabilities transferred):Accounts receivable, net
    
    $
    34,000Equipment, net
    
    
    37,000Intangibles, net
    
    
    575,000Deferred revenue
    
    
    (739,000
    )Net
    
    
    (93,000
    )Goodwill
    
    
    4,797,000Net proceeds:Cash receivable
    
    
    150,000Note receivable, net
    
    
    Service obligation
    
    
    (30,000
    )Transaction fees
    
    
    (167,000
    )Net proceeds
    
    
    (47,000
    )Loss on sale of product line
    
    $
    (4,751,000
    )
   Sale of Web Inspector and Message Inspector Product Lines
  8




---



##### Table of Contents



Net assets sold (liabilities transferred):Equipment, net
    
    $
    15,000Prepaid expenses
    
    
    165,000Intangibles, net
    
    
    1,499,000Initial deferred revenue
    
    
    (1,546,000
    )Net
    
    
    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 of product lines
    
    $
    950,000
    8. Restricted Cash and Marketable Securities
  9




---



##### Table of Contents



9. Accounts Receivable
 March 31,
    
    
    December 31,2006
    
    
    2005Gross trade accounts receivable
    
    $
    3,138,000
    
    
    $
    3,136,000Allowance for returns and doubtful accounts
    
    
    (75,000
    )
    
    
    (35,000
    )Unpaid portion of deferred revenue
    
    
    (2,964,000
    )
    
    
    (2,969,000
    )Trade receivables, net
    
    
    99,000
    
    
    
    132,000Taxes receivable
    
    
    297,000
    
    
    
    Other receivable
    
    
    17,000
    
    
    
    17,000Total receivables, net
    
    $
    413,000
    
    
    $
    149,000
  10. Intangible Assets and Goodwill
  March 31, 2006
    
    December 31, 2005Accumulated
    
    
    
    
    
    
    
    
    
    AccumulatedCost
    
    Amortization
    
    Net
    
    Cost
    
    Amortization
    
    NetDeveloped technology
    
    $
    2,034,000
    
    
    $
    1,655,000
    
    
    $
    379,000
    
    
    $
    2,034,000
    
    
    $
    1,475,000
    
    
    $
    559,000
   AccumulatedCost
    
    AmortizationBeginning balance at January 1, 2006
    
    $
    2,034,000
    
    
    $
    1,475,000Amortization of intangibles
    
    
    
    
    
    
    180,000Ending balance at March 31, 2006
    
    $
    2,034,000
    
    
    $
    1,655,000
  Nine months ended December 31, 2006
    
    $
    356,0002007
    
    
    23,000Total
    
    $
    379,000
  11. Customer Deposit
  10




---



##### Table of Contents



12. Notes Payable
  AdditionalDiscountStated
    
    
    Effective
    
    
    
    
    
    
    December 31,
    
    
    from
    
    
    Discount/
    
    
    
    
    
    
    March 31,Interest
    
    
    Interest
    
    
    
    
    
    
    2005 Net
    
    
    Additional
    
    
    Premium
    
    
    Payments
    
    
    2006 NetRate
    
    
    Rate
    
    
    Term
    
    
    Book Value
    
    
    Warrants
    
    
    Amortization
    
    
    Made
    
    
    Book ValueConvertible promissory
notes payable
    
    
    7.47
    %
    
    
    34.51
    %
    
    
    2007
    
    
    $
    4,404,000
    
    
    $
    (40,000
    )
    
    $
    140,000
    
    
    $
    
    
    
    $
    4,504,000Promissory note
payable
    
    
    4.50
    %
    
    
    11.00
    %
    
    
    2007
    
    
    
    2,226,000
    
    
    
    
    
    
    
    104,000
    
    
    
    
    
    
    
    2,330,000Short-term promissory
notes
    
    
    6.99
    %
    
    
    6.99
    %
    
    
    2006
    
    
    
    268,000
    
    
    
    
    
    
    
    
    
    
    
    (76,000
    )
    
    
    192,000Total notes
payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    6,898,000
    
    
    $
    (40,000
    )
    
    $
    244,000
    
    
    $
    (76,000
    )
    
    $
    7,026,000
 Convertible Promissory Notes Payable
    11




---



##### Table of Contents




    
    The principal was payable in four installments of $5,000,000 on October 31 and December
31, 2005 (collectivity, the 2005 Payments), November 2, 2006 and 2007.
    
    The 2005 Payments could be redeemed at 105% of principal and could 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 volume weighted average price
(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. Any portion
of the 2005 payments which are not or cannot be redeemed in stock must be paid in cash at
105% of principal.
    
    If the Company paid 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 (or lower exercise price if anti-dilution provisions are triggered). The
exercise price of these warrants, if issued, would be $6.00 (or lower exercise price if
anti-dilution provisions are triggered) and the warrants will expire 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 2006 and 2007 payments may be paid in stock if the Companys common stock closes
above $6.00 per share for 15 of 20 days before the payment date and if the Company has
enough shares available for issuance.
    
    The Company has the right to prepay the 2006 and 2007 payments at any time at 105% of the
outstanding principal amount of the notes, plus accrued interest if the Company is not in a
share deficiency situation. In addition, 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 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, or lower if anti-dilution clauses are triggered.
    
    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 notes stated interest rate is the six-month London Inter Bank Offering Rate
(LIBOR) plus 300 basis points and is reset every six months (this rate was reset on
November 1, 2005 to 7.47%).
    
    At the Companys option, and assuming the Company has not reached the maximum shares
allowed under the notes, interest on the notes is payable quarterly in cash or common stock
valued at a 10% discount to the 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).
 12




---



##### Table of Contents




    
    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. The Company was 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 was to be reduced to $9,000,000
at the time the December 31, 2005, payment was made. When the November 2, 2006, payment is
made, the required cash balance was to be further reduced to $5,000,000 through the notes
maturity.
 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
   2005 payment activity on the convertible promissory notes payable:
 13




---



##### Table of Contents



Adjustments to the stock conversion price and warrant exercise price
   December 31, 2005
    
    
    
    
    
    
    
    
    
    
    March 31, 2006AllocationAdditional
    
    
    of
    
    
    
    
    
    
    AdjustedWarrants
    
    
    Exercise
    
    
    Warrants
    
    
    Additional
    
    
    Warrants
    
    
    Exercise
    
    
    ShareWarrant Grants:
    
    Outstanding
    
    
    Price
    
    
    Issued
    
    
    Warrants
    
    
    Outstanding
    
    
    Price
    
    
    DeficiencyConvertible promissory
notes payable, initial
warrants
    
    
    450,422
    
    
    
    5.38
    
    
    
    
    
    
    
    
    
    
    
    450,422
    
    
    
    5.24
    
    
    
    293,331Increase due to repricing
for 2005 Private Placement
    
    
    115,244
    
    
    
    5.38
    
    
    
    29,796
    
    
    
    (12,550
    )
    
    
    132,490
    
    
    
    5.24
    
    
    
    17,246Re-pricing of initial
warrants, Sept 23, 2005
    
    
    118,672
    
    
    
    2.15
    
    
    
    
    
    
    
    1,942
    
    
    
    120,614
    
    
    
    2.15
    
    
    
    61,278Re-pricing of initial
warrants, Oct 28, 2005
    
    
    87,442
    
    
    
    1.82
    
    
    
    
    
    
    
    1,432
    
    
    
    88,874
    
    
    
    1.82
    
    
    
    45,153Re-pricing of initial
warrants, Dec 1, 2005
    
    
    125,914
    
    
    
    1.69
    
    
    
    
    
    
    
    3,364
    
    
    
    129,278
    
    
    
    1.69
    
    
    
    66,321Re-pricing of initial
warrants, Dec 9, 2005
    
    
    217,550
    
    
    
    1.44
    
    
    
    
    
    
    
    5,812
    
    
    
    223,362
    
    
    
    1.44
    
    
    
    104,089Additional warrants issued
due to 2005 cash payments
on convertible promissory
notes payable
    
    
    795,590
    
    
    
    5.38
    
    
    
    21,257
    
    
    
    
    
    
    
    816,847
    
    
    
    5.24
    
    
    
    218,040Convertible promissory
notes payable broker
warrants
    
    
    166,667
    
    
    
    6.00
    
    
    
    
    
    
    
    
    
    
    
    166,667
    
    
    
    6.00
    
    
    
    166,667Total
    
    
    2,077,501
    
    
    
    
    
    
    
    51,053
    
    
    
    
    
    
    
    2,128,554
    
    
    
    
    
    
    
    972,125
 14




---



##### Table of Contents



Share deficiency
  Effective yield and interest expense
 Effect of a subsequent event
 Promissory Note Payable
  15




---



##### Table of Contents



Short-term Note Payable
  13. Earnings Per Share and Potential Dilution
  16




---



##### Table of Contents



Three Months Ended March 31,2006
    
    
    2005Stock options (see Note 5)
    
    
    8,871,059
    
    
    
    8,199,682Warrants issued in relation to debt and equity arrangements
    
    
    7,640,282
    
    
    
    3,573,219Shares issuable for conversion of convertible promissory notes payable (see Note 12)
    
    
    954,199
    
    
    
    3,333,333Total antidilutive securities excluded from earnings per share calculation
    
    
    17,465,540
    
    
    
    15,106,234
     14. Contingencies
    17




---



##### Table of Contents



15. Subsequent Events
      18




---



##### Table of Contents



ITEM 2.
 MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Overview
   
    
    ZixVPM (Virtual Private Messenger): an e-messaging gateway service that provides
company-wide privacy protection for inbound and outbound email communications.
    
    ZixAuditor: an assessment service used to analyze email traffic patterns and monitor
compliance with corporate and regulatory policies.
    
    ZixPort: a secure Web-messaging portal.
  19




---



##### Table of Contents



Critical Accounting Policies and Estimates
  Long-Lived Assets
   Goodwill and Other Intangible Assets,
 20




---



##### Table of Contents



Deferred Tax Assets
 Revenue 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,
    21




---



##### Table of Contents



Deferred Cost of Revenues
 Stock-based compensation Share-Based Payment Accounting for Stock Issued to Employees
   22




---



##### Table of Contents



Three Months Ended March 31,2006
    
    2005Risk-free interest rate
    
    
    4.58
    %
    
    
    3.10
    %Expected option life
    
    6 years
    
    3.6 yearsExpected stock price volatility
    
    
    97.5
    %
    
    
    98.0
    %Expected dividend yield
    
    
    
    
    
    
    Fair value of options granted
    
    $
    1.34
    
    
    $
    2.69
   Three Months EndedMarch 31, 2005Net loss, as reported
    
    $
    (9,572,000
    )Deduct pro forma stock compensation expense
computed under the fair value method
    
    
    (1,761,000
    )Pro forma net loss
    
    $
    (11,333,000
    )Basic and diluted loss per common share:As reported
    
    $
    (0.30
    )Pro forma
    
    $
    (0.35
    )
 23




---



##### Table of Contents



Results of Operations
 First Quarter 2006 Summary of Operations
 Financial Statement
 
    
    Revenue for the quarter ended March 31, 2006, was $3,895,000 from all products compared
with $3,583,000 for the same period 2005.
    
    Revenue from the two core products of Email Encryption and e-Prescribing was $3,895,000
for the quarter ended March 31, 2006, compared with $2,876,000 for the same period in 2005.
    
    Net loss for the quarter ended March 31, 2006, was $6,874,000 compared with $9,572,000
for the same period in 2005.
    
    Ending unrestricted cash balance was $14,158,000 and the balance in restricted accounts
was $5,137,000 on March 31, 2006.
    
    There was no significant change in the Companys debt position in the quarter.
    
    Cash used from operations was $5,546,000, and overall cash and cash equivalent balances
decreased by $6,082,000 in the quarter.
 Operations
 
    
    The Company secured new first year orders in the quarter ended March 31, 2006, totaling
$1,011,000 for its Email Encryption services and maintained over 95% renewal rate of Email
Encryption customers.
    
    The Company deployed 885 new e-Prescribing devices to physicians under sponsorship
arrangements with several large insurance payors.
    
    The Company exceeded 1,170,000 electronic prescriptions transacted in the three months
ended March 31, 2006, through its e-Prescribing service.
 Subsequent Event, Private Placement of Common Stock and Warrants (see Note 15 to the condensed
consolidated financial statements)
 
    
    On April 5, 2006, the Company sold, in a private placement transaction, an aggregate of
9,930,000 units consisting of (i) one share of common stock of the Company, par value $0.01
per share and (ii) a related warrant to purchase 0.60 of one share of common stock. The
units will be sold for a purchase price of $1.19 per unit. Total proceeds from the
transaction are expected to be approximately $11.8 million (net proceeds to the Company are
expected to be $10.9 million after estimated transaction costs). The Company intends to use
the net proceeds for working capital and general corporate purposes, including funding the
Companys business plan.
 Revenues
   24




---



##### Table of Contents



VarianceThree Months Ended March 31,
    
    
    2006 vs. 20052006
    
    
    2005
    
    
    $
    
    
    %Services
    
    $
    3,895,000
    
    
    $
    3,298,000
    
    
    $
    597,000
    
    
    
    18
    %Hardware
    
    
    
    
    
    
    185,000
    
    
    
    (185,000
    )
    
    
    (100
    %)Software
    
    
    
    
    
    
    100,000
    
    
    
    (100,000
    )
    
    
    (100
    %)Total revenues
    
    $
    3,895,000
    
    
    $
    3,583,000
    
    
    $
    312,000
    
    
    
    9
    %
   VarianceThree months ended, March 31,
    
    
    2006 vs. 20052006
    
    
    2005
    
    
    $
    
    
    %Email Encryption
    
    $
    3,333,000
    
    
    $
    2,044,000
    
    
    $
    1,289,000
    
    
    
    63
    %e-Prescribing
    
    
    562,000
    
    
    
    832,000
    
    
    
    (270,000
    )
    
    
    (32
    %)Subtotal before divested products or services
    
    
    3,895,000
    
    
    
    2,876,000
    
    
    
    1,019,000
    
    
    
    35
    %MI/WI Products
    
    
    
    
    
    
    637,000
    
    
    
    (637,000
    )
    
    
    (100
    %)Dr. Chart
    
    
    
    
    
    
    70,000
    
    
    
    (70,000
    )
    
    
    (100
    %)Subtotal divested products or services
    
    
    
    
    
    
    707,000
    
    
    
    (707,000
    )
    
    
    (100
    %)Total revenues
    
    $
    3,895,000
    
    
    $
    3,583,000
    
    
    $
    312,000
    
    
    
    9
    %
    25




---



##### Table of Contents



Revenue Indicators  Backlog, Orders, and Deployments
 Company-wide backlog 
   Email Encryption Orders 
  e-Prescribing Deployments and Active Users 
 26




---



##### Table of Contents



e-Prescribing Transaction and Usage Fees 
  Customer Deposit
   27




---



##### Table of Contents



Cost of Revenues
   VarianceThree months ended, March 31,
    
    
    2006 vs. 20052006
    
    
    2005
    
    
    $
    
    
    %Email Encryption
    
    $
    1,466,000
    
    
    $
    1,314,000
    
    
    $
    152,000
    
    
    
    12
    %e-Prescribing
    
    
    1,909,000
    
    
    
    1,800,000
    
    
    
    109,000
    
    
    
    6
    %Subtotal before divested products or services
    
    
    3,375,000
    
    
    
    3,114,000
    
    
    
    261,000
    
    
    
    8
    %Divested (MI/WI and Dr. Chart) products
    
    
    
    
    
    
    777,000
    
    
    
    (777,000
    )
    
    
    (100
    %)Total cost of revenues
    
    $
    3,375,000
    
    
    $
    3,891,000
    
    
    $
    (516,000
    )
    
    
    (13
    %)
   28




---



##### Table of Contents



Research and Development Expenses
   VarianceThree Months Ended March 31,
    
    2006 vs. 20052006
    
    2005
    
    $
    
    %Total research and development
    
    $
    1,595,000
    
    
    $
    1,975,000
    
    
    $
    (380,000
    )
    
    
    (19
    %)
  Selling, General and Administrative Expenses
   VarianceThree Months Ended March 31,
    
    2006 vs. 20052006
    
    2005
    
    $
    
    %Total selling, general and administrative expenses
    
    $
    6,592,000
    
    
    $
    7,502,000
    
    
    $
    (910,000
    )
    
    
    (12
    %)
  Customer Deposit Forfeiture
  29




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##### Table of Contents



Interest Expense
  Stated
    
    
    
    
    
    
    Financing
    
    
    
    
    
    
    TotalInterest
    
    
    Discount
    
    
    Cost
    
    
    Warrants
    
    
    Intereston Notes
    
    
    Amortization
    
    
    Amortization
    
    
    Issued
    
    
    ExpenseConvertible promissory note payable
    
    $
    93,000
    
    
    $
    140,000
    
    
    $
    63,000
    
    
    $
    10,000
    
    
    $
    306,000Promissory note payable
    
    
    
    
    
    
    104,000
    
    
    
    
    
    
    
    
    
    
    
    104,000Short-term promissory note
    
    
    4,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,000Capital Leases
    
    
    4,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,000Total notes payable
    
    $
    101,000
    
    
    $
    244,000
    
    
    $
    63,000
    
    
    $
    10,000
    
    
    $
    418,000
   Investment and Other Income
  Gain on Sale of Product Line
  Income Taxes
   Net Loss
  30




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Liquidity and Capital Resources
 Overview
    
    
    New subscriptions (termed new first-year orders) for the Email Encryption service
    
    Renewal rates for the Email Encryption service
    
    New insurance payor sponsorships of the e-Prescribing service to physicians
    
    Successful adoption and usage of the e-Prescribing service by physicians
    
    Retention of the users (physicians) of the e-Prescribing service
    
    Future transaction fees (or related fees) associated with the use of the e-Prescribing service
    
    The ability to increase the business volume with reasonable cost increases
   31




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##### Table of Contents



Sources and Uses of Cash Summary
   Three Months Ended, March 31,2006
    
    
    2005
    
    
    VarianceOperating Cash Receipts (Products existing
on December 31, 2005)
    
    $
    4,896,000
    
    
    $
    3,154,000
    
    
    $
    1,742,000Operating Cash Receipts (Products divested
in 2005)
    
    
    
    
    
    
    919,000
    
    
    
    (919,000
    )Net Operating Cash Spending
    
    
    (10,442,000
    )
    
    
    (11,459,000
    )
    
    
    1,017,000Net Cash Used by Operating Activities
    
    $
    (5,546,000
    )
    
    $
    (7,386,000
    )
    
    $
    1,840,000
   32




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Cash Sources
  
    
    contractual backlog
    
    Email Encryption growth and retention
    
    e-Prescribing growth and retention
    
    e-Prescribing transaction-based fees
 Backlog
 Email Encryption growth and retention
 e-Prescribing growth and retention
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##### Table of Contents



e-Prescribing transaction-based fees
 Cash Requirements
    Debt Instruments and Related Covenants
  1.
    
    Convertible Promissory Notes Payable: $5,000,0002.
    
    Promissory Note Payable: $2,700,0003.
    
    Short-term Promissory Notes: $192,000
 Convertible Promissory Notes Payable
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##### Table of Contents



Promissory Note Payable
 Short-term Promissory Notes
 Liquidity Summary
    
    
    Relatively low contractual spending commitments in 2006
    
    Historically high renewal rates for Email Encryption
    
    Continued growth in the Email Encryption business
    
    Increased mix of cash receipts attributable to the more profitable out years of contracts
    
    The discretionary nature of the cash spend in excess of cash receipts in the emerging area of e-Prescribing
    
    General flexibility of spending in other areas
  35




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##### Table of Contents



Options and Warrants of ZixCorp Common Stock
  Summary of Outstanding Options and WarrantsVested SharesTotal Value
    
    
    (included in
    
    
    Total ValueOutstanding
    
    
    of Outstanding
    
    
    outstanding
    
    
    of VestedExercise Price Range
    
    Shares
    
    
    Shares
    
    
    shares)
    
    
    Shares$1.44 - $3.50
    
    
    6,395,977
    
    
    $
    18,301,002
    
    
    
    4,518,491
    
    
    $
    12,980,697$3.51 - $4.99
    
    
    2,908,529
    
    
    
    12,255,558
    
    
    
    1,924,905
    
    
    
    8,168,047$5.00 - $5.99
    
    
    3,106,727
    
    
    
    16,163,743
    
    
    
    3,106,727
    
    
    
    16,163,743$6.00 - $8.99
    
    
    1,490,565
    
    
    
    9,651,844
    
    
    
    1,115,690
    
    
    
    7,334,263$9.00 - $19.99
    
    
    1,470,848
    
    
    
    16,022,437
    
    
    
    1,238,047
    
    
    
    13,560,256$21.38 - $57.60
    
    
    1,138,695
    
    
    
    60,573,436
    
    
    
    1,138,695
    
    
    
    60,573,436Total
    
    
    16,511,341
    
    
    $
    132,968,020
    
    
    
    13,042,555
    
    
    $
    118,780,442
  Off-Balance Sheet Arrangements
  36




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##### Table of Contents



Contractual Obligations, Contingent Liabilities and Commitments
  Payments Due by PeriodTotal
    
    
    < 1 Year
    
    
    1-3 Year
    
    
    3-5 Years
    
    
    > 5 YearsDebt (long-term and short-term)
    
    $
    7,892,000
    
    
    $
    7,892,000
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating leases
    
    
    8,574,000
    
    
    
    1,405,000
    
    
    
    2,248,000
    
    
    
    1,817,000
    
    
    
    3,104,000Capital lease
    
    
    103,000
    
    
    
    103,000
    
    
    
    
    
    
    
    
    
    
    
    401k funding obligation
    
    
    68,000
    
    
    
    68,000
    
    
    
    
    
    
    
    
    
    
    
    John Ryan consulting agreement
    
    
    140,000
    
    
    
    120,000
    
    
    
    20,000
    
    
    
    
    
    
    
    Total cash obligations
    
    
    16,777,000
    
    
    
    9,588,000
    
    
    
    2,268,000
    
    
    
    1,817,000
    
    
    
    3,104,000Interest on obligations
    
    
    474,000
    
    
    
    334,000
    
    
    
    140,000
    
    
    
    
    
    
    
    Total
    
    $
    17,251,000
    
    
    $
    9,922,000
    
    
    $
    2,408,000
    
    
    $
    1,817,000
    
    
    $
    3,104,000
      
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
  
 PART II  OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
  37




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ITEM 1A. Risk Factors
 (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. If any of the
following risks actually occurs, our business, financial condition, results of operations or cash
flow 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 consolidated financial statements and
the related notes.
 We have incurred significant operating losses in previous years and we continue to use
significant amounts of cash for our business operations, which could result in us having
insufficient cash to fund our operations under our current business plan.
   The market may not broadly accept our Email Encryption and e-Prescribing solutions and
services, which would prevent us from operating profitably.
  Failure to enter into additional or to maintain existing sponsorship agreements for our
PocketScript e-Prescribing service and generate other revenue opportunities from PocketScript could
harm our business.
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##### Table of Contents



Healthcare providers may fail to adopt our PocketScript service.
  Failure to significantly increase our base of PocketScript users or obtain significant
prescription transaction fees may result in failure to achieve the critical mass of physicians and
revenue to build a successful business.
    Competition in our businesses is expected to increase, which could cause our business to fail.
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##### Table of Contents



Our inability to successfully and timely develop and introduce new e-messaging and
e-Prescribing services and related services and to implement technological changes could harm our
business.
   If the market for Email Encryption and e-Prescribing services and related services does not
continue to grow, demand for our solutions and services will be adversely affected.
  Future asset impairments could affect our financial results.
   Capacity limits on our technology and network hardware and software may be difficult to
project, and we may not be able to expand and/or 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 solutions and
services.
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Pending litigation could have a material impact on our operating results and financial
condition.
    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.
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##### Table of Contents



Defects or errors in our services could harm our business.
  Public key cryptography technology is subject to risks.
  We depend on key personnel.
  We rely on third parties.
   We could be affected by government regulation.
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##### Table of Contents



Our stock price may be volatile.
  One investor owns a large percentage of our outstanding stock and could significantly
influence the outcome of actions.
  We have a certain 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, or complying with the
covenants of the debt could restrict certain desired business actions.
  
    
    result in our inability to comply with the financial and other restrictive covenants in our outstanding convertible 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; and
    
    limit our flexibility to plan for, and react to, changes in our business and our industry.
 We have a significant amount of convertible securities and related warrants outstanding and
may issue additional equity securities in the future. Conversion or redemption of our outstanding
convertible note into our common stock, exercise of the outstanding warrants, and future issuances
or conversion of other securities will dilute the ownership interests of existing shareholders.
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We may have liability for indemnification claims arising from the sale of our Web Inspector,
Message Inspector, and
Dr. Chart ® product lines.
  NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
  44




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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
  
 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.4.1
    
    Securities Purchase Agreement, dated as of April 4, 2006, by and between Zix
Corporation and the Purchasers listed on Schedule A thereto. Filed as Exhibit 4.1 to
the Companys Form 8-K, dated April 5, 2006, and incorporated herein by reference.4.2
    
    Form of Warrant to purchase shares of Common Stock of Zix Corporation. Filed as
Exhibit 4.2 to the Companys Form 8-K, dated April 5, 2006, and incorporated herein by
reference.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 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, President and Chief Executive 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.**
    
    Furnished herewith. 45




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SIGNATURE
  ZIX CORPORATION(Registrant)Date: May 10, 2006
    
    
    
    By: /s/ Bradley C. AlmondBradley C. AlmondVice President, Chief Financial
Officer, and
Treasurer(Principal Financial
Officer and
Duly Authorized Officer)
 46