##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 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
    
    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 an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act).
 Yes þ No 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 October 28, 2005Common Stock, par value $.01 per share
    

    41,333,239




---



INDEX
 PageNumberPART I-FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets at September 30, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2005 and 2004
    
    
    4Condensed Consolidated Statement of Stockholders Equity for the nine months ended September 30, 2005
    
    
    5Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    46Item 4. Controls and Procedures
    
    
    47PART II-OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    47Item 6. Exhibits
    
    
    48Office Center SubleaseCertification of Richard D. Spurr, CEO, President and COO, Pursuant to Section 302Certification of Bradley c. Almond, VP, CFO and Treasurer, Pursuant to Section 302Certifications Pursuant to Section 906
  2




---



##### Table of Contents



ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
 ZIX CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    17,780,000
    
    
    $
    3,856,000Marketable securities
    
    
    
    
    
    
    16,000,000Accounts receivable, net
    
    
    325,000
    
    
    
    561,000Notes receivable, net
    
    
    491,000
    
    
    
    Prepaid and other current assets
    
    
    1,240,000
    
    
    
    1,950,000Total current assets
    
    
    19,836,000
    
    
    
    22,367,000Restricted cash
    
    
    10,413,000
    
    
    
    10,374,000Property and equipment, net
    
    
    4,148,000
    
    
    
    5,024,000Intangible assets, net
    
    
    738,000
    
    
    
    3,832,000Goodwill
    
    
    2,161,000
    
    
    
    9,119,000Deferred financing costs and other assets
    
    
    891,000
    
    
    
    1,526,000$
    38,187,000
    
    
    $
    52,242,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    685,000
    
    
    $
    1,234,000Accrued expenses
    
    
    4,057,000
    
    
    
    4,709,000Deferred revenue
    
    
    6,759,000
    
    
    
    6,372,000Customer deposits
    
    
    1,000,000
    
    
    
    968,000Capital lease obligations
    
    
    225,000
    
    
    
    130,000Short-term note payable
    
    
    28,000
    
    
    
    193,000Convertible promissory notes payable
    
    
    6,374,000
    
    
    
    3,848,000Total current liabilities
    
    
    19,128,000
    
    
    
    17,454,000Long-term liabilities:Deferred revenue
    
    
    1,194,000
    
    
    
    1,731,000Customer deposit
    
    
    2,000,000
    
    
    
    3,000,000Convertible promissory notes payable
    
    
    9,546,000
    
    
    
    13,347,000Promissory note payable
    
    
    2,125,000
    
    
    
    1,840,000Capital lease obligations and other
    
    
    252,000
    
    
    
    105,000Total long-term liabilities
    
    
    15,117,000
    
    
    
    20,023,00034,245,000
    
    
    
    37,477,000Contingencies (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; 43,264,746 issued and
40,937,565 outstanding on September 30, 2005 and 34,584,406 issued and 32,257,225
outstanding on December 31, 2004
    
    
    433,000
    
    
    
    346,000Additional paid-in capital
    
    
    291,464,000
    
    
    
    269,406,000Treasury stock, at cost; 2,327,181 common shares in 2005 and 2004
    
    
    (11,507,000
    )
    
    
    (11,507,000
    )Accumulated deficit
    
    
    (276,448,000
    )
    
    
    (243,480,000
    )Total stockholders equity
    
    
    3,942,000
    
    
    
    14,765,000$
    38,187,000
    
    
    $
    52,242,000
  3




---



##### Table of Contents



ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Services
    
    $
    3,467,000
    
    
    $
    2,895,000
    
    
    $
    9,964,000
    
    
    $
    8,168,000Hardware
    
    
    17,000
    
    
    
    685,000
    
    
    
    443,000
    
    
    
    1,007,000Software
    
    
    
    
    
    
    273,000
    
    
    
    109,000
    
    
    
    1,042,000Total revenues
    
    
    3,484,000
    
    
    
    3,853,000
    
    
    
    10,516,000
    
    
    
    10,217,000Costs and expenses:Cost of revenues
    
    
    3,580,000
    
    
    
    4,541,000
    
    
    
    10,979,000
    
    
    
    11,419,000Research and development
    
    
    1,495,000
    
    
    
    2,242,000
    
    
    
    5,005,000
    
    
    
    7,398,000Selling, general and administrative
    
    
    6,192,000
    
    
    
    7,071,000
    
    
    
    20,253,000
    
    
    
    22,226,000Customer deposit forfeiture
    
    
    
    
    
    
    
    
    
    
    (960,000
    )
    
    
    Net loss on sale of product lines
    
    
    4,649,000
    
    
    
    
    
    
    
    3,699,000
    
    
    
    Asset impairment charge
    
    
    
    
    
    
    675,000
    
    
    
    
    
    
    
    675,000Total costs and expenses
    
    
    15,916,000
    
    
    
    14,529,000
    
    
    
    38,976,000
    
    
    
    41,718,000Operating loss
    
    
    (12,432,000
    )
    
    
    (10,676,000
    )
    
    
    (28,460,000
    )
    
    
    (31,501,000
    )Other (expense) income:Investment and other income
    
    
    178,000
    
    
    
    84,000
    
    
    
    464,000
    
    
    
    221,000Interest expense
    
    
    (2,205,000
    )
    
    
    (89,000
    )
    
    
    (5,031,000
    )
    
    
    (229,000
    )Recovery of previously impaired investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70,000Total other (expense) income
    
    
    (2,027,000
    )
    
    
    (5,000
    )
    
    
    (4,567,000
    )
    
    
    62,000Loss before income taxes
    
    
    (14,459,000
    )
    
    
    (10,681,000
    )
    
    
    (33,027,000
    )
    
    
    (31,439,000
    )Income tax benefit (expense)
    
    
    (22,000
    )
    
    
    (23,000
    )
    
    
    59,000
    
    
    
    (79,000
    )Net loss
    
    $
    (14,481,000
    )
    
    $
    (10,704,000
    )
    
    $
    (32,968,000
    )
    
    $
    (31,518,000
    )Basic and diluted net loss per common share
    
    $
    (0.40
    )
    
    $
    (0.33
    )
    
    $
    (0.98
    )
    
    $
    (1.01
    )Weighted average common shares outstanding
    
    
    36,499,291
    
    
    
    32,028,923
    
    
    
    33,744,143
    
    
    
    31,308,134
  4




---



##### Table of Contents



ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
 Stockholders
EquityCommon Stock
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    TotalPaid-In
    
    
    Treasury
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Capital
    
    
    Stock
    
    
    Deficit
    
    
    EquityBalance, January 1, 2005
    
    
    34,584,406
    
    
    $
    346,000
    
    
    $
    269,406,000
    
    
    $
    (11,507,000
    )
    
    $
    (243,480,000
    )
    
    $
    14,765,000Private placement of common stock (Note
12)
    
    
    6,302,318
    
    
    
    63,000
    
    
    
    14,546,000
    
    
    
    
    
    
    
    
    
    
    
    14,609,000Issuance of common stock upon exercise
of warrants
    
    
    700,519
    
    
    
    7,000
    
    
    
    1,348,000
    
    
    
    
    
    
    
    
    
    
    
    1,355,000Issuance of common stock upon exercise
of stock options
    
    
    10,833
    
    
    
    
    
    
    
    28,000
    
    
    
    
    
    
    
    
    
    
    
    28,000Common stock issued in lieu of cash
compensation
    
    
    349,615
    
    
    
    4,000
    
    
    
    1,008,000
    
    
    
    
    
    
    
    
    
    
    
    1,012,000Issuance of common stock for redemption
of convertible promissory notes
payable
    
    
    1,093,130
    
    
    
    11,000
    
    
    
    2,311,000
    
    
    
    
    
    
    
    
    
    
    
    2,322,000Issuance of common stock for payment of
interest on convertible promissory
notes payable
    
    
    223,925
    
    
    
    2,000
    
    
    
    606,000
    
    
    
    
    
    
    
    
    
    
    
    608,000Revaluation 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
    
    
    
    
    
    
    
    
    
    
    
    2,518,000Non-employee stock-based compensation
    
    
    
    
    
    
    
    
    
    
    96,000
    
    
    
    
    
    
    
    
    
    
    
    96,000Other
    
    
    
    
    
    
    
    
    
    
    (28,000
    )
    
    
    
    
    
    
    
    
    
    
    (28,000
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,968,000
    )
    
    
    (32,968,000
    )Balance, September 30, 2005
    
    
    43,264,746
    
    
    $
    433,000
    
    
    $
    291,464,000
    
    
    $
    (11,507,000
    )
    
    $
    (276,448,000
    )
    
    $
    3,942,000
  5




---



##### Table of Contents



ZIX CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine Months Ended September 30,2005
    
    
    2004Operating activities:Net loss
    
    $
    (32,968,000
    )
    
    $
    (31,518,000
    )Non-cash items in net loss:Depreciation and amortization
    
    
    3,246,000
    
    
    
    3,605,000Acquired in-process research and development
    
    
    
    
    
    
    306,000Asset impairment charge
    
    
    
    
    
    
    675,000Amortization of debt discount, financing costs and other
    
    
    4,053,000
    
    
    
    Employee stock compensation expense
    
    
    
    
    
    
    1,115,000Common stock issued in lieu of cash compensation
    
    
    1,012,000
    
    
    
    2,445,000Common stock issued in lieu of cash interest payment
    
    
    608,000
    
    
    
    Non-employee stock-based compensation
    
    
    96,000
    
    
    
    30,000Recovery of investment in Maptuit Corporation
    
    
    
    
    
    
    (70,000
    )Customer deposit forfeiture
    
    
    (960,000
    )
    
    
    Loss on sale of product lines
    
    
    3,699,000
    
    
    
    Changes in operating assets and liabilities, excluding effects of acquisitions:Accounts receivable
    
    
    339,000
    
    
    
    46,000Other assets
    
    
    686,000
    
    
    
    (361,000
    )Accounts payable
    
    
    (549,000
    )
    
    
    978,000Deferred revenue
    
    
    2,233,000
    
    
    
    1,958,000Customer deposits received
    
    
    (8,000
    )
    
    
    3,968,000Accrued and other liabilities
    
    
    (671,000
    )
    
    
    531,000Net cash used by operating activities
    
    
    (19,184,000
    )
    
    
    (16,292,000
    )Investing activities:Purchases of property and equipment
    
    
    (1,299,000
    )
    
    
    (2,622,000
    )Purchases of marketable securities
    
    
    
    
    
    
    (4,977,000
    )Sales and maturities of marketable securities
    
    
    16,000,000
    
    
    
    11,957,000Purchase of restricted cash investment
    
    
    (39,000
    )
    
    
    (100,000
    )Proceeds from sale of product lines
    
    
    2,809,000
    
    
    
    Purchase of MyDocOnline
    
    
    
    
    
    
    (282,000
    )Cash received from Maptuit Corporation
    
    
    
    
    
    
    70,000Net cash provided by investing activities
    
    
    17,471,000
    
    
    
    4,046,000Financing activities:Proceeds from private placement of common stock
    
    
    15,016,000
    
    
    
    Payment of expenses relating to private placement of common stock
    
    
    (333,000
    )
    
    
    Proceeds from exercise of stock options
    
    
    28,000
    
    
    
    5,379,000Proceeds from exercise of warrants
    
    
    1,355,000
    
    
    
    15,343,000Payment of short term note payable
    
    
    (249,000
    )
    
    
    Payment of capital lease
    
    
    (152,000
    )
    
    
    Proceeds from promissory note payable
    
    
    
    
    
    
    3,000,000Other
    
    
    (28,000
    )
    
    
    Net cash provided by financing activities
    
    
    15,637,000
    
    
    
    23,722,000Increase in cash and cash equivalents
    
    
    13,924,000
    
    
    
    11,476,000Cash and cash equivalents, beginning of period
    
    
    3,856,000
    
    
    
    6,599,000Cash and cash equivalents, end of period
    
    $
    17,780,000
    
    
    $
    18,075,000
  6




---



##### Table of Contents



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




---



##### Table of Contents



8




---



##### 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,
     9




---



##### Table of Contents



4. Stock-based Employee Compensation
 Accounting for Stock-Based Compensation, Accounting for Stock Issued to Employees
  Three Months Ended September 30
    
    
    Nine Months Ended September 302005
    
    
    2004
    
    
    2005
    
    
    2004Net loss, as reported
    
    $
    (14,481,000
    )
    
    $
    (10,704,000
    )
    
    $
    (32,968,000
    )
    
    $
    (31,518,000
    )Add employee stock based compensation
expense recorded under the intrinsic value
method
    
    
    
    
    
    
    40,000
    
    
    
    
    
    
    
    1,115,000Deduct pro forma stock based compensation
expense computed under the fair value
method
    
    
    (1,383,000
    )
    
    
    (2,160,000
    )
    
    
    (4,745,000
    )
    
    
    (7,126,000
    )Pro forma net loss
    
    $
    (15,864,000
    )
    
    $
    (12,824,000
    )
    
    $
    (37,713,000
    )
    
    $
    (37,529,000
    )Basic and diluted net loss per common share:As reported
    
    $
    (0.40
    )
    
    $
    (0.33
    )
    
    $
    (0.98
    )
    
    $
    (1.01
    )Pro forma
    
    $
    (0.43
    )
    
    $
    (0.40
    )
    
    $
    (1.12
    )
    
    $
    (1.20
    )
 10




---



##### Table of Contents



5. Supplemental Cash Flow Information
  Nine Months Ended September, 302005
    
    
    2004Cash paid for interest
    
    $
    307,000
    
    
    $
    Cash paid for income tax
    
    $
    321,000
    
    
    $
    148,000Noncash investing and financing activities:Assets acquired on capital lease
    
    $
    160,000
    
    
    $
    Note receivable relating to the sale of Message Inspector and Web
Inspector product lines (Note 6)
    
    $
    1,434,000
    
    
    $
    Stock redemption of convertible promissory notes payable (Note 11)
    
    $
    2,322,000
    
    
    $
    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
    
    
    $
    Accrued expenses relating to private placement of common stock
    
    $
    (74,000
    )
    
    $
    Common stock issued for purchase of MyDocOnline (Note 6)
    
    $
    
    
    
    $
    9,037,000Issuance of warrants in connection with promissory notes payable
    
    $
    
    
    
    $
    1,475,000
 6. Business Sales and Acquisitions
 Acquisition of MyDocOnline, Inc. and sale of Dr. Chart, a product of MyDocOnline
  Working capital items:Receivables and prepaid expenses
    
    $
    354,000Deferred revenue
    
    
    (140,000
    )Net working capital acquired
    
    
    214,000Property and equipment
    
    
    1,293,000Customer relationships
    
    
    658,000Developed technology
    
    
    2,051,000Goodwill
    
    
    4,797,000In-process research and development
    
    
    306,000$
    9,319,000
    11




---



##### Table of Contents



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
    
    
    (150,000
    )Net proceeds
    
    
    (30,000
    )Loss on sale of product line
    
    $
    (4,734,000
    )
  Sale of Web Inspector and Message Inspector Product Lines
    Net assets sold (liabilities transferred):Equipment, net
    
    $
    15,000Prepaid expenses
    
    
    165,000Intangibles, net
    
    
    1,499,000Initial deferred revenue
    
    
    (1,546,000
    )Subsequent additional transfer of deferred revenue, net
    
    
    (85,000
    )Net
    
    
    48,000Goodwill
    
    
    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
    
    $
    1,035,000
 12




---



##### Table of Contents



7. Restricted Cash and Marketable Securities
   8. Accounts Receivable
 September 30,
    
    
    December 31,2005
    
    
    2004Gross accounts receivable
    
    $
    2,849,000
    
    
    $
    3,732,000Allowance for returns and doubtful accounts
    
    
    (106,000
    )
    
    
    (74,000
    )Unpaid portion of deferred revenue
    
    
    (2,418,000
    )
    
    
    (3,097,000
    )Accounts receivable, net
    
    $
    325,000
    
    
    $
    561,000
   9. Intangible Assets and Goodwill
  September 30, 2005
    
    
    December 31, 2004Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedCost
    
    
    Amortization
    
    
    Net
    
    
    Cost
    
    
    Amortization
    
    
    NetDeveloped technology
    
    $
    2,034,000
    
    
    $
    1,296,000
    
    
    $
    738,000
    
    
    $
    3,541,000
    
    
    $
    1,347,000
    
    
    $
    2,194,000Customer contract and relationships
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,994,000
    
    
    
    596,000
    
    
    
    1,398,000Trademarks and trade names
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    432,000
    
    
    
    192,000
    
    
    
    240,000Total intangible assets
    
    $
    2,034,000
    
    
    $
    1,296,000
    
    
    $
    738,000
    
    
    $
    5,967,000
    
    
    $
    2,135,000
    
    
    $
    3,832,000
  13




---



##### Table of Contents



AccumulatedCost
    
    
    AmortizationBeginning balance at January 1, 2005
    
    $
    5,967,000
    
    
    $
    2,135,000Amortization of intangibles
    
    
    
    
    
    
    1,020,000Sale of intangibles to CyberGuard
    
    
    (2,711,000
    )
    
    
    (1,212,000
    )Sale of intangibles to MITEM
    
    
    (1,222,000
    )
    
    
    (647,000
    )Ending balance at September 30, 2005
    
    $
    2,034,000
    
    
    $
    1,296,000
  Three months ended December 31, 2005
    
    $
    180,0002006
    
    
    535,0002007
    
    
    23,000Total
    
    $
    738,000
  10. Customer Deposit
    14




---



##### Table of Contents



11. Notes Payable
  December 31,
    
    
    Additional
    
    
    
    
    
    
    Additional Debt
    
    
    September 30,Stated
    
    
    Effective
    
    
    
    
    
    
    2004
    
    
    Discount from
    
    
    Discount /
    
    
    Incurred
    
    
    2005Interest
    
    
    Interest
    
    
    
    
    
    
    Net Book
    
    
    Debt
    
    
    Premium
    
    
    (Payments
    
    
    Net BookRate
    
    
    Rate
    
    
    Term
    
    
    Value
    
    
    Amendments
    
    
    Amortization
    
    
    Made)
    
    
    ValueConvertible
promissory notes
payable
    
    
    6.4
    %
    
    
    30.3
    %
    
    
    2007
    
    
    $
    17,195,000
    
    
    $
    (2,143,000
    )
    
    $
    3,190,000
    
    
    $
    (2,322,000
    )
    
    $
    15,920,000Promissory note payable
    
    
    4.5
    %
    
    
    11.0
    %
    
    
    2007
    
    
    
    1,840,000
    
    
    
    
    
    
    
    285,000
    
    
    
    
    
    
    
    2,125,000Short-term promissory notes
    
    
    5.1
    %
    
    
    5.1
    %
    
    
    2005
    
    
    
    193,000
    
    
    
    
    
    
    
    
    
    
    
    84,000(249,000
    )
    
    
    28,000Total notes payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    19,228,000
    
    
    $
    (2,143,000
    )
    
    $
    3,475,000
    
    
    $
    (2,487,000
    )
    
    $
    18,073,000
 Convertible Promissory Notes Payable
   
    
    The principal is 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 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.
    
    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 (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 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. In the third quarter
2005 the exercise price was lowered to $5.59 due to the private placement of common stock
(see Note 12).
    
    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.
    
    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. 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.
    
    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.
 15




---



##### Table of Contents




    
    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 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 at the time the December 31, 2005 payment is made. The required cash
balance will further decrease to $5,000,000 in November 2006 through the notes maturity when
the November 2, 2006 payment is made.
    
    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 19.99%
(approximately 6.2 million shares as of the effective date of the amendments) 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;
 16




---



##### Table of Contents




    
    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.
 
    
    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 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.
 Third quarter 2005 adjustment to the stock conversion price and warrant exercise price
 Third quarter redemptions of the convertible promissory notes payable
 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.
 17




---



##### Table of Contents



Accounting for Convertible
Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Features Application of Issue No. 98-5 to Certain Convertible Instruments
    Promissory Note Payable
   Short-term Note Payable
  18




---



##### Table of Contents



12. Private Placement of Common Stock
      13. Earnings Per Share and Potential Dilution
  Three Months ended September 30,
    
    
    Nine Months ended September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Stock options
    
    
    8,136,794
    
    
    
    6,523,792
    
    
    
    8,087,683
    
    
    
    5,901,444Warrants issued in
relation to debt
and equity
arrangements
    
    
    3,918,502
    
    
    
    2,406,552
    
    
    
    3,810,345
    
    
    
    2,743,418Shares issuable for
conversion of
convertible
promissory notes
payable (see Note
11)
    
    
    3,441,422
    
    
    
    
    
    
    
    3,369,759
    
    
    
    Total antidilutive
securities excluded
from earnings per
share calculation
    
    
    15,496,718
    
    
    
    8,930,344
    
    
    
    15,267,787
    
    
    
    8,644,862
 19




---



##### Table of Contents



14. Contingencies
      20




---



##### Table of Contents



15. Related Party Transactions
  16. Subsequent Events
   
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Overview
  21




---



##### Table of Contents



Critical Accounting Policies and Estimates
  22




---



##### Table of Contents



Long-Lived Assets
      Deferred Tax Assets
 Accounting for Income Taxes,
  23




---



##### Table of Contents



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,
     24




---



##### Table of Contents



Third Quarter 2005 Summary of Operations
  
 
 
 
 
 
 
 1.
    
    Independence Blue Cross for 250 deployments.2.
    
    Aetna Life Insurance Company for 1,000 deployments.
 
 
 25




---



##### Table of Contents




 Results of Operations
 Revenues
    3-monthVariance
    
    
    
    
    
    
    
    
    
    
    9-monthVarianceThree Months Ended September 30,
    
    
    2005 vs. 2004
    
    
    Nine Months Ended September 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %
    
    
    2005
    
    
    2004
    
    
    $
    
    
    %Services
    
    $
    3,467,000
    
    
    $
    2,895,000
    
    
    $
    572,000
    
    
    
    20
    %
    
    $
    9,964,000
    
    
    $
    8,168,000
    
    
    $
    1,796,000
    
    
    
    22
    %Hardware
    
    
    17,000
    
    
    
    685,000
    
    
    
    (668,000
    )
    
    
    (98
    %)
    
    
    443,000
    
    
    
    1,007,000
    
    
    
    (564,000
    )
    
    
    (56
    %)Software
    
    
    
    
    
    
    273,000
    
    
    
    (273,000
    )
    
    
    (100
    %)
    
    
    109,000
    
    
    
    1,042,000
    
    
    
    (933,000
    )
    
    
    (90
    %)Total revenues
    
    $
    3,484,000
    
    
    $
    3,853,000
    
    
    $
    (369,000
    )
    
    
    (10
    %)
    
    $
    10,516,000
    
    
    $
    10,217,000
    
    
    $
    299,000
    
    
    
    3
    %
  3-monthVariance
    
    
    
    
    
    
    
    
    
    
    9-monthVarianceThree Months Ended September 30,
    
    
    2005 vs. 2004
    
    
    Nine Months Ended September 30,
    
    
    2005 vs. 20042005
    
    
    2004
    
    
    $
    
    
    %
    
    
    2005
    
    
    2004
    
    
    $
    
    
    %eSecure
    
    $
    2,687,000
    
    
    $
    2,805,000
    
    
    $
    (118,000
    )
    
    
    (4
    %)
    
    $
    7,811,000
    
    
    $
    8,377,000
    
    
    $
    (566,000
    )
    
    
    (7
    %)eHealth
    
    
    797,000
    
    
    
    1,048,000
    
    
    
    (251,000
    )
    
    
    (24
    %)
    
    
    2,705,000
    
    
    
    1,840,000
    
    
    
    865,000
    
    
    
    47
    %Total revenues
    
    $
    3,484,000
    
    
    $
    3,853,000
    
    
    $
    (369,000
    )
    
    
    (10
    %)
    
    $
    10,516,000
    
    
    $
    10,217,000
    
    
    $
    299,000
    
    
    
    3
    %
  26




---



##### Table of Contents



3-monthVariance
    
    
    
    
    
    
    
    
    
    9-monthVarianceThree Months Ended September 30,
    
    2005 vs. 2004
    
    Nine Months Ended September 30,
    
    2005 vs. 20042005
    
    2004
    
    $
    
    %
    
    2005
    
    2004
    
    $
    
    %Total revenue as reported
    
    $
    3,484,000
    
    
    $
    3,853,000
    
    
    $
    (369,000
    )
    
    
    (10
    %)
    
    $
    10,516,000
    
    
    $
    10,217,000
    
    
    $
    299,000
    
    
    
    3
    %Less: Revenue from MI/WI
    
    
    
    
    
    
    (1,039,000
    )
    
    
    1,039,000
    
    
    
    (100
    %)
    
    
    (646,000
    )
    
    
    (3,029,000
    )
    
    
    2,383,000
    
    
    
    (79
    %)Less: Revenue from Dr.
Chart
    
    
    (135,000
    )
    
    
    (98,000
    )
    
    
    (37,000
    )
    
    
    38
    %
    
    
    (330,000
    )
    
    
    (374,000
    )
    
    
    44,000
    
    
    
    (12
    %)Revenue excluding
product lines sold
    
    $
    3,349,000
    
    
    $
    2,716,000
    
    
    $
    633,000
    
    
    
    23
    %
    
    $
    9,540,000
    
    
    $
    6,814,000
    
    
    $
    2,726,000
    
    
    
    40
    %
 27




---



##### Table of Contents



Cost of Revenues
  1.
    
    A decrease in costs due to the sale of MI/WI 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 ePrescribing market.
  28




---



##### Table of Contents



3-monthVariance
    
    
    
    
    
    
    
    
    
    9-monthVarianceThree Months Ended September 30,
    
    2005 vs. 2004
    
    Nine Months Ended September 30,
    
    2005 vs. 20042005
    
    2004
    
    $
    
    %
    
    2005
    
    2004
    
    $
    
    %Total cost of
revenues
    
    $
    3,580,000
    
    
    $
    4,541,000
    
    
    $
    (961,000
    )
    
    
    (21
    %)
    
    $
    10,979 ,000
    
    
    $
    11,419,000
    
    
    $
    (440,000
    )
    
    
    (4
    %)
    Research and Development
  29




---



##### Table of Contents



3-monthVariance
    
    
    
    
    
    
    
    
    
    9-monthVarianceThree Months Ended September 30,
    
    2005 vs. 2004
    
    Nine Months Ended September 30,
    
    2005 vs. 20042005
    
    2004
    
    $
    
    %
    
    2005
    
    2004
    
    $
    
    %Total research
and development
expenses
    
    $
    1,495,000
    
    
    $
    2,242,000
    
    
    $
    (747,000
    )
    
    
    (33
    %)
    
    $
    5,005,000
    
    
    $
    7,398,000
    
    
    $
    (2,393,000
    )
    
    
    (32
    %)
   Selling, General and Administrative
   3-monthVariance
    
    
    
    
    
    
    
    
    
    9-monthVarianceThree Months Ended September 30,
    
    2005 vs. 2004
    
    Nine Months Ended September 30,
    
    2005 vs. 20042005
    
    2004
    
    $
    
    %
    
    2005
    
    2004
    
    $
    
    %Total selling,
general and
administrative
expenses
    
    $
    6,192,000
    
    
    $
    7,071,000
    
    
    $
    (879,000
    )
    
    
    (12
    %)
    
    $
    20,253,000
    
    
    $
    22,226,000
    
    
    $
    (1,973,000
    )
    
    
    (9
    %)
   Customer Deposit Forfeiture
  30




---



##### Table of Contents



Gain / Loss on Sale of Product Lines
    Investment and Other Income
  Interest Expense
   Stated
    
    
    
    
    
    
    
    
    
    
    Financing
    
    
    TotalInterest
    
    
    Discount
    
    
    Premium
    
    
    Cost
    
    
    Intereston Notes
    
    
    Amortization
    
    
    Accretion
    
    
    Amortization
    
    
    ExpenseConvertible promissory notes payable
    
    $
    890,000
    
    
    $
    2,804,000
    
    
    $
    386,000
    
    
    $
    635,000
    
    
    $
    4,715,000Promissory note payable
    
    
    
    
    
    
    285,000
    
    
    
    
    
    
    
    
    
    
    
    285,000Short-term promissory notes
    
    
    6,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,000Capital Leases
    
    
    25,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,000Total interest expense
    
    $
    921,000
    
    
    $
    3,089,000
    
    
    $
    386,000
    
    
    $
    635,000
    
    
    $
    5,031,000
   31




---



##### Table of Contents



Recovery of Previously Impaired Investment
  Income Taxes
   Net Loss
   Three monthsThree months
    
    
    Three months
    
    
    endedended March
    
    
    ended June 30,
    
    
    September 30,31, 2005
    
    
    2005
    
    
    2005Net Loss
    
    $
    (9,572,000
    )
    
    $
    (8,915,000
    )
    
    $
    (14,481,000
    )Significant and Non-recurring
Items:Gain on sale
of MI/WI
    
    
    (950,000
    )
    
    
    
    
    
    
    (85,000
    )Customer deposit forfeiture
    
    
    
    
    
    
    (960,000
    )
    
    
    Loss on sale of Dr. Chart
    
    
    
    
    
    
    
    
    
    
    4,734,000Net loss excluding significant
and non-recurring items
    
    $
    (10,522,000
    )
    
    $
    (9,875,000
    )
    
    $
    (9,832,000
    )
 32




---



##### Table of Contents



Liquidity and Capital Resources
 Overview
    1)
    
    Divest non-core products and continue to focus on the Secure Messaging
and ePrescribing businesses.2)
    
    Continue adding new subscriptions and retain the existing customer base
in the more mature Secure Messaging product line.3)
    
    Fund the growth in the early market stage ePrescribing business to the
extent that it reaches sufficient levels of physician deployments to make it
cash flow accretive.
    Sources and Uses of Cash Summary
  33




---



##### Table of Contents



Nine
    
    
    NineMonths
    
    
    Months
    
    
    Variance forEnded
    
    
    Ended
    
    
    the nineSeptember
    
    
    September
    
    
    month30, 2005
    
    
    30, 2004
    
    
    periodsOperating Cash Receipts
    
    $
    13,807,000
    
    
    $
    12,235,000
    
    
    $
    1,572,000Customer Deposit
Received
    
    
    (8,000
    )
    
    
    3,968,000
    
    
    
    (3,976,000
    )Operating Cash Spending
    
    
    (32,983,000
    )
    
    
    (32,495,000
    )
    
    
    (488,000
    )Net Cash Used by
Operating Activities
    
    
    (19,184,000
    )
    
    
    (16,292,000
    )
    
    
    (2,892,000
    )Net Cash Used by
Investing Activities
    
    
    17,471,000
    
    
    
    4,046,000
    
    
    
    13,425,000Net Cash Used by
Financing Activities
    
    
    15,637,000
    
    
    
    23,722,000
    
    
    
    (8,085,000
    )Change in Cash and
Cash Equivalents
    
    $
    13,924,000
    
    
    $
    11,476,000
    
    
    $
    2,448,000Ending Cash and Cash
Equivalents
    
    $
    17,780,000
    
    
    $
    18,085,000
    
    
    $
    (305,000
    )
    34




---



##### 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
   35




---



##### Table of Contents



$2,700,000 Promissory Note Payable
 $277,000 Short-term Promissory Notes
 Cash Requirements
  Cash Sources
  Backlog 
 Sale of the Message and Web Inspector product business 
 Continued Growth of Secure Messaging Business 
 36




---



##### Table of Contents



New e-Prescribing Payors 
 Private Placement of
Common Stock 
 Sale of Dr
Chart Product Line 
  Liquidity Summary
  37




---



##### 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$1.81  $4.99
    
    
    4,018,373
    
    
    $
    14,878,000
    
    
    
    2,573,774
    
    
    $
    9,196,000$5.00  $5.75
    
    
    2,737,892
    
    
    
    14,562,000
    
    
    
    2,444,697
    
    
    
    13,095,000$6.00  $8.89
    
    
    1,939,331
    
    
    
    13,007,000
    
    
    
    1,176,980
    
    
    
    8,115,000$9.00  $19.75
    
    
    1,803,229
    
    
    
    21,032,000
    
    
    
    1,302,390
    
    
    
    15,766,000$21.38  $57.60
    
    
    1,163,695
    
    
    
    61,141,000
    
    
    
    1,163,695
    
    
    
    61,141,000Total
    
    
    11,662,520
    
    
    $
    124,620,000
    
    
    
    8,661,536
    
    
    $
    107,313,000
 Off-Balance Sheet Arrangements
  38




---



##### Table of Contents



Contractual Obligations, Contingent Liabilities and Commitments
  Payments Due by PeriodTotal
    
    
    < 1 Year
    
    
    1-3 Year
    
    
    3-5 Years
    
    
    > 5 YearsLong-term debt
    
    $
    20,906,000
    
    
    $
    8,206,000
    
    
    $
    12,700,000
    
    
    $
    
    
    
    $
    Operating leases
    
    
    9,643,000
    
    
    
    1,465,000
    
    
    
    2,472,000
    
    
    
    1,936,000
    
    
    
    3,770,000Capital lease
    
    
    225,000
    
    
    
    225,000
    
    
    
    
    
    
    
    
    
    
    
    401k funding requirement
    
    
    191,000
    
    
    
    191,000
    
    
    
    
    
    
    
    
    
    
    
    Total cash obligations
    
    
    30,965,000
    
    
    
    10,087,000
    
    
    
    15,172,000
    
    
    
    1,936,000
    
    
    
    3,770,000Interest on obligations
    
    
    1,168,000
    
    
    
    687,000
    
    
    
    481,000
    
    
    
    
    
    
    
    Total
    
    $
    32,133,000
    
    
    $
    10,774,000
    
    
    $
    15,653,000
    
    
    $
    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 us having insufficient cash to fund our operations under our current
business plan.
  We have a significant amount of convertible securities outstanding ...
 39




---



##### Table of Contents



The market may not broadly accept our secure e-messaging and e-prescribing solutions and
services, which would prevent us from operating profitably.
 ®
 Failure to enter into additional sponsorship agreements for our PocketScript e-prescribing
service or maintain existing and generate other revenue opportunities from PocketScript could harm
our business.
   40




---



##### Table of Contents



If healthcare providers fail to adopt our PocketScript service, 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.
      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.
   41




---



##### Table of Contents



If the market for secure e-messaging and e-prescribing services and related services does not
continue to grow, demand for our solutions 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.
    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.
 TM
 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.
   42




---



##### Table of Contents



® 
 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.
  43




---



##### 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 could be affected by government regulation.
   Our stock price may be volatile.
  44




---



##### Table of Contents



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.
 We have a significant amount of convertible securities outstanding, have recently issued a
significant amount of warrants in a private placement, and may issue additional equity securities
in the future. Conversion or redemption of the notes 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.
   45




---



##### Table of Contents



We may have liability for indemnification claims arising from the sale of our Web
Inspector ® , Message Inspector ® , and Dr. Chart ® product lines.
  We may encounter other unanticipated risks and uncertainties in the markets we serve or in
developing new 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
   
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  46




---



##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES
  
 PART II  OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  47




---



##### Table of Contents



ITEM 6. EXHIBITS
 a. Exhibits
  Exhibit No.
    
    Description of Exhibits2.1
    
    Asset Purchase Agreement, entered into as of September 30, 2005, among Mitem
Corporation, Zix Corporation, and MyDocOnline, Inc. (excluding the Disclosure Schedule
and Exhibits). Filed as Exhibit 2.1 to the Companys Form 8-K, dated October 5, 2005,
and incorporated herein by reference.3.1
    
    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 September
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
    
    Securities Purchase Agreement, dated as of August 9, 2005, by and between Zix
Corporation and the Purchasers listed on Schedule A thereto (including schedules,
appendices and exhibits). Filed as Exhibit 4.1 to the Companys Form 8-K, dated
October 21, 2005, and incorporated herein by reference.4.2
    
    Promissory Note, dated September 30, 2005, payable by Mitem Corporation in the original
principal amount of $550,000. Filed as Exhibit 2.2 to the Companys Form 8-K, dated
October 5, 2005, and incorporated herein by reference.4.3
    
    Warrant, dated September 30, 2005, issued by Mitem Corporation exercisable for 400,000
shares of common stock of Mitem Corporation. Filed as Exhibit 2.3 to the Companys
Form 8-K, dated October 5, 2005, and incorporated herein by reference.4.4
    
    Letter Agreement, dated September 14, 2005, between Zix Corporation and HFTP Investment
LLC, Gaia Offshore Master Fund Ltd, and Caerus Fund Ltd. Filed as Exhibit 4.1 to the
Companys Form 8-K, dated September 26, 2005, and incorporated herein by reference.10.1
    
    Escrow Agreement, dated as of August 9, 2005, by and between Zix Corporation and
JPMorgan Chase Bank, N.A, as escrow agent (including exhibits and schedules). Filed as
Exhibit 10.1 to the Companys Form 8-K, dated October 21, 2005, and incorporated herein
by reference.10.2*
    
    Office Center Sub-Lease, dated September 28, 2005, including an addendum, dated October
5, 2005, between American Exec Cupertino, Inc. (dba American Executive Center) and Zix
Corporation.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.**
    
    Furnished herewith.




---



##### Table of Contents



SIGNATURE
  ZIX CORPORATION(Registrant)Date: November 9, 2005
    
    /s/ Bradley C. AlmondBradley C. AlmondVice President, Chief Financial Officer, andTreasurer
 49