##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 Form 10-K
 (Mark One)
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2007
 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 or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification Number)
 2711 N. 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)
 Securities Registered Pursuant to Section 12(b) of the Act:
 Common Stock$0.01 Par Value
    
    NASDAQ
  o þ
  o þ
 þ o
 o
  o Large accelerated filer
    
    þ Accelerated filer
    
    o Non-accelerated filer
    
    o Smaller reporting company(Do not check if a smaller reporting company)
 o þ




---



##### 



TABLE OF CONTENTS
 PART IItem 1.
    
    Business
    
    
    3Item 1A.
    
    Risk Factors
    
    
    11Item 1B.
    
    Unresolved Staff Comments
    
    
    18Item 2.
    
    Properties
    
    
    18Item 3.
    
    Legal Proceedings
    
    
    18Item 4.
    
    Submission of Matters to Vote of Security Holders
    
    
    19PART IIItem 5.
    
    Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    19Item 6.
    
    Selected Financial Data
    
    
    21Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    22Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    45Item 8.
    
    Financial Statements and Supplementary Data
    
    
    45Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
    
    
    45Item 9A.
    
    Controls and Procedures
    
    
    45Item 9B.
    
    Other Information
    
    
    47PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    47Item 11.
    
    Executive Compensation
    
    
    47Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    47Item 13.
    
    Certain Relationships and Related Transactions
    
    
    47Item 14.
    
    Principal Accountant Fees and Services
    
    
    47PART IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    47Form of Stock Option AgreementStock Option Agreement - Richard D. SpurrStock Option Agreement - Richard D. SpurrSeverance Agreement - Barry W. WilsonForm of Separation Pay AgreementDescription of 2008 Management Variable Compensation PlanDescription of Compensation for Members of Board of DirectorsSubsidiariesConsent of Whitley Penn LLPConsent of Deloitte & Touche LLPCertification of Richard D. Spurr Pursuant to Section 302Certification of Barry W. Wilson Pursuant to Section 302Certification Pursuant to Section 906
  2




---



##### Table of Contents



PART I
 
 Item 1. Business
    ®
 Business Segments
 Email Encryption
 Segment Overview:
  Email Encryption Service:
 3




---



##### Table of Contents




   ZixVPM®
   ZixConnect
 ZixDirect ®
 ZixPort®
 4




---



##### Table of Contents



ZixMail®
 ZixAuditor®
 Email Encryption Competition:
     5




---



##### Table of Contents



e-Prescribing
 Segment Overview:
   e-Prescribing Services and Solutions
 PocketScript®
  6




---



##### Table of Contents



e-Prescribing Competition:
  Regulatory Drivers for Market Growth
 Regulatory Drivers for Market Growth
    7




---



##### Table of Contents



®
 Sales and Marketing
    Employees
  8




---



##### Table of Contents



Research and Development; Patents and Trademarks
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Email Encryption
    
    $
    2,748,000
    
    
    $
    2,837,000
    
    
    $
    2,001,000e-Prescribing
    
    
    2,574,000
    
    
    
    3,248,000
    
    
    
    4,025,000Corporate
    
    
    
    
    
    
    
    
    
    
    494,000Total Research & Development
    
    $
    5,322,000
    
    
    $
    6,085,000
    
    
    $
    6,520,000
   Availability of Raw Material; Working Capital Items
  Compliance with Environmental Regulations
  Governmental Contracts
  Significant Customers
  9




---



##### Table of Contents



Sales Backlog
  December 31, 2007
    
    
    December 31, 2006Email Encryption
    
    $
    28,314,000
    
    
    $
    22,552,000e-Prescribing
    
    
    3,478,000
    
    
    
    3,961,000Total backlog
    
    $
    31,792,000
    
    
    $
    26,513,000
   Seasonality
  Geographic Information
  Available Information
   www.sec.gov.
 www.zixcorp.com.
 10




---



##### Table of Contents



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 our PocketScript
e-Prescribing service continues to use significant amounts of cash.
  The market may not broadly accept our Email Encryption and PocketScript e-Prescribing
services, which would prevent us from operating profitably.  End-users of our PocketScript service may not continue to use the service Item 7. Managements Discussion and Analysis of Financial Conditions and Results of
Operations, Liquidity and Capital Resources, .
 Failure to enter into additional or to maintain existing sponsorship agreements for our
PocketScript e-Prescribing service and generate other revenue sources from our PocketScript service
could harm our business. Item 7.
Managements Discussion and Analysis of Financial Conditions and Results of Operations, Liquidity
and Capital Resources, .
 11




---



##### Table of Contents



Physicians and other healthcare providers may fail to adopt our PocketScript service.
 End-users of our PocketScript service may not continue to use the service. The market may not
broadly accept our Email Encryption and PocketScript e-Prescribing services, which would prevent us
from operating profitably Physicians and other healthcare providers may fail to adopt our
PocketScript Service ) Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations, Revenue Indicators 
Backlog, Orders and Deployments.
 Failure to significantly increase our base of PocketScript users or obtain significant
prescription transaction fees, or other fees may result in failure to achieve the critical mass of
physicians and revenue to build a successful business.
  12




---



##### Table of Contents



Competition in our businesses is expected to increase, which could impair our prospects and
cause our business to fail.
  Regulatory Drivers for
Market Growth
  Our inability to successfully timely develop and introduce new Email Encryption and
e-Prescribing services and related services and to implement technological changes could harm our
business.
  13




---



##### Table of Contents



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.
    14




---



##### Table of Contents



We may have to defend our rights in intellectual property that we use in our services, which
could be disruptive and expensive to our business.
 Defects or errors in our services could harm our business.
 Public key cryptography technology is subject to risks.
 We depend on key personnel.
 We rely on third parties.
   15




---



##### Table of Contents



We could be affected by government regulation.
     Our stock price may be volatile.
 We have a significant amount of stock options and warrants outstanding and may issue
additional equity securities in the future. Exercise of the outstanding options and warrants, and
future issuances of other securities will dilute the ownership interests of existing shareholders.
 16




---



##### Table of Contents



The Company may be required to pay liquidated damages in the event one or more of the
registration statements it has filed with the SEC for the benefit of third parties ceases to be
effective.
  NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
 Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations, NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  17




---



##### Table of Contents



Item 1B. Unresolved Staff Comments
  
 Item 2. Properties
   
 Item 3. Legal Proceedings
      18




---



##### Table of Contents



Item 4. Submission of Matters to Vote of Security Holders
  
 PART II
 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
  2007
    
    2006Quarter Ended
    
    High
    
    Low
    
    High
    
    LowMarch 31
    
    $
    1.93
    
    
    $
    1.14
    
    
    $
    2.53
    
    
    $
    1.30June 30
    
    $
    2.49
    
    
    $
    1.63
    
    
    $
    1.48
    
    
    $
    0.84September 30
    
    $
    2.18
    
    
    $
    1.56
    
    
    $
    1.15
    
    
    $
    0.51December 31
    
    $
    6.24
    
    
    $
    1.81
    
    
    $
    1.42
    
    
    $
    0.55
     19




---



##### Table of Contents



The stock price performance depicted on the graph below is not necessarily indicative of future
stock price performance. The graph will not be deemed incorporated by reference in any filing by us
under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate
the graph by reference.
 COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
 
 
 *
    
    $100 invested on 12/31/02 in stock or index-including reinvestment of dividends.Fiscal year ending December 31. 20




---



##### Table of Contents



Item 6. Selected Financial Data
  Year Ended December 31,2007
    
    2006
    
    2005
    
    2004
    
    2003(In thousands, except per share data)Statement of Operations Data:Revenues(1)
    
    $
    24,114
    
    
    $
    18,358
    
    
    $
    13,964
    
    
    $
    14,127
    
    
    $
    5,840Cost of revenues(2)
    
    
    (10,866
    )
    
    
    (12,552
    )
    
    
    (14,194
    )
    
    
    (15,878
    )
    
    
    (8,211
    )Research and development expenses(2)
    
    
    (5,322
    )
    
    
    (6,085
    )
    
    
    (6,520
    )
    
    
    (9,331
    )
    
    
    (5,896
    )Selling, general and administrative expenses(2)
    
    
    (17,961
    )
    
    
    (23,188
    )
    
    
    (26,358
    )
    
    
    (29,399
    )
    
    
    (19,907
    )Customer deposit forfeiture(3)
    
    
    2,000
    
    
    
    1,000
    
    
    
    960
    
    
    
    
    
    
    
    Net gain (loss) on sale of product lines(4)
    
    
    
    
    
    
    53
    
    
    
    (3,716
    )
    
    
    
    
    
    
    Loss on extinguishment of convertible debt(5)
    
    
    (255
    )
    
    
    (871
    )
    
    
    (1,283
    )
    
    
    
    
    
    
    Asset impairment charge(6)
    
    
    
    
    
    
    (125
    )
    
    
    (288
    )
    
    
    (675
    )
    
    
    Interest expense(7)
    
    
    (171
    )
    
    
    (1,126
    )
    
    
    (6,848
    )
    
    
    (801
    )
    
    
    (13
    )Gain on derivatives (8)
    
    
    
    
    
    
    4,043
    
    
    
    
    
    
    
    
    
    
    
    Loss from continuing operations
    
    
    (8,102
    )
    
    
    (19,508
    )
    
    
    (43,596
    )
    
    
    (42,040
    )
    
    
    (27,667
    )Basic and diluted loss per common share from
continuing operations(9)
    
    
    (0.13
    )
    
    
    (0.34
    )
    
    
    (1.20
    )
    
    
    (1.33
    )
    
    
    (1.23
    )Shares used in computing basic and diluted loss
per common share
    
    
    60,424
    
    
    
    57,068
    
    
    
    36,452
    
    
    
    31,533
    
    
    
    23,525Balance Sheet Data:Working capital(10)
    
    
    (979
    )
    
    
    (897
    )
    
    
    9,348
    
    
    
    4,913
    
    
    
    7,283Total assets
    
    
    19,474
    
    
    
    20,366
    
    
    
    34,115
    
    
    
    52,242
    
    
    
    26,419Debt obligations(11)
    
    
    
    
    
    
    2,916
    
    
    
    7,063
    
    
    
    19,252
    
    
    
    Stockholders equity (deficit)
    
    
    (289
    )
    
    
    927
    
    
    
    10,397
    
    
    
    14,765
    
    
    
    17,919
 
 The Company acquired substantially all of the operating assets and the businesses of PocketScript,
Elron Software, and MyDocOnline in July and September of 2003, and January 2004, respectively. The
results of operations of PocketScript, Elron Software, and MyDocOnline are included in the
Companys results of operations from their dates of acquisition. On March 11, 2005, the MI/WI
product lines, which were acquired in the Elron acquisition, were sold to CyberGuard (see Note 6 to
the consolidated financial statements). On September 30, 2005, the Dr. Chart product line was sold
to MITEM (see Note 6 to the consolidated financial statements). During 2000 and extending through
the third quarter of 2003, the Companys reporting classification was that of a development stage
company.Notes on Selected Financial Data(1)

    Revenue for the years 2003 through 2005 include the acquisitions of MyDocOnline in
January 2004 and PocketScript and Elron Software in July and September 2003. Revenues
resulting from these acquisitions totaled $4.0 million, $4.2 million and $1.3 million in
2005, 2004, and 2003, respectively. On March 11, 2005, the MI/WI product lines, which were
acquired in the Elron acquisition, were sold to CyberGuard. During 2005, the MI/WI product
lines contributed $0.6 million to total revenues (see Note 6 to the consolidated financial
statements) versus revenues in 2004 and 2003 of $4.1 million and $1.3 million respectively.
On September 30, 2005, the Dr. Chart product line was sold to MITEM. During 2005, this
product line contributed $0.3 million to total revenues (see Note 6 to the consolidated
financial statements) versus revenues in 2004 of $0.5 million.(2)

    In 2007, 2006, 2005, 2004, and 2003, expenses associated with continuing operations
include non-cash stock-based compensation of $1.3 million, $2.8 million, $1.1 million, $4.1
million, and $1.0 million, respectively. On January 1, 2006, the Company adopted Statement
of Financial Accounting Standards (SFAS) 123(R), Share Based Payment, which resulted in
the incremental stock-based compensation costs. For the preceding years, these non-cash
expenses were often in association with reductions in force and related severance
agreements. 21




---



##### Table of Contents



(3)
    
    See Note 12 to the consolidated financial statements for an explanation of the customer
deposit forfeiture.(4)
    
    See Note 6 to the consolidated financial statements for an explanation on the sale of the
product lines.(5)
    
    See Note 13 to the consolidated financial statements for an explanation on the early
extinguishment of debt items.(6)
    
    See Notes 6 and 10 to the consolidated financial statements for an explanation on asset
impairment charges.(7)
    
    Interest expenses of $0.2 million in 2007 related primarily to the Companys promissory
note to sanofi-aventis, which was also paid in full as of December 31, 2007 (see Note 13 to
the consolidated financial statements). In 2006, interest expense included $0.7 million
related to the Companys convertible notes, which were also retired that year. In 2005,
interest expense includes $6.4 million related to the Companys $20 million in convertible
notes and related warrants issued on November 2, 2004. The interest expense from the initial
purchase agreement included amortization of the warrants value as a discount on the notes,
deferred finance charges and stated interest. In 2005, the Company restructured the notes
and created a beneficial conversion feature which was valued at $2.5 million and fully
amortized in 2005 (see Note 13 to the consolidated financial statements). In 2004, interest
expense also included charges of $0.5 million, which relates to the $20 million convertible
notes.(8)
    
    Due to certain terms of the April 2006 private placement, some elements of the
transaction were recorded as derivative liabilities and were revalued each quarter with the
change in value being recorded as a gain or loss. The 2006 gain was primarily from a change
in the fair value of warrants as compared to the value on the date of closing. On December
21, 2006, the Financial Accounting Standards Board (FASB) issued Staff Position Emerging
Issues Task Force (EITF) 00-19-2, Accounting for Registration Payment Arrangementswhich
resulted in the Company prospectively adjusting the remaining balance of the derivative
liabilities relating to the private placement directly to retained earnings as of October 1,
2006 (see Note 14 to the consolidated financial statements).(9)
    
    In calculating the basic and diluted loss per common share for 2003, the Companys loss
from continuing operations and net loss have been increased by $1.4 million, representing
the preferred stock dividends associated with the Series A and Series B convertible
preferred stocks.(10)
    
    Working capital includes deferred revenue totaling $12.6 million as of December 31, 2007.(11)
    
    The Company had zero debt obligations at December 31, 2007. Debt obligations at December
31, 2006, consist of promissory notes payable totaling $2.7 million and a short-term
promissory note totaling $0.3 million. Debt obligations at December 31, 2005, consist of
convertible promissory notes payable totaling $4.4 million, promissory notes payable totaling
$2.2 million, a short-term promissory note totaling $0.3 million and capital leases totaling
$0.2 million. All notes payable are shown net of unamortized discounts. December 31, 2004,
balance consisted of convertible promissory notes payable totaling $17.2 million, promissory
note payable totaling $1.8 million and capital leases totaling $0.2 million (see Note 13 to
the consolidated financial statements). 
 Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview
  22




---



##### Table of Contents




    
    Rate of new subscriptions (termed new first year orders) for the Email Encryption
Service;
    
    Renewal rates for the Email Encryption Service;
    
    Additional payor sponsorship of the e-Prescribing service to physicians by new or
existing insurance payors;
    
    Successful adoption and usage of the e-Prescribing service by physicians;
    
    Retention of the users (physicians) of the e-Prescribing service as indicated by
subscription renewals;
    
    Future transaction fees (or related fees) associated with the use of the e-Prescribing
service; and
    
    Our ability to increase business volume with reasonable cost increases.
   Critical Accounting Policies and Estimates
  Inventory
 23




---



##### Table of Contents



Property and Equipment, Long-Lived and Other Intangible Assets, Depreciation and Amortization
    Goodwill
 Goodwill and Other Intangible Assets
  24




---



##### Table of Contents



Deferred Tax Assets
 Revenue Recognition Software Revenue Recognition, Modification of SOP 97-2, Software Revenue
Recognition, With respect to Certain Transactions, Revenue Arrangements
with Multiple Deliverables, Revenue Recognition in Financial Statements,
    25




---



##### Table of Contents



Deferred Cost of Revenue
 Stock-based compensation Share-Based
Payment Accounting for Stock Issued to
Employees
  Share Based Payment,
 Year Ended December 31,2007
    
    2006
    
    2005Risk-free interest rate
    
    
    3.81
    %
    
    
    4.59
    %
    
    
    3.41
    %Expected option life
    
    5.8 years
    
    5.8 years
    
    3.6 yearsExpected stock price volatility
    
    
    81
    %
    
    
    93
    %
    
    
    96
    %Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    Fair value of options granted
    
    $
    2.87
    
    
    $
    1.03
    
    
    $
    2.31
  26




---



##### Table of Contents



Year EndedDecember 31, 2005Net loss, as reported
    
    $
    (43,596,000
    )Add employee stock compensation expense recorded under the
intrinsic value method
    
    
    Deduct pro forma stock compensation expense computed under
the fair value method
    
    
    (6,166,000
    )Pro forma net loss
    
    $
    (49,762,000
    )Basic and diluted loss per common share: As reported
    
    $
    (1.20
    )Pro forma
    
    $
    (1.37
    )
 Full Year 2007 Summary of Operations
 Financial
 
    
    Revenue for the year 2007 was $24,114,000 from all products compared with $18,358,000
in 2006 and $13,964,000 in 2005 (2005 revenue includes $976,000 from divested product
lines).
    
    Gross margin for 2007 was $13,248,000 or 55% of revenues compared to a $5,806,000 or
32% of revenues in 2006.
 
    
    Email Encryption  gross margin for this segment was $13,621,000 or 76% of
revenues compared to $8,727,000 or 62% of revenues in 2006.
    
    E-Prescribing  gross loss for this segment was $373,000 or a negative 6% of
revenues compared to a loss of $2,921,000 or a negative 69% of revenues in 2006.
 
    
    Net loss for the year 2007 was $8,102,000 compared with $19,508,000 in 2006 and
$43,596,000 in 2005.
    
    Ending unrestricted cash and marketable securities was $12,258,000 and the balance in restricted accounts
was $25,000 on December 31, 2007.
 sanofi-aventis Debt Restructuring and Payment
 
    
    In December 2007, the Company paid in full a promissory note issued to sanofi-aventis U.S.
Inc. including the $1,600,000 principal amount, plus accrued interest. The promissory note
had been originally issued in January 2004 to a predecessor-in-interest to sanofi-aventis U.S.
Inc. and had been restructured in February 2007 (see Note 13 to the consolidated financial
statements). With this payment, the Company ended calendar year 2007 with no short-term or
long-term indebtedness for borrowed money.
 Financing Activities Resulting from Exercise of Warrants and Options
 
    
    During the fourth quarter of 2007, the Company received cash proceeds totaling approximately
$3,652,000 for the exercise of 2,147,940 warrants and $542,000 for the exercise of 145,689
stock options. With these incremental cash receipts, the Company elected to prepay the
$1,600,000 promissory note mentioned immediately above and to prepay certain 2008 procurements
totaling approximately $700,000.
 27




---



##### Table of Contents



Results of Operations
 Revenues
  Variance
    
    
    VarianceYear Ended December 31,
    
    
    2007 vs. 2006
    
    
    2006 vs. 20052007
    
    
    2006
    
    
    2005
    
    
    $
    
    
    %
    
    
    $
    
    
    %Services
    
    $
    24,114,000
    
    
    $
    18,358,000
    
    
    $
    13,412,000
    
    
    $
    5,756,000
    
    
    
    31
    %
    
    $
    4,946,000
    
    
    
    37
    %Hardware
    
    
    
    
    
    
    
    
    
    
    443,000
    
    
    
    
    
    
    
    
    
    
    
    (443,000
    )
    
    
    (100
    %)Software
    
    
    
    
    
    
    
    
    
    
    109,000
    
    
    
    
    
    
    
    
    
    
    
    (109,000
    )
    
    
    (100
    %)Total revenues
    
    $
    24,114,000
    
    
    $
    18,358,000
    
    
    $
    13,964,000
    
    
    $
    5,756,000
    
    
    
    31
    %
    
    $
    4,394,000
    
    
    
    31
    %
   Variance
    
    
    VarianceYear Ended December 31,
    
    
    2007 vs. 2006
    
    
    2006 vs. 20052007
    
    
    2006
    
    
    2005
    
    
    $
    
    
    %
    
    
    $
    
    
    %Email Encryption
    
    $
    17,982,000
    
    
    $
    14,094,000
    
    
    $
    10,007,000
    
    
    $
    3,888,000
    
    
    
    28
    %
    
    $
    4,087,000
    
    
    
    41
    %e-Prescribing
    
    
    6,132,000
    
    
    
    4,264,000
    
    
    
    2,981,000
    
    
    
    1,868,000
    
    
    
    44
    %
    
    
    1,283,000
    
    
    
    43
    %Subtotal before
divested products or
services
    
    
    24,114,000
    
    
    
    18,358,000
    
    
    
    12,988,000
    
    
    
    5,756,000
    
    
    
    31
    %
    
    
    5,370,000
    
    
    
    41
    %MI/WI Products
    
    
    
    
    
    
    
    
    
    
    646,000
    
    
    
    
    
    
    
    
    
    
    
    (646,000
    )
    
    
    (100
    %)Dr. Chart and Connect
    
    
    
    
    
    
    
    
    
    
    330,000
    
    
    
    
    
    
    
    
    
    
    
    (330,000
    )
    
    
    (100
    %)Subtotal divested
products or services
    
    
    
    
    
    
    
    
    
    
    976,000
    
    
    
    
    
    
    
    
    
    
    
    (976,000
    )
    
    
    (100
    %)Total revenues
    
    $
    24,114,000
    
    
    $
    18,358,000
    
    
    $
    13,964,000
    
    
    $
    5,756,000
    
    
    
    31
    %
    
    $
    4,394,000
    
    
    
    31
    %
 Email Encryption 
  e-Prescribing 
 28




---



##### Table of Contents



Divested Products:
 Revenue Outlook:
 Backlog, Orders, and Deployments
 Company-wide backlog 
   29




---



##### Table of Contents



Email Encryption Orders 
  2007
    
    
    2006Three month period ending:December 31,
    
    $
    1,406,000
    
    
    $
    1,089,000September 30,
    
    
    1,359,000
    
    
    
    1,234,000June 30,
    
    
    1,397,000
    
    
    
    1,372,000March 31,
    
    
    1,352,000
    
    
    
    970,000Total new first year orders for the twelve months ending December 31,
    
    $
    5,514,000
    
    
    $
    4,665,000
    e-Prescribing 
  30




---



##### Table of Contents



31




---



##### Table of Contents



Cost of Revenues
  Variance
    
    
    VarianceYear Ended December 31,
    
    
    2007 vs. 2006
    
    
    2006 vs. 20052007
    
    
    2006
    
    
    2005
    
    
    $
    
    
    %
    
    
    $
    
    
    %Email Encryption
    
    $
    4,361,000
    
    
    $
    5,367,000
    
    
    $
    5,263,000
    
    
    $
    (1,006,000
    )
    
    
    (19
    %)
    
    $
    104,000
    
    
    
    2
    %e-Prescribing
    
    
    6,505,000
    
    
    
    7,185,000
    
    
    
    7,325,000
    
    
    
    (680,000
    )
    
    
    (9
    %)
    
    
    (140,000
    )
    
    
    (2
    %)Subtotal
    
    
    10,866,000
    
    
    
    12,552,000
    
    
    
    12,588,000
    
    
    
    (1,686,000
    )
    
    
    (13
    %)
    
    
    (36,000
    )
    
    
    (0
    %)Divested Products:MI/WI & Dr Chart
    
    
    
    
    
    
    
    
    
    
    1,606,000
    
    
    
    
    
    
    
    
    
    
    
    (1,606,000
    )
    
    
    (100
    %)Total Cost of Revenues
    
    $
    10,866,000
    
    
    $
    12,552,000
    
    
    $
    14,194,000
    
    
    $
    (1,686,000
    )
    
    
    (13
    %)
    
    $
    (1,642,000
    )
    
    
    (12
    %)
    32




---



##### Table of Contents



Email Encryption 
 e-Prescribing 
 Divested Products 
 Research and Development Expenses
  Variance
    
    VarianceYear Ended December 31,
    
    2007 vs. 2006
    
    2006 vs. 20052007
    
    2006
    
    2005
    
    $
    
    %
    
    $
    
    %Total research and
development
expenses
    
    $
    5,322,000
    
    
    $
    6,085,000
    
    
    $
    6,520,000
    
    
    $
    (763,000
    )
    
    
    (13
    %)
    
    $
    (435,000
    )
    
    
    (7
    %)
    33




---



##### Table of Contents



Selling, General and Administrative Expenses
   Variance
    
    VarianceYear Ended December 31,
    
    2007 vs. 2006
    
    2006 vs. 20052007
    
    2006
    
    2005
    
    $
    
    %
    
    $
    
    %Total selling, general
and administrative
expenses
    
    $
    17,961,000
    
    
    $
    23,188,000
    
    
    $
    26,358,000
    
    
    $
    (5,227,000
    )
    
    
    (23
    %)
    
    $
    (3,170,000
    )
    
    
    (12
    %)
    34




---



##### Table of Contents



Customer Deposit Forfeiture
  Gain/Loss on Sale of Product Lines
   
    
    On March 11, 2005, the Company sold its Web Inspector and Message Inspector product
lines to CyberGuard Corporation. The total sales price was $3,626,000 consisting of
$2,126,000 in cash and a $1,500,000 note receivable due in three equal payments in 2005,
which was subsequently paid in full. The net gain recognized on the sale of the Web
Inspector and Message Inspector product lines was $1,035,000.
    
    On September 30, 2005, the Company sold its Dr. Chart product line to MITEM. The total
sales price was $700,000 consisting of $150,000 in cash and a note receivable in the
original principal amount of $550,000, which was subject to adjustments at closing. The
note was fully reserved due to the Companys determination that collection was not
reasonably likely given MITEMs financial position, the early stages of its product
development and the extended payment terms of the note. The Company recognized a net loss
on the sale of Dr. Chart of $4,751,000.
  Asset Impairment Charge
  Loss on Impairment of Operating Lease
  35




---



##### Table of Contents



Interest Expense
  Stated
    
    
    
    
    
    
    
    
    
    
    Financing
    
    
    
    
    
    
    TotalInterest on
    
    
    Discount
    
    
    Premium
    
    
    Cost
    
    
    Warrants
    
    
    InterestNotes
    
    
    Amortization
    
    
    Accretion
    
    
    Amortization
    
    
    Issued
    
    
    Expense2007Promissory note payable*
    
    
    60,000
    
    
    
    88,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    148,000Short-term promissory
notes
    
    
    9,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,000Capital leases and other
    
    
    14,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,000Total interest expense
    
    $
    83,000
    
    
    $
    88,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    171,0002006Convertible promissory
notes payable
    
    $
    185,000
    
    
    $
    354,000
    
    
    $
    
    
    
    $
    122,000
    
    
    $
    10,000
    
    
    $
    671,000Promissory note payable*
    
    
    
    
    
    
    435,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    435,000Short-term promissory
notes
    
    
    11,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,000Capital leases and other
    
    
    9,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,000Total interest expense
    
    $
    205,000
    
    
    $
    789,000
    
    
    $
    
    
    
    $
    122,000
    
    
    $
    10,000
    
    
    $
    1,126,0002005Convertible promissory
notes payable
    
    $
    1,152,000
    
    
    $
    3,909,000
    
    
    $
    500,000
    
    
    $
    816,000
    
    
    $
    47,000
    
    
    $
    6,424,000Promissory note payable*
    
    
    
    
    
    
    386,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    386,000Short-term promissory
notes
    
    
    7,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,000Capital leases
    
    
    31,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,000Total interest expense
    
    $
    1,190,000
    
    
    $
    4,295,000
    
    
    $
    500,000
    
    
    $
    816,000
    
    
    $
    47,000
    
    
    $
    6,848,000
  
 *
    
    For the sanofi-aventis note payable, both the original note and restructured note (see Note
13 to the consolidated financial statements). Investment and Other Income
  Gain on Valuation of Derivative Liabilities
  Accounting for Registration
Payment Arrangements
 36




---



##### Table of Contents



Income Taxes
     Net Loss
   Year Ended December 31,2007
    
    
    2006
    
    
    2005Unusual Items:(Gain) or Loss on sale of product lines:Gain on sale of MI/WI
    
    $
    
    
    
    $
    
    
    
    $
    (1,035,000
    )Loss on sale of Dr. Chart
    
    
    
    
    
    
    
    
    
    
    4,751,000Customer deposit forfeiture
    
    
    (2,000,000
    )
    
    
    (1,000,000
    )
    
    
    (960,000
    )Asset impairment charge
    
    
    
    
    
    
    125,000
    
    
    
    288,000Loss on impairment of operating lease
    
    
    100,000
    
    
    
    
    
    
    
    Gain on derivatives
    
    
    
    
    
    
    (4,043,000
    )
    
    
    Loss on extinguishment of convertible debt
    
    
    255,000
    
    
    
    871,000
    
    
    
    1,283,000Total unusual items
    
    $
    (1,645,000
    )
    
    $
    (4,047,000
    )
    
    $
    4,327,000
  37




---



##### Table of Contents



Liquidity and Capital Resources
 Overview
      
    
    Rate of new subscriptions (termed new first year orders) for the Email Encryption
Service;
    
    Renewal rates for the Email Encryption Service;
    
    Additional payor sponsorship of the e-Prescribing service to physicians by new or
existing insurance payors;
    
    Successful adoption and usage of the e-Prescribing service by physicians;
    
    Retention of the users (physicians) of the e-Prescribing service as indicated by
subscription renewals;
    
    Future transaction fees (or related fees) associated with the use of the e-Prescribing
service; and
    
    Our ability to increase business volume with reasonable cost increases.
 Email Encryption
 38




---



##### Table of Contents



e-Prescribing
      39




---



##### Table of Contents



Sources and Uses of Cash Summary
   Twelve Months
    
    
    Twelve MonthsEnded
    
    
    Ended
    
    
    Variance forDecember 31,
    
    
    December 31,
    
    
    the twelve2007
    
    
    2006
    
    
    month periodOperating Cash Receipts
    
    $
    29,954,000
    
    
    $
    20,551,000
    
    
    $
    2,586,000Operating Cash Receipts (Products divested in 2005)
    
    
    
    
    
    
    5,000
    
    
    
    (5,000
    )Net Operating Cash Spending
    
    
    (31,397,000
    )
    
    
    (37,234,000
    )
    
    
    12,654,000Net Cash Used by Operating Activities
    
    $
    (1,443,000
    )
    
    $
    (16,678,000
    )
    
    $
    15,235,000
     40




---



##### Table of Contents



Cash Sources
  
    
    contractual backlog
    
    Email Encryption growth and retention
    
    e-Prescribing growth and retention
    
    e-Prescribing transaction and performance-based fees
 Backlog
 Email Encryption growth and retention
 e-Prescribing growth and retention
 e-Prescribing transaction and performance-based fees
 41




---



##### Table of Contents



Cash Requirements
     42




---



##### Table of Contents



Liquidity Summary
    Options and Warrants of ZixCorp Common Stock
  Summary of Outstanding Options and WarrantsVested SharesTotal Value of
    
    
    (included inOutstanding
    
    
    Outstanding
    
    
    outstanding
    
    
    Total Value ofExercise Price Range
    
    Shares
    
    
    Shares
    
    
    shares)
    
    
    Vested Shares$1.21 - $1.99
    
    
    7,018,085
    
    
    $
    10,864,000
    
    
    
    5,629,143
    
    
    $
    8,758,000$2.00 - $3.49
    
    
    4,942,106
    
    
    
    14,753,000
    
    
    
    4,427,972
    
    
    
    13,318,000$3.50 - $4.99
    
    
    4,036,067
    
    
    
    18,069,000
    
    
    
    2,580,976
    
    
    
    11,141,000$5.00 - $5.99
    
    
    600,354
    
    
    
    3,048,000
    
    
    
    600,354
    
    
    
    3,048,000$6.00 - $8.99
    
    
    1,022,715
    
    
    
    6,539,000
    
    
    
    1,022,715
    
    
    
    6,539,000$9.00 - $19.99
    
    
    1,266,495
    
    
    
    13,474,000
    
    
    
    1,266,495
    
    
    
    13,474,000$20.00 - $57.60
    
    
    1,087,695
    
    
    
    58,960,000
    
    
    
    1,087,695
    
    
    
    58,960,000Total
    
    
    19,973,517
    
    
    $
    125,707,000
    
    
    
    16,615,350
    
    
    $
    115,238,000
 Off-Balance Sheet Arrangements
  43




---



##### Table of Contents



Contractual Obligations and Contingent Liabilities and Commitments
  Payments Due by PeriodTotal
    
    < 1 Year
    
    2-3 Years
    
    4-5 Years
    
    > 5 YearsOperating leases
    
    $
    6,749,000
    
    
    $
    1,220,000
    
    
    $
    2,122,000
    
    
    $
    1,855,000
    
    
    $
    1,552,000
   Recent Accounting Pronouncements
   Share-Based
Payment.
 Business Combinations Non-controlling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51
 44




---



##### Table of Contents



Item 7A. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 8. Financial Statements and Supplementary Data
  
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
  
 Item 9A. Controls and Procedures
 Evaluation of Disclosure Controls and Procedure
 Annual Report on Form 10-K ,
 Managements Report on Internal Control Over Financial Reporting
    Changes in Internal Controls over Financial Reporting
  45




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 Internal ControlIntegrated
Framework Managements Report on Internal Control Over Financial Reporting.
    Internal
ControlIntegrated Framework
   
 46




---



##### Table of Contents



Item 9B. Other Information
  
 PART III
 
 Item 10. Directors and Executive Officers of the Registrant
  www.zixcorp.com
 
 Item 11. Executive Compensation
  
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  
 Item 13. Certain Relationships and Related Transactions
  
 Item 14. Principal Accountant Fees and Services
  
 PART IV
 
 Item 15. Exhibits and Financial Statement Schedules
 Financial Statements
  Financial Statement Schedules
  47




---



##### Table of Contents



Exhibits
 ExhibitNumber
    
    
    
    Description3.1
    
    
    
    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
    
    
    
    Specimen certificate for common stock of Zix Corporation. Filed as
Exhibit 4.1 to Zix Corporations Annual Report on Form 10-K for the year
ended December 31, 1999, and incorporated herein by reference.4.2
    
    
    
    Form of Warrant, dated June 24, 2003, to purchase shares of common stock
of Zix Corporation, issued by Zix Corporation (issued in connection with
a $5.25 million financing in 2003). Filed as Exhibit 4.2 to Zix
Corporations Current Report on Form 8-K, dated June 25, 2003, and
incorporated herein by reference.4.3
    
    
    
    Warrant to purchase 166,667 shares of common stock of Zix Corporation
re-issued to Iroquois Master Fund, Ltd., dated December 17, 2007, which
was originally issued by Zix Corporation to Rodman & Renshaw, LLC.,
dated as of November 2, 2004 and filed as Exhibit 4.1 to Zix
Corporations Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2005, and incorporated herein by reference.4.4
    
    
    
    Warrant to purchase 108,964 shares of common stock of Zix Corporation
re-issued to Iroquois Master Fund, Ltd., dated December 17, 2007, which
was originally issued by Zix Corporation to Rodman & Renshaw, LLC.,
dated as of November 2, 2004 and filed as Exhibit 4.2 to Zix
Corporations Report on Form 8-K dated December 29, 2006, and
incorporated herein by reference.4.5
    
    
    
    Form of Common Stock Purchase Warrant, dated as of November 2, 2004,
issued by Zix Corporation to Omicron Master Trust and Amulet Limited
issued in connection with a $20 million convertible note financing in
2004). Filed as Exhibit 4.4 to Zix Corporations Current Report on Form
8-K, dated November 4, 2004, and incorporated herein by reference.4.6
    
    
    
    Form of Amended and Restated Common Stock Purchase Warrant to purchase
shares of Zix Corporation issued to Omicron Master Trust and Amulet
Limited, dated as of July 22, 2005 (excluding exhibits) issued in
connection with a $20 million convertible note financing in 2004). Filed
as Exhibit 4.4 to Zix Corporations Current Report on Form 8-K, dated
April 14, 2005, and incorporated herein by reference.4.7
    
    
    
    Form of Warrant, dated August 9, 2005, to purchase shares of Common
Stock of Zix Corporation (including appendices) (issued in connection
with a $26.3 million private placement in 2005). Filed as Exhibit 4.2 to
Zix Corporations Current Report on Form 8-K, dated August 9, 2005, and
incorporated herein by reference.4.8
    
    
    
    Warrant, dated September 30, 2005, issued to Zix Corporation by MITEM
Corporation and exercisable for 400,000 shares of common stock of MITEM
Corporation issued in connection with the sale of the Dr. Chart assets
in 2005. Filed as Exhibit 2.3 to Zix Corporations Current Report on
Form 8-K, dated October 5, 2005, and incorporated herein by reference.4.9
    
    
    
    Form of Warrant, as of April 6, 2006, to purchase approximately 5.9
million shares of Common Stock of Zix Corporation (issued to various
purchasers in connection with an $11.8 million private placement in
2006). Filed as Exhibit 4.2 to Zix Corporations Report on Form 8-K
dated April 5, 2006, and incorporated herein by reference.4.10
    
    
    
    Warrant, dated February 22, 2007, to purchase 145,853 shares of Common Stock issued by Zix Corporation to
sanofi-aventis, U.S. Inc. issued in connection with the exchange of a promissory note and issuance of a $1.6 million
promissory note. Filed as Exhibit 4.3 to
Zix Corporations Current Report on Form 8-K, dated February 28, 2007, and
incorporated herein by reference.
 48




---



##### Table of Contents



ExhibitNumber
    
    
    
    Description4.11
    
    
    
    Registration Rights Agreement, dated June 24, 2003, by and among Zix Corporation and the investors named therein
(issued in connection with the $5.75 million financing). Filed as Exhibit 4.3 to Zix Corporations Current Report on
Form 8-K, dated June 25, 2003, and incorporated herein by reference.4.12
    
    
    
    Registration Rights Agreement, dated July 22, 2003, between Zix Corporation and Pocket Script, L.L.C. Filed as Exhibit
4.2 to Zix Corporations Current Report on Form 8-K, dated July 23, 2003, and incorporated herein by reference.4.13
    
    
    
    Registration Rights Agreement, dated September 2, 2003, between Zix Corporation and Elron Software, Inc. Filed as
Exhibit 4.3 to Zix Corporations Current Report on Form 8-K, dated September 4, 2003, and incorporated herein by
reference.4.14
    
    
    
    Registration Rights Agreement, dated January 30, 2004, by and among Zix Corporation, Aventis Inc., a Pennsylvania
corporation, and Aventis Holdings Inc., a Delaware corporation. Filed as Exhibit 4.2 to Zix Corporations Current
Report on Form 8-K, dated February 10, 2004, and incorporated herein by reference.4.15
    
    
    
    Form of Registration Rights Agreement, dated as of November 2, 2004, by and between Zix Corporation and the Investors
named therein (issued in connection with a $20 million convertible note private placement). Filed as Exhibit 4.5 to Zix
Corporations Current Report on Form 8-K, dated November 4, 2004, and incorporated herein by reference.4.16
    
    
    
    Form of Amended and Restated Registration Rights Agreement by and between Zix Corporation and the Investors (excluding
exhibits) (issued in connection with a $20 million convertible note private placement). Filed as Exhibit 4.5 to Zix
Corporations Current Report on Form 8-K, dated April 14, 2005, and incorporated herein by reference.4.17
    
    
    
    Securities Purchase Agreement, dated June 24, 2003, by and among Zix Corporation and the investors named therein
(including schedules but excluding exhibits) in connection with a $5.75 million financing in 2003). Filed as Exhibit
4.1 to Zix Corporations Current Report on Form 8-K, dated June 25, 2003, and incorporated herein by reference.4.18
    
    
    
    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) (issued in connection with a $26.3 million private
placement in 2005). Filed as Exhibit 4.1 to Zix Corporations Current Report on Form 8-K/A, dated October 21, 2005, and
incorporated herein by reference.4.19
    
    
    
    Securities Purchase Agreement, dated as of April 4, 2006, by and between Zix Corporation and the Purchasers listed on
Schedule A thereto (in connection with an $11.8 million private placement in 2006). Filed as Exhibit 4.1 to Zix
Corporations Report on Form 8-K dated April 5, 2006, and incorporated herein by reference.4.20
    
    
    
    Purchase Agreement, dated as of November 1, 2004, by and between Zix Corporation and Omicron Master Trust (excluding
schedules and exhibits) in connection with a $20 million convertible note financing in 2004). Filed as Exhibit 4.1 to
Zix Corporations Current Report on Form 8-K, dated November 4, 2004, and incorporated herein by reference.4.21
    
    
    
    Amendment No. 1 to Purchase Agreement, dated as of April 13, 2005, by and between Zix Corporation and Omicron Master
Trust (excluding schedules and exhibits) in connection with a restructuring of the $20 million convertible note
financing in 2004. Filed as Exhibit 4.1 to Zix Corporations Current Report on Form 8-K, dated April 14, 2005, and
incorporated herein by reference.4.22
    
    
    
    Purchase Agreement, dated as of November 1, 2004, by and between Zix Corporation and Amulet Limited (excluding
schedules and exhibits) in connection with a $20 million convertible note financing in 2004. Filed as Exhibit 4.2 to
Zix Corporations Current Report on Form 8-K, dated November 4, 2004, and incorporated herein by reference.4.23
    
    
    
    Amendment No. 1 to Purchase Agreement, dated as of April 13, 2005, by and between Zix Corporation and Amulet Limited
(excluding schedules and exhibits) in connection with a restructuring of the $20 million convertible note financing in
2004. Filed as Exhibit 4.2 to Zix Corporations Current Report on Form 8-K, dated April 14, 2005, and incorporated
herein by reference.
 49




---



##### Table of Contents



ExhibitNumber
    
    
    
    Description10.1
    
    
    
    1990 Stock Option Plan of Zix Corporation (Amended and Restated as of September 1999). Filed as Exhibit 10.1 to Zix
Corporations Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999, and incorporated herein
by reference.10.2
    
    
    
    1992 Stock Option Plan of Zix Corporation (Amended and Restated as of August 2000). Filed as Exhibit 10.2 to Zix
Corporations Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference.10.3
    
    
    
    1995 Long-Term Incentive Plan of Zix Corporation (Amended and Restated as of September 20, 2000). Filed as Exhibit 10.3
to Zix Corporations Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000, and incorporated
herein by reference.10.4
    
    
    
    1996 Employee Stock Purchase Plan of Zix Corporation (Amended and Restated as of July 1, 2000). Filed as Exhibit 10.2
to Zix Corporations Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2000, and incorporated
herein by reference.10.5
    
    
    
    Zix Corporation 1999 Directors Stock Option Plan (Amended and Restated as of August 1, 2002). Filed as Exhibit 10.1 to
Zix Corporations Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002, and incorporated herein
by reference.10.6
    
    
    
    Zix Corporation 2001 Employee Stock Option Plan (Amended and Restated as of June 7, 2007). Filed as Exhibit 10.6 to
Zix Corporations Report on Form 8-K, filed June 12, 2007, and incorporated herein by reference.10.7
    
    
    
    Zix Corporations 2001 Stock Option Plan (Amended and Restated as of June 7, 2007). Filed as Exhibit 10.5 to Zix
Corporations Report on Form 8-K, filed June 12, 2007, and incorporated herein by reference.10.8
    
    
    
    Zix Corporation 2003 Stock Compensation Plan (Amended and Restated in October 2003). Filed as Exhibit 10.1 to Zix
Corporations Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2003, and incorporated herein
by reference.10.9
    
    
    
    Zix Corporations 2003 New Employee Stock Option Plan (Amended and Restated as of June 7, 2007). Filed as Exhibit 10.4
to Zix Corporations Report on Form 8-K, filed June 12, 2007, and incorporated herein by reference.10.10
    
    
    
    Zix Corporation 2004 Stock Option Plan (Amended and Restated as of June 7, 2007). Filed as Exhibit 10.3 to Zix
Corporations Report on Form 8-K, filed June 12, 2007, and incorporated herein by reference.10.11
    
    
    
    Zix Corporation 2004 Stock Option Plan (Amended and Restated as of May 25, 2005). Filed as Exhibit 10.1 to Zix
Corporations Registration Statement on Form S-8 (Registration No. 333-126576), dated July 13, 2005, and incorporated
herein by reference.10.12
    
    
    
    Zix Corporation 2004 Directors Stock Option Plan, dated May 6, 2004. Filed as Exhibit 10.2 to Zix Corporations
Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004, and incorporated herein by reference.10.14
    
    
    
    Zix Corporation 2005 Stock Compensation Plan (Amended and Restated as of June 13, 2006) Filed as Exhibit 10.2 to Zix
Corporations Current Report on Form 8-K, filed June 14, 2006, and incorporated herein by reference.10.13
    
    
    
    Zix Corporation 2006 Directors Stock Option Plan (Amended and Restated as of June 13, 2006) Filed as Exhibit 10.12 to
Zix Corporations Current Report on Form 8-K, filed June 14, 2006, and incorporated herein by reference.10.15
    
    
    
    Form of Stock Option Agreement (with no change in control provision) for Zix Corporation Stock Option Plans. Filed as
Exhibit 10.2 to Zix Corporations Registration Statement on Form S-8 (Registration No. 333-126576), dated July 13,
2005, and incorporated herein by reference.10.16
    
    
    
    Form of Stock Option Agreement (with change in control provision) for Zix Corporation Stock Option Plans. Filed as
Exhibit 10.3 to Zix Corporations Registration Statement on Form S-8 (Registration No. 333-126576), dated July 13,
2005, and incorporated herein by reference.
 50




---



##### Table of Contents



ExhibitNumber
    
    
    
    Description10. 17*
    
    ___
    
    Form of Stock Option Agreement (with acceleration event provision) for Zix Corporation Stock Option Plans and
applicable to option agreements held by the Companys chief executive officer and direct reports.10.18
    
    
    
    Zix Corporation 401(k) Retirement Plan. Filed as Exhibit 10.10 to Zix Corporations Annual Report on Form 10-K for the
year ended December 31, 2003, and incorporated herein by reference.10.19
    
    
    
    Adoption Agreement relating to Zix Corporation 401(k) Retirement Plan. Filed as Exhibit 10.11 to Zix Corporations
Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference.10.20
    
    
    
    Stock Option Agreement, dated February 24, 2004, between Zix Corporation and Richard D. Spurr, covering 650,000 shares
at $10.80 exercise price per share. Filed as Exhibit 10.15 to Zix Corporations Annual Report on Form 10-K for the year
ended December 31, 2003, and incorporated herein by reference.10.21
    
    
    
    Stock Option Agreement, dated November 17, 2004, between Zix Corporation and Richard D. Spurr, covering 350,000 shares
at $6.00 exercise price per share. Filed as Exhibit 10.18 to Zix Corporations Annual Report on Form 10-K for the year
ended December 31, 2004, and incorporated herein by reference.10.22
    
    
    
    Stock Option Agreement, dated March 23, 2005, between Zix Corporation and Richard D. Spurr, covering 350,000 shares at
$3.78 exercise price per share. Filed as Exhibit 10.2 to Zix Corporations Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2005, and incorporated herein by reference.10.23
    
    
    
    Stock Option Agreement, dated March 2, 2006, between Zix Corporation and Richard D. Spurr, covering 350,000 shares at
$4.00 exercise price per share. Filed as Exhibit 10.25 to Zix Corporations Annual Report on Form 10-K for the year
ended December 31, 2006, and incorporated herein by reference.10.24*
    
    
    
    Stock Option Agreement, dated December 18, 2006, between Zix Corporation and Richard D. Spurr, covering 400,000 shares
at $1.50 exercise price per share.10.25*
    
    
    
    Stock Option Agreement, dated December 20, 2007, between Zix Corporation and Richard D. Spurr, covering 400,000 shares
at $4.87 exercise price per share.10.26
    
    
    
    Form of Zix Corporation Stock Option Agreement between Zix Corporation and Ronald A. Woessner. Filed as Exhibit 10.19
to Zix Corporations Annual Report on Form 10-K for the year ended December 31, 2004, and incorporated herein by
reference.10.27
    
    
    
    Form of Zix Corporation Outside Director Stock Option Agreement. Filed as Exhibit 10.3 to Zix Corporations Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 2004, and incorporated herein by reference.10.28
    
    ___
    
    Form of Stock Option Agreement for Zix Corporation 2006 Directors Stock Option Plan. Filed as Exhibit 10.3 to Zix
Corporations Registration Statement on Form S-8 (Registration No. 333-126576), dated July 13, 2005, and incorporated
herein by reference.10.29
    
    ___
    
    Zix Corporation 401(k) Retirement Plan. Filed as Exhibit 10.10 to Zix Corporations Annual Report on Form 10-K for the
year ended December 31, 2003, and incorporated herein by reference.10.30
    
    ___
    
    Adoption Agreement relating to Zix Corporation 401(k) Retirement Plan. Filed as Exhibit 10.11 to Zix Corporations
Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference.10.31
    
    
    
    Severance Agreement, dated December 10, 2007, between Zix Corporation and Richard D. Spurr. Filed as Exhibit 10.1 to
Zix Corporations Report on Form 8-K, dated December 11, 2007, and incorporated herein by reference.10.32
    
    
    
    Severance Agreement, dated February 25, 2002, between Zix Corporation and Ronald A. Woessner. Filed as Exhibit 10.18 to
Zix Corporations Annual Report on Form 10-K for the year ended December 31, 2001, and incorporated herein by
reference.10.33
    
    
    
    Form of Severance Agreement between Zix Corporation and certain executive officers. Filed as Exhibit 10.2 to Zix
Corporations Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002, and incorporated herein by
reference.
 51




---



##### Table of Contents



ExhibitNumber
    
    
    
    Description10.34*
    
    
    
    Severance Agreement, amended and
restated as of March 10, 2008, between Zix Corporation and Barry W. Wilson.10.35*
    
    ___
    
    Form of Separation Pay Agreement between Zix Corporation and certain executive officers.10.36
    
    ___
    
    Description of 2007 Management Variable Compensation Plan. Filed as Exhibit 10.7 to Zix Corporations Report on Form
8-K, filed June 12, 2007, and incorporated herein by reference.10.37*
    
    ___
    
    Description of 2008 Management Variable Compensation Plan.10.38*
    
    
    
    Description of Compensation for Members of Zix Corporation Board of Directors.10.39
    
    
    
    Lease Agreement, dated December 29, 2003, between Zix Corporation and 7-Eleven, Inc. (excluding exhibits) (relating to
Zix Corporations Dallas, Texas facilities). Filed as Exhibit 10.24 to Zix Corporations Annual Report on Form 10-K for
the year ended December 31, 2003, and incorporated herein by reference.10.40
    
    
    
    Office Lease Agreement, dated February 28, 2005, between Gateway Rosewood, Inc. and Zix SCM, Inc. (relating to Zix
Corporations Burlington, Massachusetts facility). Filed as Exhibit 10.26 to Zix Corporations Annual Report on Form
10-K for the year ended December 31, 2004, and incorporated herein by reference.10.41
    
    
    
    Lease Agreement, dated November 27, 2000, between MyDocOnline, Inc. and Ft. Round Rock Ltd. and related Amendments No.
1 and No. 2 (excluding exhibits) (relating to Zix Corporations Austin, Texas facility). Filed as Exhibit 10.27 to Zix
Corporations Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference.10.42
    
    
    
    Amendment No. 3 to Lease Agreement, dated November 27, 2000, between MyDocOnline, Inc. and Ft. Round Rock Ltd., as
amended (relating to Zix Corporations Austin, Texas facility). Filed as Exhibit 10.28 to Zix Corporations Annual
Report on Form 10-K for the year ended December 31, 2004, and incorporated herein by reference.10.43
    
    
    
    Facilities Service Agreement, entered into as of June 25, 2003, by and between Collocation Solutions, LLC and Zix
Corporation (excluding schedule and exhibit). Filed as Exhibit 10.33 to Zix Corporations Annual Report on Form 10-K
for the year ended December 31, 2003, and incorporated herein by reference.10.44
    
    
    
    Lease, dated March 9, 2004, between Duke Realty Ohio and PocketScript, Inc. (excluding exhibits) (relating to Zix
Corporations Mason, Ohio facility). Filed as Exhibit 10.34 to Zix Corporations Annual Report on Form 10-K for the
year ended December 31, 2003, and incorporated herein by reference.10.45
    
    
    
    Sublease Agreement between ZixCorp Canada, Inc. and Intelligent Photonics Control Corp., dated May 20, 2005 (relating
to Zix Corporations Ontario, Canada facility). Filed as Exhibit 10.1 to Zix Corporations Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2005, and incorporated herein by reference.10.46
    
    
    
    Amendment and Confirmation of Sublease, dated February 27, 2006, amongst Elk Property Management Limited (Landlord),
Intelligent Photonics Control Corp. (Tenant), 6447309 Canada Inc. (Assignee), ZixCorp Canada, Inc. and Zix Corporation
(excluding schedules). Filed as Exhibit 10.40 to Zix Corporations Annual Report on Form 10-K for the year ended
December 31, 2005, and incorporated herein by reference.10.47
    
    
    
    Sublease, dated as of July 20, 2006, between ZixCorp Canada, Inc., as Tenant, and Peleton Photonic Systems, Inc., as
Subtenant. Filed as Exhibit 10.1 to Zix Corporations Quarterly Report on Form 10-Q for the period ended September 30,
2006, and incorporated herein by reference.10.48
    
    
    
    Letter of Agreement dated September 12, 2006 between MITEM Corporation and Zix Corporation. Filed as Exhibit 10.2 to
Zix Corporations Quarterly Report on Form 10-Q for the period ended September 30, 2006, and incorporated herein by
reference.
 52




---



##### Table of Contents



ExhibitNumber
    
    
    
    Description16.1
    
    
    
    Letter From Deloitte & Touche LLP to the SEC. Filed as Exhibit 16.1 to Zix Corporations Current Report on Form 8-K,
dated September 26, 2006, and incorporated herein by reference.21.1*
    
    
    
    Subsidiaries of Zix Corporation.23.1*
    
    
    
    Consent of Independent Registered Public Accounting Firm (Whitley Penn LLP).23.2*
    
    
    
    Consent of Independent Registered Public Accounting Firm (Deloitte & Touche, LLP).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 Barry W. Wilson, 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 Barry W. Wilson, Chief
Financial Officer and Treasurer of the Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Filed herewith.
    
    Management contract or compensatory plan or arrangement. 53




---



##### Table of Contents



SIGNATURES
  ZIX CORPORATIONBy:
    /s/ BARRY W. WILSONBarry W. WilsonChief Financial Officer and Treasurer  Signature
    
    Title/s/ RICHARD D. SPURR

(Richard D. Spurr)
    
    Chairman, Chief Executive Officer, President and Director (Principal
Executive Officer)/s/ BARRY W. WILSON

(Barry W. Wilson)
    
    Chief Financial Officer and Treasurer (Principal
Financial and Accounting Officer)/s/ ROBERT C. HAUSMANN

(Robert C. Hausmann)
    
    Director/s/ CHARLES N. KAHN III

(Charles N. Kahn III)
    
    Director/s/ JAMES S. MARSTON

(James S. Marston)
    
    Director/s/ ANTONIO R. SANCHEZ III

(Antonio R. Sanchez III)
    
    Director/s/ PAUL E. SCHLOSBERG

(Paul E. Schlosberg)
    
    Director
 54




---



##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 Reports of Independent Registered Public Accounting Firms
    
    
    F-2Consolidated Balance Sheets at December 31, 2007 and 2006
    
    
    F-4Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005
    
    
    F-5Consolidated Statements of Stockholders Equity (Deficit) for the years ended December
31, 2007, 2006 and 2005
    
    
    F-6Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
    Internal Control Integrated Framework
  
 F-2




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
     
 F-3




---



##### Table of Contents



CONSOLIDATED BALANCE SHEETS
 December 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,524,000
    
    
    $
    12,783,000Marketable securities
    
    
    1,734,000
    
    
    
    Receivables, net
    
    
    1,119,000
    
    
    
    746,000Prepaid and other current assets
    
    
    1,545,000
    
    
    
    2,178,000Total current assets
    
    
    14,922,000
    
    
    
    15,707,000Restricted cash
    
    
    25,000
    
    
    
    35,000Property and equipment, net
    
    
    2,297,000
    
    
    
    2,404,000Intangible assets, net
    
    
    
    
    
    
    23,000Goodwill
    
    
    2,161,000
    
    
    
    2,161,000Deferred financing costs and other assets
    
    
    69,000
    
    
    
    36,000Total assets
    
    $
    19,474,000
    
    
    $
    20,366,000LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    231,000
    
    
    $
    221,000Accrued expenses
    
    
    3,064,000
    
    
    
    3,079,000Deferred revenue
    
    
    12,606,000
    
    
    
    8,388,000Customer deposit
    
    
    
    
    
    
    2,000,000Short-term note payable
    
    
    
    
    
    
    255,000Promissory notes payable
    
    
    
    
    
    
    2,661,000Total current liabilities
    
    
    15,901,000
    
    
    
    16,604,000Long-term liabilities:Deferred revenue
    
    
    3,497,000
    
    
    
    2,496,000Deferred rent
    
    
    365,000
    
    
    
    339,000Total long-term liabilities
    
    
    3,862,000
    
    
    
    2,835,000Total liabilities
    
    
    19,763,000
    
    
    
    19,439,000Commitments and contingencies (Note 18)Stockholders equity (deficit):Preferred stock, $1 par value, 10,000,000 shares authorized;
none issued and outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 175,000,000 shares authorized;
64,959,649 issued and 62,632,468 outstanding in 2007 and
61,966,020 issued and 59,638,839 outstanding in 2006
    
    
    650,000
    
    
    
    620,000Additional paid-in capital
    
    
    329,186,000
    
    
    
    322,330,000Treasury stock, at cost; 2,327,181 common shares in 2007 and 2006
    
    
    (11,507,000
    )
    
    
    (11,507,000
    )Accumulated deficit
    
    
    (318,618,000
    )
    
    
    (310,516,000
    )Total stockholders equity (deficit)
    
    
    (289,000
    )
    
    
    927,000$
    19,474,000
    
    
    $
    20,366,000
  F-4




---



##### Table of Contents



ZIX CORPORATION
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Year Ended December 31,2007
    
    
    2006
    
    
    2005Revenues:Services
    
    $
    24,114,000
    
    
    $
    18,358,000
    
    
    $
    13,412,000Hardware
    
    
    
    
    
    
    
    
    
    
    443,000Software
    
    
    
    
    
    
    
    
    
    
    109,000Total revenues
    
    
    24,114,000
    
    
    
    18,358,000
    
    
    
    13,964,000Costs and expenses:Cost of revenues
    
    
    10,866,000
    
    
    
    12,552,000
    
    
    
    14,194,000Research and development expenses
    
    
    5,322,000
    
    
    
    6,085,000
    
    
    
    6,520,000Selling, general and administrative expenses
    
    
    17,961,000
    
    
    
    23,188,000
    
    
    
    26,358,000Customer deposit forfeiture
    
    
    (2,000,000
    )
    
    
    (1,000,000
    )
    
    
    (960,000
    )Net (gain) loss on sale of product lines
    
    
    
    
    
    
    (53,000
    )
    
    
    3,716,000Asset impairment charge
    
    
    
    
    
    
    125,000
    
    
    
    288,000Loss on impairment of operating lease
    
    
    100,000
    
    
    
    
    
    
    
    Total costs and expenses
    
    
    32,249,000
    
    
    
    40,897,000
    
    
    
    50,116,000Operating loss
    
    
    (8,135,000
    )
    
    
    (22,539,000
    )
    
    
    (36,152,000
    )Other income (expense):Investment and other income
    
    
    640,000
    
    
    
    925,000
    
    
    
    776,000Interest expense
    
    
    (171,000
    )
    
    
    (1,126,000
    )
    
    
    (6,848,000
    )Gain on derivatives (see Note 14)
    
    
    
    
    
    
    4,043,000
    
    
    
    Loss on extinguishment of convertible debt
    
    
    (255,000
    )
    
    
    (871,000
    )
    
    
    (1,283,000
    )Total other income (expense)
    
    
    214,000
    
    
    
    2,971,000
    
    
    
    (7,355,000
    )Loss before income taxes
    
    
    (7,921,000
    )
    
    
    (19,568,000
    )
    
    
    (43,507,000
    )Income tax benefit (expense)
    
    
    (181,000
    )
    
    
    60,000
    
    
    
    (89,000
    )Net loss
    
    $
    (8,102,000
    )
    
    $
    (19,508,000
    )
    
    $
    (43,596,000
    )Basic and diluted loss per common share:
    
    $
    (0.13
    )
    
    $
    (0.34
    )
    
    $
    (1.20
    )Basic and diluted weighted average common
shares outstanding
    
    
    60,424,251
    
    
    
    57,067,678
    
    
    
    36,452,000
  F-5




---



##### Table of Contents



ZIX CORPORATION
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
 Stockholders Equity (Deficit)Additional
    
    
    
    
    
    
    
    
    
    
    TotalCommon Stock
    
    
    Paid-In
    
    
    Treasury
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Capital
    
    
    Stock
    
    
    Deficit
    
    
    Equity (Deficit)Balance, January 1, 2005
    
    
    34,584,406
    
    
    $
    346,000
    
    
    $
    269,406,000
    
    
    $
    (11,507,000
    )
    
    $
    (243,480,000
    )
    
    $
    14,765,000Issuance of common stock and related warrants
upon private investment
    
    
    10,503,862
    
    
    
    105,000
    
    
    
    24,096,000
    
    
    
    
    
    
    
    
    
    
    
    24,201,000Issuance of common stock upon exercise
of warrants
    
    
    1,209,712
    
    
    
    12,000
    
    
    
    2,076,000
    
    
    
    
    
    
    
    
    
    
    
    2,088,000Issuance of common stock upon exercise of
stock options
    
    
    10,833
    
    
    
    
    
    
    
    28,000
    
    
    
    
    
    
    
    
    
    
    
    28,000Employee stock compensation expense
    
    
    349,615
    
    
    
    4,000
    
    
    
    1,008,000
    
    
    
    
    
    
    
    
    
    
    
    1,012,000Common stock issued in lieu of cash redemption
of convertible promissory notes
    
    
    4,856,129
    
    
    
    48,000
    
    
    
    8,403,000
    
    
    
    
    
    
    
    
    
    
    
    8,451,000Common stock issued in lieu of cash payments
for interest on convertible promissory notes
    
    
    418,004
    
    
    
    4,000
    
    
    
    918,000
    
    
    
    
    
    
    
    
    
    
    
    922,000Valuation of additional anti-dilutive warrants
issued upon private placement
    
    
    
    
    
    
    
    
    
    
    153,000
    
    
    
    
    
    
    
    
    
    
    
    153,000Valuation of additional warrants issued
upon retirement of convertible promissory
notes payable
    
    
    
    
    
    
    
    
    
    
    146,000
    
    
    
    
    
    
    
    
    
    
    
    146,000Revaluation of outstanding warrants resulting
from restructure of convertible promissory
note payable
    
    
    
    
    
    
    
    
    
    
    (375,000
    )
    
    
    
    
    
    
    
    
    
    
    (375,000
    )Valuation of beneficial conversion feature
resulting from the restructure of promissory
note payable
    
    
    
    
    
    
    
    
    
    
    2,518,000
    
    
    
    
    
    
    
    
    
    
    
    2,518,000Non-employee stock-based compensation
    
    
    
    
    
    
    
    
    
    
    110,000
    
    
    
    
    
    
    
    
    
    
    
    110,000Other
    
    
    
    
    
    
    
    
    
    
    (26,000
    )
    
    
    
    
    
    
    
    
    
    
    (26,000
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (43,596,000
    )
    
    
    (43,596,000
    )Balance, December 31, 2005
    
    
    51,932,561
    
    
    
    519,000
    
    
    
    308,461,000
    
    
    
    (11,507,000
    )
    
    
    (287,076,000
    )
    
    
    10,397,000Issuance of common stock and related
warrants upon private investment (net of
issuance costs)
    
    
    9,930,000
    
    
    
    100,000
    
    
    
    4,648,000
    
    
    
    
    
    
    
    
    
    
    
    4,748,000Common 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
    
    
    21,263
    
    
    
    
    
    
    
    30,000
    
    
    
    
    
    
    
    
    
    
    
    30,000Employee share-based compensation costs
through September 30, 2006
    
    
    
    
    
    
    
    
    
    
    2,008,000
    
    
    
    
    
    
    
    
    
    
    
    2,008,000Valuation of additional warrants issued relating
to the convertible promissory notes payable
    
    
    
    
    
    
    
    
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    50,000Valuation of beneficial conversion feature in
convertible promissory note resulting from
the private placement of common stock
    
    
    
    
    
    
    
    
    
    
    459,000
    
    
    
    
    
    
    
    
    
    
    
    459,000Valuation of additional anti-dilutive warrants
issued upon private placement of common
stock
    
    
    
    
    
    
    
    
    
    
    74,000
    
    
    
    
    
    
    
    
    
    
    
    74,000Valuation of additional warrants issued upon
retirement of convertible promissory note
    
    
    
    
    
    
    
    
    
    
    6,000
    
    
    
    
    
    
    
    
    
    
    
    6,000Reversal of unamortized valuation of beneficial
conversion feature upon retirement of
convertible promissory note
    
    
    
    
    
    
    
    
    
    
    (365,000
    )
    
    
    
    
    
    
    
    
    
    
    (365,000
    )Non-employee stock-based compensation
through September 30, 2006
    
    
    
    
    
    
    
    
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    1,000Net loss through September 30, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,111,000
    )
    
    
    (16,111,000
    )Balance, September 30, 2006
    
    
    61,966,020
    
    
    
    620,000
    
    
    
    315,528,000
    
    
    
    (11,507,000
    )
    
    
    (303,187,000
    )
    
    
    1,454,000Cumulative effect of change in accounting
principle (see Note 14)
    
    
    
    
    
    
    
    
    
    
    5,979,000
    
    
    
    
    
    
    
    (3,932,000
    )
    
    
    2,047,000Employee share-based compensations costs,
October 1 - December 31, 2006
    
    
    
    
    
    
    
    
    
    
    800,000
    
    
    
    
    
    
    
    
    
    
    
    800,000Non-employee stock-based compensation,
October 1  December 31, 2006
    
    
    
    
    
    
    
    
    
    
    23,000
    
    
    
    
    
    
    
    
    
    
    
    23,000Net loss, October 1 through December 31, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,397,000
    )
    
    
    (3,397,000
    )Balance, December 31, 2006
    
    
    61,966,020
    
    
    
    620,000
    
    
    
    322,330,000
    
    
    
    (11,507,000
    )
    
    
    (310,516,000
    )
    
    
    927,000Issuance of common stock upon exercise of stock
options
    
    
    145,689
    
    
    
    1,000
    
    
    
    541,000
    
    
    
    
    
    
    
    
    
    
    
    542,000Issuance of common stock upon exercise of warrants
    
    
    2,147,940
    
    
    
    22,000
    
    
    
    3,630,000
    
    
    
    
    
    
    
    
    
    
    
    3,652,000Issuance of common stock upon restructure of
promissory note payable
    
    
    700,000
    
    
    
    7,000
    
    
    
    1,386,000
    
    
    
    
    
    
    
    
    
    
    
    1,393,000Employee share-based compensation costs
    
    
    
    
    
    
    
    
    
    
    1,059,000
    
    
    
    
    
    
    
    
    
    
    
    1,059,000Non-employee stock-based compensation
    
    
    
    
    
    
    
    
    
    
    205,000
    
    
    
    
    
    
    
    
    
    
    
    205,000Other
    
    
    
    
    
    
    
    
    
    
    35,000
    
    
    
    
    
    
    
    
    
    
    
    35,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,102,000
    )
    
    
    (8,102,000
    )Balance, December 31, 2007
    
    
    64,959,649
    
    
    $
    650,000
    
    
    $
    329,186,000
    
    
    $
    (11,507,000
    )
    
    $
    (318,618,000
    )
    
    $
    (289,000
    )
  F-6




---



##### Table of Contents



ZIX CORPORATION
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Year Ended December 31,2007
    
    
    2006
    
    
    2005Operating activities:Net loss
    
    $
    (8,102,000
    )
    
    $
    (19,508,000
    )
    
    $
    (43,596,000
    )Non-cash items in net loss:Depreciation and amortization
    
    
    1,578,000
    
    
    
    2,754,000
    
    
    
    4,104,000Amortization of debt discount/premium,
financing costs, and other
    
    
    88,000
    
    
    
    910,000
    
    
    
    5,543,000Valuation of additional warrants issued
upon cash payment of convertible debt
    
    
    
    
    
    
    10,000
    
    
    
    47,000Common stock issued to employees and
non-employees in lieu of cash
    
    
    
    
    
    
    187,000
    
    
    
    Loss on extinguishment of debt
    
    
    255,000
    
    
    
    871,000
    
    
    
    1,283,000Gain on derivative liabilities (see Note 14)
    
    
    
    
    
    
    (4,043,000
    )
    
    
    Asset impairment charge
    
    
    
    
    
    
    125,000
    
    
    
    288,000Employee stock based compensation expense
    
    
    1,059,000
    
    
    
    2,808,000
    
    
    
    1,012,000Common stock issued in lieu of cash
interest payments
    
    
    
    
    
    
    
    
    
    
    922,000Non-employee stock-based compensation
    
    
    205,000
    
    
    
    24,000
    
    
    
    110,000Customer deposit forfeiture
    
    
    (2,000,000
    )
    
    
    (1,000,000
    )
    
    
    (960,000
    )Changes in deferred taxes
    
    
    (33,000
    )
    
    
    1,000
    
    
    
    Net (gain)/loss on sale of product lines
    
    
    
    
    
    
    (53,000
    )
    
    
    3,716,000Changes in operating assets and liabilities:Accounts receivable
    
    
    (373,000
    )
    
    
    (597,000
    )
    
    
    365,000Prepaid and other assets
    
    
    649,000
    
    
    
    (9,000
    )
    
    
    362,000Accounts payable
    
    
    (23,000
    )
    
    
    (993,000
    )
    
    
    51,000Deferred revenue
    
    
    5,219,000
    
    
    
    2,536,000
    
    
    
    2,628,000Customer deposits
    
    
    
    
    
    
    
    
    
    
    (8,000
    )Accrued and other liabilities
    
    
    35,000
    
    
    
    (701,000
    )
    
    
    (768,000
    )Net cash used by operating activities
    
    
    (1,443,000
    )
    
    
    (16,678,000
    )
    
    
    (24,901,000
    )Investing activities:Purchases of property and equipment
    
    
    (1,431,000
    )
    
    
    (1,239,000
    )
    
    
    (1,734,000
    )Purchases of marketable securities
    
    
    (1,734,000
    )
    
    
    
    
    
    
    Sales and maturities of marketable securities
    
    
    
    
    
    
    
    
    
    
    16,000,000Purchase of restricted cash investment
    
    
    
    
    
    
    
    
    
    
    (35,000
    )Proceeds from restricted cash investments
    
    
    10,000
    
    
    
    5,100,000
    
    
    
    5,274,000Proceeds from sale of product lines
    
    
    
    
    
    
    53,000
    
    
    
    3,262,000Net cash (used in) provided by investing
activities
    
    
    (3,155,000
    )
    
    
    3,914,000
    
    
    
    22,767,000Financing activities:Proceeds from private placement of common stock
    
    
    
    
    
    
    11,817,000
    
    
    
    26,288,000Payment of expenses relating to private
placement of common stock
    
    
    
    
    
    
    (853,000
    )
    
    
    (2,057,000
    )Proceeds from exercise of stock options
    
    
    542,000
    
    
    
    
    
    
    
    28,000Proceeds from exercise of warrants
    
    
    3,652,000
    
    
    
    
    
    
    
    2,088,000Payment of short term note payable, capital
lease, and other
    
    
    (255,000
    )
    
    
    (457,000
    )
    
    
    (530,000
    )Payment of premium on convertible debt
    
    
    
    
    
    
    (200,000
    )
    
    
    (348,000
    )Payment of convertible debt
    
    
    
    
    
    
    (5,000,000
    )
    
    
    (6,951,000
    )Payment of promissory note payable
    
    
    (1,600,000
    )
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    2,339,000
    
    
    
    5,307,000
    
    
    
    18,518,000(Decrease) increase in cash and cash equivalents
    
    
    (2,259,000
    )
    
    
    (7,457,000
    )
    
    
    16,384,000Cash and cash equivalents, beginning of year
    
    
    12,783,000
    
    
    
    20,240,000
    
    
    
    3,856,000Cash and cash equivalents, end of year
    
    $
    10,524,000
    
    
    $
    12,783,000
    
    
    $
    20,240,000
  F-7




---



##### Table of Contents



ZIX CORPORATION
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Company Overview and Liquidity
       F-8




---



##### Table of Contents



F-9




---



##### Table of Contents



2. Summary of Significant Accounting Policies
 Consolidation
 Use of Estimates
 Cash Equivalents and Restricted Cash
 Inventory
 Property and Equipment, Long-Lived and Other Intangible Assets, Depreciation and Amortization
  F-10




---



##### Table of Contents



Goodwill
 Goodwill and Other Intangible Assets
   Deferred Tax Assets
 Leases
 Contingent Liabilities Accounting for Contingencies.
 F-11




---



##### 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,
      F-12




---



##### Table of Contents



Customer Indemnification Guarantees
 Warranty Costs
 Deferred Cost of Revenue
 Software Development Costs
  Advertising Expense
 Stock Based Compensation Share-Based
Payment
  F-13




---



##### Table of Contents



Earnings Per Share
 Recent Accounting Pronouncements
   Share-Based
Payment.
 Business Combinations Non-controlling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51
 3. Segment Information
   F-14




---



##### Table of Contents



Year Ended December 31,(unaudited)2007
    
    
    2006
    
    
    2005Revenue:Email Encryption
    
    $
    17,982,000
    
    
    $
    14,094,000
    
    
    $
    10,007,000e-Prescribing
    
    
    6,132,000
    
    
    
    4,264,000
    
    
    
    2,981,000Corporate
    
    
    
    
    
    
    
    
    
    
    976,000Total revenues
    
    
    24,114,000
    
    
    
    18,358,000
    
    
    
    13,964,000Gross margin:Email Encryption
    
    
    13,621,000
    
    
    
    8,727,000
    
    
    
    4,744,000e-Prescribing
    
    
    (373,000
    )
    
    
    (2,921,000
    )
    
    
    (4,344,000
    )Corporate
    
    
    
    
    
    
    
    
    
    
    (630,000
    )Total gross margin
    
    
    13,248,000
    
    
    
    5,806,000
    
    
    
    (230,000
    )Direct costs:Email Encryption
    
    
    10,750,000
    
    
    
    10,920,000
    
    
    
    11,826,000e-Prescribing
    
    
    7,005,000
    
    
    
    9,848,000
    
    
    
    10,164,000Corporate
    
    
    
    
    
    
    
    
    
    
    1,225,000Total direct costs
    
    
    17,755,000
    
    
    
    20,768,000
    
    
    
    23,215,000Unallocated (expense) / income:Marketing, general and administrative expense
    
    
    (5,528,000
    )
    
    
    (8,505,000
    )
    
    
    (9,663,000
    )Gain (loss) on sales of product lines
    
    
    
    
    
    
    53,000
    
    
    
    (3,716,000
    )Asset impairment charge
    
    
    
    
    
    
    (125,000
    )
    
    
    (288,000
    )Operating lease impairment charge
    
    
    (100,000
    )
    
    
    
    
    
    
    Customer deposit forfeiture
    
    
    2,000,000
    
    
    
    1,000,000
    
    
    
    960,000Gain on derivatives
    
    
    
    
    
    
    4,043,000
    
    
    
    Loss on extinguishment of debt
    
    
    (255,000
    )
    
    
    (871,000
    )
    
    
    (1,283,000
    )Investment and other income
    
    
    640,000
    
    
    
    925,000
    
    
    
    776,000Interest expense
    
    
    (171,000
    )
    
    
    (1,126,000
    )
    
    
    (6,848,000
    )Total unallocated expenses
    
    
    (3,414,000
    )
    
    
    (4,606,000
    )
    
    
    (20,062,000
    )Loss before income taxes
    
    $
    (7,921,000
    )
    
    $
    (19,568,000
    )
    
    $
    (43,507,000
    )
   F-15




---



##### Table of Contents



December 31,2007
    
    
    2006Total assets:Email Encryption
    
    $
    3,730,000
    
    
    $
    3,377,000e-Prescribing
    
    
    1,272,000
    
    
    
    1,813,000Corporate
    
    
    14,472,000
    
    
    
    15,176,000Total assets
    
    $
    19,474,000
    
    
    $
    20,366,000
 4. Stock Options and Stock-based Employee Compensation
  Authorized
    
    
    Options
    
    
    Options
    
    
    AvailableShares
    
    
    Outstanding
    
    
    Vested
    
    
    for GrantEmployee and Director Stock Option Plans:1992 Stock Option Plan
    
    
    450,000
    
    
    
    64,666
    
    
    
    64,666
    
    
    
    1995 Long-term Incentive Plan
    
    
    1,825,000
    
    
    
    1,117,500
    
    
    
    1,088,333
    
    
    
    1996 Directors Stock Option Plan
    
    
    225,000
    
    
    
    30,000
    
    
    
    30,000
    
    
    
    1999 Directors Stock Option Plan
    
    
    975,000
    
    
    
    775,059
    
    
    
    775,059
    
    
    
    2001 Stock Option Plan
    
    
    2,525,000
    
    
    
    1,960,412
    
    
    
    1,238,215
    
    
    
    94,0722001 Employee Stock Option Plan
    
    
    300,000
    
    
    
    167,142
    
    
    
    139,589
    
    
    
    80,7602003 New Employee Stock Option Plan
    
    
    500,000
    
    
    
    159,700
    
    
    
    147,800
    
    
    
    340,3002004 Stock Option Plan
    
    
    5,000,000
    
    
    
    3,853,324
    
    
    
    1,524,037
    
    
    
    1,106,0752004 Directors Stock Option Plan
    
    
    300,000
    
    
    
    246,042
    
    
    
    235,209
    
    
    
    2006 Directors Stock Option Plan
    
    
    750,000
    
    
    
    389,868
    
    
    
    162,639
    
    
    
    360,132Total employee and director stock option plans
    
    
    12,850,000
    
    
    
    8,763,713
    
    
    
    5,405,547
    
    
    
    1,981,339Executive Stock Option Agreements:Richard D. Spurr, Chairman, President and CEO
    
    
    650,000
    
    
    
    650,000
    
    
    
    650,000
    
    
    
    Other executive stock option agreements
    
    
    450,000
    
    
    
    125,000
    
    
    
    125,000
    
    
    
    Total executive stock option agreements
    
    
    1,100,000
    
    
    
    775,000
    
    
    
    775,000
    
    
    
    Total
    
    
    13,950,000
    
    
    
    9,538,713
    
    
    
    6,180,547
    
    
    
    1,981,339
  Employee and Director Stock Option Plans
  Executive Stock Option Agreements:
 Richard D. Spurr
 Other Executive Stock Option Agreements
 F-16




---



##### Table of Contents



Other Stock Option Agreements:
  Accounting Treatment
 Share-Based Payment
   Year Ended December 31,2007
    
    
    2006Cost of revenues
    
    $
    136,000
    
    
    $
    177,000Research and development expenses
    
    
    106,000
    
    
    
    127,000Selling, general and administrative expenses
    
    
    1,022,000
    
    
    
    2,504,000Stock-based compensation expense
    
    $
    1,264,000
    
    
    $
    2,808,000
   F-17




---



##### Table of Contents



Transition Election Related to Accounting for the Tax
Effects of Share-Based Payment Awards
  Year EndedDecember 31, 2005Net loss, as reported
    
    $
    (43,596,000
    )Add employee stock compensation expense recorded under the
intrinsic value method
    
    
    Deduct pro forma stock compensation expense computed under
the fair value method
    
    
    (6,166,000
    )Pro forma net loss
    
    $
    (49,762,000
    )Basic and diluted loss per common share: As reported
    
    $
    (1.20
    )Pro forma
    
    $
    (1.37
    )
   Share Based Payment
 Year Ended December 31,2007
    
    2006
    
    2005Risk-free interest rate
    
    
    3.81
    %
    
    
    4.59
    %
    
    
    3.41
    %Expected option life
    
    5.8 years
    
    5.8 years
    
    3.6 yearsExpected stock price volatility
    
    
    81
    %
    
    
    93
    %
    
    
    96
    %Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    Fair value of options granted
    
    $
    2.87
    
    
    $
    1.03
    
    
    $
    2.31
 F-18




---



##### Table of Contents



Stock Option Activity
  WeightedWeighted
    
    AverageAverage
    
    RemainingExercise
    
    ContractualShares
    
    Price
    
    Term (Yrs)Outstanding at January 1, 2005
    
    
    8,020,029
    
    
    $
    7.64Granted at market price
    
    
    976,200
    
    
    $
    3.64Granted above market price
    
    
    138,780
    
    
    $
    3.05Cancelled or expired
    
    
    (1,528,761
    )
    
    $
    7.72Exercised
    
    
    (10,833
    )
    
    $
    2.61Outstanding at December 31, 2005
    
    
    7,595,415
    
    
    $
    7.03Granted at market price
    
    
    15,000
    
    
    $
    1.93Granted above market price
    
    
    3,968,486
    
    
    $
    2.27Cancelled or expired
    
    
    (1,902,592
    )
    
    $
    5.44Exercised
    
    
    
    
    
    $
    Outstanding at December 31, 2006
    
    
    9,676,309
    
    
    $
    5.38Granted at market price
    
    
    1,713,552
    
    
    $
    4.00Cancelled or expired
    
    
    (1,705,459
    )
    
    $
    5.39Exercised
    
    
    (145,689
    )
    
    $
    3.72Outstanding at December 31, 2007
    
    
    9,538,713
    
    
    $
    5.16
    
    
    
    7.04Options exercisable at December 31, 2007
    
    
    6,180,546
    
    
    $
    6.27
    
    
    
    5.92
    Options Outstanding
    
    Options ExercisableWeighted Average
    
    Weighted
    
    
    
    
    
    WeightedRange of
    
    Number
    
    Remaining
    
    Average
    
    Number
    
    AverageExercise Prices
    
    Outstanding
    
    Contractual Life
    
    Exercise Price
    
    Exercisable
    
    Exercise Price$1.21  $1.99
    
    
    2,189,399
    
    
    
    8.47
    
    
    $
    1.54
    
    
    
    800,457
    
    
    $
    1.57$2.00  $3.49
    
    
    1,423,057
    
    
    
    7.70
    
    
    $
    2.85
    
    
    
    908,923
    
    
    $
    2.89$3.50  $4.99
    
    
    3,032,332
    
    
    
    7.87
    
    
    $
    4.48
    
    
    
    1,577,241
    
    
    $
    4.22$5.00  $5.99
    
    
    600,354
    
    
    
    5.37
    
    
    $
    5.08
    
    
    
    600,354
    
    
    $
    5.08$6.00  $8.99
    
    
    856,048
    
    
    
    5.66
    
    
    $
    6.47
    
    
    
    856,048
    
    
    $
    6.47$9.00  $19.99
    
    
    1,266,495
    
    
    
    4.31
    
    
    $
    10.64
    
    
    
    1,266,495
    
    
    $
    10.64$20.00  $57.60
    
    
    171,028
    
    
    
    1.64
    
    
    $
    36.02
    
    
    
    171,028
    
    
    $
    36.029,538,713
    
    
    
    7.04
    
    
    $
    5.16
    
    
    
    6,180,546
    
    
    $
    6.27
  Reserved Common Stock
  F-19




---



##### Table of Contents



Common Stock Issued in Lieu of Cash
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Common stock issued to
employees for compensation in
lieu of cash
    
    $
    
    
    
    $
    157,000
    
    
    $
    1,012,000Stock granted to third parties
    
    
    
    
    
    
    30,000
    
    
    
    110,000Total
    
    $
    
    
    
    $
    187,000
    
    
    $
    1,122,000
 5. Supplemental Cash Flow Information
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Cash interest paid
    
    $
    83,000
    
    
    $
    265,000
    
    
    $
    389,000Income tax (refund) payment
    
    $
    175,000
    
    
    $
    (12,000
    )
    
    $
    261,000Issuance of common stock and warrants related to the restructure
of the prior promissory notes payable (see Note 6)
    
    $
    1,393,000
    
    
    $
    
    
    
    $
    Issuance of replacement promissory note payable
(see Note 6)
    
    $
    1,474,000
    
    
    $
    
    
    
    $
    Assets acquired on capital lease
    
    $
    
    
    
    $
    
    
    
    $
    160,000Payables related to purchases of assets
    
    $
    33,000
    
    
    $
    99,000
    
    
    $
    34,000Assets sold to customers as part of their subscription service
    
    $
    16,000
    
    
    $
    45,000
    
    
    $
    Insurance premiums financed by short-term note payable
(see Note 13)
    
    $
    
    
    
    $
    279,000
    
    
    $
    367,000Stock redemption of convertible promissory notes payable
(see Note 13)
    
    $
    
    
    
    $
    
    
    
    $
    8,451,000Valuation of additional anti-dilutive warrants issued upon
private placement
    
    $
    
    
    
    $
    130,000
    
    
    $
    153,000Revaluation of warrants resulting from restructuring of
convertible promissory notes (see Note 13)
    
    $
    
    
    
    $
    
    
    
    $
    375,000Valuation of beneficial conversion feature resulting from
restructure of convertible promissory notes payable (see Note 13)
    
    $
    
    
    
    $
    94,000
    
    
    $
    2,518,000Accrued expenses relating to private placement common stock
(see Note 14)
    
    $
    35,000
    
    
    $
    55,000
    
    
    $
    30,000Accumulated effect of adjustment resulting from change in
accounting principle for previously recorded derivative
    
    $
    
    
    
    $
    2,047,000
    
    
    $
    
 6. Business Sales and Acquisitions
 MyDocOnline, Inc.
  F-20




---



##### Table of Contents



Elron Software, Inc.
    F-21




---



##### Table of Contents



7. Accounts Receivable
 December 312007
    
    
    2006Gross accounts receivable
    
    $
    4,513,000
    
    
    $
    4,523,000Allowance for returns and doubtful accounts
    
    
    (66,000
    )
    
    
    (71,000
    )Unpaid portion of deferred revenue
    
    
    (3,328,000
    )
    
    
    (3,706,000
    )Receivables, net
    
    $
    1,119,000
    
    
    $
    746,000
   8. Prepaid and other current assets
 December 312007
    
    
    2006Inventory
    
    $
    218,000
    
    
    $
    767,000Deferred cost of sales charges
    
    
    301,000
    
    
    
    334,000Prepaid insurance, maintenance and other
    
    
    1,013,000
    
    
    
    1,025,000Tax-related
    
    
    13,000
    
    
    
    52,000Prepaid and other current assets
    
    $
    1,545,000
    
    
    $
    2,178,000
 Inventory
 Deferred Cost of Revenue
 F-22




---



##### Table of Contents



Prepaid insurance, maintenance and other
 9. Property and Equipment
 December 312007
    
    
    2006Computer and office equipment and software
    
    $
    26,042,000
    
    
    $
    30,711,000Leasehold improvements
    
    
    4,825,000
    
    
    
    4,815,000Furniture and fixtures
    
    
    1,221,000
    
    
    
    1,224,00032,088,000
    
    
    
    36,750,000Less accumulated depreciation and amortization
    
    
    (29,791,000
    )
    
    
    (34,346,000
    )$
    2,297,000
    
    
    $
    2,404,000
     10. Intangible Assets and Goodwill
  December 31,2007
    
    
    2006Intangible asset cost
    
    $
    2,034,000
    
    
    $
    2,034,000Accumulated amortization
    
    
    (2,034,000
    )
    
    
    (2,011,000
    )Net intangible assets
    
    $
    
    
    
    $
    23,000
   AccumulatedCost
    
    
    AmortizationBalance at January 1, 2007
    
    $
    2,034,000
    
    
    $
    2,011,000Amortization of intangibles
    
    
    
    
    
    
    23,000Ending balance at December 31, 2007
    
    $
    2,034,000
    
    
    $
    2,034,000
 F-23




---



##### Table of Contents



11. Accrued Expenses
 2007
    
    
    2006Employee compensation and benefits
    
    $
    1,292,000
    
    
    $
    1,199,000Professional fees
    
    
    606,000
    
    
    
    628,000Taxes
    
    
    790,000
    
    
    
    875,000Other
    
    
    376,000
    
    
    
    377,000Total accrued expenses
    
    $
    3,064,000
    
    
    $
    3,079,000
 12. Customer Deposit
   13. Notes Payable
  Sanofi-aventis Promissory Note Payable
 Current Status
 Original incurrence of debt 
 
    
    Concurrent with the MyDocOnline acquisition on January 30, 2004, sanofi-aventis, U.S.
Inc., loaned the Company $3,000,000 due March 15, 2007, with a stated interest rate of
4.5%. The principal portion of the note was payable in either cash or shares of the
Companys common stock, based on the then-current value of such shares. Additionally, at
sanofi-aventis discretion and after the $4,000,000 customer deposit from sanofi-aventis
under the Master Services Agreement had been consumed (see Note 12), the principal portion
of the note may have been paid in the form of additional services provided to
sanofi-aventis by the Company pursuant to the terms of such services agreement. Should
sanofi-aventis have chosen to not have the note paid in the form of services, the Company
would have been required to pay the note in cash or stock at maturity, however, at an
amount equal to 90% of the face amount of the loan, or $2,700,000, which the Company
considered its minimum liability.
    
    Concurrent with the issuance of the note payable to sanofi-aventis, the Company issued
warrants to purchase 145,853 shares of its common stock at $13.01 per share. All of these
warrants expired in early
 F-24




---



##### Table of Contents



2007. Based on relative fair values at time of issuance, the loan proceeds were allocated to
the note payable of $1,525,000 and to the warrants of $1,475,000 based on the relative fair
values of the note payable and warrants. The resulting discount on the note payable of
$1,175,000 on the minimum liability of $2,700,000 was amortized to interest expense over the
three-year loan life to yield an effective interest rate of 11%.
 Restructuring of the original debt
 
    
    In February 2007, the Company entered into a definitive agreement with sanofi-aventis to
restructure the $3,000,000 indebtedness under the original promissory note. Pursuant to
this agreement the Company satisfied its obligations under the original note by means of
(i) a prepayment on the original note in the form of 700,000 unrestricted shares of the
Companys common stock, and (ii) following such prepayment, the delivery to sanofi-aventis
of a secured promissory note in the principal amount of $1,600,000 and the issuance of a
five year warrant for 145,853 shares at an exercise price of $4.48 per share which replaced
the warrant to purchase 145,853 shares of common stock that was issued on the date of the
original transaction. The fair value of the warrants was calculated to be $126,000 and
recorded as discount on the new note, while using the BSOPM. The $126,000 value for the
warrants representing the discount on the new note was to be amortized as interest expense
over the life of the new note. Further, the fair value of the new note was calculated
based on an estimated interest rate that the Company could obtain independently.
    
    The new note was payable in eight quarterly installments of $200,000 each, with the
first payment due in April 2008 and the final payment due in January 2010. The new note was
fully secured by a letter of credit in favor of sanofi-aventis and bore interest at the
rate of 5%. The letter of credit caused the Company to record $1,675,000 of cash as
restricted in the first quarter of 2007. The value of the letter of credit and
corresponding restricted cash balance would be automatically reduced as the Company made
periodic principal payments to sanofi-aventis.
    
    No additional consideration was given by or on behalf of sanofi-aventis or received by
the Company in connection with the delivery of the 700,000 common stock shares in partial
prepayment of the original note, and no consideration was given or received by the Company
in exchange for the new note and the new warrant, other than the cancellation of the
original note and the cancellation of a security agreement relating to the original note.
    
    The two tables below illustrate the accounting treatment applied to the restructuring of
the indebtedness, which was handled as an extinguishment of the Original Note and the
issuance of the New Note:
 Debt Extinguishment Determination:Present value of new note payable
    
    $
    1,474,000Issuance of common stock (700,000 shares @ $1.81/share)
    
    
    1,267,000Black Scholes value of warrants issued
    
    
    126,000Paid fees & expenses
    
    
    11,000Total consideration given
    
    $
    2,878,000Loss on extinguishment of debt
    
    
    (178,000
    )Original note value
    
    $
    2,700,000Recording of New Note:New note value
    
    $
    1,600,000Discount on note payable
    
    
    (126,000
    )Issuance of common stock (700,000 shares @ $0.01/share)
    
    
    7,000Additional paid in capital
    
    
    1,260,000Additional paid in warrants
    
    
    126,000Accrued expenses
    
    
    11,000Total consideration given
    
    $
    2,878,000
 F-25




---



##### Table of Contents



Extinguishment of the restructured debt 
 
    
    In December 2007, the Company paid in full the $1,600,000 principal amount, plus accrued
interest owing under the new note. As a result of this early payment, the Company recorded
a $77,000 loss on the extinguishment of debt, representing the unamortized balance of the discount on the new
note. Further, sanofi-aventis surrendered the Letter of Credit instrument to the issuing
bank, which in turn cancelled the Letter of Credit instrument and released the associated
restriction on the $1,675,000 cash deposit. At December 31, 2007, the cash deposit remained
invested in a one-year certificate of deposit investment instrument with a maturity date of
February 22, 2008, has an interest rate of 4.16% and is reported as current, marketable
securities in the Companys consolidated balance sheets. Upon the maturity of the
certificate of deposit instrument in the first quarter of 2008, the principal amount, plus
accrued interest were reclassified to cash and cash equivalents.
 Convertible Promissory Notes Payable
 Current Status
  Original issuance of convertible promissory notes payable
    
    On November 2, 2004, the Company entered into purchase agreements with Omicron Master
Trust (Omicron) and Amulet Limited (Amulet, together with Omicron, the Investors), in
which the Company issued and sold to the Investors $20,000,000 aggregate principal amount
of secured, convertible notes and warrants to purchase 1,000,000 shares of the Companys
common stock at an exercise price of $6.00 a share. The warrants were all exercisable and
expire November 2, 2009. At the time the notes were issued, the Companys common stock had
a fair value of $4.88 per share. The Company incurred approximately $1,598,000 of
financing costs with this original issuance, which were deferred and amortized over the
life of the notes using the effective interest method. Financing costs included the BSOPM
value of warrants to purchase 166,667 shares of common stock at $6.00 per share which were
issued to the brokers of the transaction.Amendments to original convertible promissory notes payable
    
    In April 2005, the Company entered into amendments with the Investors to restructure the
original purchase agreements signed in November 2004.Accounting treatment of the amended convertible promissory notes payable -
 
    
    The Company accounted for the notes and related warrants using the
provisions of EITF Issue No. 00-19, Accounting for Derivative Financial
instruments Indexed to, and Potentially Settled in a Companys Own Stockand
APB No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants.Under the provisions of EITF 00-19, the notes were recorded as a
liability as they did not meet the requirements of being accounted for as
equity. Under the provisions of APB No. 14, the proceeds received from the
notes were allocated between the notes and the warrants based on their relative
fair values at the time of issuance. Based on relative fair values at the time
the notes were amended, the total discount on the convertible notes payable as
of April 2005 was $2,086,000. This balance was amortized to interest expense
using the effective interest method over the then-remaining term of the notes.
    
    The amended notes also contained a beneficial conversion feature resulting
from the stock redemption being valued at the daily volume weighted average
price less 10%. Per EITF Issue No. 98-5, Accounting for Convertible Securities
with Beneficial Conversion Features of Contingently Adjustable Conversion
Featuresand EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments, the beneficial conversion feature is valued using the
intrinsic value method based on the net book value of the amended notes after
all
 F-26




---



##### Table of Contents



discounts are taken into effect. Using this approach, the intrinsic value of the
beneficial conversion feature was calculated to be $2,518,000. This amount was
allocated to the discount against the notes and additional paid-in capital in
2005. This balance was fully amortized to interest expense using the effective
interest method through December 31, 2005, the date of the last payment to which
the beneficial conversion feature was applicable.
    
    The Company incurred approximately $287,000 of costs in relation to the
amendments to the convertible promissory notes. These costs were recorded as a
period expense in the first quarter of 2005. However, the remaining unamortized
balance of the financing costs incurred in relation to the issuance of the
initial notes on November 2, 2004, continued to be reported as a deferred
financing cost asset and amortized over the then-remaining life of the amended
notes using the effective interest method.
 2005 payment activity on the convertible promissory notes payable
 
    
    Through a series of transactions beginning in May 2005, the Company made all
required note payments ($10,000,000) using a combination of common stock
($8,049,000) and cash ($1,951,000). In accordance with the terms of the amended
agreement, the Company issued 145,032 warrants equaling 70% of the common stock
that would be issued to the investor to retire that portion of the principal
paid in cash at $5.38 per share. These warrants were valued at $47,000 using
the BSOPM.
    
    On December 30, 2005, the Company transacted an early extinguishment of 50%
of the remaining outstanding balance of the convertible promissory notes
payable ($5,000,000). As part of the partial debt extinguishment the Company
paid the 5% early payment premium and all accrued interest. Additionally, per
the amended terms of the notes, 650,558 warrants were issued equaling 70% of
the common stock that would be issued to the investor to retire that portion of
the principal paid in cash at $5.38 per share. These warrants were valued at
$100,000 using the BSOPM. The Company also recognized 50% of the remaining
unamortized deferred financing costs ($338,000) and unamortized discount
($595,000). The total loss on the early extinguishment was $1,283,000.
    
    After all payments were made on the convertible promissory notes payable,
the principal balance of the remaining note was $5,000,000, excluding any
unamortized discounts, as of December 31, 2005.
 The effects of anti-dilution clauses
 
    
    The amended convertible promissory notes payable had certain weighted
average anti-dilution clauses that adjust the debt conversion and warrant
exercise price if the Company issued common stock below $6.00 per share. In the
third quarter of 2005, the Company raised net proceeds of $24,201,000 through a
private placement of common stock. As a result of this action, the number of
warrants originally granted under the convertible promissory notes on November
2, 2004, increased from 1,000,000 to 1,115,244 and the exercise price of those
warrants decreased from $6.00 per share to $5.38 per share. The conversion
price of the convertible promissory note payable was also adjusted from $6.00
per share to $5.38 per share. The 115,244 additional warrants were valued at
$153,000 using the BSOPM and recorded as additional discount on the convertible
promissory note payable in 2005.
    
    In the first quarter 2006, the Company issued under the anti-dilution
clauses of the amended notes an additional 51,054 warrants valued at $50,000
using the BSOPM and the exercise price on the warrants declined from $5.38 to
$5.24. This action also caused the conversion price on the existing note
payable to decrease from $5.38 to $5.24. Of the $50,000 value of the warrants,
$10,000 was recorded as interest expense as 21,257 of the warrants related to
2005 payment activity. The remaining $40,000 was recorded as additional
discount on the
convertible promissory note, interest expense and additional paid-in capital.
 F-27




---



##### Table of Contents




    
    As discussed further in Note 14, in April 2006, the Company issued 9,930,000
shares of its common stock and 5,958,000 warrants to purchase the Companys
common stock to various investors in a private placement transaction.
Additional warrants for the purchase of 198,600 shares of common stock were
issued to the underwriters of the private placement. The private placement had
the following impacts on the warrants relating to the convertible promissory
notes payable:
 
    
    Per anti-dilution terms included in the amended
convertible promissory notes payable, the Company issued additional
warrants to purchase 264,718 shares of common stock. These warrants have
either expired or will expire on the following schedule: 57,529 in November
2006 and 2007, 25,651 in November 2008 and 124,009 in November 2009. The
additional warrants were valued at $74,000 using the BSOPM and recorded as
discount against the outstanding note and amortized to interest expense
using the effective interest method.
    
    The conversion price of the outstanding convertible
promissory notes payable was reduced from $5.24 per share to $4.47 per
share. The reduced conversion price caused the Company to record the
intrinsic value of a beneficial conversion feature as the adjusted
conversion price was reset to a price below the market price of the
Companys stock on the date the notes were originally issued (November 2,
2004). The intrinsic value of the adjusted conversion price is $459,000 and
was recorded as additional discount on the remaining convertible promissory
note payable and was amortized to interest expense using the effective
interest method.
 2006 payment activity on the convertible promissory notes payable
 
    
    On June 23, 2006, the Company and the remaining note holder agreed on terms
for early extinguishment of the remaining $5,000,000 convertible promissory
note payable. Based on the terms of the early extinguishment agreement the
following actions were taken:
 o
    
    The Company retired the full $5,000,000 using
restricted cash and paid a $200,000 early payment premium plus accrued
interest for a total payoff amount of $5,259,000.o
    
    In accordance with the terms of the note, the
Company issued warrants to the note holder to purchase an additional
782,998 shares of common stock at $4.47 per share. In November 2006 50%
of these warrants expired, and in November 2007 the remaining 50%
expired. These warrants were valued at $6,000 using the BSOPM.o
    
    Upon repayment of the convertible promissory
note payable, the Company wrote-off all unamortized discounts and
deferred financing costs against the loss on extinguishment of debt.
The total loss on extinguishment of debt was $871,000 and consisted of
$200,000 for early payment premium, $449,000 for write-off of
unamortized discount, $216,000, for write-off of unamortized financing
costs and $6,000 for the value of warrants issued upon extinguishment.o
    
    The unamortized portion of the beneficial
conversion feature recorded as a result of the April 2006 private
placement of common stock was $365,000 on June 23, 2006. As the
beneficial conversion feature could no longer be exercised at the time
the convertible promissory note was repaid, the remaining $365,000
balance was reversed out of additional paid-in capital and discount on
notes payable.
 F-28




---



##### Table of Contents



Effective yield and interest expense
 
    
    After all discounts, stated interest, payment premiums, issuance of
warrants, beneficial conversion features and financing costs are taken into
account, the effective yield on the amended convertible notes payable was
28.30%. The effective yield increased to 37.41% when the loss on early
extinguishment of debt, recorded in 2005 and 2006, was included in the
calculation. The total interest expense relating to the convertible promissory
notes payable was $671,000 and $6,424,000 for the years ended December 31, 2006
and 2005, respectively, and included the stated interest expense, discount
amortization, premium accretion, issuance of warrants and deferred financing
cost amortization.
 Short-term Notes Payable
  14. April 2006 Private Placement of Common Stock
     F-29




---



##### Table of Contents



Gross proceeds
    
    $
    11,817,000Less:Fair value of warrants issued to investors in the private placement
    
    
    (5,979,000
    )Fair value of liquidated damages
    
    
    (123,000
    )Potential future payments to transaction underwriters
    
    
    (59,000
    )Warrants issued to underwriters
    
    
    (199,000
    )Cash issuance costs
    
    
    (908,000
    )Proceeds allocated to common stock
    
    $
    4,549,000
 Warrants issued to investors in the private placement
 Liquidated damages
 Potential future payments to transaction underwriters
 Warrants issued to underwriters
 Common stock
  Accounting for Registration
Payment Arrangements
 
    
    Warrants issued to investors in the private placement The warrants issued to
investors were no longer considered a derivative liability and the initial value of the
warrants ($5,979,000) was reclassified to additional paid-in capital by reducing the
derivative liability by $1,950,000 (the September 30, 2006, value after revaluation) and a
cumulative adjustment to accumulated deficit of $4,029,000 (the cumulative gain recognized
on the warrants in the second and third quarters of 2006).
    
    Liquidated damages The liquidated damages were no longer considered a derivative
liability and the September 30, 2006, value of the liquidated damages ($97,000) was
written-off through a cumulative adjustment to the September 30, 2006, accumulated
deficit.
    
    Potential future payments to transaction underwriters The potential future payments
to the transaction underwriters were considered a contingent liability in accordance with
FASB Statement No. 5, Accounting for Contingencies,and recorded as an accrued expense.This contingent liability is revalued
each quarter with the change in valuation being recorded as a gain or loss in the statement
of operations. The total liability recorded is $51,000 at December 31, 2007, and is included
in accrued expense.
 F-30




---



##### Table of Contents



15. Equity Financing Arrangements and Related Warrants
 Warrants Summary
  December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    December 31,2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    2007Warrants
    
    Warrants
    
    Warrants
    
    Warrants
    
    Warrants
    
    Exercise
    
    WarrantWarrant Grants:
    
    Outstanding
    
    Issued
    
    Expired
    
    Exercised
    
    Outstanding
    
    Price
    
    Expiration2006 private placement of common stock
    
    
    5,958,000
    
    
    
    
    
    
    
    
    
    
    
    (1,545,000
    )
    
    
    4,413,000
    
    
    $
    1.54
    
    
    Oct 20112006 private placement agent warrants
    
    
    198,600
    
    
    
    
    
    
    
    
    
    
    
    (198,600
    )
    
    
    
    
    
    
    1.54
    
    
    Oct 20112005 private placement of common stock
    
    
    3,466,274
    
    
    
    
    
    
    
    
    
    
    
    (234,300
    )
    
    
    3,231,974
    
    
    
    3.04
    
    
    Aug 20102005 private placement broker warrants
    
    
    108,964
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    108,964
    
    
    
    3.04
    
    
    Aug 20102005 private placement agent warrants
    
    
    178,111
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    178,111
    
    
    
    3.04
    
    
    Aug 20102004 private placement of convertible
notes payable
    
    
    1,269,050
    
    
    
    
    
    
    
    
    
    
    
    (170,040
    )
    
    
    1,099,010
    
    
    
    4.47 1.42
    
    
    Nov 20092004 private placement broker warrants
    
    
    166,667
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    166,667
    
    
    
    6.00
    
    
    Nov 2009Additional warrants issued with cash
payment
of convertible promissory notes payable
    
    
    957,556
    
    
    
    
    
    
    
    (782,998
    )
    
    
    
    
    
    
    174,558
    
    
    
    4.47
    
    
    Nov 2006  Nov 20082003 private placement of common stock
    
    
    181,452
    
    
    
    
    
    
    
    (181,452
    )
    
    
    
    
    
    
    
    
    
    
    4.96
    
    
    June 20072002 private placement of equity
securities
    
    
    916,667
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    916,667
    
    
    
    57.60
    
    
    May 2010Promissory note payable (see Note 13)
    
    
    145,853
    
    
    
    145,853
    
    
    
    (145,853
    )
    
    
    
    
    
    
    145,853
    
    
    
    4.48
    
    
    Jan 2012Total
    
    
    13,547,194
    
    
    
    145,853
    
    
    
    (1,110,303
    )
    
    
    (2,147,940
    )
    
    
    10,434,804
  2006 Private Placement of Common Stock and Warrants
     F-31




---



##### Table of Contents



2005 Private Placement of Common Stock and Warrants
      2004 Private Placement of Convertible Notes Payable and Related Transactions
    F-32




---



##### Table of Contents



2006 Private Placement of Common Stock and Warrants
 
    
    Per anti-dilution terms included in the amended convertible promissory notes payable,
the Company issued additional warrants to purchase 264,718 shares of common stock. These
warrants expire on the following schedule: 57,529 expired in November 2006, 57,529 expired
in November 2007, 25,651 expire in November 2008, and 124,009 expire in November 2009.
    
    The exercise prices of the warrants relating to the convertible promissory notes
payable were reduced from a range of $1.44 to $5.24 to a range of $1.42 to $4.47.
    16. Earnings Per Share and Potential Dilution
  2007
    
    2006
    
    2005Stock options
    
    
    9,538,713
    
    
    
    9,676,309
    
    
    
    7,595,415Warrants issued in relation to debt and equity arrangements
(see Note 13)
    
    
    10,434,804
    
    
    
    13,547,194
    
    
    
    7,589,230Shares issuable for conversion of convertible promissory
notes payable
    
    
    
    
    
    
    700,000
    
    
    
    929,368Total antidilutive securities excluded from EPS Calculation
    
    
    19,973,517
    
    
    
    23,923,503
    
    
    
    16,114,013
  F-33




---



##### Table of Contents



17. Significant Customers
  18. Commitments and Contingencies
 Leases and Debt
   2008
    
    2009
    
    2010
    
    2011
    
    2012
    
    Thereafter
    
    TotalOperating leases
    
    $
    1,220,000
    
    
    $
    1,130,000
    
    
    $
    992,000
    
    
    $
    968,000
    
    
    $
    887,000
    
    
    $
    1,552,000
    
    
    $
    6,749,000
  Lawsuits
  F-34




---



##### Table of Contents



19. Income Taxes
  2007
    
    
    2006
    
    
    2005Current:U.S
    
    $
    
    
    
    $
    
    
    
    $
    State
    
    
    13,000
    
    
    
    (24,000
    )
    
    
    30,000Foreign
    
    
    197,000
    
    
    
    (36,000
    )
    
    
    59,000DeferredForeign
    
    
    (29,000
    )
    
    
    
    
    
    
    $
    181,000
    
    
    $
    (60,000
    )
    
    $
    89,000
 F-35




---



##### Table of Contents



2007
    
    
    2006
    
    
    2005Expected tax benefit at U.S. statutory rate
    
    $
    (2,723,000
    )
    
    $
    (6,597,000
    )
    
    $
    (14,760,000
    )Unbenefited U.S. losses, net
    
    
    2,741,000
    
    
    
    7,915,000
    
    
    
    14,772,000Nondeductible expense and nontaxable income
    
    
    (17,000
    )
    
    
    (1,326,000
    )
    
    
    47,000State income taxes
    
    
    13,000
    
    
    
    (24,000
    )
    
    
    30,000Foreign income taxes
    
    
    168,000
    
    
    
    (36,000
    )
    
    
    Other
    
    
    (1,000
    )
    
    
    8,000
    
    
    
    $
    181,000
    
    
    $
    (60,000
    )
    
    $
    89,000
  2007
    
    
    2006Deferred tax assets:Reserves currently nondeductible
    
    $
    643,000
    
    
    $
    1,347,000U.S. net operating loss carryforwards
    
    
    97,987,000
    
    
    
    88,627,000State net operating loss carryforwards
    
    
    1,826,000
    
    
    
    529,000Tax credit carryforwards
    
    
    3,347,000
    
    
    
    3,239,000Stock-based compensation
    
    
    2,710,000
    
    
    
    2,361,000Start-up costs
    
    
    87,000
    
    
    
    87,000Intangible assets
    
    
    3,576,000
    
    
    
    4,045,000Depreciable assets
    
    
    1,947,000
    
    
    
    1,809,000Other assets
    
    
    940,000
    
    
    
    3,771,000Total deferred tax assets
    
    
    113,063,000
    
    
    
    105,815,000Less valuation allowance
    
    
    (112,995,000
    )
    
    
    (105,767,000
    )Net deferred tax assets
    
    
    68,000
    
    
    
    48,000Deferred tax liability:Unrecognized gain on derivatives
    
    
    (4,000
    )
    
    
    Prepaid Interest
    
    
    
    
    
    
    (13,000
    )Net deferred income taxes
    
    $
    64,000
    
    
    $
    35,000
     F-36




---



##### Table of Contents



20. Loss on Impairment of Operating Lease
  21. Employee Benefit Plan
 4 01(k) Plan
 22. Quarterly Results of Operations (Unaudited)
  Quarter EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 312007Revenues
    
    $
    5,387,000
    
    
    $
    5,555,000
    
    
    $
    6,191,000
    
    
    $
    6,981,000Cost of revenues
    
    
    (2,853,000
    )
    
    
    (2,647,000
    )
    
    
    (2,662,000
    )
    
    
    (2,704,000
    )Net loss
    
    
    (1,641,000
    )
    
    
    (3,135,000
    )
    
    
    (1,936,000
    )
    
    
    (1,390,000
    )Basic and diluted net loss per common share
    
    
    (0.03
    )
    
    
    (0.05
    )
    
    
    (0.03
    )
    
    
    (0.02
    )2006Revenues
    
    $
    3,895,000
    
    
    $
    4,209,000
    
    
    $
    4,710,000
    
    
    $
    5,544,000Cost of revenues
    
    
    (3,375,000
    )
    
    
    (3,090,000
    )
    
    
    (3,131,000
    )
    
    
    (2,956,000
    )Net loss
    
    
    (6,874,000
    )
    
    
    (5,086,000
    )
    
    
    (4,151,000
    )
    
    
    (3,397,000
    )Basic and diluted net loss per common share
    
    
    (0.14
    )
    
    
    (0.09
    )
    
    
    (0.07
    )
    
    
    (0.06
    )
  
    
    In the first quarter of 2007 the Company restructured its existing indebtedness to
sanofi-aventis originally due March 2007. This restructuring resulted in the issuance of
700,000 shares of ZixCorp common stock and a five year warrant for 145,853 shares at a
price of $4.48 per share (see Note 15). The net effect of this restructuring was a $177,000
loss on extinguishment of debt (see Note 13).
    
    In the fourth quarter of 2007 the Company received approximately $4,200,000 in cash
following the exercise of outstanding warrants and stock options (see Note 15). These
proceeds were used in part to pay the $1,600,000 balance on the restructured promissory
debt to sanofi-aventis (see Note 15) and to prepay certain 2008 procurements totaling
approximately $700,000.
  
    
    In the second quarter of 2006 the Company recognized a $2,930,000 gain on revaluation
of derivative liabilities recorded as a result of April 2006 private placement of common
stock (see Note 14).
    
    In the second quarter of 2006 the Company paid the remaining $5,000,000 balance of its
convertible
promissory note payable ahead of the maturity date, recording a loss of $871,000 on the
extinguishment of the note (see Note 13).
    
    In the third quarter of 2006 the Company recognized a $1,120,000 gain on revaluation of
derivative liabilities recorded as a result of April 2006 private placement of common stock
(see Note 14).
 F-37