##### 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, 2004                                                 
|          
|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
    Incorporation or Organization) |  | (I.R.S. Employer 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:


|                 |  |                                       
|---------------- |  | --------------------------------------
|None             |  | Not Applicable                        
|(Title of Class) |  | (Name of Exchange on Which Registered)

Securities Registered Pursuant to Section 12(g) of the
Act:


Common Stock


$0.01 Par Value


(Title of Class)


þ o


o


þ o














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TABLE OF CONTENTS



|                                                              |                                                                                                                      |  |  |  |  |  |  | 
|------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                                       
|                                                              | Item 1. Business                                                                                                    
|                                                              | Item 2. Properties                                                                                                  
|                                                              | Item 3. Legal Proceedings                                                                                           
|                                                              | 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
|                                                              | Item 6. Selected Financial Data                                                                                     
|                                                              | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations                       
|NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS          
|                                                              | 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                                                                                    
|Report of Independent Registered Public Accounting Firm      
|                                                              | Item 9B. Other Information                                                                                          
|PART III                                                     
|                                                              | Item 10. Directors and Executive Officers of the Registrant                                                         
|                                                              | 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 Accounting Fees and Services                                                                     
|PART IV                                                      
|                                                              | Item 15. Exhibits, Financial Statement Schedule                                                                     
|SIGNATURES                                                   
|INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                   
|Stock Option Agreement-Richard D Spurr                       
|Stock Option Agreement                                       
|Description of Compensation for Members of Board of Directors
|Office Lease Agreement                                       
|Amendment to Lease Agreement                                 
|Office Lease Agreement                                       
|Letter Agreement                                             
|Amendment to Master Services Agreement                       
|Subsidiaries                                                 
|Consent of Independent Registered Public Accounting Firm     
|Consent of Independent Registered Public Accounting Firm     
|Certification of Richard Spurr, President and Acting CEO     
|Certification of Brad Almond, Chief Financial Officer        
|Certification of President and Acting CEO and CFO            



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##### Table of Contents






PART I







|        |         
|------- | --------
|Item 1. | Business





tm tm


Communications Protection Solutions








1



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| |   |                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | ZixVPM® (Virtual Private Messenger)  an
    e-messaging gateway solution that provides company-wide privacy
    protection for inbound and outbound email communications



| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | ZixVPM
    Alliancetm 
    an easy and economical way to enable direct, two-way secure
    communication between partner companies
|
| |  | ZixVPM Small
    Businesstm 
    full-featured version of ZixVPM scaled to fewer users                                            



| |   |                                         
| | - | ----------------------------------------
| |  | ZixPort®  a secure Web-messaging portal



| |   |                                                                                                
| | - | -----------------------------------------------------------------------------------------------
| |  | ZixPort Small
    Businesstm 
    full featured version of ZixPort scaled to smaller companies



| |   |                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | ZixMail®  a desktop solution for manually
    encrypting and securely delivering email                                                                                   
|
| |  | ZixAuditor®  an assessment service used
    to analyze email traffic patterns and monitor compliance with
    corporate and regulatory policies                          
|
| |  | Message Inspector®  a comprehensive email
    filtering software that enables a company to monitor, manage
    and, if necessary, block unauthorized email communications
|
| |  | Web Inspector®  Web filtering software
    that helps organizations enforce Internet acceptable use
    policies by monitoring and blocking inappropriate Web sites      



Care Delivery Solutions










2



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Regulatory Drivers for Market Growth








Company History






3



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tm PC Magazines




Business Acquisitions








Solutions and Services




| |                                              
| | ---------------------------------------------
| | Communications Protection Solutions (eSecure)



4



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| |   |                                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| |  | Privacy with encryption                                                                          
|
| |  | Authentication                                                                                   
|
| |  | Integrity of messages                                                                            
|
| |  | Non-repudiation  senders cannot deny sending, and
    recipients cannot deny receiving, messages





| |   |                                   
| | - | ----------------------------------
| |  | Certified receipts                
|
| |  | Storage security                  
|
| |  | Time stamps that are non-reputable
|
| |  | Corporate policy enforcement      



ZixVPM, ZixVPM Alliance, and ZixVPM Small
Business








5



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ZixAuditor




ZixMail




ZixPort and ZixPort Small
Business




6



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Message Inspector


Web Inspector






| |                                  
| | ---------------------------------
| | Care Delivery Solutions (eHealth)

PocketScript




Dr. Chart


7



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Strategic Focus






Competition




Communications Protection Solutions
Competition






8



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Care Delivery Solutions Competition








Sales and Marketing




9



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tm








Employees




Research and Development; Patents and Trademarks








| |   |                                                                                                                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Secure Message Forwarding System  The system
    enables secure messages to be sent to recipients who do not have
    a pair of public and private keys and do not have a desktop
    client. It also provides interoperability between different
    types of encryption systems (patent 6,732,101).                                          
|
| |  | Secure Transmission System  The system
    incorporates many innovations that make sending and receiving
    encrypted email easy. The key innovations include real time
    public key retrieval, transaction certificates, and
    sending encrypted messages using a non-SMTP protocol through a
    forwarding server (patent 6,760,752).

10



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Significant Customers






Sales Backlog




|                   |  |   |            | 
|------------------ |  | - | ---------- | 
|Secure e-Messaging |  | $ | 13,100,000 | 
|PocketScript       |  |   | 3,000,000  | 
|Elron              |  |   | 1,800,000  | 
|MyDocOnline        |  |   | 5,500,000  | 
|                   |  |   |           
|Total backlog      |  | $ | 23,400,000 | 
|                   |  |   |           







Geographic Information




11



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Available Information






www.sec.gov.


www.zixcorp.com.







|        |           
|------- | ----------
|Item 2. | Properties



|                        |  |               |  |                 
|----------------------- |  | ------------- |  | ----------------
|Location                |  | Approx. Sq Ft |  | Lease Expiration
|                        |  |               |  |                 
|Dallas, TX              |  | 42,900        |  | September 2014  
|Boca Raton, FL          |  | 1,800         |  | January 2006    
|Mason, OH               |  | 5,600         |  | August 2009     
|Burlington, MA          |  | 11,700        |  | March 2005      
|Ottawa, Ontario, Canada |  | 13,000        |  | August 2005     
|Austin, TX              |  | 200           |  | July 2006       
|Round Rock, TX          |  | 10,400        |  | December 2007   








|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings



12



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|        |                                                  
|------- | -------------------------------------------------
|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



|              |  |      |       |  |      |   |      |      |  |   |       |  |  |   |      | 
|------------- |  | ---- | ----- |  | ---- | - | ---- | ---- |  | - | ----- |  |  | - | ---- | 
|              |  | 2004 |       |  | 2003 |  
|              |  |      |       |  |      |  
|Quarter Ended |  | High |       |  | Low  |   |      | High |  |   | Low   | 
|              |  |      |       |  |      |   |      |      |  |   |       | 
|March 31      |  | $    | 17.50 |  |      | $ | 8.04 |      |  | $ | 5.13  |  |  | $ | 3.90 | 
|June 30       |  | $    | 18.55 |  |      | $ | 6.33 |      |  | $ | 5.43  |  |  | $ | 3.72 | 
|September 30  |  | $    | 7.95  |  |      | $ | 3.81 |      |  | $ | 10.00 |  |  | $ | 3.09 | 
|December 31   |  | $    | 6.25  |  |      | $ | 3.84 |      |  | $ | 10.10 |  |  | $ | 6.36 | 







13



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|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data



|                                                                          |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                          |  | Year Ended December 31,               |        
|                                                                          |  |                                       |        
|                                                                          |  | 2004                                  |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |        
|                                                                          |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        
|                                                                          |  | (In thousands, except per share data) |        
|Statement of Operations Data(1):                                          |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Revenues(2)                                                               |  | $                                     | 14,127  |   |      | $ | 5,840   |      |  | $ | 1,672   |   |  | $    | 317     |   |  | $ | 394     |  
|Cost of revenues(3)                                                       |  |                                       | (15,878 | ) |      |   | (8,211  | )    |  |   | (8,999  | ) |  |      | (14,996 | ) |  |   | (10,821 | )
|Research and development expenses(3)                                      |  |                                       | (9,331  | ) |      |   | (5,896  | )    |  |   | (6,180  | ) |  |      | (9,019  | ) |  |   | (8,661  | )
|Selling, general and administrative expenses(3)                           |  |                                       | (29,399 | ) |      |   | (19,907 | )    |  |   | (19,335 | ) |  |      | (29,892 | ) |  |   | (32,162 | )
|Asset impairment charge(4)                                                |  |                                       | (675    | ) |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Interest expense(5)                                                       |  |                                       | (801    | ) |      |   | (13     | )    |  |   | (2,141  | ) |  |      |        |   |  |   |        |  
|Loss from continuing operations                                           |  |                                       | (42,040 | ) |      |   | (27,667 | )    |  |   | (34,299 | ) |  |      | (56,794 | ) |  |   | (49,322 | )
|Basic and diluted loss per common share from continuing
    operations(6) |  |                                       | (1.33   | ) |      |   | (1.23   | )    |  |   | (2.07   | ) |  |      | (3.32   | ) |  |   | (3.03   | )
|Shares used in computing basic and diluted loss per common share          |  |                                       | 31,533  |   |      |   | 23,525  |      |  |   | 18,129  |   |  |      | 17,083  |   |  |   | 16,266  |  
|Balance Sheet Data:                                                       |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Working capital(9)                                                        |  |                                       | 4,913   |   |      |   | 7,283   |      |  |   | 13,668  |   |  |      | 17,266  |   |  |   | 48,685  |  
|Total assets                                                              |  |                                       | 52,242  |   |      |   | 26,419  |      |  |   | 21,000  |   |  |      | 32,436  |   |  |   | 78,677  |  
|Long-term obligations(7)                                                  |  |                                       | 19,252  |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Convertible preferred stock(8)                                            |  |                                       |        |   |      |   |        |      |  |   | 5,653   |   |  |      |        |   |  |   |        |  
|Stockholders, equity                                                      |  |                                       | 14,765  |   |      |   | 17,919  |      |  |   | 11,545  |   |  |      | 27,529  |   |  |   | 75,130  |  






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | During 1998, the Company sold all of its then operating
    businesses and, accordingly, the gains on the sale of these
    businesses were presented as discontinued operations. 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 Web Inspector and Message Inspector product lines,
    which were acquired in the Elron acquisition, were sold to
    CyberGuard Corporation (see Note 22 to the consolidated

14



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| |                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | financial statements). Revenues for the Web Inspector and
    Message Inspector product lines were $4,073,000 and $1,250,000
    in 2004 and 2003, respectively.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | During 2000 and extending through the third quarter of 2003, the
    Companys reporting classification was that of a
    Development Stage Company. Revenues were insignificant during
    years 2000, 2001 and 2002. The respective increases in revenue
    were mainly due to the nature of the Companys
    subscription-based secure e-messaging business which is
    experiencing renewal rates of 95% combined with continued
    additions of new customers. Revenue growth was further bolstered
    by the acquisitions of MyDocOnline in January 2004 and
    PocketScript and Elron Software in July and September 2003.
    Increased revenues resulting from these acquisitions totaled
    $4.2 million and $1.3 million in 2004 and 2003,
    respectively. On March 11, 2005, the Web Inspector and
    Message Inspector product lines, which were acquired in the
    Elron acquisition, were sold to CyberGuard Corporation. During
    2004, these product lines contributed $4,073,000 to total
    revenues (see Note 22 to the consolidated financial
    statements).
|   
|(3) | In 2004, 2003, 2002, 2001 and 2000, expenses associated with
    continuing operations include non-cash stock-based compensation
    of $4.1 million, $1.0 million, $2.5 million,
    $8.4 million and $11.8 million, respectively. In 2001,
    cost of revenues includes a $3 million write-off of digital
    identification certificates. Selling, general and administrative
    expenses include advertising costs of $0.7 million,
    $1.4 million, $2.9 million, $4.5 million and
    $10.3 million for 2004, 2003, 2002, 2001 and 2000,
    respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(4) | During the third quarter of 2004, the Company determined that it
    would focus on the Companys two core markets and reduce
    costs relating to the Companys products and services in
    non-core markets. Accordingly, management determined that it
    would suspend research and development investment for the
    Connect service, which was a product acquired in the MyDocOnline
    acquisition, cease sales and marketing efforts to obtain new
    customers for the Connect service and, where reasonably feasible
    and appropriate, migrate existing Connect customers to other
    vendors. As a result, an impairment of the developed technology
    asset was recognized for $675,000 (see Notes 3 and 7 to the
    consolidated financial statements).                                                                                                                                                                                                                                                                                                                
|   
|(5) | In 2004, interest expense includes charges of $0.5 million,
    which relates to the purchase agreements with Omicron Master
    Trust and Amulet Limited (together with Omicron, the
    Investors), pursuant to which the Company issued and
    sold to the Investors $20 million aggregate principal
    amount of secured, convertible notes and related warrants. Also
    included in 2004, are charges of $0.3 million relating to
    the $3 million secured promissory note with Aventis in
    association with the MyDocOnline acquisition. In 2002, interest
    expense includes a non-recurring, non-cash charge of
    $1.7 million representing the beneficial conversion feature
    resulting from the issuance of notes payable convertible into
    shares of common stock at an effective price less than the fair
    market value of the common stock on the date the notes were
    issued (see Note 10 to the consolidated financial
    statements).                                                                                                                
|   
|(6) | In calculating the basic and diluted loss per common share for
    2003 and 2002, the Companys loss from continuing
    operations and net loss have been increased by $1.4 million
    and $3.2 million, respectively, representing the preferred
    stock dividends associated with the Series A and
    Series B convertible preferred stocks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(7) | Long-term obligations consist of convertible promissory notes
    payable totaling $17.2 million, promissory notes payable
    totaling $1.8 million and capital leases totaling
    $0.2 million. All notes payable are shown net of
    unamortized discounts. On March 16, 2005, the Company
    agreed with Investors to restructure the $20 million
    convertible promissory notes payable and related warrants (see
    Note 22 to the consolidated financial statements).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(8) | With regards to the outstanding shares in 2002, all of these
    shares and related accrued dividends were converted throughout
    2003 into shares of the Companys common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(9) | Working capital excludes restricted cash of $10.4 million
    and includes customer deposits and deferred revenue totaling
    $7.3 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations

Overview












16



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Critical Accounting Policies


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




Leases


Goodwill Goodwill and Other Intangible
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,


17



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18



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Software Development Costs




Stock-based Employee Compensation Accounting for Stock-Based
Compensation, Accounting for Stock Issued to Employees


Critical Accounting Estimates and Judgments




Property and Equipment, Depreciation


Long-Lived, Other Intangible Assets and
Goodwill


19



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Deferred Tax Assets Accounting for Income Taxes,




20



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Results of Operations




| |         
| | --------
| | Revenues





|               |  |                         |  |               |  |            |               |            |  |   |     |   |   |            |   |  |     |  
|-------------- |  | ----------------------- |  | ------------- |  | ---------- | ------------- | ---------- |  | - | --- | - | - | ---------- | - |  | --- | -
|               |  |                         |  | Variance      |  |            | Variance      |           
|               |  | Year Ended December 31, |  | 2004 vs. 2003 |  |            | 2003 vs. 2002 |           
|               |  |                         |  |               |  |            |               |           
|               |  | 2004                    |  | 2003          |  | 2002       |               | $          |  | % |     |   | $ |            | % | 
|               |  |                         |  |               |  |            |               |            |  |   |     |   |   |            |   | 
|Services       |  | $11,282,000             |  | $5,134,000    |  | $1,672,000 |               | $6,148,000 |  |   | 120 | % |   | $3,462,000 |   |  | 207 | %
|Hardware       |  | 1,519,000               |  |              |  |           |               | 1,519,000  |  |   | NA  |   |   |           |   |  |    |  
|Software       |  | 1,326,000               |  | 706,000       |  |           |               | 620,000    |  |   | 88  | % |   | 706,000    |   |  | NA  |  
|               |  |                         |  |               |  |            |               |            |  |   |     |   |   |            |   | 
|Total revenues |  | $14,127,000             |  | $5,840,000    |  | $1,672,000 |               | $8,287,000 |  |   | 142 | % |   | $4,168,000 |   |  | 249 | %
|               |  |                         |  |               |  |            |               |            |  |   |     |   |   |            |   | 









21



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22



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| |                 
| | ----------------
| | Cost of Revenues



23



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|                       |  |                         |            |          |               |   |           |               |  |   |           |  |  |   |           |  |   |  |    |   |  |   |          |   |  |  |    |   
|---------------------- |  | ----------------------- | ---------- | -------- | ------------- | - | --------- | ------------- |  | - | --------- |  |  | - | --------- |  | - |  | -- | - |  | - | -------- | - |  |  | -- | --
|                       |  |                         |            | Variance |               |   | Variance  |              
|                       |  | Year Ended December 31, |            |          | 2004 vs. 2003 |   |           | 2003 vs. 2002 | 
|                       |  |                         |            |          |               |   |           |               | 
|                       |  | 2004                    |            |          | 2003          |   |           | 2002          |  |   | $         |  |  | % |           |  | $ |  |    | % | 
|                       |  |                         |            |          |               |   |           |               |  |   |           |  |  |   |           |  |   |  |    |   | 
|Total cost of revenues |  | $                       | 15,878,000 |          |               | $ | 8,211,000 |               |  | $ | 8,999,000 |  |  | $ | 7,667,000 |  |   |  | 93 | % |  | $ | (788,000 | ) |  |  | (9 | %)

tm








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| |                                  
| | ---------------------------------
| | Research and Development Expenses





|                               |  |                         |           |          |               |   |           |               |  |   |           |  |  |   |           |  |   |  |    |   |  |   |          |   |  |  |    |   
|------------------------------ |  | ----------------------- | --------- | -------- | ------------- | - | --------- | ------------- |  | - | --------- |  |  | - | --------- |  | - |  | -- | - |  | - | -------- | - |  |  | -- | --
|                               |  |                         |           | Variance |               |   | Variance  |              
|                               |  | Year Ended December 31, |           |          | 2004 vs. 2003 |   |           | 2003 vs. 2002 | 
|                               |  |                         |           |          |               |   |           |               | 
|                               |  | 2004                    |           |          | 2003          |   |           | 2002          |  |   | $         |  |  | % |           |  | $ |  |    | % | 
|                               |  |                         |           |          |               |   |           |               |  |   |           |  |  |   |           |  |   |  |    |   | 
|Total research and development |  | $                       | 9,331,000 |          |               | $ | 5,896,000 |               |  | $ | 6,180,000 |  |  | $ | 3,435,000 |  |   |  | 58 | % |  | $ | (284,000 | ) |  |  | (5 | %)







| |                                             
| | --------------------------------------------
| | Selling, General and Administrative Expenses



|                                                   |  |                         |            |          |               |   |            |               |  |   |            |  |  |   |           |  |   |  |    |   |  |   |         |  |  |  |    | 
|-------------------------------------------------- |  | ----------------------- | ---------- | -------- | ------------- | - | ---------- | ------------- |  | - | ---------- |  |  | - | --------- |  | - |  | -- | - |  | - | ------- |  |  |  | -- | 
|                                                   |  |                         |            | Variance |               |   | Variance   |              
|                                                   |  | Year Ended December 31, |            |          | 2004 vs. 2003 |   |            | 2003 vs. 2002 | 
|                                                   |  |                         |            |          |               |   |            |               | 
|                                                   |  | 2004                    |            |          | 2003          |   |            | 2002          |  |   | $          |  |  | % |           |  | $ |  |    | % | 
|                                                   |  |                         |            |          |               |   |            |               |  |   |            |  |  |   |           |  |   |  |    |   | 
|Total selling, general and administrative expenses |  | $                       | 29,399,000 |          |               | $ | 19,907,000 |               |  | $ | 19,335,000 |  |  | $ | 9,492,000 |  |   |  | 48 | % |  | $ | 572,000 |  |  |  | 3% | 



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| |                        
| | -----------------------
| | Asset Impairment Charge



Accounting for the Impairment or Disposal of Long-Lived
Assets.




| |                 
| | ----------------
| | Interest Expense





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| |                            
| | ---------------------------
| | Investment and Other Income





| |                                           
| | ------------------------------------------
| | Recovery of Previously Impaired Investment





| |             
| | ------------
| | Income Taxes







| |                                
| | -------------------------------
| | Loss from Continuing Operations





| |                        
| | -----------------------
| | Discontinued Operations







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Liquidity and Capital Resources














28



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| |                                     
| | ------------------------------------
| | Actions Taken in First Quarter 2005:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Sale of Web Inspector/ Message Inspector (collectively the
    Inspector) Product Line: On March 11, 2005,
    the Company entered into an agreement to sell the Inspector
    product line to CyberGuard for $3,336,000 in cash, net of
    transaction fees totaling $290,000 (see Note 22 to the
    consolidated financial statements). These products operated on a
    cash neutral basis so their elimination will not impact the
    Companys on-going operating cash requirements. The sale
    does not include the current Inspector accounts receivable
    totaling approximately $374,000 which the Company anticipates
    collecting from customers in the near term.
|
| |  | Workforce Reductions: In January 2005, the Company
    reduced it workforce by approximately 10%. This was done
    selectively so that the core business operations and sales
    momentum would not be adversely impacted. The Company forecasts
    that the reduction will result in a net improvement of
    $2,500,000 to $3,000,000 in cash expenditures during 2005.                                                                                                                                                                                                                                                                                                            
|
| |  | Restructure $20,000,000 Convertible Promissory
    Notes Payable: The Company agreed to amend the terms of
    its convertible promissory notes payable on March 16, 2005
    (see Note 10 to the consolidated financial statements). The
    new terms will allow the Company to repay the first $5,000,000
    installment, which was scheduled to be paid in cash in November
    2005, in stock prior to July 31, 2005 (see Note 22 to
    the consolidated financial statements).                                                                                                                                                                                                  

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| |                                                                                              
| | ---------------------------------------------------------------------------------------------
| | Improvements from Secure Messaging as a result of the
    subscription model of the business:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Continued Growth of Secured e-Messaging Business: The
    Company expects incremental cash receipts in the range of
    $3,500,000 to 5,500,000 compared to 2004 for the Secure
    Messaging products. This growth is somewhat predicable based on
    past trends due to the subscription nature of the business,
    whereby, the Company has been consistently adding new annual
    service contracts while experiencing very minimal attrition of
    existing and renewing customers. At the low end of this range,
    the Company assumes they will collect contractually billed
    amounts, experience continued renewal rates of 95%, and continue
    new customer orders at the same rate demonstrated over the last
    2 years. Should new first year customer orders increase 20%
    quarter on quarter throughout 2005, the high end of the range
    should be reached.



Options and Warrants of ZixCorp Common Stock




|                     |  |                                             |            |               |                |   |              |             |  |             |           |  |  |   |             | 
|-------------------- |  | ------------------------------------------- | ---------- | ------------- | -------------- | - | ------------ | ----------- |  | ----------- | --------- |  |  | - | ----------- | 
|                     |  | Summary of Outstanding Options and Warrants |           
|                     |  |                                             |           
|                     |  |                                             |            | Vested Shares |                |   |             
|                     |  |                                             |            | Total Value   |                |   | (included in |             |  | Total Value |          
|                     |  | Outstanding                                 |            |               | of Outstanding |   |              | outstanding |  |             | of Vested | 
|Exercise Price Range |  | Shares                                      |            |               | Shares         |   |              | shares)     |  |             | Shares    | 
|                     |  |                                             |            |               |                |   |              |             |  |             |           | 
|$ 2.50 - $ 4.99      |  |                                             | 3,466,774  |               |                | $ | 14,395,000   |             |  |             | 2,073,194 |  |  | $ | 8,451,000   | 
|$ 5.00 - $ 5.75      |  |                                             | 1,822,468  |               |                |   | 9,423,000    |             |  |             | 1,318,614 |  |  |   | 6,898,000   | 
|$ 6.00 - $ 8.89      |  |                                             | 3,151,149  |               |                |   | 20,383,000   |             |  |             | 1,807,607 |  |  |   | 11,580,000  | 
|$ 9.00 - $19.75      |  |                                             | 1,989,162  |               |                |   | 23,054,000   |             |  |             | 1,102,222 |  |  |   | 13,662,000  | 
|$21.38 - $57.60      |  |                                             | 1,163,695  |               |                |   | 61,141,000   |             |  |             | 1,163,695 |  |  |   | 61,141,000  | 
|                     |  |                                             |            |               |                |   |              |             |  |             |           | 
|Total                |  |                                             | 11,593,248 |               |                | $ | 128,396,000  |             |  |             | 7,465,332 |  |  | $ | 101,732,000 | 
|                     |  |                                             |            |               |                |   |              |             |  |             |           | 

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Off-Balance Sheet Arrangements




Contractual Obligations and Contingent Liabilities and
Commitments




|                        |                        |                        |            |            |          |   |           |           |  |   |            |            |  |           |           |           |  |   |           |           | 
|----------------------- | ---------------------- | ---------------------- | ---------- | ---------- | -------- | - | --------- | --------- |  | - | ---------- | ---------- |  | --------- | --------- | --------- |  | - | --------- | --------- | 
|                        |                        | Payments Due by Period |           
|                        |                        |                        |           
|                        |                        | Total                  |            |            | < 1 Year |   |           | 1-3 Year  |  |   | 3-5 Years  |            |  | > 5 Years |          
|                        |                        |                        |            |            |          |   |           |           |  |   |            |            |  |           |          
|Long-term debt          |                        | $                      | 22,893,000 |            |          | $ | 5,193,000 |           |  | $ | 12,700,000 |            |  | $         | 5,000,000 |           |  | $ |          |          
|Operating leases        |                        |                        | 9,523,000  |            |          |   | 1,315,000 |           |  |   | 2,194,000  |            |  |           | 1,801,000 |           |  |   | 4,213,000 |          
|Capital lease           |                        |                        | 217,000    |            |          |   | 130,000   |           |  |   | 87,000     |            |  |           |          |           |  |   |          |          
|                        |                        |                        |            |            |          |   |           |           |  |   |            |            |  |           |          
|                        | Total cash obligations |                        |            | 32,633,000 |          |   |           | 6,638,000 |  |   |            | 14,981,000 |  |           |           | 6,801,000 |  |   |           | 4,213,000 | 
|Interest on obligations |                        |                        | 2,519,000  |            |          |   | 1,046,000 |           |  |   | 1,250,000  |            |  |           | 223,000   |           |  |   |          |          
|                        |                        |                        |            |            |          |   |           |           |  |   |            |            |  |           |          
|                        | Total                  |                        | $          | 35,152,000 |          |   | $         | 7,684,000 |  |   | $          | 16,231,000 |  |           | $         | 7,024,000 |  |   | $         | 4,213,000 | 
|                        |                        |                        |            |            |          |   |           |           |  |   |            |            |  |           |          







Recent Accounting Pronouncements


SFAS No. 123(R), Share-Based
Payment Share-Based Payment, Accounting for Stock-Based
Compensation Accounting for Stock Issued to Employees.






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EITF No. 04-8, The effect of Contingently
Convertible Instruments on Diluted Earning Per
Share The Effect of Contingently Convertible
Instruments on Diluted Earning Per Share


FSP FAS129-1, Disclosure Requirements under FASB
Statement No. 129 Relating to Contingently Financial
Instruments Disclosure
Requirements under FASB Statement No. 129 Relating to
Contingently Convertible Financial Instruments


Risks and Uncertainties


(In these risk factors, we, us,
our, and ZixCorp refer to Zix
Corporation and its wholly-owned subsidiaries.)


An investment in our common stock involves a high degree of
risk. You should carefully consider the following risk factors
in evaluating an investment in our common stock. The risks
described below are not the only ones that we face. Additional
risks that we do not yet know of or that we currently think are
immaterial may also impair our business operations. If any of
the following risks actually occurs, our business, financial
condition, or results of operations could be materially and
adversely affected. In such case, the trading price of our
common stock could decline, and you could lose all or part of
your investment. You should also refer to the other information
set forth in this report, including our consolidated financial
statements and the related notes.


We continue to use significant amounts of cash.


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The market may not broadly accept our e-messaging and
e-prescribing products and services and related applications and
services, which would prevent us from operating
profitably.


Failure to enter into new sponsorship agreements for or
generate other revenue opportunities from our PocketScript
e-prescribing service could harm our business.




Competition in our businesses is expected to increase,
which could cause our business to fail.






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Our inability to successfully and timely develop and
introduce new e-messaging, e-prescribing, and e-transaction
products and related applications and services and to implement
technological changes could harm our business.




If the market for secure e-messaging, e-prescribing, and
e-transaction products and related applications and services
does not continue to grow, demand for our services will be
adversely affected.


If healthcare providers fail to adopt the PocketScript and
MyDocOnline solutions, we will fail to achieve the critical mass
of physicians and patients to build a successful
business.


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Capacity limits on our technology and network hardware and
software may be difficult to project, and we may not be able to
expand and upgrade our systems to meet increased use, which
would result in reduced revenues.


Security interruptions to our data centers could disrupt
our business, and any security breaches could expose us to
liability and negatively impact customer demand for our
services.








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Pending litigation could have a material impact on our
operating results and financial condition.






We may have to defend our rights in intellectual property
that we use in our services, which could be disruptive and
expensive to our business.


Defects or errors in our services could harm our
business.


Public key cryptography technology is subject to
risks.


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We depend on key personnel.


We could be affected by government regulation.




Our stock price may be volatile.


Our directors and executive officers own a substantial
percentage of our securities. Their ownership could enable them
to exercise significant control over corporate decisions and to
implement corporate acts that are not in the best interests of
our shareholders as a group.


One investor owns a large percentage of our outstanding
stock and could significantly influence the outcome of
actions.


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We have a substantial amount of debt and may be unable to
service or refinance this debt or servicing this debt may
restrict cash available for our business operations.




| |   |                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | result in our inability to comply with the financial and other
    restrictive covenants in the notes, which among other things,
    require us to maintain specified cash levels and limit our
    ability to incur debt and sell assets, which could, in turn,
    result in an event of default that if not cured or waived could
    have a material adverse effect on our operations;
|
| |  | require us to dedicate a substantial portion of our cash flow
    from operations to make scheduled principal payments on our debt
    or to meet required cash reserves, thereby reducing the
    availability of our cash flow for working capital, capital
    investments, and other business activities;                                                                             
|
| |  | increase our vulnerability to adverse industry and general
    economic conditions;                                                                                                                                                                                                                                                                                                       
|
| |  | limit our ability to obtain additional financing to fund future
    working capital, capital investments, and other business
    activities;                                                                                                                                                                                                                                              
|
| |  | limit our ability to refinance our indebtedness on terms that
    are commercially reasonable or at all; and                                                                                                                                                                                                                                                                              
|
| |  | limit our flexibility to plan for, and react to, changes in our
    business and our industry.                                                                                                                                                                                                                                                                                            

We have a significant amount of convertible securities,
including the convertible promissory notes payable (the
Notes) and the warrants, outstanding and may issue
additional equity securities in the future. Conversion or
redemption of the Notes into our common stock, exercise of the
warrants and issuance or conversion of other securities will
dilute the ownership interests of existing shareholders.




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We may have liability for indemnification claims arising
from the sale of our Web Inspector and Message Inspector product
lines.


We may encounter other unanticipated risks and
uncertainties in the markets we serve or in developing new
products and services, and we cannot assure that we will be
successful in responding to any unanticipated risks or
uncertainties.





NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS











|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About Market
    Risk



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|        |                                            
|------- | -------------------------------------------
|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,


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Annual Report on Form 10-K


Managements Report on Internal Control Over Financial
Reporting




Internal Control  Integrated Framework


Changes in Internal Controls over Financial Reporting




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Report of Independent Registered Public Accounting Firm






Internal Control 
Integrated Framework














| |                          
| | -------------------------
| | /s/ Deloitte &
    Touche





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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 Accounting Fees and Services



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PART IV







|         |                                       
|-------- | --------------------------------------
|Item 15. | Exhibits, Financial Statement Schedule

Financial Statements




Financial Statement Schedules




Exhibits


|        |   |    |  |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|------- | - | -- |  | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |    |  |            
|Number  |   |    |  | Description
|        |   |    |  |            
|        | 2 | .1 |  |            |  | Asset Purchase Agreement, dated as of January 30, 2004, by
    and among Zix Corporation, MyDocOnline, Inc., Aventis
    Pharmaceuticals Holdings Inc., and Aventis Pharmaceuticals Inc.
    (excluding schedules and exhibits). Filed as Exhibit 2.1 to
    Zix Corporations Form 8-K, dated February 10, 2004,
    and incorporated herein by reference.                                                                                                                                                                                                                                                         
|        | 2 | .2 |  |            |  | Purchase Agreement, dated as of November 1, 2004, by and
    between Zix Corporation and Omicron Master Trust (excluding
    schedules and exhibits). Filed as Exhibit 4.1 to Zix
    Corporations Form 8-K, dated November 4, 2004, and
    incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                     
|        | 2 | .3 |  |            |  | Purchase Agreement, dated as of November 1, 2004, by and
    between Zix Corporation and Amulet Limited (excluding schedules
    and exhibits). Filed as Exhibit 4.2 to Zix
    Corporations Form 8-K, dated November 4, 2004, and
    incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                           
|        | 2 | .4 |  |            |  | Asset Purchase Agreement, dated July 22, 2003, between Zix
    Corporation and Pocket Script L.L.C. (excluding schedules and
    exhibits). Filed as Exhibit 4.1 to Zix Corporations
    Form 8-K, dated July 23, 2003, and incorporated herein
    by reference.                                                                                                                                                                                                                                                                                                                                                  
|        | 2 | .5 |  |            |  | Asset Purchase Agreement, dated September 2, 2003, among
    Zix Corporation, Zix Acquisition Corporation, Elron Software,
    Inc., Elron Electronic Industries, Ltd., and Elron Software
    (2000), Ltd. (excluding schedules and exhibits). Filed as
    Exhibit 4.1 to Zix Corporations Form 8-K, dated
    September 4, 2003, and incorporated herein by reference.                                                                                                                                                                                                                                          
|        | 2 | .6 |  |            |  | Asset Purchase Agreement, entered into as of March 11,
    2005, by and between CyberGuard Corporation and Zix SCM, Inc.
    (excluding the Disclosure Schedule and Annexes). Filed as
    Exhibit 2.1 to Zix Corporations Form 8-K, dated
    March 17, 2005, and incorporated herein by reference.                                                                                                                                                                                                                                                                                                               
|        | 2 | .7 |  |            |  | Promissory Note, dated March 11, 2005, payable by
    CyberGuard Corporation in the original principal amount of
    $1,500,000. Filed as Exhibit 2.2 to Zix Corporations
    Form 8-K, dated March 17, 2005, and incorporated herein by
    reference.                                                                                                                                                                                                                                                                                                                                                            
|        | 3 | .1 |  |            |  | Articles of Amendment to the Articles of Incorporation of Zix
    Corporation, as filed with the Texas Secretary of State on
    August 1, 2002. Filed as Exhibit 3.1 to Zix
    Corporations Quarterly Report on Form 10-Q for the
    quarterly period ended June 30, 2002, and incorporated
    herein by reference. Restated Articles of Incorporation of Zix
    Corporation, as filed with the Texas Secretary of State on
    December 4, 2001. Filed as Exhibit 3.1 to Zix
    Corporations Annual Report on Form 10-K for the year
    ended December 31, 2001, and incorporated herein by
    reference.
|        | 3 | .2 |  |            |  | Restated Bylaws of Zix Corporation, dated October 30, 2002.
    Filed as Exhibit 3.2 to Zix Corporations Quarterly
    Report on Form 10-Q for the quarterly period ended
    September 30, 2002, and incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                                                            
|        | 4 | .1 |  |            |  | 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.                                                                                                                                                                                                                                                                                                                                                                                              

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|        |   |     |  |   |             |                                                                                                                                                                                                                                                                                                                         
|------- | - | --- |  | - | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |     |  |   |            
|Number  |   |     |  |   | Description
|        |   |     |  |   |            
|        | 4 | .2  |  |  |             | Form of Common Stock Warrant Certificate. Filed as Exhibit 4.1
    in Zix Corporations Registration Statement on
    Form S-3 (Commission No. 333-83934), dated
    March 7, 2002, and incorporated herein by reference.                                                                                               
|        | 4 | .3  |  |  |             | Form of Warrant, dated September 18, 2002, to purchase
    shares of common stock of Zix Corporation, issued by Zix
    Corporation. Filed as Exhibit 4.2 to Zix Corporations
    Form 8-K, dated September 20, 2002, and incorporated
    herein by reference.                                                        
|        | 4 | .4  |  |  |             | Form of Warrant, dated September 18, 2002, to purchase
    shares of common stock of Zix Corporation, issued by Zix
    Corporation. Filed as Exhibit 4.6 to Zix Corporations
    Form 8-K, dated September 20, 2002, and incorporated
    herein by reference.                                                        
|        | 4 | .5  |  |  |             | Form of Warrant to purchase shares of common stock of Zix
    Corporation, issued by Zix Corporation. Filed as
    Exhibit 4.2 to Zix Corporations Form 8-K, dated
    March 4, 2003, and incorporated herein by reference.                                                                                            
|        | 4 | .6  |  |  |             | Warrant, dated as of January 30, 2004, of Zix Corporation
    to Aventis Holdings Inc. for the purchase of 145,853 shares
    of Zix Corporations common stock. Filed as
    Exhibit 4.4 to Zix Corporations Form 8-K, dated
    February 10, 2004, and incorporated herein by reference.                             
|        | 4 | .7  |  |  |             | Form of Common Stock Purchase Warrant, dated as of
    November 2, 2004, issued by Zix Corporation. Filed as
    Exhibit 4.4 to Zix Corporations Form 8-K, dated
    November 4, 2004, and incorporated herein by reference.                                                                                           
|        | 4 | .8  |  |  |             | Secured Promissory Note of Zix Corporation to Aventis Inc.,
    dated January 30, 2004, in the original principal amount of
    $3,000,000. Filed as Exhibit 4.1 to Zix Corporations
    Form 8-K, dated February 10, 2004, and incorporated
    herein by reference.                                                  
|        | 4 | .9  |  |  |             | Security Agreement, dated as of January 30, 2004, by and
    between Zix Corporation and Aventis Inc. Filed as Exhibit 4.3 to
    Zix Corporations Form 8-K, dated February 10, 2004,
    and incorporated herein by reference.                                                                                        
|        | 4 | .10 |  |  |             | Form of Convertible Note Due 2005 - 2008 of Zix
    Corporation, dated as of November 2, 2004 (including
    exhibits). Filed as Exhibit 4.3 to Zix Corporations
    Form 8-K, dated November 4, 2004, and incorporated
    herein by reference.                                                                       
|        | 4 | .11 |  |  |             | Security Agreement, dated as of November 2, 2004, made by
    Zix Corporation to Law Offices of Brian W. Pusch, as collateral
    agent on behalf of the holders named therein. Filed as
    Exhibit 4.6 to Zix Corporations Form 8-K, dated
    November 4, 2004, and incorporated herein by reference.               
|        | 4 | .12 |  |  |             | Registration Rights Agreement, dated September 16, 2002, by
    and among Zix Corporation and the Investors named therein. Filed
    as Exhibit 4.3 to Zix Corporations Form 8-K, dated
    September 20, 2002, and incorporated herein by reference.                                                                  
|        | 4 | .13 |  |  |             | Registration Rights Agreement, dated September 17, 2002, by
    and among Zix Corporation and the Buyers named therein. Filed as
    Exhibit 4.7 to Zix Corporations Form 8-K, dated
    September 20, 2002, and incorporated herein by reference.                                                                     
|        | 4 | .14 |  |  |             | 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 Form 8-K, dated July 23, 2003,
    and incorporated herein by reference.                                                                                        
|        | 4 | .15 |  |  |             | Registration Rights Agreement, dated September 2, 2003,
    between Zix Corporation and Elron Software, Inc. Filed as
    Exhibit 4.3 to Zix Corporations Form 8-K, dated
    September 4, 2003, and incorporated herein by reference.                                                                                 
|        | 4 | .16 |  |  |             | 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 Form 8-K,
    dated February 10, 2004, and incorporated herein by
    reference.
|        | 4 | .17 |  |  |             | Form of Registration Rights Agreement, dated as of
    November 2, 2004, by and between Zix Corporation and the
    Investors named therein. Filed as Exhibit 4.5 to Zix
    Corporations Form 8-K, dated November 4, 2004,
    and incorporated herein by reference.                                                  

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|        |    |      |  |   |             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------- | -- | ---- |  | - | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |   |            
|Number  |    |      |  |   | Description
|        |    |      |  |   |            
|        | 10 | .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, dated
    May 4, 2001. Filed as Exhibit 10.1 to Zix
    Corporations Quarterly Report on Form 10-Q for the
    quarterly period ended March 31, 2001, and incorporated
    herein by reference.                                                                                                                                                                                                                                                                                                                                                                                                       
|        | 10 | .7  |  |  |             | Zix Corporations 2001 Stock Option Plan (Amended and
    Restated as of May 6, 2003). Filed as Exhibit 10.7 to
    Zix Corporations Annual Report on Form 10-K for the year
    ended December 31, 2003, 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,
    dated October 1, 2003. Filed as Exhibit 10.9 to Zix
    Corporations Annual Report on Form 10-K for the year ended
    December 31, 2003, and incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                                                                                             
|        | 10 | .10 |  |  |             | Zix Corporation 2004 Stock Option Plan, dated May 6, 2004.
    Filed as Exhibit 10.1 to Zix Corporations Quarterly
    Report on Form 10-Q for the quarterly period ended
    March 31, 2004, and incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | 10 | .11 |  |  |             | 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 | .12  |  |  |             | 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 | .13  |  |  |             | 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 | .14 |  |  |             | Stock Option Agreement, effective as of November 14, 2001,
    between John Ryan and Zix Corporation. Filed as Exhibit 4.2
    in Zix Corporations Registration Statement on
    Form S-8 (Registration No. 333-74890), dated
    December 11, 2001, and incorporated herein by reference.
    Portions of this exhibit were omitted pursuant to a request for
    confidential treatment that was filed with the SEC on
    November 26, 2001. On December 5, 2001, the SEC
    approved the filing of this exhibit omitting the portions for
    which confidential treatment was requested. The omitted
    information has been filed with the SEC.
|        | 10 | .15 |  |  |             | Employment Agreement, effective as of November 14, 2001,
    between John Ryan and Zix Corporation. Filed as Exhibit 4.1
    in Zix Corporations Registration Statement on
    Form S-8 (Registration No. 333-74890), dated
    December 11, 2001, and incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                                               

47



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|        |    |       |  |   |             |                                                                                                                                                                                                                                                                                                                                                  
|------- | -- | ----- |  | - | ----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |       |  |   |            
|Number  |    |       |  |   | Description
|        |    |       |  |   |            
|        | 10 | .16  |  |  |             | Employment Agreement, entered into as of January 20, 2004,
    between Zix Corporation and Richard Spurr. Filed as
    Exhibit 10.14 to Zix Corporations Annual Report on
    Form 10-K for the year ended December 31, 2003, and
    incorporated herein by reference.                                                                         
|        | 10 | .17  |  |  |             | Stock Option Agreement, dated February 24, 2004, between
    Zix Corporation and Richard Spurr. 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 | .18* |  |  |             | Stock Option Agreement, dated November 17, 2004, between
    Zix Corporation and Richard D. Spurr.                                                                                                                                                                                                                                               
|        | 10 | .19* |  |  |             | Form of Zix Corporation Stock Option Agreement between Zix
    Corporation and Brad Almond and Ronald A. Woessner.                                                                                                                                                                                                                               
|        | 10 | .20  |  |  |             | Form of Outside Director Stock Option Agreement, dated
    January 2, 2004, between Zix Corporation and James S.
    Marston, Dr. Ben G. Streetman and Michael E. Keane. 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 | .21  |  |  |             | Outside Director Stock Option Agreement, dated May 6, 2004,
    between Zix Corporation and Antonio R. Sanchez III. Filed
    as Exhibit 10.4 to Zix Corporations Quarterly Report
    on Form 10-Q for the quarterly period ended June 30,
    2004, and incorporated herein by reference.                                                     
|        | 10 | .22  |  |  |             | 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 | .23  |  |  |             | 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.                                                                                
|        | 10 | .24* |  |  |             | Description of Compensation for Members of Zix Corporation Board
    of Directors.                                                                                                                                                                                                                                                               
|        | 10 | .25   |  |  |             | Lease Agreement, dated December 29, 2003, between Zix
    Corporation and 7-Eleven, Inc. (excluding exhibits). 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 | .26*  |  |  |             | Office Lease Agreement, dated February 28, 2005, between
    Gateway Rosewood, Inc. and Zix SCM, Inc.                                                                                                                                                                                                                                            
|        | 10 | .27   |  |  |             | Lease Agreement, dated November 27, 2000, between
    MyDocOnline, Inc. and Ft. Round Rock Ltd. and related
    Amendments No. 1 and No. 2 (excluding exhibits). 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 | .28*  |  |  |             | Amendment No. 3 to Lease Agreement, dated November 27,
    2000, between MyDocOnline, Inc. and Ft. Round Rock Ltd., as
    amended.                                                                                                                                                                                                              
|        | 10 | .29   |  |  |             | Sublease Agreement, dated August 1, 2002, between Zix
    Corporation, Optiwave Corporation and Waidt
    Construction &Developments LTD (excluding schedules and
    exhibits). Filed as Exhibit 10.23 to Zix Corporations
    Annual Report on Form 10-K for the year ended
    December 31, 2002, and incorporated herein by reference.      
|        | 10 | .30   |  |  |             | Sublease Amendment Agreement, dated September 30, 2002,
    between Zix Corporation, Optiwave Corporation and Waidt
    Construction & Developments LTD (excluding exhibits).
    Filed as Exhibit 10.24 to Zix Corporations Annual
    Report on Form 10-K for the year ended December 31,
    2002, and incorporated herein by reference.     
|        | 10 | .31   |  |  |             | Sublease Amendment Agreement, dated November 19, 2002,
    between Zix Corporation, Optiwave Corporation and Waidt
    Construction & Developments LTD (excluding exhibits).
    Filed as Exhibit 10.25 to Zix Corporations Annual
    Report on Form 10-K for the year ended December 31,
    2002, and incorporated herein by reference.      
|        | 10 | .32   |  |  |             | Sublease Amendment Agreement, dated July 17, 2003, between
    Zix Corporation, Optiwave Corporation and Waidt
    Construction & Developments LTD (excluding exhibits).
    Filed as Exhibit 10.32 to Zix Corporations Annual
    Report on Form 10-K for the year ended December 31, 2003,
    and incorporated herein by reference.          

48



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|        |    |      |  |   |             |                                                                                                                                                                                                                                                                                                                                                                                        
|------- | -- | ---- |  | - | ----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |   |            
|Number  |    |      |  |   | Description
|        |    |      |  |   |            
|        | 10 | .33  |  |  |             | 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 | .34  |  |  |             | Lease, dated March 9, 2004, between Duke Realty Ohio and
    PocketScript, Inc. (excluding exhibits). 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 | .35* |  |  |             | Office Lease Agreement, dated December 31, 2004, between
    MyDocOnline, Inc. and Coneca Properties, LTD.                                                                                                                                                                                                                                                                             
|        | 10 | .36  |  |  |             | Master Services Agreement, dated January 30, 2004, by and
    between Zix Corporation and Aventis Inc. Filed as Exhibit 10.1
    to Zix Corporations Form 8-K, dated February 10,
    2004, and incorporated herein by reference. Portions of this
    exhibit were omitted and filed separately with the SEC pursuant
    to a request for confidential treatment filed with the SEC.
|        | 10 | .37* |  |  |             | Letter Agreement, dated September 12, 2004, amending the
    Master Services Agreement, dated January 30, 2004, by and
    between Zix Corporation and Aventis Inc.                                                                                                                                                                                                                    
|        | 10 | .38* |  |  |             | Amendment No. 2 to Master Services Agreement, dated
    March 7, 2005, between Zix Corporation and Aventis Inc. and
    a member of the Sanofi-Aventis Group.                                                                                                                                                                                                                          
|        | 16 | .1   |  |  |             | Letter From Ernst & Young LLP to the SEC. Filed as
    Exhibit 16.1 to Zix Corporations Form 8-K, dated
    June 23, 2004, and incorporated herein by reference.                                                                                                                                                                                                                      
|        | 21 | .1*  |  |  |             | Subsidiaries of Zix Corporation.                                                                                                                                                                                                                                                                                                                                                       
|        | 23 | .1*  |  |  |             | Consent of Independent Registered Public Accounting Firm
    (Deloitte & Touche, LLP).                                                                                                                                                                                                                                                                                                 
|        | 23 | .2*  |  |  |             | Consent of Independent Registered Public Accounting Firm
    (Ernst & Young, LLP).                                                                                                                                                                                                                                                                                                     
|        | 31 | .1*  |  |  |             | Certification of Richard D. Spurr, President, Chief Operating
    Officer, and Chief Executive Officer of the Company, pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                  
|        | 31 | .2*  |  |  |             | Certification of Bradley C. Almond, Vice President, Chief
    Financial Officer, and Treasurer of the Company, pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                          
|        | 32 | .1*  |  |  |             | Certification of Richard D. Spurr, President, Chief Operating
    Officer, and Chief Executive Officer of the Company and Bradley
    C. Almond, Vice President, Chief Financial Officer, and
    Treasurer of the Company, pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                             






|  |                
|- | ---------------
|* | Filed herewith.



|  |                                                         
|- | --------------------------------------------------------
| | Management contract or compensatory plan or arrangement.

49



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##### Table of Contents






SIGNATURES






| |                
| | ---------------
| | Zix Corporation



| |     |                      
| | --- | ---------------------
| | By: | /s/ Bradley C. Almond

| |                                      
| | -------------------------------------
| |                                      
| | Bradley C. Almond                    
| | Vice President,                      
| | Chief Financial Officer and Treasurer



|                                                           |  |                                                                                                        |  | 
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------ |  | 
|Signature                                                  |  | Title                                                                                                 
|                                                           |  |                                                                                                       
|                                                          
|/s/ John A. Ryan(John
    A. Ryan)                         |  | Chairman and Director                                                                                 
|                                                          
|/s/ Richard D. Spurr(Richard
    D. Spurr)                 |  | Chief Executive Officer, President and
    Chief Operating Officer
    (Principal Executive Officer)  
|                                                          
|/s/ Bradley C. Almond(Bradley
    C. Almond)               |  | Vice President, Chief Financial Officer and Treasurer
    (Principal Financial and Accounting Officer)
|                                                          
|/s/ Michael E. Keane(Michael
    E. Keane)                 |  | Director                                                                                              
|                                                          
|/s/ James S. Marston(James
    S. Marston)                 |  | Director                                                                                              
|                                                          
|/s/ Antonio R.
    Sanchez III(Antonio
    R. Sanchez III) |  | Director                                                                                              
|                                                          
|/s/ Dr. Ben G.
    Streetman(Dr. Ben
    G. Streetman)     |  | Director                                                                                              

50



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##### Table of Contents






INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


|                                                                                                                                             |  |  |     | 
|-------------------------------------------------------------------------------------------------------------------------------------------- |  |  | --- | 
|Reports of Independent Registered Public
    Accounting Firms                                                                                |  |  | F-2 | 
|Consolidated Balance Sheets at
    December 31, 2004 and 2003                                                                                |  |  | F-4 | 
|Consolidated Statements of Operations for
    the years ended December 31, 2004, 2003 and 2002                                               |  |  | F-5 | 
|Consolidated Statements of Convertible
    Preferred Stock and Stockholders Equity for the years
    ended December 31, 2004, 2003 and 2002 |  |  | F-6 | 
|Consolidated Statements of Cash Flows for
    the years ended December 31, 2004, 2003 and 2002                                               |  |  | F-7 | 
|Notes to Consolidated Financial
    Statements                                                                                               |  |  | F-8 | 

F-1



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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM












Internal Control 
Integrated Framework




| |                              
| | -----------------------------
| | /s/ Deloitte &
    Touche LLP





F-2



---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM














| |                          
| | -------------------------
| | /s/ Ernst & Young
    LLP





F-3



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##### Table of Contents



ZIX CORPORATION


CONSOLIDATED BALANCE SHEETS


|                                          |                                                                                                                                                                                         |                             |            |              |            |   |            |              |            | 
|----------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ---------- | ------------ | ---------- | - | ---------- | ------------ | ---------- | 
|                                          |                                                                                                                                                                                         | December 31,                |           
|                                          |                                                                                                                                                                                         |                             |           
|                                          |                                                                                                                                                                                         | 2004                        |            |              | 2003       |  
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|ASSETS                                   
|Current assets:                           |                                                                                                                                                                                         |                             |            |              |            |   |            |             
|                                          | Cash and cash equivalents                                                                                                                                                               |                             | $          | 3,856,000    |            |   | $          | 6,599,000    |           
|                                          | Marketable securities                                                                                                                                                                   |                             |            | 16,000,000   |            |   |            | 6,982,000    |           
|                                          | Receivables, net                                                                                                                                                                        |                             |            | 561,000      |            |   |            | 359,000      |           
|                                          | Prepaid and other current assets                                                                                                                                                        |                             |            | 1,950,000    |            |   |            | 1,147,000    |           
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                          |                                                                                                                                                                                         | Total current assets        |            |              | 22,367,000 |   |            |              | 15,087,000 | 
|Restricted cash                           |                                                                                                                                                                                         |                             | 10,374,000 |              |            |   | 271,000    |             
|Property and equipment, net               |                                                                                                                                                                                         |                             | 5,024,000  |              |            |   | 3,151,000  |             
|Intangible assets, net                    |                                                                                                                                                                                         |                             | 3,832,000  |              |            |   | 3,589,000  |             
|Goodwill                                  |                                                                                                                                                                                         |                             | 9,119,000  |              |            |   | 4,321,000  |             
|Deferred financing costs and other assets |                                                                                                                                                                                         |                             | 1,526,000  |              |            |   |           |             
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                          |                                                                                                                                                                                         | $                           | 52,242,000 |              |            | $ | 26,419,000 |             
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                         
|LIABILITIES AND STOCKHOLDERS EQUITY     
|Current liabilities:                      |                                                                                                                                                                                         |                             |            |              |            |   |            |             
|                                          | Accounts payable                                                                                                                                                                        |                             | $          | 1,234,000    |            |   | $          | 516,000      |           
|                                          | Accrued expenses                                                                                                                                                                        |                             |            | 4,709,000    |            |   |            | 3,222,000    |           
|                                          | Deferred revenue                                                                                                                                                                        |                             |            | 6,372,000    |            |   |            | 4,066,000    |           
|                                          | Customer deposit                                                                                                                                                                        |                             |            | 968,000      |            |   |            |             |           
|                                          | Capital lease obligations                                                                                                                                                               |                             |            | 130,000      |            |   |            |             |           
|                                          | Short-term note payable                                                                                                                                                                 |                             |            | 193,000      |            |   |            |             |           
|                                          | Convertible promissory notes payable                                                                                                                                                    |                             |            | 3,848,000    |            |   |            |             |           
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                          |                                                                                                                                                                                         | Total current liabilities   |            |              | 17,454,000 |   |            |              | 7,804,000  | 
|Long-term liabilities:                    |                                                                                                                                                                                         |                             |            |              |            |   |            |             
|                                          | Deferred revenue                                                                                                                                                                        |                             |            | 1,731,000    |            |   |            | 696,000      |           
|                                          | Customer deposit                                                                                                                                                                        |                             |            | 3,000,000    |            |   |            |             |           
|                                          | Convertible promissory notes payable                                                                                                                                                    |                             |            | 13,347,000   |            |   |            |             |           
|                                          | Promissory notes payable                                                                                                                                                                |                             |            | 1,840,000    |            |   |            |             |           
|                                          | Capital lease obligations and other                                                                                                                                                     |                             |            | 105,000      |            |   |            |             |           
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                          |                                                                                                                                                                                         | Total long-term liabilities |            |              | 20,023,000 |   |            |              | 696,000    | 
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                          |                                                                                                                                                                                         |                             | 37,477,000 |              |            |   | 8,500,000  |             
|Commitments and contingencies (Note 15)   |                                                                                                                                                                                         |                             |            |              |            |   |            |             
|                                         
|Stockholders equity:                     |                                                                                                                                                                                         |                             |            |              |            |   |            |             
|                                          | Preferred stock, $1 par value, 10,000,000 shares
    authorized;
    none issued and outstanding                                                                                        |                             |            |             |            |   |            |             |           
|                                          | Common stock, $0.01 par value, 175,000,000 shares
    authorized;
    34,584,406 issued and 32,257,225 outstanding in 2004 and
    31,155,646 issued and 28,828,465 outstanding in 2003 |                             |            | 346,000      |            |   |            | 312,000      |           
|                                          | Additional paid-in capital                                                                                                                                                              |                             |            | 269,406,000  |            |   |            | 230,554,000  |           
|                                          | Treasury stock, at cost; 2,327,181 common shares in 2004 and 2003                                                                                                                       |                             |            | (11,507,000  | )          |   |            | (11,507,000  | )         
|                                          | Accumulated deficit                                                                                                                                                                     |                             |            | (243,480,000 | )          |   |            | (201,440,000 | )         
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                          |                                                                                                                                                                                         | Total stockholders equity  |            |              | 14,765,000 |   |            |              | 17,919,000 | 
|                                          |                                                                                                                                                                                         |                             |            |              |            |  
|                                          |                                                                                                                                                                                         | $                           | 52,242,000 |              |            | $ | 26,419,000 |             
|                                          |                                                                                                                                                                                         |                             |            |              |            |  



F-4



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##### Table of Contents



ZIX CORPORATION


CONSOLIDATED STATEMENTS OF OPERATIONS


|                                                    |                                              |                              |             |            |            |   |             |            |            |   |             |            |            |  
|--------------------------------------------------- | -------------------------------------------- | ---------------------------- | ----------- | ---------- | ---------- | - | ----------- | ---------- | ---------- | - | ----------- | ---------- | ---------- | -
|                                                    |                                              | Year Ended December 31,      |            
|                                                    |                                              |                              |            
|                                                    |                                              | 2004                         |             |            | 2003       |   |             | 2002       |           
|                                                    |                                              |                              |             |            |            |   |             |            |           
|Revenues:                                           |                                              |                              |             |            |            |   |             |            |            |   |             |           
|                                                    | Services                                     |                              | $           | 11,282,000 |            |   | $           | 5,134,000  |            |   | $           | 1,672,000  |           
|                                                    | Hardware                                     |                              |             | 1,519,000  |            |   |             |           |            |   |             |           |           
|                                                    | Software                                     |                              |             | 1,326,000  |            |   |             | 706,000    |            |   |             |           |           
|                                                    |                                              |                              |             |            |            |   |             |            |           
|                                                    |                                              | Total revenues               |             |            | 14,127,000 |   |             |            | 5,840,000  |   |             |            | 1,672,000  |  
|Costs and expenses:                                 |                                              |                              |             |            |            |   |             |            |            |   |             |           
|                                                    | Cost of revenues                             |                              |             | 15,878,000 |            |   |             | 8,211,000  |            |   |             | 8,999,000  |           
|                                                    | Research and development expenses            |                              |             | 9,331,000  |            |   |             | 5,896,000  |            |   |             | 6,180,000  |           
|                                                    | Selling, general and administrative expenses |                              |             | 29,399,000 |            |   |             | 19,907,000 |            |   |             | 19,335,000 |           
|                                                    | Asset impairment charge                      |                              |             | 675,000    |            |   |             |           |            |   |             |           |           
|                                                    |                                              |                              |             |            |            |   |             |            |           
|                                                    |                                              | Total costs and expenses     |             |            | 55,283,000 |   |             |            | 34,014,000 |   |             |            | 34,514,000 |  
|                                                    |                                              |                              |             |            |            |   |             |            |           
|Operating loss                                      |                                              |                              | (41,156,000 | )          |            |   | (28,174,000 | )          |            |   | (32,842,000 | )         
|Other (expense) income:                             |                                              |                              |             |            |            |   |             |            |            |   |             |           
|                                                    | Investment and other income                  |                              |             | 332,000    |            |   |             | 138,000    |            |   |             | 319,000    |           
|                                                    | Interest expense                             |                              |             | (801,000   | )          |   |             | (13,000    | )          |   |             | (2,141,000 | )         
|                                                    | Recovery of previously impaired investment   |                              |             | 70,000     |            |   |             | 530,000    |            |   |             | 96,000     |           
|                                                    |                                              |                              |             |            |            |   |             |            |           
|                                                    |                                              | Total other (expense) income |             |            | (399,000   | ) |             |            | 655,000    |   |             |            | (1,726,000 | )
|                                                    |                                              |                              |             |            |            |   |             |            |           
|Loss from continuing operations before income taxes |                                              |                              | (41,555,000 | )          |            |   | (27,519,000 | )          |            |   | (34,568,000 | )         
|Income taxes                                        |                                              |                              | (485,000    | )          |            |   | (148,000    | )          |            |   | 269,000     |           
|                                                    |                                              |                              |             |            |            |   |             |            |           
|Loss from continuing operations                     |                                              |                              | (42,040,000 | )          |            |   | (27,667,000 | )          |            |   | (34,299,000 | )         
|Discontinued operations                             |                                              |                              |            |            |            |   | 89,000      |            |            |   | 862,000     |           
|                                                    |                                              |                              |             |            |            |   |             |            |           
|Net loss                                            |                                              | $                            | (42,040,000 | )          |            | $ | (27,578,000 | )          |            | $ | (33,437,000 | )         
|                                                    |                                              |                              |             |            |            |   |             |            |           
|Basic and diluted loss per common share:            |                                              |                              |             |            |            |   |             |            |            |   |             |           
|                                                    | Continuing operations                        |                              | $           | (1.33      | )          |   | $           | (1.23      | )          |   | $           | (2.07      | )         
|                                                    | Discontinued operations                      |                              |             |           |            |   |             |           |            |   |             | 0.05       |           
|                                                    |                                              |                              |             |            |            |   |             |            |           
|                                                    | Net loss                                     |                              | $           | (1.33      | )          |   | $           | (1.23      | )          |   | $           | (2.02      | )         
|                                                    |                                              |                              |             |            |            |   |             |            |           
|Weighted average common shares outstanding          |                                              |                              | 31,533,000  |            |            |   | 23,525,077  |            |            |   | 18,128,796  |           
|                                                    |                                              |                              |             |            |            |   |             |            |           



F-5



---



##### Table of Contents



ZIX CORPORATION


CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS EQUITY


|                           |                                                                                                     |                       |           |              |        |                      |            |            |   |          |            |           |             |         |         |               |       |   |             |            |   |   |             |         |   |   |              |             |   |   |            |             |  
|-------------------------- | --------------------------------------------------------------------------------------------------- | --------------------- | --------- | ------------ | ------ | -------------------- | ---------- | ---------- | - | -------- | ---------- | --------- | ----------- | ------- | ------- | ------------- | ----- | - | ----------- | ---------- | - | - | ----------- | ------- | - | - | ------------ | ----------- | - | - | ---------- | ----------- | -
|                           |                                                                                                     |                       |           |              |        | Stockholders Equity |           
|                           |                                                                                                     |                       |           |              |        |                      |           
|                           |                                                                                                     |                       |           | Common Stock |        |                      |           
|                           |                                                                                                     | Convertible Preferred |           |              |        |                      |            |           
|                           |                                                                                                     | Stock                 |           |              |        |                      | Additional |            |   |          |            | Total     |            
|                           |                                                                                                     |                       |           |              |        |                      | Paid-In    |            |   | Treasury |            |           | Accumulated |         |         | Stockholders |      
|                           |                                                                                                     | Shares                |           |              | Amount |                      |            | Shares     |   |          | Amount     |           |             | Capital |         |               | Stock |   |             | Deficit    |   |   | Equity      |        
|                           |                                                                                                     |                       |           |              |        |                      |            |            |   |          |            |           |             |         |         |               |       |   |             |            |   |   |             |        
|Balance, January 1, 2002   |                                                                                                     |                       |          |              |        |                      |           |            |   |          | 19,861,118 |           |             | $       | 199,000 |               |       | $ | 174,583,000 |            |   | $ | (11,414,000 | )       |   | $ | (135,839,000 | )           |   | $ | 27,529,000 |            
|                           | Common stock issued to Tumbleweed for patents                                                       |                       |           |             |        |                      |            |           |   |          |            | 116,833   |             |         |         | 1,000         |       |   |             | 761,000    |   |   |             |        |   |   |              |            |   |   |            | 762,000     |  
|                           | Common stock issued to Yahoo! for services                                                          |                       |           |             |        |                      |            |           |   |          |            | 468,514   |             |         |         | 5,000         |       |   |             | 2,530,000  |   |   |             |        |   |   |              |            |   |   |            | 2,535,000   |  
|                           | Common stock issued to former employees in lieu of severance                                        |                       |           |             |        |                      |            |           |   |          |            | 68,622    |             |         |         | 1,000         |       |   |             | 173,000    |   |   |             |        |   |   |              |            |   |   |            | 174,000     |  
|                           | Series A convertible preferred stock issued for cash, net
    of issuance costs                     |                       |           | 819,886      |        |                      |            | 2,184,000  |   |          |            |          |             |         |         |              |       |   |             |           |   |   |             |        |   |   |              |            |   |   |            |            |  
|                           | Warrants related to Series A convertible preferred stock
    issued for cash, net of issuance costs |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 964,000    |   |   |             |        |   |   |              |            |   |   |            | 964,000     |  
|                           | Series A convertible preferred stock converted into common
    stock                                |                       |           | (54,327      | )      |                      |            | (145,000   | ) |          |            | 51,690    |             |         |         |              |       |   |             | 145,000    |   |   |             |        |   |   |              |            |   |   |            | 145,000     |  
|                           | Series B convertible preferred stock issued for cash, net
    of issuance costs                     |                       |           | 1,304,815    |        |                      |            | 3,213,000  |   |          |            |          |             |         |         |              |       |   |             |           |   |   |             |        |   |   |              |            |   |   |            |            |  
|                           | Warrants related to Series B convertible preferred stock
    issued for cash, net of issuance costs |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 1,420,000  |   |   |             |        |   |   |              |            |   |   |            | 1,420,000   |  
|                           | Series B convertible preferred stock converted into common
    stock                                |                       |           | (58,100      | )      |                      |            | (156,000   | ) |          |            | 56,210    |             |         |         | 1,000         |       |   |             | 155,000    |   |   |             |        |   |   |              |            |   |   |            | 156,000     |  
|                           | Dividends on Series A and Series B convertible
    preferred stock                                  |                       |           |             |        |                      |            | 557,000    |   |          |            |          |             |         |         |              |       |   |             | 2,624,000  |   |   |             |        |   |   |              | (3,181,000  | ) |   |            | (557,000    | )
|                           | Beneficial conversion feature resulting from the issuance of
    convertible notes payable          |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 1,698,000  |   |   |             |        |   |   |              |            |   |   |            | 1,698,000   |  
|                           | Warrants related to convertible notes payable issued for cash,
    net of issuance costs            |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 1,113,000  |   |   |             |        |   |   |              |            |   |   |            | 1,113,000   |  
|                           | Convertible notes payable converted into common stock                                               |                       |           |             |        |                      |            |           |   |          |            | 2,141,811 |             |         |         | 21,000        |       |   |             | 6,744,000  |   |   |             |        |   |   |              |            |   |   |            | 6,765,000   |  
|                           | Amortization of unearned stock-based compensation                                                   |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 2,304,000  |   |   |             |        |   |   |              |            |   |   |            | 2,304,000   |  
|                           | Other                                                                                               |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 67,000     |   |   |             | (93,000 | ) |   |              |            |   |   |            | (26,000     | )
|                           | Net loss                                                                                            |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             |           |   |   |             |        |   |   |              | (33,437,000 | ) |   |            | (33,437,000 | )
|                           |                                                                                                     |                       |           |              |        |                      |            |            |   |          |            |           |             |         |         |               |       |   |             |            |   |   |             |        
|Balance, December 31, 2002 |                                                                                                     |                       | 2,012,274 |              |        |                      | 5,653,000  |            |   |          | 22,764,798 |           |             |         | 228,000 |               |       |   | 195,281,000 |            |   |   | (11,507,000 | )       |   |   | (172,457,000 | )           |   |   | 11,545,000 |            
|                           | Issuance of common stock upon exercise of stock options                                             |                       |           |             |        |                      |            |           |   |          |            | 2,358,968 |             |         |         | 23,000        |       |   |             | 12,942,000 |   |   |             |        |   |   |              |            |   |   |            | 12,965,000  |  
|                           | Series A convertible preferred stock converted into common
    stock                                |                       |           | (765,559     | )      |                      |            | (2,814,000 | ) |          |            | 787,424   |             |         |         | 8,000         |       |   |             | 2,806,000  |   |   |             |        |   |   |              |            |   |   |            | 2,814,000   |  
|                           | Series B convertible preferred stock converted into common
    stock                                |                       |           | (1,246,715   | )      |                      |            | (4,244,000 | ) |          |            | 1,271,653 |             |         |         | 13,000        |       |   |             | 4,231,000  |   |   |             |        |   |   |              |            |   |   |            | 4,244,000   |  
|                           | Dividends on Series A and Series B convertible
    preferred stock                                  |                       |           |             |        |                      |            | 1,405,000  |   |          |            |          |             |         |         |              |       |   |             |           |   |   |             |        |   |   |              | (1,405,000  | ) |   |            | (1,405,000  | )
|                           | Common stock and related warrants issued for cash in private
    placements, net of issuance costs  |                       |           |             |        |                      |            |           |   |          |            | 1,566,758 |             |         |         | 16,000        |       |   |             | 5,592,000  |   |   |             |        |   |   |              |            |   |   |            | 5,608,000   |  
|                           | Common stock issued for purchase of PocketScript                                                    |                       |           |             |        |                      |            |           |   |          |            | 362,903   |             |         |         | 3,000         |       |   |             | 1,383,000  |   |   |             |        |   |   |              |            |   |   |            | 1,386,000   |  
|                           | Common stock issued for purchase of Elron Software                                                  |                       |           |             |        |                      |            |           |   |          |            | 1,709,402 |             |         |         | 17,000        |       |   |             | 6,316,000  |   |   |             |        |   |   |              |            |   |   |            | 6,333,000   |  
|                           | Promissory note payable converted into common stock                                                 |                       |           |             |        |                      |            |           |   |          |            | 262,454   |             |         |         | 3,000         |       |   |             | 1,010,000  |   |   |             |         |   |   |              |             |   |   |            | 1,013,000   |  
|                           | Common stock issued in lieu of cash compensation                                                    |                       |           |             |        |                      |            |           |   |          |            | 71,286    |             |         |         | 1,000         |       |   |             | 483,000    |   |   |             |        |   |   |              |            |   |   |            | 484,000     |  
|                           | Amortization of unearned stock-based compensation                                                   |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 550,000    |   |   |             |        |   |   |              |            |   |   |            | 550,000     |  
|                           | Other                                                                                               |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | (40,000    | ) |   |             |        |   |   |              |            |   |   |            | (40,000     | )
|                           | Net loss                                                                                            |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             |           |   |   |             |        |   |   |              | (27,578,000 | ) |   |            | (27,578,000 | )
|                           |                                                                                                     |                       |           |              |        |                      |            |            |   |          |            |           |             |         |         |               |       |   |             |            |   |   |             |        
|Balance, December 31, 2003 |                                                                                                     |                       |          |              |        |                      |           |            |   |          | 31,155,646 |           |             |         | 312,000 |               |       |   | 230,554,000 |            |   |   | (11,507,000 | )       |   |   | (201,440,000 | )           |   |   | 17,919,000 |            
|                           | Issuance of common stock upon exercise of stock options                                             |                       |           |             |        |                      |            |           |   |          |            | 1,005,812 |             |         |         | 10,000        |       |   |             | 5,489,000  |   |   |             |        |   |   |              |            |   |   |            | 5,499,000   |  
|                           | Issuance of common stock upon exercise of warrants                                                  |                       |           |             |        |                      |            |           |   |          |            | 1,379,746 |             |         |         | 14,000        |       |   |             | 15,329,000 |   |   |             |        |   |   |              |            |   |   |            | 15,343,000  |  
|                           | Common stock issued for purchase of MyDocOnline                                                     |                       |           |             |        |                      |            |           |   |          |            | 583,411   |             |         |         | 6,000         |       |   |             | 9,031,000  |   |   |             |        |   |   |              |            |   |   |            | 9,037,000   |  
|                           | Valuation of warrants assigned to promissory note payable                                           |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 1,475,000  |   |   |             |        |   |   |              |            |   |   |            | 1,475,000   |  
|                           | Valuation of warrants assigned to convertible promissory notes
    payable                          |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 3,511,000  |   |   |             |        |   |   |              |            |   |   |            | 3,511,000   |  
|                           | Employee stock compensation expense                                                                 |                       |           |             |        |                      |            |           |   |          |            | 459,791   |             |         |         | 4,000         |       |   |             | 3,890,000  |   |   |             |        |   |   |              |            |   |   |            | 3,894,000   |  
|                           | Amortization of unearned stock-based compensation                                                   |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | 179,000    |   |   |             |        |   |   |              |            |   |   |            | 179,000     |  
|                           | Other                                                                                               |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             | (52,000    | ) |   |             |        |   |   |              |            |   |   |            | (52,000     | )
|                           | Net loss                                                                                            |                       |           |             |        |                      |            |           |   |          |            |          |             |         |         |              |       |   |             |           |   |   |             |        |   |   |              | (42,040,000 | ) |   |            | (42,040,000 | )
|                           |                                                                                                     |                       |           |              |        |                      |            |            |   |          |            |           |             |         |         |               |       |   |             |            |   |   |             |        
|Balance, December 31, 2004 |                                                                                                     |                       |          |              |        |                      |           |            |   |          | 34,584,406 |           |             | $       | 346,000 |               |       | $ | 269,406,000 |            |   | $ | (11,507,000 | )       |   | $ | (243,480,000 | )           |   | $ | 14,765,000 |            
|                           |                                                                                                     |                       |           |              |        |                      |            |            |   |          |            |           |             |         |         |               |       |   |             |            |   |   |             |        



F-6



---



##### Table of Contents



ZIX CORPORATION


CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |           |             |            |             |           |             |  
|------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------ | --------------------------------------------------- | ----------- | --------- | ----------- | --------- | ----------- | --------- | ----------- | ---------- | ----------- | --------- | ----------- | -
|                                                                         |                                                                                                                | Year Ended December 31,                                                                    |                                                    
|                                                                         |                                                                                                                |                                                                                            |                                                    
|                                                                         |                                                                                                                | 2004                                                                                       |                                                     |             | 2003      |             |           | 2002        |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|Operating activities:                                                    |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |           |             |            |            
|                                                                         | Loss from continuing operations                                                                                |                                                                                            | $                                                   | (42,040,000 | )         |             | $         | (27,667,000 | )         |             | $          | (34,299,000 | )        
|                                                                         | Non-cash items in loss from continuing operations:                                                             |                                                                                            |                                                     |             |           |             |           |             |           |             |            |             |          
|                                                                         |                                                                                                                | Depreciation and amortization                                                              |                                                     |             | 4,820,000 |             |           |             | 3,676,000 |             |            |             | 7,500,000 |            
|                                                                         |                                                                                                                | Amortization of debt financing costs                                                       |                                                     |             | 107,000   |             |           |             |          |             |            |             |          |            
|                                                                         |                                                                                                                | Amortization of discount on convertible promissory notes payable                           |                                                     |             | 200,000   |             |           |             |          |             |            |             | 368,000   |            
|                                                                         |                                                                                                                | Amortization of discount on promissory note payable                                        |                                                     |             | 315,000   |             |           |             |          |             |            |             |          |            
|                                                                         |                                                                                                                | Acquired in-process research and development                                               |                                                     |             | 306,000   |             |           |             |          |             |            |             |          |            
|                                                                         |                                                                                                                | Asset impairment charge                                                                    |                                                     |             | 675,000   |             |           |             |          |             |            |             |          |            
|                                                                         |                                                                                                                | Employee stock compensation expense                                                        |                                                     |             | 3,894,000 |             |           |             | 484,000   |             |            |             |          |            
|                                                                         |                                                                                                                | Amortization of unearned stock-based compensation                                          |                                                     |             | 179,000   |             |           |             | 550,000   |             |            |             | 2,478,000 |            
|                                                                         |                                                                                                                | Stock issued to Tumbleweed for patents                                                     |                                                     |             |          |             |           |             |          |             |            |             | 762,000   |            
|                                                                         |                                                                                                                | Stock issued to Yahoo! for services                                                        |                                                     |             |          |             |           |             |          |             |            |             | 1,935,000 |            
|                                                                         |                                                                                                                | Beneficial conversion feature resulting from the issuance of
    convertible notes payable |                                                     |             |          |             |           |             |          |             |            |             | 1,698,000 |            
|                                                                         |                                                                                                                | Recovery of investment in Maptuit Corporation                                              |                                                     |             | (70,000   | )           |           |             | (530,000  | )           |            |             |          |            
|                                                                         |                                                                                                                | Other non-cash expenses                                                                    |                                                     |             |          |             |           |             | 13,000    |             |            |             |          |            
|                                                                         | Changes in operating assets and liabilities, excluding effects
    of acquisitions:                            |                                                                                            |                                                     |             |           |             |           |             |           |             |            |             |          
|                                                                         |                                                                                                                | Accounts receivable                                                                        |                                                     |             | (1,000    | )           |           |             | 1,039,000 |             |            |             | (214,000  | )          
|                                                                         |                                                                                                                | Other assets                                                                               |                                                     |             | (492,000  | )           |           |             | 601,000   |             |            |             | (262,000  | )          
|                                                                         |                                                                                                                | Accounts payable                                                                           |                                                     |             | 718,000   |             |           |             | 89,000    |             |            |             | 292,000   |            
|                                                                         |                                                                                                                | Deferred revenue                                                                           |                                                     |             | 3,201,000 |             |           |             | 2,985,000 |             |            |             | 481,000   |            
|                                                                         |                                                                                                                | Customer deposits                                                                          |                                                     |             | 3,968,000 |             |           |             |          |             |            |             |          |            
|                                                                         |                                                                                                                | Accrued and other liabilities                                                              |                                                     |             | 1,453,000 |             |           |             | (21,000   | )           |            |             | (417,000  | )          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         |                                                                                                                |                                                                                            | Net cash used by operating activities               |             |           | (22,767,000 | )         |             |           | (18,781,000 | )          |             |           | (19,678,000 | )
|Investing activities:                                                    |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |           |             |            |            
|                                                                         | Purchases of property and equipment                                                                            |                                                                                            |                                                     | (3,393,000  | )         |             |           | (2,252,000  | )         |             |            | (845,000    | )        
|                                                                         | Purchases of marketable securities                                                                             |                                                                                            |                                                     | (35,582,000 | )         |             |           | (11,951,000 | )         |             |            | (19,894,000 | )        
|                                                                         | Sales and maturities of marketable securities                                                                  |                                                                                            |                                                     | 26,564,000  |           |             |           | 11,944,000  |           |             |            | 23,856,000  |          
|                                                                         | Purchase of restricted cash investment                                                                         |                                                                                            |                                                     | (10,103,000 | )         |             |           |            |           |             |            |            |          
|                                                                         | Cash received from Maptuit Corporation                                                                         |                                                                                            |                                                     | 70,000      |           |             |           | 530,000     |           |             |            |            |          
|                                                                         | Purchase of PocketScript                                                                                       |                                                                                            |                                                     |            |           |             |           | (50,000     | )         |             |            |            |          
|                                                                         | Purchase of MyDocOnline                                                                                        |                                                                                            |                                                     | (282,000    | )         |             |           |            |           |             |            |            |          
|                                                                         | Cash acquired in the purchase of Elron Software                                                                |                                                                                            |                                                     |            |           |             |           | 1,000,000   |           |             |            |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         |                                                                                                                |                                                                                            | Net cash (used in) provided by investing activities |             |           | (22,726,000 | )         |             |           | (779,000    | )          |             |           | 3,117,000   |  
|Financing activities:                                                    |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |           |             |            |            
|                                                                         | Proceeds from exercise of stock options                                                                        |                                                                                            |                                                     | 5,499,000   |           |             |           | 12,965,000  |           |             |            |            |          
|                                                                         | Proceeds from exercise of warrants                                                                             |                                                                                            |                                                     | 15,343,000  |           |             |           | 5,608,000   |           |             |            |            |          
|                                                                         | Proceeds from promissory note payable                                                                          |                                                                                            |                                                     | 3,000,000   |           |             |           |            |           |             |            |            |          
|                                                                         | Proceeds from convertible promissory notes, net of issuance costs                                              |                                                                                            |                                                     | 18,908,000  |           |             |           |            |           |             |            | 7,509,000   |          
|                                                                         | Proceeds from private placement of convertible preferred stock
    and related warrants, net of issuance costs |                                                                                            |                                                     |            |           |             |           |            |           |             |            | 7,781,000   |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         |                                                                                                                |                                                                                            | Net cash provided by financing activities           |             |           | 42,750,000  |           |             |           | 18,573,000  |            |             |           | 15,290,000  |  
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|Decrease in cash and cash equivalents                                    |                                                                                                                |                                                                                            | (2,743,000                                          | )           |           |             | (987,000  | )           |           |             | (1,271,000 | )          
|Cash and cash equivalents, beginning of year                             |                                                                                                                |                                                                                            | 6,599,000                                           |             |           |             | 7,586,000 |             |           |             | 8,857,000  |            
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|Cash and cash equivalents, end of year                                   |                                                                                                                | $                                                                                          | 3,856,000                                           |             |           | $           | 6,599,000 |             |           | $           | 7,586,000  |            
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|Supplemental cash flow information:                                      |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |           |             |            |            
|                                                                         | Cash interest paid                                                                                             |                                                                                            | $                                                   | (1,000      | )         |             | $         |            |           |             | $          |            |          
|                                                                         | Income tax (payment) refund                                                                                    |                                                                                            | $                                                   | (163,000    | )         |             | $         |            |           |             | $          | 499,000     |          
|Supplemental schedule of noncash investing and financing
    activities: |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |           |             |            |            
|                                                                         | Common stock issued for purchase of MyDocOnline (see Note 3)                                                   |                                                                                            | $                                                   | 9,037,000   |           |             | $         |            |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Issuance of warrants related to convertible promissory notes
    payable (see Note 10)                         |                                                                                            | $                                                   | 3,511,000   |           |             | $         |            |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Issuance of warrants related to promissory note payable (see
    Note 10)                                      |                                                                                            | $                                                   | 1,475,000   |           |             | $         |            |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Assets acquired on capital lease                                                                               |                                                                                            | $                                                   | 213,000     |           |             | $         |            |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Insurance premiums financed by short-term note payable (see
    Note 10)                                       |                                                                                            | $                                                   | 193,000     |           |             | $         |            |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Common stock issued for purchase of PocketScript                                                               |                                                                                            | $                                                   |            |           |             | $         | 1,386,000   |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Common stock issued for purchase of Elron Software                                                             |                                                                                            | $                                                   |            |           |             | $         | 6,333,000   |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Promissory note payable converted to common stock                                                              |                                                                                            | $                                                   |            |           |             | $         | 1,013,000   |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Accretion of dividends on Series A and B convertible
    preferred stock                                       |                                                                                            | $                                                   |            |           |             | $         | 1,405,000   |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          
|                                                                         | Conversion of Series A and B convertible preferred stock
    into common stock                                 |                                                                                            | $                                                   |            |           |             | $         | 7,058,000   |           |             | $          |            |          
|                                                                         |                                                                                                                |                                                                                            |                                                     |             |           |             |           |             |          



F-7



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




|   |                               
|-- | ------------------------------
|1. | Company Overview and Liquidity









tm






F-8



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)






| |                                     
| | ------------------------------------
| | Actions Taken in First Quarter 2005:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Sale of Web Inspector/ Message Inspector (collectively the
    Inspector) Product Line: On March 11, 2005,
    the Company entered into an agreement to sell the Inspector
    product line to CyberGuard for $3,336,000 in cash, net of
    transaction fees totaling $290,000 (see Note 22). These
    products operated on a cash neutral basis so their elimination
    will not impact the Companys on-going operating cash
    requirements. The sale does not include the current Inspector
    accounts receivable totaling approximately $374,000 which the
    Company anticipates collecting from customers in the near term.
|
| |  | Workforce Reductions: In January 2005, the Company
    reduced it workforce by approximately 10%. This was done
    selectively so that the core business operations and sales
    momentum would not be adversely impacted. The Company forecasts
    that the reduction will result in a net improvement of
    $2,500,000 to $3,000,000 (unaudited) in cash expenditures during
    2005.                                                                                                                                                                                                                                               
|
| |  | Restructure $20,000,000 Convertible Promissory
    Notes Payable: The Company agreed to amend the terms of
    its convertible promissory notes payable on March 16, 2005
    (see Note 10). The new terms will allow the Company to
    repay the first $5,000,000 installment, which was scheduled to
    be paid in cash in November 2005, in stock prior to
    July 31, 2005 (see Note 22).                                                                                                                                                                                                                                           



| |                                                                                              
| | ---------------------------------------------------------------------------------------------
| | Improvements from Secure Messaging as a result of the
    subscription model of the business:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Continued Growth of Secured e-Messaging Business: The
    Company expects incremental cash receipts in the range of
    $3,500,000 to $5,500,000 (unaudited) compared to 2004 for
    the Secure Messaging products. This growth is somewhat
    predicable based on past trends due to the subscription nature
    of the business, whereby, the Company has been consistently
    adding new annual service contracts while experiencing very
    minimal attrition of existing and renewing customers. At the low
    end of this range, the Company assumes they will collect
    contractually billed amounts, experience continued renewal rates
    of 95%, and continue new customer orders at the same rate
    demonstrated over the last 2 years. Should new first year
    customer orders increase 20% quarter on quarter throughout 2005,
    the high end of the range should be reached.





|   |                                                                         
|-- | ------------------------------------------------------------------------
|2. | Basis of Presentation and Summary of Significant
    Accounting Policies

Consolidation


F-9



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)


Use of Estimates


Cash Equivalents and Marketable Securities




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




Goodwill Goodwill and Other Intangible
Assets,


Deferred Tax Assets


Leases


F-10



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




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-11



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)










Software Development Costs




Advertising Expense


Stock-based Employee Compensation Accounting for
Stock-Based Compensation, Accounting for Stock
Issued to Employees


F-12



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|                                                                                      |  |      |             |   |      |   |             |      |  |   |             |  
|------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                      |  | 2004 |             |   | 2003 |   |             | 2002 | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|Net loss, as reported                                                                 |  | $    | (42,040,000 | ) |      | $ | (27,578,000 | )    |  | $ | (33,437,000 | )
|Add employee stock compensation expense recorded under the
    intrinsic value method |  |      | 1,115,000   |   |      |   |            |      |  |   | 1,590,000   |  
|Deduct pro forma stock compensation expense computed under the
    fair value method  |  |      | (9,214,000  | ) |      |   | (4,502,000  | )    |  |   | (3,174,000  | )
|                                                                                      |  |      |             |   |      |   |             |      | 
|Pro forma net loss                                                                    |  | $    | (50,139,000 | ) |      | $ | (32,080,000 | )    |  | $ | (35,021,000 | )
|                                                                                      |  |      |             |   |      |   |             |      | 
|Basic and diluted pro forma loss per common share                                     |  | $    | (1.59       | ) |      | $ | (1.42       | )    |  | $ | (2.11       | )
|                                                                                      |  |      |             |   |      |   |             |      | 



|                                |                         |      |            |      |      |  |            |      |  |  |            |      | 
|------------------------------- | ----------------------- | ---- | ---------- | ---- | ---- |  | ---------- | ---- |  |  | ---------- | ---- | 
|                                |                         | 2004 |            |      | 2003 |  |            | 2002 | 
|                                |                         |      |            |      |      |  |            |      | 
|Risk-free interest rate         |                         |      | 1.86       | %    |      |  | 1.77       | %    |  |  | 2.56       | %   
|Expected option life            |                         |      | 2.5  years |      |      |  | 2.5  years |      |  |  | 2.7  years |     
|Expected stock price volatility |                         |      | 108        | %    |      |  | 103        | %    |  |  | 129        | %   
|Expected dividend yield         |                         |      |           |      |      |  |           |      |  |  |           |     
|Fair value of options:          |                         |      |            |      |      |  |            |      |  |  |            |     
|                                | Granted at market price |      | $          | 4.23 |      |  | $          | 2.63 |  |  | $          | 3.18 | 

Earnings Per Share


Comprehensive Loss


Reclassifications


Recent Accounting Pronouncements


SFAS No. 123(R), Share-Based
Payment Share-Based Payment, Accounting for Stock-Based
Compensation Accounting for Stock Issued to Employees.


F-13



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)














EITF No. 04-8, The effect of Contingently
Convertible Instruments on Diluted Earning Per
Share The Effect of Contingently
Convertible Instruments on Diluted Earning Per Share


FSP FAS129-1, Disclosure Requirements under FASB
Statement No. 129 Relating to Contingently Financial
Instruments Disclosure
Requirements under FASB Statement No. 129 Relating to
Contingently Convertible Financial Instruments




|   |                      
|-- | ---------------------
|3. | Business Acquisitions



| |                  
| | -----------------
| | MyDocOnline, Inc.



F-14



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)






|                                                                      |                        |   |           |           | 
|--------------------------------------------------------------------- | ---------------------- | - | --------- | --------- | 
|Fair market value of 583,411 shares of the Companys
    common stock |                        | $ | 9,037,000 |          
|Transaction costs                                                     |                        |   | 282,000   |          
|                                                                      |                        |   |          
|                                                                      | Total acquisition cost |   | $         | 9,319,000 | 
|                                                                      |                        |   |          





|                                    |                                  |                              |           |          |         | 
|----------------------------------- | -------------------------------- | ---------------------------- | --------- | -------- | ------- | 
|Working capital items:              |                                  |                              |           |         
|                                    | Receivables and prepaid expenses |                              | $         | 354,000  |        
|                                    | Deferred revenue                 |                              |           | (140,000 | )      
|                                    |                                  |                              |          
|                                    |                                  | Net working capital acquired |           |          | 214,000 | 
|Property and equipment              |                                  |                              | 1,292,000 |         
|Customer relationships              |                                  |                              | 658,000   |         
|Developed technology                |                                  |                              | 2,051,000 |         
|Goodwill                            |                                  |                              | 4,798,000 |         
|In-process research and development |                                  |                              | 306,000   |         
|                                    |                                  |                              |          
|                                    |                                  | $                            | 9,319,000 |         
|                                    |                                  |                              |          







F-15



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)






| |                     
| | --------------------
| | Elron Software, Inc.





|                                                                                  |                            |   |           |           | 
|--------------------------------------------------------------------------------- | -------------------------- | - | --------- | --------- | 
|Fair market value of
    1,709,402 shares of the Companys common stock           |                            | $ | 6,333,000 |          
|Fair market value of the
    5.75% $1,000,000 convertible promissory note payable |                            |   | 1,000,000 |          
|Transaction costs                                                                 |                            |   | 136,000   |          
|                                                                                  |                            |   |          
|                                                                                  | Total
    acquisition cost |   | $         | 7,469,000 | 
|                                                                                  |                            |   |          





|                                     |                                          |                              |           |           |         | 
|------------------------------------ | ---------------------------------------- | ---------------------------- | --------- | --------- | ------- | 
|Working capital items:               |                                          |                              |           |          
|                                     | Cash                                     |                              | $         | 1,000,000 |        
|                                     | Receivables and prepaid expenses         |                              |           | 587,000   |        
|                                     | Accounts payable and accrued liabilities |                              |           | (487,000  | )      
|                                     | Deferred revenue                         |                              |           | (776,000  | )      
|                                     |                                          |                              |          
|                                     |                                          | Net working capital acquired |           |           | 324,000 | 
|Property and equipment               |                                          |                              | 113,000   |          
|Developed technology                 |                                          |                              | 943,000   |          
|Customer contracts and relationships |                                          |                              | 1,336,000 |          
|Trademarks and trade names           |                                          |                              | 432,000   |          
|Goodwill                             |                                          |                              | 4,321,000 |          
|                                     |                                          |                              |          
|                                     |                                          | $                            | 7,469,000 |          
|                                     |                                          |                              |          



F-16



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)






| |                   
| | ------------------
| | PocketScript, Inc.





|                                                                      |                        |   |           |           | 
|--------------------------------------------------------------------- | ---------------------- | - | --------- | --------- | 
|Cash payment                                                          |                        | $ | 50,000    |          
|Fair market value of 362,903 shares of the Companys
    common stock |                        |   | 1,386,000 |          
|Transaction costs                                                     |                        |   | 21,000    |          
|                                                                      |                        |   |          
|                                                                      | Total acquisition cost |   | $         | 1,457,000 | 
|                                                                      |                        |   |          





|                       |                  |                                  |           |          |          |  
|---------------------- | ---------------- | -------------------------------- | --------- | -------- | -------- | -
|Working capital items: |                  |                                  |           |         
|                       | Accounts payable |                                  | $         | (40,000  | )       
|                       | Deferred revenue |                                  |           | (175,000 | )       
|                       |                  |                                  |          
|                       |                  | Working capital deficit acquired |           |          | (215,000 | )
|Property and equipment |                  |                                  | 346,000   |         
|Developed technology   |                  |                                  | 1,326,000 |         
|                       |                  |                                  |          
|                       |                  | $                                | 1,457,000 |         
|                       |                  |                                  |          





| |                                   
| | ----------------------------------
| | Consolidated Pro Forma Information



F-17



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|                                                      |  |      |             |  
|----------------------------------------------------- |  | ---- | ----------- | -
|                                                      |  | 2003 |            
|                                                      |  |      |            
|Revenues                                              |  | $    | 11,167,000  |  
|                                                      |  |      |            
|Net loss                                              |  | $    | (56,841,000 | )
|Preferred stock dividends (see Note 11)               |  |      | (1,405,000  | )
|                                                      |  |      |            
|Net loss applicable to common stock                   |  | $    | (58,246,000 | )
|                                                      |  |      |            
|Basic and diluted loss per common share               |  | $    | (2.31       | )
|                                                      |  |      |            
|Weighted average shares used in per share calculation |  |      | 25,251,212  |  
|                                                      |  |      |            





|   |                                          
|-- | -----------------------------------------
|4. | Restricted Cash and Marketable Securities





|                        |  |             |            |  |      |   |           | 
|----------------------- |  | ----------- | ---------- |  | ---- | - | --------- | 
|                        |  | December 31 |           
|                        |  |             |           
|                        |  | 2004        |            |  | 2003 |  
|                        |  |             |            |  |      |  
|Commercial paper        |  | $           |           |  |      | $ | 4,990,000 | 
|Asset-backed securities |  |             | 16,000,000 |  |      |   | 1,992,000 | 
|                        |  |             |            |  |      |  
|                        |  | $           | 16,000,000 |  |      | $ | 6,982,000 | 
|                        |  |             |            |  |      |  





|   |                    
|-- | -------------------
|5. | Accounts Receivable

|                                            |                  |             |            |         |      |   |            |         | 
|------------------------------------------- | ---------------- | ----------- | ---------- | ------- | ---- | - | ---------- | ------- | 
|                                            |                  | December 31 |           
|                                            |                  |             |           
|                                            |                  | 2004        |            |         | 2003 |  
|                                            |                  |             |            |         |      |  
|Gross accounts receivable                   |                  | $           | 3,732,000  |         |      | $ | 2,306,000  |        
|Allowance for returns and doubtful accounts |                  |             | (74,000    | )       |      |   | (93,000    | )      
|Unpaid portion of deferred revenue          |                  |             | (3,097,000 | )       |      |   | (1,854,000 | )      
|                                            |                  |             |            |         |      |  
|                                            | Receivables, net |             | $          | 561,000 |      |   | $          | 359,000 | 
|                                            |                  |             |            |         |      |  



F-18



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|   |                       
|-- | ----------------------
|6. | Property and Equipment

|                                               |  |             |             |   |      |   |             |  
|---------------------------------------------- |  | ----------- | ----------- | - | ---- | - | ----------- | -
|                                               |  | December 31 |            
|                                               |  |             |            
|                                               |  | 2004        |             |   | 2003 |  
|                                               |  |             |             |   |      |  
|Computer equipment and software                |  | $           | 32,467,000  |   |      | $ | 29,757,000  |  
|Leasehold improvements                         |  |             | 4,581,000   |   |      |   | 4,622,000   |  
|Office equipment, furniture and fixtures       |  |             | 1,333,000   |   |      |   | 1,084,000   |  
|                                               |  |             |             |   |      |  
|                                               |  |             | 38,381,000  |   |      |   | 35,463,000  |  
|Less accumulated depreciation and amortization |  |             | (33,357,000 | ) |      |   | (32,312,000 | )
|                                               |  |             |             |   |      |  
|                                               |  | $           | 5,024,000   |   |      | $ | 3,151,000   |  
|                                               |  |             |             |   |      |  







|   |                               
|-- | ------------------------------
|7. | Intangible Assets and Goodwill



|                                    |                         |                   |           |             |                   |   |           |           |  |   |             |           |  |              |           |           |     |   |         |         |  |   |           |           | 
|----------------------------------- | ----------------------- | ----------------- | --------- | ----------- | ----------------- | - | --------- | --------- |  | - | ----------- | --------- |  | ------------ | --------- | --------- | --- | - | ------- | ------- |  | - | --------- | --------- | 
|                                    |                         | December 31, 2004 |           |             | December 31, 2003 |  
|                                    |                         |                   |           |             |                   |  
|                                    |                         |                   |           | Accumulated |                   |   |           |           |  |   | Accumulated |           |  |             
|                                    |                         | Cost              |           |             | Amortization      |   |           | Net       |  |   | Cost        |           |  | Amortization |           |           | Net |  
|                                    |                         |                   |           |             |                   |   |           |           |  |   |             |           |  |              |           |           |     |  
|Developed technology                |                         | $                 | 3,541,000 |             |                   | $ | 1,347,000 |           |  | $ | 2,194,000   |           |  | $            | 2,269,000 |           |     | $ | 289,000 |         |  | $ | 1,980,000 |          
|Customer contract and relationships |                         |                   | 1,994,000 |             |                   |   | 596,000   |           |  |   | 1,398,000   |           |  |              | 1,336,000 |           |     |   | 111,000 |         |  |   | 1,225,000 |          
|Trademarks and trade names          |                         |                   | 432,000   |             |                   |   | 192,000   |           |  |   | 240,000     |           |  |              | 432,000   |           |     |   | 48,000  |         |  |   | 384,000   |          
|                                    |                         |                   |           |             |                   |   |           |           |  |   |             |           |  |              |           |           |     |  
|                                    | Total intangible assets |                   | $         | 5,967,000   |                   |   | $         | 2,135,000 |  |   | $           | 3,832,000 |  |              | $         | 4,037,000 |     |   | $       | 448,000 |  |   | $         | 3,589,000 | 
|                                    |                         |                   |           |             |                   |   |           |           |  |   |             |           |  |              |           |           |     |  





F-19



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|                                          |  |      |           |             |              |   |           |  
|----------------------------------------- |  | ---- | --------- | ----------- | ------------ | - | --------- | -
|                                          |  |      |           | Accumulated |             
|                                          |  | Cost |           |             | Amortization |  
|                                          |  |      |           |             |              |  
|Beginning balance at January 1, 2004      |  | $    | 4,037,000 |             |              | $ | 448,000   |  
|MyDocOnline acquisition                   |  |      | 2,709,000 |             |              |   |          |  
|Asset impairment charge                   |  |      |          |             |              |   | 675,000   |  
|Straight line amortization of intangibles |  |      |          |             |              |   | 1,791,000 |  
|Less write-off of impaired asset          |  |      | (779,000  | )           |              |   | (779,000  | )
|                                          |  |      |           |             |              |  
|Ending balance at December 31, 2004       |  | $    | 5,967,000 |             |              | $ | 2,135,000 |  
|                                          |  |      |           |             |              |  

Impairment Charge




|      |  |   |           | 
|----- |  | - | --------- | 
|2005  |  | $ | 1,728,000 | 
|2006  |  |   | 1,391,000 | 
|2007  |  |   | 545,000   | 
|2008  |  |   | 155,000   | 
|2009  |  |   | 13,000    | 
|      |  |   |          
|Total |  | $ | 3,832,000 | 
|      |  |   |          



F-20



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|   |                 
|-- | ----------------
|8. | Accrued Expenses

|                                   |  |      |           |  |      |   |           | 
|---------------------------------- |  | ---- | --------- |  | ---- | - | --------- | 
|                                   |  | 2004 |           |  | 2003 |  
|                                   |  |      |           |  |      |  
|Employee compensation and benefits |  | $    | 2,056,000 |  |      | $ | 1,824,000 | 
|Professional fees                  |  |      | 481,000   |  |      |   | 129,000   | 
|Taxes                              |  |      | 884,000   |  |      |   | 254,000   | 
|Insurance                          |  |      | 160,000   |  |      |   | 82,000    | 
|Interest                           |  |      | 178,000   |  |      |   |          | 
|Other                              |  |      | 950,000   |  |      |   | 933,000   | 
|                                   |  |      |           |  |      |  
|Total accrued expenses             |  | $    | 4,709,000 |  |      | $ | 3,222,000 | 
|                                   |  |      |           |  |      |  



|   |                 
|-- | ----------------
|9. | Customer Deposit







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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|    |              
|--- | -------------
|10. | Notes Payable



|                                     |                     |          |      |  |           |  |       |                      |  |  |            |  |       |             |            |            |          |   |            |            |   |   |         |         |   |   |            |            | 
|------------------------------------ | ------------------- | -------- | ---- |  | --------- |  | ----- | -------------------- |  |  | ---------- |  | ----- | ----------- | ---------- | ---------- | -------- | - | ---------- | ---------- | - | - | ------- | ------- | - | - | ---------- | ---------- | 
|                                     |                     |          |      |  |           |  |       | At December 31, 2004 |  |  |            |  |      
|                                     |                     | Stated   |      |  | Effective |  |       |                      |  |  |            |  | Total |             |            | Net Book   |         
|                                     |                     | Interest |      |  | Interest  |  |       | Note                 |  |  | Cash Value |  |       | Unamortized |            |            | Payments |   |            | Value of   |  
|                                     |                     | Rate     |      |  | Rate      |  |       | Expiration           |  |  | of Notes   |  |       | Discount    |            |            | Made     |   |            | Notes      |  
|                                     |                     |          |      |  |           |  |       |                      |  |  |            |  |       |             |            |            |          |   |            |            |  
|Convertible promissory notes payable |                     |          | 5.3% |  |           |  | 14.6% |                      |  |  | Nov 2008   |  |       | $           | 20,000,000 |            |          | $ | (2,805,000 | )          |   | $ |        |         |   | $ | 17,195,000 |           
|Promissory note payable              |                     |          | 4.5% |  |           |  | 11.0% |                      |  |  | Mar 2007   |  |       |             | 2,700,000  |            |          |   | (860,000   | )          |   |   |        |         |   |   | 1,840,000  |           
|Short-term promissory note           |                     |          | 5.1% |  |           |  | 5.1%  |                      |  |  | Oct 2005   |  |       |             | 212,000    |            |          |   |           |            |   |   | (19,000 | )       |   |   | 193,000    |           
|                                     |                     |          |      |  |           |  |       |                      |  |  |            |  |       |             |            |            |          |   |            |            |  
|                                     | Total notes payable |          |      |  |           |  |       |                      |  |  |            |  |       |             | $          | 22,912,000 |          |   | $          | (3,665,000 | ) |   | $       | (19,000 | ) |   | $          | 19,228,000 | 
|                                     |                     |          |      |  |           |  |       |                      |  |  |            |  |       |             |            |            |          |   |            |            |  



| |                                     
| | ------------------------------------
| | Convertible Promissory Notes Payable











| |    |                                                                                                                                                                                                                                                                                                                                                                                                                     
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. | no event of default or repurchase event,
    as such terms are defined in the convertible notes, under the
    notes has occurred,                                                                                                                                                                                                                                                                              
|
| | 2. | there is an effective registration statement on file with the
    SEC covering the shares of stock to be issued with respect to
    the payment of principal and the registration statement has been
    effective during the 20 consecutive trading days preceding
    the principal payment date and is reasonably expected to be
    effective for at least 30 days following the issuance of
    the shares; and

F-22



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 3. | 110% of the sum of the number of common stock shares to be
    issued to a particular holder on the scheduled principal payment
    date, plus the number of common stock shares previously issued
    to that holder, plus the number of common stock shares then
    issuable upon conversion of the note held by that holder or
    exercise of the warrants held by that holder is less than the
    portion of a maximum share amount allocated to such holder
    (initially 3,407,801 shares for each original note holder).







Accounting for Derivative Financial
instruments Indexed to, and Potentially Settled in a
Companys Own Stock Accounting
for Convertible Debt and Debt Issued with Stock Purchase
Warrants.




F-23



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)










| |                        
| | -----------------------
| | Promissory Note Payable







| |                        
| | -----------------------
| | Short-term Note Payable



F-24



---



##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|    |                                                   
|--- | --------------------------------------------------
|11. | Equity Financing Arrangements and Related Warrants



| |                 
| | ----------------
| | Warrants Summary



|                                                          |  |              |           |  |          |   |          |             |  |  |               |   |  |              |            |  |             |  |        |            |  |  |           |  |  |  |           | 
|--------------------------------------------------------- |  | ------------ | --------- |  | -------- | - | -------- | ----------- |  |  | ------------- | - |  | ------------ | ---------- |  | ----------- |  | ------ | ---------- |  |  | --------- |  |  |  | --------- | 
|                                                          |  | December 31, |           |  |          |   |          |             |  |  |               |   |  |              |           
|                                                          |  | 2003         |           |  |          |   | Warrants |             |  |  |               |   |  | December 31, |            |  |            
|                                                          |  | Warrants     |           |  | Exercise |   |          | Issued/     |  |  | Exercise      |   |  | Expired      |            |  | Warrants    |  |        | Warrant    | 
|Warrant Grants:                                           |  | Outstanding  |           |  | Price    |   |          | (Exercised) |  |  | Cash Received |   |  | Warrants     |            |  | Outstanding |  |        | Expiration | 
|                                                          |  |              |           |  |          |   |          |             |  |  |               |   |  |              |            |  |             |  |        |            | 
|2003 Private Placement                                    |  |              | 191,533   |  |          | $ | 4.96     |             |  |  | (10,081       | ) |  | $            | 50,000     |  |             |  |       |            |  |  | 181,452   |  |  |  | June 2007 | 
|Private placement of convertible equity securities        |  |              | 648,172   |  |          |   | 3.51     |             |  |  |              |   |  |              |           |  |             |  |       |            |  |  | 648,172   |  |  |  | Sept 2005 | 
|Series A Convertible Preferred Stock                      |  |              | 243,899   |  |          |   | 4.42     |             |  |  |              |   |  |              |           |  |             |  |       |            |  |  | 243,899   |  |  |  | Sept 2006 | 
|Series B Convertible Preferred Stock                      |  |              | 421,284   |  |          |   | 4.42     |             |  |  | (150,775      | ) |  |              | 666,000    |  |             |  |       |            |  |  | 270,509   |  |  |  | Sept 2006 | 
|2002 private placement of equity securities               |  |              | 916,667   |  |          |   | 57.60    |             |  |  |              |   |  |              |           |  |             |  |       |            |  |  | 916,667   |  |  |  | May 2010  | 
|2002 private placement of equity securities               |  |              | 1,222,223 |  |          |   | 12.00    |             |  |  | (1,218,890    | ) |  |              | 14,627,000 |  |             |  | (3,333 | )          |  |  |          |  |  |  |          | 
|Promissory note payable (see Note 10)                     |  |              |          |  |          |   | 13.01    |             |  |  | 145,853       |   |  |              |           |  |             |  |       |            |  |  | 145,853   |  |  |  | Jan 2006  | 
|Convertible promissory note payable (see Notes 10 and 22) |  |              |          |  |          |   | 6.00     |             |  |  | 1,000,000     |   |  |              |           |  |             |  |       |            |  |  | 1,000,000 |  |  |  | Nov 2009  | 
|Debt broker warrants (see Note 10)                        |  |              |          |  |          |   | 6.00     |             |  |  | 166,667       |   |  |              |           |  |             |  |       |            |  |  | 166,667   |  |  |  | Nov 2009  | 
|                                                          |  |              |           |  |          |   |          |             |  |  |               |   |  |              |            |  |             |  |        |            | 
|Total                                                     |  |              | 3,643,778 |  |          |   |          |             |  |  | (67,226       | ) |  | $            | 15,343,000 |  |             |  | (3,333 | )          |  |  | 3,573,219 |  |  |  |           | 
|                                                          |  |              |           |  |          |   |          |             |  |  |               |   |  |              |            |  |             |  |        |            | 





| |                                                    
| | ---------------------------------------------------
| | 2003 Private Placement of Common Stock and Warrants





| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | 2002 Private Placement of Convertible Equity Securities
    and Related Transactions in 2003



Issuance and Conversion of Convertible Notes


F-25



---



##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)








Series A Convertible Preferred Stock






F-26



---



##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




Series B Convertible Preferred Stock








| |                                            
| | -------------------------------------------
| | 2002 Private Placement of Equity Securities





| |                                           
| | ------------------------------------------
| | Other Equity Arrangements in 2000 and 2002

Common Stock Issued to Yahoo! Inc.


F-27



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




Common Stock Issued to Tumbleweed Communications
Corp.


Common Stock Issued to Entrust, Inc.


F-28



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|    |                                           
|--- | ------------------------------------------
|12. | Employee, Director and Other Stock Options



|                                          |                                            |                                                |            |           |             |         |           |           |           |  |           |   |           | 
|----------------------------------------- | ------------------------------------------ | ---------------------------------------------- | ---------- | --------- | ----------- | ------- | --------- | --------- | --------- |  | --------- | - | --------- | 
|                                          |                                            |                                                |            |           |             | Options |          
|                                          |                                            | Authorized                                     |            |           | Options     |         |           | Available |          
|                                          |                                            | Shares                                         |            |           | Outstanding |         |           | for Grant |          
|                                          |                                            |                                                |            |           |             |         |           |           |          
|Employee and Director Stock Option Plans: |                                            |                                                |            |           |             |         |           |           |           |  |           |  
|1990 Stock Option Plan                    |                                            |                                                | 345,045    |           |             |         | 31,250    |           |           |  |          |  
|1992 Stock Option Plan                    |                                            |                                                | 450,000    |           |             |         | 76,666    |           |           |  |          |  
|1995 Long-term Incentive Plan             |                                            |                                                | 1,825,000  |           |             |         | 785,534   |           |           |  |          |  
|1996 Directors Stock Option Plan         |                                            |                                                | 225,000    |           |             |         | 85,000    |           |           |  |          |  
|1999 Directors Stock Option Plan         |                                            |                                                | 975,000    |           |             |         | 853,917   |           |           |  |          |  
|2001 Stock Option Plan                    |                                            |                                                | 2,525,000  |           |             |         | 1,577,790 |           |           |  | 492,133   |  
|2001 Employee Stock Option Plan           |                                            |                                                | 300,000    |           |             |         | 167,171   |           |           |  | 89,282    |  
|2003 New Employee Stock Option Plan       |                                            |                                                | 500,000    |           |             |         | 343,200   |           |           |  | 156,800   |  
|2004 Stock Option Plan                    |                                            |                                                | 2,000,000  |           |             |         | 1,930,840 |           |           |  | 69,160    |  
|2004 Directors Stock Option Plan         |                                            |                                                | 300,000    |           |             |         | 50,000    |           |           |  | 250,000   |  
|Cook Employee Transferred Options         |                                            |                                                | 807,127    |           |             |         | 182,100   |           |           |  |          |  
|                                          |                                            |                                                |            |           |             |         |           |           |          
|                                          |                                            | Total employee and director stock option plans |            |           | 10,252,172  |         |           |           | 6,083,468 |  |           |   | 1,057,375 | 
|Executive Stock Option Agreements:        |                                            |                                                |            |           |             |         |           |           |           |  |           |  
|                                          | John A. Ryan, Chairman and former CEO      |                                                |            | 1,000,000 |             |         |           | 1,000,000 |           |  |           |  |          
|                                          | Richard G. Spurr, President and acting CEO |                                                |            | 650,000   |             |         |           | 650,000   |           |  |           |  |          
|                                          | Other executive stock option agreements    |                                                |            | 450,000   |             |         |           | 216,561   |           |  |           |  |          
|                                          |                                            |                                                |            |           |             |         |           |           |          
|                                          |                                            | Total executive stock option agreements        |            |           | 2,100,000   |         |           |           | 1,866,561 |  |           |   |          | 
|Other Stock Option Agreements             |                                            |                                                | 70,000     |           |             |         | 70,000    |           |           |  |          |  
|                                          |                                            |                                                |            |           |             |         |           |           |          
|Total                                     |                                            |                                                | 12,422,172 |           |             |         | 8,020,029 |           |           |  | 1,057,375 |  
|                                          |                                            |                                                |            |           |             |         |           |           |          



| |                                         
| | ----------------------------------------
| | Employee and Director Stock Option Plans



Cook Employee Transferred Options


F-29



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




| |                                   
| | ----------------------------------
| | Executive Stock Option Agreements:

John A. Ryan


Richard D. Spurr


Other Executive Stock Option Agreements




| |                               
| | ------------------------------
| | Other Stock Option Agreements:





| |                      
| | ---------------------
| | Stock Option Activity



|                                 |                         |        |           |                  |                |  |          |          | 
|-------------------------------- | ----------------------- | ------ | --------- | ---------------- | -------------- |  | -------- | -------- | 
|                                 |                         |        |           | Weighted Average |               
|                                 |                         | Shares |           |                  | Exercise Price | 
|                                 |                         |        |           |                  |                | 
|Outstanding at January 1, 2002   |                         |        | 6,707,619 |                  |                |  | $ 10.01  |         
|                                 | Granted at market price |        |           | 1,894,580        |                |  |          | $   4.57 | 
|                                 | Cancelled               |        |           | (2,087,182       | )              |  |          | $   8.95 | 
|                                 |                         |        |           |                  |                | 
|Outstanding at December 31, 2002 |                         |        | 6,515,017 |                  |                |  | $   8.77 |         
|                                 | Granted at market price |        |           | 2,436,676        |                |  |          | $   4.54 | 
|                                 | Cancelled               |        |           | (1,105,589       | )              |  |          | $ 10.42  | 
|                                 | Exercised               |        |           | (1,885,387       | )              |  |          | $   5.83 | 
|                                 |                         |        |           |                  |                | 
|Outstanding at December 31, 2003 |                         |        | 5,960,717 |                  |                |  | $   7.66 |         
|                                 | Granted at market price |        |           | 3,793,716        |                |  |          | $   6.99 | 
|                                 | Cancelled               |        |           | (728,592         | )              |  |          | $   9.15 | 
|                                 | Exercised               |        |           | (1,005,812       | )              |  |          | $   5.47 | 
|                                 |                         |        |           |                  |                | 
|Outstanding at December 31, 2004 |                         |        | 8,020,029 |                  |                |  | $   7.64 |         
|                                 |                         |        |           |                  |                | 

F-30



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|                |                     |                     |             |                     |           |                  |  |                |  |             |  |  |                |  |  |  |         | 
|--------------- | ------------------- | ------------------- | ----------- | ------------------- | --------- | ---------------- |  | -------------- |  | ----------- |  |  | -------------- |  |  |  | ------- | 
|                |                     | Options Outstanding |             | Options Exercisable |          
|                |                     |                     |             |                     |          
|                |                     |                     |             | Weighted Average    |           | Weighted         |  |                |  | Weighted    | 
|Range of        |                     |                     | Number      |                     |           | Remaining        |  | Average        |  | Number      |  |  | Average        | 
|Exercise Prices |                     |                     | Outstanding |                     |           | Contractual Life |  | Exercise Price |  | Exercisable |  |  | Exercise Price | 
|                |                     |                     |             |                     |           |                  |  |                |  |             |  |  |                | 
|                | $  2.50 -   $  4.99 |                     |             |                     | 2,122,742 |                  |  | 5.0            |  | $  4.21     |  |  | 729,162        |  |  |  | $  4.12 | 
|                | $  5.00 -   $  5.75 |                     |             |                     | 1,822,468 |                  |  | 7.4            |  | $  5.17     |  |  | 1,318,614      |  |  |  | $  5.23 | 
|                | $  6.00 -   $  8.89 |                     |             |                     | 1,984,482 |                  |  | 8.0            |  | $  6.74     |  |  | 640,940        |  |  |  | $  7.15 | 
|                | $  9.00 -   $19.75  |                     |             |                     | 1,843,309 |                  |  | 5.9            |  | $11.48      |  |  | 956,369        |  |  |  | $12.30  | 
|                | $21.38 -  $44.63    |                     |             |                     | 247,028   |                  |  | 4.3            |  | $33.76      |  |  | 247,028        |  |  |  | $33.76  | 
|                |                     |                     |             |                     |           |                  |  |                |  |             |  |  |                | 
|                |                     |                     |             |                     | 8,020,029 |                  |  |                |  |             |  |  | 3,892,113      |  |  |  |         | 
|                |                     |                     |             |                     |           |                  |  |                |  |             |  |  |                | 





| |                      
| | ---------------------
| | Reserved Common Stock





| |                             
| | ----------------------------
| | Employee Stock Purchase Plan





| |                   
| | ------------------
| | Stock Compensation



|                                                          |  |      |           |  |      |   |           |      |  |   |           | 
|--------------------------------------------------------- |  | ---- | --------- |  | ---- | - | --------- | ---- |  | - | --------- | 
|                                                          |  | 2004 |           |  | 2003 |   |           | 2002 | 
|                                                          |  |      |           |  |      |   |           |      | 
|Stock compensation relating to accelerated option vesting |  | $    | 1,115,000 |  |      | $ |          |      |  | $ |          | 
|Stock granted in lieu of compensation                     |  |      | 2,779,000 |  |      |   | 484,000   |      |  |   |          | 
|Stock options granted to third parties                    |  |      | 179,000   |  |      |   | 550,000   |      |  |   | 2,478,000 | 
|                                                          |  |      |           |  |      |   |           |      | 
|Total                                                     |  | $    | 4,073,000 |  |      | $ | 1,034,000 |      |  | $ | 2,478,000 | 
|                                                          |  |      |           |  |      |   |           |      | 





F-31



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)






|    |                                          
|--- | -----------------------------------------
|13. | Earnings Per Share and Potential Dilution



|                                                                         |  |      |             |   |      |   |             |      |  |   |             |  
|------------------------------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                         |  | 2004 |             |   | 2003 |   |             | 2002 | 
|                                                                         |  |      |             |   |      |   |             |      | 
|Net loss from continuing operations before preferred stock
    dividends |  | $    | (42,040,000 | ) |      | $ | (27,667,000 | )    |  | $ | (34,299,000 | )
|Preferred stock dividends                                                |  |      |            |   |      |   | (1,405,000  | )    |  |   | (3,181,000  | )
|                                                                         |  |      |             |   |      |   |             |      | 
|Net loss from continuing operations attributable to common stock         |  | $    | (42,040,000 | ) |      | $ | (29,072,000 | )    |  | $ | (37,480,000 | )
|                                                                         |  |      |             |   |      |   |             |      | 
|Loss from continuing operations per common share basic and
    diluted   |  | $    | (1.33       | ) |      | $ | (1.23       | )    |  | $ | (2.07       | )
|                                                                         |  |      |             |   |      |   |             |      | 
|Weighted average common shares  basic and diluted                       |  |      | 31,533,000  |   |      |   | 23,525,077  |      |  |   | 18,128,796  |  
|                                                                         |  |      |             |   |      |   |             |      | 



|                                                                                         |  |      |            |  |      |  |           |      |  |  |            | 
|---------------------------------------------------------------------------------------- |  | ---- | ---------- |  | ---- |  | --------- | ---- |  |  | ---------- | 
|                                                                                         |  | 2004 |            |  | 2003 |  |           | 2002 | 
|                                                                                         |  |      |            |  |      |  |           |      | 
|Stock options                                                                            |  |      | 8,020,029  |  |      |  | 6,048,217 |      |  |  | 6,624,739  | 
|Warrants issued in relation to debt and equity arrangements (see
    Note 11)            |  |      | 3,573,219  |  |      |  | 3,643,778 |      |  |  | 4,151,558  | 
|Shares issuable for conversion of convertible promissory notes
    payable (see Note 10) |  |      | 3,333,333  |  |      |  |          |      |  |  |           | 
|Series A convertible preferred stock                                                     |  |      |           |  |      |  |          |      |  |  | 728,395    | 
|Series B convertible preferred stock                                                     |  |      |           |  |      |  |          |      |  |  | 1,187,348  | 
|                                                                                         |  |      |            |  |      |  |           |      | 
|Total antidilutive securities excluded from EPS calculation                              |  |      | 14,926,581 |  |      |  | 9,691,995 |      |  |  | 12,692,040 | 
|                                                                                         |  |      |            |  |      |  |           |      | 





F-32



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)








|    |                                                               
|--- | --------------------------------------------------------------
|14. | Significant Customers and Subsequent Sale of Product
    Lines







|    |                              
|--- | -----------------------------
|15. | Commitments and Contingencies



| |                
| | ---------------
| | Leases and Debt





|                        |  |      |           |  |      |   |           |      |  |   |           |  |  |      |           |  |            |   |         |       |  |   |           |  |  |   |            | 
|----------------------- |  | ---- | --------- |  | ---- | - | --------- | ---- |  | - | --------- |  |  | ---- | --------- |  | ---------- | - | ------- | ----- |  | - | --------- |  |  | - | ---------- | 
|                        |  | 2005 |           |  | 2006 |   |           | 2007 |  |   | 2008      |  |  | 2009 |           |  | Thereafter |   |         | Total | 
|                        |  |      |           |  |      |   |           |      |  |   |           |  |  |      |           |  |            |   |         |       | 
|Long-term debt          |  | $    | 5,193,000 |  |      | $ | 5,000,000 |      |  | $ | 7,700,000 |  |  | $    | 5,000,000 |  |            | $ |        |       |  | $ |          |  |  | $ | 22,893,000 | 
|Operating leases        |  |      | 1,315,000 |  |      |   | 1,108,000 |      |  |   | 1,086,000 |  |  |      | 905,000   |  |            |   | 896,000 |       |  |   | 4,213,000 |  |  |   | 9,523,000  | 
|Capital lease           |  |      | 130,000   |  |      |   | 87,000    |      |  |   |          |  |  |      |          |  |            |   |        |       |  |   |          |  |  |   | 217,000    | 
|                        |  |      |           |  |      |   |           |      |  |   |           |  |  |      |           |  |            |   |         |       | 
|Total cash obligations  |  |      | 6,638,000 |  |      |   | 6,195,000 |      |  |   | 8,786,000 |  |  |      | 5,905,000 |  |            |   | 896,000 |       |  |   | 4,213,000 |  |  |   | 32,633,000 | 
|Interest on obligations |  |      | 1,046,000 |  |      |   | 760,000   |      |  |   | 490,000   |  |  |      | 223,000   |  |            |   |        |       |  |   |          |  |  |   | 2,519,000  | 
|                        |  |      |           |  |      |   |           |      |  |   |           |  |  |      |           |  |            |   |         |       | 
|Total                   |  | $    | 7,684,000 |  |      | $ | 6,955,000 |      |  | $ | 9,276,000 |  |  | $    | 6,128,000 |  |            | $ | 896,000 |       |  | $ | 4,213,000 |  |  | $ | 35,152,000 | 
|                        |  |      |           |  |      |   |           |      |  |   |           |  |  |      |           |  |            |   |         |       | 



F-33



---



##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)








| |         
| | --------
| | Lawsuits











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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)








|    |             
|--- | ------------
|16. | Income Taxes



|          |         |      |         |         |      |   |         |         |   |   |          |          |  
|--------- | ------- | ---- | ------- | ------- | ---- | - | ------- | ------- | - | - | -------- | -------- | -
|          |         | 2004 |         |         | 2003 |   |         | 2002    |  
|          |         |      |         |         |      |   |         |         |  
|Current:  |         |      |         |         |      |   |         |         |   |   |          |         
|          | U.S.    |      | $       |        |      |   | $       |        |   |   | $        | (269,000 | )
|          | Foreign |      |         | 501,000 |      |   |         | 167,000 |   |   |          |         |  
|Deferred: |         |      |         |         |      |   |         |         |   |   |          |         
|          | Foreign |      |         | (16,000 | )    |   |         | (19,000 | ) |   |          |         |  
|          |         |      |         |         |      |   |         |         |  
|          |         | $    | 485,000 |         |      | $ | 148,000 |         |   | $ | (269,000 | )       
|          |         |      |         |         |      |   |         |         |  



|                                            |  |      |             |   |      |   |            |      |  |   |             |  
|------------------------------------------- |  | ---- | ----------- | - | ---- | - | ---------- | ---- |  | - | ----------- | -
|                                            |  | 2004 |             |   | 2003 |   |            | 2002 | 
|                                            |  |      |             |   |      |   |            |      | 
|Expected tax benefit at U.S. statutory rate |  | $    | (14,128,000 | ) |      | $ | (9,336,000 | )    |  | $ | (11,753,000 | )
|Unbenefited U.S. losses, net                |  |      | 14,144,000  |   |      |   | 9,571,000  |      |  |   | 10,986,000  |  
|Nondeductible expense                       |  |      | 469,000     |   |      |   |           |      |  |   | 670,000     |  
|Other                                       |  |      |            |   |      |   | (87,000    | )    |  |   | (172,000    | )
|                                            |  |      |             |   |      |   |            |      | 
|                                            |  | $    | 485,000     |   |      | $ | 148,000    |      |  | $ | (269,000    | )
|                                            |  |      |             |   |      |   |            |      | 

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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|                          |                                        |      |             |            |      |   |             |            | 
|------------------------- | -------------------------------------- | ---- | ----------- | ---------- | ---- | - | ----------- | ---------- | 
|                          |                                        | 2004 |             |            | 2003 |  
|                          |                                        |      |             |            |      |  
|Deferred tax assets:      |                                        |      |             |            |      |   |             |           
|                          | Nondeductible reserves                 |      | $           | 630,000    |      |   | $           | 156,000    | 
|                          | U.S. net operating loss carryforwards  |      |             | 72,527,000 |      |   |             | 57,543,000 | 
|                          | State net operating loss carryforwards |      |             | 1,761,000  |      |   |             |           | 
|                          | Capital loss carryforwards             |      |             | 987,000    |      |   |             | 987,000    | 
|                          | Tax credit carryforwards               |      |             | 2,986,000  |      |   |             | 2,986,000  | 
|                          | Stock-based compensation               |      |             | 3,519,000  |      |   |             | 4,612,000  | 
|                          | Start-up costs                         |      |             | 96,000     |      |   |             | 589,000    | 
|                          | Intangible assets                      |      |             | 1,371,000  |      |   |             | 758,000    | 
|                          | Investment in equity securities        |      |             |           |      |   |             | 21,000     | 
|                          | Other assets                           |      |             | 2,013,000  |      |   |             | 2,189,000  | 
|                          |                                        |      |             |            |      |  
|                          | Total deferred tax assets              |      |             | 85,890,000 |      |   |             | 69,841,000 | 
|Less valuation allowance  |                                        |      | (85,528,000 | )          |      |   | (69,822,000 | )         
|                          |                                        |      |             |            |      |  
|Net deferred tax assets   |                                        |      | 362,000     |            |      |   | 19,000      |           
|Deferred tax liability:   |                                        |      |             |            |      |   |             |           
|Prepaid Interest          |                                        |      | (327,000    | )          |      |   |            |           
|                          |                                        |      |             |            |      |  
|Net deferred income taxes |                                        | $    | 35,000      |            |      | $ | 19,000      |           
|                          |                                        |      |             |            |      |  









|    |                           
|--- | --------------------------
|17. | Related Party Transactions



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)










|    |                      
|--- | ---------------------
|18. | Employee Benefit Plan

401(k) Plan




|    |                        
|--- | -----------------------
|19. | Discontinued Operations



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)










|    |                                     
|--- | ------------------------------------
|20. | International Distribution Agreement





|    |                                            
|--- | -------------------------------------------
|21. | Quarterly Results of Operations (Unaudited)



|                                |  |               |             |   |         |   |            |              |  |   |             |   |  |   |             |  
|------------------------------- |  | ------------- | ----------- | - | ------- | - | ---------- | ------------ |  | - | ----------- | - |  | - | ----------- | -
|                                |  | Quarter Ended |            
|                                |  |               |            
|                                |  | March 31      |             |   | June 30 |   |            | September 30 |  |   | December 31 |  
|                                |  |               |             |   |         |   |            |              |  |   |             |  
|2004                            |  |               |             |   |         |   |            |              |  |   |             |   |  |   |             |  
|Revenues                        |  | $             | 2,843,000   |   |         | $ | 3,521,000  |              |  | $ | 3,853,000   |   |  | $ | 3,910,000   |  
|Cost of revenues                |  |               | (3,174,000  | ) |         |   | (3,704,000 | )            |  |   | (4,541,000  | ) |  |   | (4,459,000  | )
|Loss from continuing operations |  |               | (10,938,000 | ) |         |   | (9,876,000 | )            |  |   | (10,704,000 | ) |  |   | (10,522,000 | )
|Net loss                        |  |               | (10,938,000 | ) |         |   | (9,876,000 | )            |  |   | (10,704,000 | ) |  |   | (10,522,000 | )
|Net loss per common share       |  |               | (0.36       | ) |         |   | (0.31      | )            |  |   | (0.33       | ) |  |   | (0.33       | )
|2003                            |  |               |             |   |         |   |            |              |  |   |             |   |  |   |             |  
|Revenues                        |  | $             | 639,000     |   |         | $ | 1,014,000  |              |  | $ | 2,219,000   |   |  | $ | 1,968,000   |  
|Cost of revenues                |  |               | (1,760,000  | ) |         |   | (1,854,000 | )            |  |   | (1,934,000  | ) |  |   | (2,633,000  | )
|Loss from continuing operations |  |               | (6,831,000  | ) |         |   | (6,055,000 | )            |  |   | (6,506,000  | ) |  |   | (8,275,000  | )
|Net loss                        |  |               | (6,831,000  | ) |         |   | (6,055,000 | )            |  |   | (6,506,000  | ) |  |   | (8,186,000  | )
|Net loss per common share       |  |               | (0.36       | ) |         |   | (0.31      | )            |  |   | (0.29       | ) |  |   | (0.29       | )



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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)






| |   |                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Company incurred an $886,000 non-cash expense in first
    quarter resulting from the acceleration of vesting of certain
    stock options held by employees who were severed from the
    Company.                              
|
| |  | In third quarter 2004 the Company decided to discontinue the
    Connect product purchased in the MyDocOnline acquisition. This
    resulted in a write-down of $675,000 of the net value attributed
    to the MyDocOnline purchase.



|    |                  
|--- | -----------------
|22. | Subsequent Events



| |                                                              
| | -------------------------------------------------------------
| | Sale of Web Inspector and Message Inspector Product
    Lines







| |                                                                      
| | ---------------------------------------------------------------------
| | Restructuring of $20,000,000 Convertible Promissory
    Notes Payable





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The initial principal payment of $5,000,000 due November 2,
    2005 is to be redeemed by July 31, 2005. The Company can
    choose to make this payment in common stock or cash. If the
    Company chooses to pay in common stock the principal will be at
    105% of face value. The common stock will be valued at 90% of
    the weighted average trading price over the 15 trading days
    prior to the redemption.                                                                                                                                           
|
| |  | The principal payment of $5,000,000 due November 2, 2008 is
    to be redeemed by December 31, 2005. The Company can choose
    to make this payment in common stock or cash. If the Company
    chooses to pay in common stock the principal will be at 105% of
    face value. The common stock will be valued at 90% of the
    weighted average trading price over the 15 trading days prior to
    the redemption.                                                                                                                                               
|
| |  | If either of the two payments noted above are made in cash the
    payment will be considered an early redemption of the debt, such
    that the Notes are payable at 105% of face value, plus accrued
    interest. In the event of an early redemption, the noteholders
    will receive warrants equal to 70% of the shares of common stock
    that they would have received if the principal amount being
    redeemed had remained outstanding and had been converted to the
    Companys common stock at the original conversion price of
    $6.00 per share.

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##### Table of Contents



ZIX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




| |   |                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The exercise price of the 1,000,000 warrants originally granted
    to the Investors will be adjusted, on a pro rata basis, to the
    applicable weighted average trading prices of the Companys
    common stock if the stock redemptions noted above occur.                                                                                                                                               
|
| |  | The Company is required to maintain minimum cash balances of
    $10,000,000 through December 31, 2005, $9,000,000 through
    November 2006 and $5,000,000 thereafter until the Notes are
    fully redeemed. Of the total minimum cash requirements 50% of
    the outstanding principal balance is required to be held in a
    separate collateral account until certain operating objectives
    are met.



F-40