ZIX CORP - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] 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
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ZIX CORPORATION
(Exact name of Registrant as Specified in its Charter)

TEXAS 75-2216818
(State of Incorporation) (I.R.S. Employer Identification Number)

2711 N. HASKELL AVENUE, SUITE 2300, 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:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK
$0.01 PAR VALUE
(TITLE OF CLASS)

Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]

As of June 30, 2002, there were 17,674,687 shares of Zix Corporation's
$0.01 par value common stock outstanding, 15,244,012 of which, having an
aggregate market value of $83,537,186, were held by non-affiliates. For purposes
of the above statement, all directors and officers of the Registrant are
presumed to be affiliates.

Portions of the Registrant's 2003 proxy statement are incorporated by
reference into Part III of this Form 10-K.
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PART I

ITEM 1. BUSINESS

OVERVIEW

Zix Corporation ("ZixCorp," "Company," "we," "our," or "us") is a global
provider of e-messaging management and protection services. We offer a portfolio
of managed on-site and hosted e-messaging solutions to securely exchange
Internet communications with any email user and protect organizations from
viruses, spam, and electronic attack, while delivering the ability to enforce
corporate policies. Our advisory services and comprehensive e-messaging
solutions enable organizations of any size to streamline operations, mitigate
the risks associated with obsolescence, negligence, and a series of email-borne
threats, and leverage the cost and time efficiencies of e-messaging.

Email has become a mission-critical means of communications for
enterprises. However, once email leaves an enterprise's secure network
environment, it enters the Internet -- a global network of computers -- and is
transmitted to the recipient through one or more Internet communication nodes.
If the email transmission is sent over the Internet as cleartext (i.e., in
unencrypted form), it could be intercepted anywhere along the path between a
sender and a recipient, permitting the theft, redirection, manipulation, or
exposure to unauthorized parties of the content of the message.

In addition, federal regulations such as the Health Insurance Portability
and Accountability Act of 1996 (HIPAA) and the Gramm-Leach-Bliley Act (GLBA)
have enhanced security awareness in general, and have prompted organizations
affected by them to increasingly consider adopting systems for ensuring data
security and privacy. In the corporate community in general, even where there
are no specific regulations, corporations may require email protection to adhere
to evolving industry best practices for protecting sensitive information for the
benefit of their customers, employees and partners.

Electronic communications are also subject to a variety of email-borne
threats, such as viruses or spam, or various forms of electronic threat,
manipulation, or attack. Failure to control and manage such risks can result in
enforcement penalties, including monetary penalties, for non-compliance with
regulatory or legal mandates; decreased productivity and efficiency; damage to
or loss of reputation, brand value, trust among partners and customers,
competitive advantage, intellectual property or other corporate assets; exposure
to negligence or liability claims; and diversion of resources to repair such
damage.

As a result of the above, corporations need security and privacy for their
email communications, control over inappropriate content in their email
communications, and the ability to manage their email systems to prevent or
reduce traffic that is unwelcome or undesirable. They require ubiquitous
coverage that is cost-effective, quickly deployed, and consistently updated to
guard against obsolescence and ineffectiveness in the face of changing external
or internal policies or other requirements.

To satisfy this need for enterprise-wide coverage and control of the risks
presented by the use of Internet email, ZixCorp delivers comprehensive, on-site
and hosted solutions for managing and protecting e-messaging. ZixCorp solutions
are managed policy-driven services for analyzing and encrypting Internet
communications and for addressing anti-virus, anti-spam, content filtering,
reporting and archiving needs. ZixCorp also provides related advisory,
consulting, installation, customization, and training services. ZixCorp
solutions are scalable, easily integrated within the organization, and quickly
deployable. All ZixCorp solutions are fully interoperable and linked by a Best
Method of Delivery(TM) protocol, which automatically determines the most direct
and most appropriate method of delivery, based on the recipient's communications
environment. This function employs a centralized directory of users' encryption
codes to enable users to send instantly and securely to users of any of its
solutions as well as to anyone with an email address, including those who do not
have any special encryption software. This Best Method of Delivery protocol
makes the service simple to use for end-users, who can exchange messages with
little or no training, and provides flexibility and ease of implementation for
information technology professionals, who avoid having to install extensive new
infrastructure to communicate securely with employees, partners, customers, and
others.

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ZixCorp services include ZixWorks(TM), a suite of fully managed hosted
services that enables users to send email securely and that protects
organizations from viruses, spam, inappropriate content, and electronic attack;
ZixPort(TM), a secure Web-messaging portal; ZixVPM(TM), an e-messaging gateway
solution that provides company-wide privacy protection for inbound and outbound
email communications combined with sophisticated policy management capabilities
for email; ZixMail(TM), a desktop (i.e., installed on a user's computer)
solution for encrypting and securely delivering email; ZixAuditor(TM), an
assessment service used to analyze email traffic patterns and monitor compliance
with corporate and regulatory policies; and ZixPSAS(TM), a subscription service
for receiving updates to policy definitions used in managing and filtering email
content and complying with corporate policies. Fully interoperable, these
services may be used separately or in combination with each other.

A subscription to any of the ZixCorp secure e-messaging services includes
the right for recipients who are not subscribers to receive secure messages from
subscribers through the ZixMessage Center(TM), a secure Web messaging portal
utilizing Secure Socket Layer (SSL) technology and integrated with all ZixCorp
services as part of all users' subscriptions.

The ZixCorp Best Method of Delivery protocol chooses one of these different
means of delivery: directly to the desktop computer of a recipient who is a
subscriber and ZixMail enabled; to the ZixVPM server of an organization that is
a subscriber and ZixVPM enabled; through ZixPort, a secure web messaging portal;
to a ZixVPM server used by an organization that is a subscriber of ZixWorks; or
to the ZixMessage Center, the secure Web-based portal of ZixCorp used for email
sent to and from non-subscribers. We believe that this ability to send the
message through different modes of delivery, either by selecting one of these
options or as an automated function, and the ability to communicate easily with
non-subscribers, who do not have any special software for encrypting messages,
make our secure e-messaging delivery products and services superior to those of
our competitors.

ZixCorp offers enterprises a choice between an on-site solution, which can
offer on-premises control and customization possibilities, and a fully hosted,
fully managed, instantly on, solution for e-messaging management and protection,
under which ZixCorp assumes the full responsibility for these operations.

ZixCorp applies its award-winning technology and subscription-based
services to enable global enterprises to securely exchange electronic content
with business partners, customers and internal employees. ZixCorp customers are
able to quickly implement ZixCorp's on-site secure e-messaging solutions within
their existing network infrastructures without requiring the addition of
extensive new infrastructure or information technology personnel, and a
corporate-wide deployment can be installed rapidly.

ZixCorp entered the secure e-messaging market in 1999. In 1998 and prior
years, as described below, ZixCorp designed, manufactured, marketed, installed
and supported a wide array of wireless data and security technology products and
solutions for a variety of industries through two primary market-oriented
groups, each with a core competency in radio frequency technology.

The Company's Electronic Security Group designed, manufactured, marketed,
installed and supported its electronic security equipment and full-service
solutions for electronic security needs to corporate and government markets
throughout the world. These products and services were marketed under the
"Cotag" and "Cardkey" brand names, and were targeted primarily to the electronic
access control, asset management and tracking, healthcare security and security
management markets.

The Company's Transportation Systems Group designed, manufactured,
marketed, installed and supported wireless equipment and systems that permitted
the remote identification of, and communication with, objects through the use of
high frequency radio frequency signals rather than bar codes, magnetic cards, or
other means. These products and systems, which were marketed under the "Amtech"
brand name, were targeted primarily to the rail, electronic toll collection and
traffic management, intermodal, airport, access control, and motor freight
markets.

The Company determined in 1998 that its businesses were low margin and the
industries in which they operated were approaching maturity. Accordingly, the
Company decided to exit its then-current businesses, and during 1998 it sold all
of its operating units and raised approximately $85 million in cash. The Company
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then began evaluating new Internet-related business opportunities -- which it
deemed to offer more promising prospects for growth and profitability than the
previous businesses. The Company perceived a need for products and services to
bring privacy, security and convenience to Internet communications and in 1999
it began developing secure e-messaging products as well as a shopping portal and
Internet payment authorization system to address these needs.

We announced our intention to enter these new businesses in 1999, and began
developing our secure e-messaging capabilities and services. In mid-1999, we
launched our ZixSecure Center(TM), a world-class data center for centralizing
the processing and distribution of public encryption keys and began operations
later that year, when we introduced early versions of our ZixMail service for
individual users. The first use of the ZixMessage Center for messages to and
from non-subscribers was fully integrated with ZixMail and introduced in July
2000. The Company began charging for its ZixMail product and services in the
first quarter of 2001 and started focusing its ZixMail sales and marketing
efforts toward the business market. Our ZixMail product received PC Magazine's
Editors' Choice Award in January 2001 for the email security category.

In the first quarter of 2002, we expanded our portfolio of products and
services for the business market with the introduction of our enterprise secure
e-messaging solution, ZixVPM. We also began offering a new assessment service,
ZixAuditor, as a means for corporations to examine and help analyze their
inbound and outbound email communications. In August 2002, we also introduced
ZixPort, a branded, Web-based, secure e-messaging portal solution that
seamlessly integrates with a company's existing portal or functions as a
standalone site. The ZixPort service is designed to mirror the look and feel of
a customer's own Web site and, when fully integrated with the existing Web site,
is able to provide the advantages of single sign-on authentication.

In February 2003, we introduced significantly expanded capabilities
designed to help corporations manage tasks that go beyond ensuring the security
and integrity of e-messages and e-message delivery. With the introduction of
ZixVPM 2.0, we added sophisticated technology, content filtering lexicons, and
other research-based assets to a powerful new policy-driven engine. ZixVPM 2.0,
the new version of our on-site server solution, enables our customers to more
effectively and efficiently ensure compliance with their corporate security,
privacy and other policies. With ZixVPM 2.0, we also introduced our Policy
Subscription and Advisory Service, which provides regular updates of definitions
to lexicons and other policies to ensure that compliance is kept up to date with
changes in regulations, interpretations, industry best practices, and individual
corporate communication environments. Our ZixWorks package of hosted solutions,
encompassing services that safeguard communications against a variety of
email-borne threats, that deliver policy-driven security and privacy, and that
comply with corporate policies for compliance purposes, was introduced in early
February 2003. With the introduction of these expanded capabilities, our company
moved to a single-source, full-service provider of a comprehensive suite of
e-messaging management and protection services.

A development stage enterprise involves risks and uncertainties, and there
are no assurances that the Company will be successful in its efforts. Successful
growth of a development stage enterprise is costly and highly competitive. The
Company's growth depends on the timely development and market acceptance of its
products and services. See Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below for a description of
certain management assumptions, risks and uncertainties relating to the
Company's operations.

ZixCorp was incorporated in Texas in 1988. ZixCorp's executive offices are
located at 2711 North Haskell Avenue, Suite 2300, LB 36, Dallas, Texas
75204-2960, (214) 370-2000. ZixCorp's secure data center is located in Dallas,
Texas.

We file annual, quarterly, current and other reports, proxy statements and
other information with the Securities and Exchange Commission, or SEC, pursuant
to the Securities Exchange Act of 1934, as amended, or the Exchange Act. You may
read and copy any materials we file with the SEC at the SEC's Public Reference
Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain
information on the operation of the SEC's Public Reference Room by calling the
SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports,
proxy and other information statements, and other information regarding issuers,
including us, that file electronically with the SEC. The address of that site is
http://www.sec.gov.
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We maintain an Internet site, the address of which is www.zixcorp.com.
Information contained on our Internet site is not part of this report. We make
available free of charge through this site, under the heading "Investor
Relations/Financials/SEC Filing," our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practicable after we electronically file such material
with, or furnish it to, the SEC.

PRODUCTS AND SERVICES

ZixVPM -- The Zix Virtual Private Messenger solution is a secure
e-messaging gateway solution that provides company-wide privacy protection for
inbound and outbound email communications combined with sophisticated policy
management capabilities. It employs encryption technology for delivering and
encrypting email transmissions to and from outside an enterprise's corporate
firewall. ZixVPM provides secure email correspondence among remote employees,
customers and business partners without requiring the enterprise to create,
deploy and manage end-user encryption keys and desktop software. ZixVPM is fully
integrated with our ZixMail service and gives us a strong differentiator in the
marketplace. Since ZixVPM is installed at the server level within an
enterprise -- and the email messages leaving that enterprise's corporate
firewall are encrypted at the server level -- the end-users of that enterprise's
email system are not required to install any software at their computer
desktops, nor are they required to obtain any public or private encryption codes
to encrypt their email messages. We believe that this ability to provide secure
delivery of email without impacting end users provides a degree of practicality
that is highly desirable in the marketplace and necessary to any wide-spread
deployment of encryption and secure email. ZixVPM can be integrated seamlessly
with a customer's own scanning and filtering tools and policies. This enterprise
solution enables our customers to automate encryption at the network level in
accordance with standard corporate policies and enforce these policies without
having to rely on discretionary judgments of individual employees about
encrypting sensitive messages.

The newest release of ZixCorp's gateway solution, ZixVPM 2.0, is delivered
with built-in enhanced policy management features, as well as auditing and
certain reporting functions, in addition to the service's pre-existing secure
email delivery capabilities. Version 2.0 can be bundled with a comprehensive
lexicon of validated policies to assist organizations in their efforts to meet
standard-of-care guidelines and various regulations, such as HIPAA and GLBA.
Additional ZixVPM policies can easily be created through an intuitive policy
management interface. This more powerful version of ZixVPM comes with a
streamlined installation process and is specifically designed to meet the
growing requirements from organizations that need to enforce increasingly
complex corporate policies brought on by regulations, risk management
considerations, and protection of intellectual property in information exchanged
via email.

ZixVPM 2.0 also incorporates a powerful and sophisticated email content
scanning engine to identify, protect, and manage messages containing sensitive
information and to ensure that malicious or inappropriate emails do not enter or
leave the enterprise. The content scanning mechanism is supported by a powerful
pattern-matching engine that incorporates word stemming, fuzzy matching, nested
document support, and proximity matching -- which permits confidential or
sensitive information to be detected even when there are errors of context,
grammar, or spelling or when content is hidden within attachments, while
preventing accidental filtering of similar but unrelated words or phrases.
Company policies can be created to force certain actions, such as encryption or
branding, of messages, based on pre-established content scanning policies.

ZixPSAS -- The Zix Policy Subscription and Advisory Service, introduced in
2003, is a service that provides continual updates to policies for the ZixVPM
lexicons as well as other filtering and scanning rules. It is designed to help
ensure the ongoing effectiveness of company compliance efforts by keeping
policies current with changing regulations, industry best practices, and a
customer's communications environment or e-messaging traffic patterns.
Subscribers also have access to advisors who can assist or manage company-
specific policies through the ZixResearch Center, the organization within
ZixCorp that centralizes and is dedicated to the development and enhancement of
these policies and other research-based assets utilized in ZixCorp solutions.
When coupled with ZixVPM 2.0, ZixPSAS removes the burden of creating, updating
and

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managing these policies from corporations, who may not have sufficient expertise
or resources to dedicate to these tasks.

ZixAuditor -- ZixAuditor is ZixCorp's assessment service used to analyze,
document, and report on the nature and characteristics of an organization's
inbound and outbound email communications with the purpose of identifying
regulated, high-risk, or proprietary content. It is used to design effective
solutions and to create and refine policies that correspond to the identified
risks and email traffic patterns of an organization. ZixAuditor provides a
concrete and quantifiable basis for justifying and determining the kind of
solution and management system needed to safeguard a customer's email traffic,
to protect itself from risks, and to enforce corporate policies. After
implementing a ZixCorp secure e-messaging solution, ZixAuditor also provides a
means of monitoring the ongoing effectiveness of that solution and of refining
over time policies used by a ZixVPM solution. Organizations may subscribe for
pre or post-installation audits or for a regular program of ongoing audits for
monitoring purposes. We believe this service to be unique in the industry and a
factor contributing to ZixCorp's expertise in the application of secure email
solutions.

ZixAuditor is built around a lexicon that enables the identification of
messages containing legal, health, financial, human resources, and other legally
protected or proprietary information. The lexicon was created in consultation
with Preston Gates & Ellis LLP, a Seattle-based law firm with a strong focus on
intellectual property rights, electronic communications, and federal privacy
regulations. As part of each assessment the lexicon is customized to include
terminology specific to a customer's organization.

ZixMail -- ZixMail is a secure email application and e-messaging service
that employs encryption technology to enable Internet users worldwide to easily
send encrypted, digitally signed communications to any email address in the
world, even if the recipient does not subscribe to ZixMail. ZixMail provides
computer desktop-level encryption and works with existing email addresses and
systems, and is available in a standalone version or in versions that integrate
fully with Microsoft Outlook(R) and Lotus Notes(R). As with ZixVPM, ZixMail does
not require the user to manually exchange or manage public encryption keys.
ZixCorp's secure data center, ZixSecure Center, automatically validates a user's
unique digital signature and distributes public keys in real time for each
message. Optional certified receipts irrefutably establish the exact time
messages are sent and opened. ZixMail is a portable solution, as ZixCorp digital
signatures used in exchanging ZixMail messages may be easily exported or
imported to other computers, at the user's discretion.

A ZixMail subscription entitles recipients who are not ZixMail subscribers
to receive and reply to ZixMail messages without additional charges through the
ZixMessage Center that provides a browser-based solution for viewing and
composing secure messages over an SSL Internet connection. Messages are stored
until the expiration date (set by the sender) or until the recipient deletes the
message. At the option of the sender, the ZixMessage Center will generate and
send a pick-up receipt and an expiration notice to the sender. The ZixMessage
Center allows ZixMail subscribers to send secure messages to non-ZixMail
subscribers, thus providing a send-to-anyone encryption solution.

As with all other ZixCorp solutions, ZixCorp's Best Method of Delivery
protocol automatically determines whether the intended recipient is already a
subscriber and ZixCorp enabled, permitting the ZixMail message to be delivered
by the appropriate ZixCorp solution, or whether the ZixMessage Center for
non-subscribers is the most direct method of delivering the message securely.
Users also have the option of forcing ZixMail messages to be sent via the
ZixMessage Center to accommodate travel or other special delivery circumstances.
ZixCorp's customers may privately brand the delivery of their secure messages to
recipients who are not ZixCorp subscribers, by subscribing to our ZixPort
service.

ZixPort -- ZixPort is a browser-based, branded secure e-messaging portal
solution. It provides businesses with a central access point to exchange private
and secure email and a vehicle that can be used to repeatedly draw customers to
the corporate portal. It is hosted, monitored, and managed in the ZixSecure
Center. ZixPort is easily deployed and has little or no impact on a company's
existing information technology, Web and security infrastructures.

The ZixPort service is designed to be branded, mirroring the look and feel
of a customer's own Web site, and can be deployed as a standalone site or
seamlessly integrated with a company's own portal, providing

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employees, customers, and partners with a transparent user experience. The
service can be integrated into an existing single sign-on security solution, can
take advantage of ZixCorp's application program interfaces in order to realize
increased efficiencies, and can lower support costs and improve customer
satisfaction by providing real-time information to subscribers. It provides
customers with broad implementation coverage in a single solution. The single
sign-on capability enables users to sign on only once to a secure Web site, yet
enjoy access to the site for multiple purposes, including the secure exchange of
email.

ZixWorks -- ZixWorks is a comprehensive suite of hosted and managed
services that provides anti-virus, anti-spam, content scanning, encryption, and
archiving capabilities for e-messaging, combining all of the essential services
for a secure e-messaging environment into a single solution. The service is
designed for both large and small organizations. ZixWorks addresses the
requirements of organizations seeking to safeguard their communications against
email-borne threats, to deliver policy-driven security, and to comply with
various regulations and mandates regarding transmittal and retention of email.

As a hosted and managed service, ZixWorks operates outside a company's
network and acts as a forward perimeter defense or firewall against external
email threats, protects customer networks, and reduces wasted network bandwidth.
The service is designed to be operational in a matter of days with no disruption
to customer networks. Ongoing administration, upgrades, and maintenance become
the responsibility of ZixCorp. An outsourced service, ZixWorks also provides
instant updates to virus and spam definitions and content scanning lexicons,
ensuring a high level of protection.

ZixCorp's centralized key management system implements, in effect, PKI
(Public Key Infrastructure) functionality for email encryption. ZixCorp's
solutions are provided as a service, thereby removing the significant
implementation burden and cost that PKI infrastructures or product solutions
require. The ZixCorp implementation is focused on ease of use for the senders
and recipients of encrypted email, while affording them the option of the
strongest methods of encryption ZixCorp offers, extended feature sets and the
flexibility of user-friendly deployment of several different kinds of fully
integrated and fully interoperable types of solutions. With ZixCorp's core
technology, ZixCorp users obtain:

- privacy with encryption

- authentication

- integrity of messages

- non-repudiation -- such that senders cannot deny sending, and recipients
cannot deny receiving, messages

ZixCorp has several approaches for its Best Method of Delivery
transmission -- with a single administrative console that allows corporations to
send electronic content to anyone ... anywhere ... at anytime, securely. Due to
ZixCorp's unique Best Method of Delivery and service capabilities, it provides
several added levels of security while assuming the burden of managing users'
public keys. These additional security components are:

- certified receipts

- storage security

- time stamps that are non-reputable

- corporate policy enforcement

ZixCorp's core technology and Best Method of Delivery is enabled by
ZixCorp's centralized directory of users' encryption codes. This centralized
directory gateway provides a stable, secure, highly responsive, and scalable
environment for all secure e-messaging needs. The centralized directory gateway
provides the following services:

- validation and distribution of public keys in real time for each message

- creation of irrefutable, time-stamped transaction certificates and
certified receipts

- delivery of secure messages via SSL Web-browser and the ZixMessage Center
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COMPETITION

In broad market terms, we operate in the e-messaging management and
protection industry. This is a broad market that includes product vendors and
service providers that often are competing in only one or a few segments of this
industry. Our recent addition of ZixWorks in 2003, a hosted service providing
anti-virus, anti-spam, content filtering, auditing, archiving and other extended
capabilities, has considerably expanded the potential scope of our addressable
market space and the range of our competitors and potential competitors. In
addition, as the public's and legislators' awareness about the need for privacy
and security of electronic communications has increased over the past few years,
an increasing number of competitors have entered the market. Although some of
these companies have substantial information technology security and email
protection product offerings, we do not perceive their product offerings to be
as attractive to the marketplace as our services because we believe we offer a
superior suite of bundled services that addresses the complete range of
requirements needed for e-messaging protection in a full-featured and flexible
solution that is both user friendly and very simple to deploy. None offer the
comprehensive, combined service capabilities that ZixWorks does as an outsourced
service. We also may have a significant price advantage in this field, as a
result of both lower direct costs and the inherent benefits that an outsourcing
model implies -- single source, less overhead, less hassle, and access to
dedicated expertise. Most other, product-only solutions require extensive
increases in overhead to implement and deploy them. In addition, we offer
technology solutions that can be made operational in a very short period of time
compared to the longer procurement and deployment cycles common with the
solutions of many of our competitors. This capability is particularly important
when it is necessary to communicate with networks of parties that are external
to the organization, as is the case in the healthcare market, a primary target
sector for us. Our registered users become part of a global "white pages"
enabling instant secure communications with other ZixCorp registered users using
our centralized key management systems and our overall unique approach to
implementing secure e-messaging technology as a service. We also enable secure
communications with non-registered users with our secure ZixMessage Center. This
instant interoperability with other users is a capability not generally found in
our competitors' solutions, and is one we deem to be of considerable advantage
to our customers.

Our service offerings are focused on the secure delivery portion of the
secure e-messaging market, a sub-segment of the broader e-messaging management
and protection market. Companies operating in this portion of the market include
content management companies, such as Tumbleweed Communications Corp., and other
secure delivery participants such as Critical Path, Authentica and Sigaba
Corporation. Technically, while these companies offer "send-to-anyone" encrypted
email, we believe they are unable to offer the benefits that come from using our
Best Method of Delivery service offering. We believe that technology alone
cannot solve our customer's challenges and, unlike our competition, we offer
several programs to add business value to our technology services. Our audit and
assessment service enables prospects and customers to establish a baseline
understanding of the security issues within their e-messaging system prior to
deploying our solutions and on an ongoing basis to ensure continued compliance
to security best practices. Our deployment methodology enables customers to
rapidly and accurately deploy our security services. Our "evangelism" marketing
program assists our customers in the awareness and education of their partners
and customers of the benefits of secure communications. Our Policy Subscription
and Advisory Service enables customers to remain confident that their
e-messaging solution remains current with legislative guidelines and policies
and offers direct access to technical advisors for consultative engagements.

Moreover, we do not believe that our competitors have made the investments
required to match our infrastructure development and service offerings. We
believe only we offer a complete secure delivery package: robust email
encryption from the sender's computer desktop; robust email encryption from the
sender's network server; policy management from the sender's network server; and
a full array of benefits and managed services provided by our multi-million
dollar ZixSecure Center. We believe this complete secure delivery solution
differentiates our product and service offerings from all other secure
e-document delivery and secure messaging market participants.

In the anti-virus segment of the market, several product companies deliver
anti-virus solutions, including Network Associates (McAfee), Symantec, and Trend
Micro. Several product companies deliver anti-spam solutions, including Elron
and SurfControl. Providers of content scanning solutions include ClearSwift and
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Tumbleweed, and there are a few service-based offerings that deliver anti-virus
or anti-spam filtering, including MessageLabs and BrightMail. However, none of
these companies offer the combined comprehensiveness of our ZixWorks solution.
Nor do any of these competitors offer their solutions as fully managed services
or have solutions that are interoperable with on-site solutions for both
individuals and corporations as well as users who have no encryption
capabilities.

SALES AND MARKETING

We are targeting the healthcare, insurance and financial services market
sectors, as well as certain international markets and the Fortune 1000
companies. The healthcare market is our highest priority, given the legislative
requirements of HIPAA, which mandates eliminating paper flow and providing
privacy and security for protected health information. The deadline for
complying with the privacy regulations promulgated under HIPAA is April 14,
2003. We believe that this pending compliance requirement will drive a
significant number of healthcare providers, payors, and others operating in the
healthcare arena to adopt or begin the process of adopting a secure e-messaging
solution to provide privacy and security for their Internet messaging
communications. We believe we will be successful in securing our fair share of
this emerging market in 2003.

New business, focused on the corporate market, is expected to be primarily
generated from ZixCorp's own direct sales efforts and, to a lesser extent, the
promotional efforts of our distributors and resellers and strategic marketing
partners. To support our sales efforts, we have undertaken an intensive
marketing campaign focused on the healthcare market. As part of this campaign,
we have used targeted direct mail, print and on-line advertising, and email
initiatives.

We have forged a professional relationship with Preston Gates & Ellis LLP,
a Seattle-based law firm with a strong focus on intellectual property rights,
electronic communications, and federal privacy regulations, and have recently
organized HealthyEmail, Inc., a nonprofit organization established for the
purpose of promoting the responsible use of email in the healthcare sector and
raising awareness of the advantages of secure email in reducing complexity and
costs, while increasing usage and satisfaction. HealthyEmail, Inc. is also
planning to make available educational material, policies and guidelines, and
tools, including ZixMail licenses at no cost to physicians and two members of
their office staff for a two year period, to enable the healthcare industry to
meet the HIPAA privacy requirements.

EMPLOYEES

ZixCorp had 150 employees as of February 28, 2003, 49 of which were based
in Canada.

RESEARCH AND DEVELOPMENT; PATENTS AND TRADEMARKS

ZixCorp's continuing operations incurred research and development expenses
of $6,180,000, $9,019,000 and $8,661,000 in 2002, 2001 and 2000, respectively.

ZixCorp has filed several patent applications covering concepts ZixCorp is
employing, or may employ, in implementing its secure e-messaging business. In
addition, ZixCorp and certain of its subsidiaries have filed applications for
trademarks and service marks, as applicable, for "ZixCorp", "ZixMail",
"ZixAuditor", "ZixPort", "ZixVPM", "ZixWorks" and other "Zix" related marks.

CUSTOMERS

ZixCorp, a development stage company, had no significant revenues in 2002,
2001 and 2000. Revenues for 2002 included $936,000, or 56% of annual revenues,
resulting from the pro-rata recognition of the future minimum payments
associated with the Company's Marketing and Distribution Agreement with Entrust,
Inc. ("Entrust"). Entrust is scheduled to pay the Company future minimum
payments aggregating $3,750,000 through January 2005, which are being recognized
as revenue ratably over the four year maximum service period ending December
2005.

8

SALES BACKLOG

ZixCorp's end-user order backlog as of January 31, 2003 totaled $2,339,000,
which includes deferred revenues on the Company's consolidated balance sheet.
Approximately 85% of this backlog is expected to be recognized as revenue in
2003. As of January 31, 2002, ZixCorp had no measurable backlog. Under its
reseller and distributor agreements with Entrust and AlphaOmega Soft Co., Ltd.,
aggregate revenues of approximately $4,000,000 are expected to be recognized
from these agreements during 2003 through 2005 based upon the Company receiving
scheduled future minimum payments.

GEOGRAPHIC INFORMATION

ZixCorp's operations are based in the United States ("U.S.") and Canada,
and its corporate assets at December 31, 2002, virtually all held in the U.S.,
were primarily comprised of cash investments and marketable securities invested
generally in high-grade U.S. corporate debt securities, daily money market funds
and a U.S. government security.

ITEM 2. PROPERTIES

ZixCorp leases approximately 38,400 square feet of space for our corporate
offices and ZixSecure Center operations in Dallas, Texas under two subleases
that expire in September 2004; approximately 13,000 square feet of space in
Ottawa, Ontario Canada for our Canadian operations under a sublease that expires
in August 2003; and approximately 6,910 square feet of space in Dallas, Texas
under a lease that expires in July 2003, which is being subleased to a third
party except for a portion of the space which is utilized for the Company's
back-up data center operations. Through December 31, 2002, ZixCorp has invested
approximately $30,500,000 in property and equipment relating to the ZixSecure
Center, a fully redundant network operations center dedicated to secure
e-message processing. Staffed 24 hours a day, seven days a week, with operations
personnel constantly monitoring the facilities, networks, and systems, the
ZixSecure Center eliminates the need for companies to build and staff their own
secure e-messaging centers to perform these operations. Features of the
ZixSecure Center include:

- Multi-level security, including cameras, access controlled with badge and
biometric hand readers and 24-hour operations personnel;

- Redundantly configured power distribution units;

- Dual uninterruptible power supplies;

- Back-up diesel generator;

- Redundantly configured power distribution units;

- Multiple ISPs;

- Redundantly configured DS3 fiber connections and redundant routers;

- Sun Microsystem servers, Solaris-based systems;

- Proven 99.99% reliability; and

- Email-based customer response center systems, including two Intel-based
servers with estimated intelligent response capacity of 20,000 inquiries
per day. Additionally, the center is equipped with telephone call
routing, a knowledge base, and a call ticketing application.

ZixCorp has two HTTP/SMTP relay systems located in Dallas, Texas. These
relays enable ZixCorp to serve those ZixMail users who choose not to use their
existing SMTP mail servers or who desire to use a HTTP-based email address, such
as a Yahoo(TM) or HotMail(TM) address.

9

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in legal proceedings that arise in the ordinary
course of business. In the opinion of management, the outcome of pending legal
proceedings will not have a material adverse effect on the Company's
consolidated financial statements.

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

On September 18, 2002, we announced the simultaneous closing of two
financing transactions pursuant to which we received $16,000,000 in gross cash
proceeds. In the first transaction, we issued the following:

- 819,886 shares of Series A Convertible Preferred Stock;

- 1,304,815 shares of Series B Convertible Preferred Stock; and

- warrants to purchase 709,528 shares of our common stock.

In the second transaction, we issued:

- 6.5% Secured Convertible Notes, in a principal amount of $8,000,000; and

- warrants to purchase 386,473 shares of our common stock.

Our common stock is listed on The Nasdaq Stock Market, and we are subject
to Marketplace Rule 4350. Marketplace Rule 4350 requires us to obtain the
approval of our shareholders before issuing our common stock at a price below
the greater of our book price or the market price of our common stock to our
officers or directors, or where the number of shares of common stock issuable is
equal to or greater than 20% of our outstanding common stock. We determined to
seek shareholder approval of the financings because certain of our officers and
directors participated in the financing and certain conversion and redemption
provisions of the securities could have resulted in our shares of common stock
being issued at less than the market price and in an amount equal to or greater
than 20% of our outstanding common stock.

On January 15, 2003, we held a special meeting of shareholders to consider
and vote upon a proposal to approve the issuance of our common stock at a price
below the greater of the book or market value of our common stock, as of
September 16, 2002, (1) to officers and directors of our company and other
holders of our Series A Convertible Preferred Stock upon conversion or
redemption of our Series A Convertible Preferred Stock and (2) in an amount
equal to or greater than 20% of our outstanding common stock upon the
conversion, redemption and/or exercise, as applicable, of our Series A
Convertible Preferred Stock, Series B Convertible Preferred Stock, 6.5% Secured
Convertible Notes and the warrants associated with the 6.5% Secured Convertible
Notes.

Our shareholders approved the proposal, according to the following vote:

10

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

ZixCorp's common stock trades on The Nasdaq Stock Market under the symbol
ZIXI. The following table shows the high and low sales prices by quarter for
2002 and 2001. These prices do not include adjustments for retail mark-ups,
mark-downs or commissions.

At February 20, 2003, there were 20,582,980 shares of common stock
outstanding held by 468 stockholders of record. On that date, the last reported
sales price of the common stock was $4.10.

ZixCorp has not paid any cash dividends on its common stock since 1995 and
does not anticipate doing so in the foreseeable future. Additionally, cash
dividends on the Company's common stock may not be paid as long as any shares of
the Company's Series A and Series B Convertible Preferred Stock are outstanding.

ZixCorp's 2003 Annual Meeting of Stockholders will be held on May 6, 2003
at 9:00 a.m. Central Time. The annual meeting date is more than 30 days prior to
the anniversary date of last year's annual meeting. The deadline for submitting
stockholder proposals to be included in ZixCorp's proxy statement or considered
at the annual meeting was not changed from February 10, 2003. Any stockholder
proposal received after February 10, 2003 will be considered untimely.

11

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial data regarding the
Company's results of operations and financial position for, and as of the end
of, each of the years in the five-year period ended December 31, 2002, which are
derived from the audited consolidated financial statements of the Company. The
consolidated financial statements and notes thereto as of December 31, 2002 and
2001, and for the years ended December 31, 2002, 2001 and 2000, and the report
of Ernst & Young LLP thereon are included elsewhere in this Form 10-K. The
selected financial data should be read in conjunction with Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the consolidated financial statements and notes thereto included elsewhere
herein.

- ---------------

(1) In 1995, the Company acquired Cotag International Limited, Cardkey Systems,
Inc., Cardkey Systems Limited and WaveNet International, Inc. WaveNet
International, Inc. was sold in 1997, while the
12

remainder of these businesses and the Company's Transportation Systems Group
were sold in 1998. The operating results of these businesses have been
classified as discontinued operations for all periods presented. See Note 7 to
the consolidated financial statements included herein.

(2) Selling, general and administrative expenses for 1998 represent the costs
associated with a holding company function.

(3) In 2002, 2001 and 2000, expenses associated with continuing operations
include non-cash stock-based compensation of $2.5 million, $8.4 million and
$11.8 million, respectively. In 2001, cost of revenues include a $3 million
write-off of digital identification certificates. See Note 3 to the
consolidated financial statements included herein. Selling, general and
administrative expenses include advertising costs of $2.9 million, $4.5
million and $10.3 million for 2002, 2001 and 2000, respectively.

(4) 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 3 to the consolidated financial
statements included herein.

(5) In 2001, realized and unrealized losses on investments includes the
write-off of the Company's $5 million investment in Maptuit Corporation. See
Note 8 to the consolidated financial statements included herein.

(6) In calculating the basic and diluted loss per common share for 2002, the
Company's loss from continuing operations and net loss have been increased
by $3.2 million, representing the preferred stock dividends associated with
the Series A and Series B convertible preferred stocks.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

In 1998 and prior years, the Company provided systems and solutions for the
intelligent transportation, electronic security and other markets. The Company's
operations included the design, manufacturing, installation and support of
hardware and software products utilizing the Company's wireless data and
security technologies. The Company determined in 1998 that the Company's
businesses were low margin and the markets in which they operated were
approaching maturity. Accordingly, the Company decided to exit its then-current
businesses, and during 1998 it sold all of its operating units. The Company then
began evaluating new Internet-related business opportunities -- which it deemed
to offer more promising prospects for growth and profitability than the previous
businesses.

The Company perceived a need for products and services to bring privacy,
security and convenience to Internet communications and since January 1999, the
Company has been developing and marketing products and services that bring
privacy, security and convenience to Internet users. In the first quarter of
2001, the Company began charging for the use of ZixMail, its initial product in
the secure e-messaging space, and began focusing its sales and marketing efforts
exclusively toward the business market. In 2002, the Company significantly
expanded its portfolio of commercial products and services, as detailed in Item
1. "Business -- Products and Services" above, and rebuilt its sales and
marketing work force under new executive leadership.

The foundation of the Company's business model for its current set of
products and services centers around the financial leverage expected to be
generated by revenues that are believed to be predominantly recurring in nature
and an efficient cost structure for its secure data center operations, the core
of which is expected to remain relatively stable. For financial accounting
purposes, subscription fees will generally be recognized as revenue on a
prorated basis over the length of the subscription period, usually one year.
Subscription fees are generally expected to be collected annually at the
beginning of the subscription period.

Anacom Communications, Inc. ("Anacom"), a privately-held provider of
real-time transaction processing services to Internet merchants purchased by the
Company in October 1999, ceased operations in June 2001 following the
unauthorized access to Anacom's databases. Anacom, an independently operated
subsidiary, was purchased in conjunction with the Company's development of a
potential product, ZixCharge(TM), which was never commercially released. The
cessation of the Anacom operations had no effect on the Company's secure
e-messaging services since the Anacom business and technologies were not used in

13

this part of the Company's business. Operating losses and liquidity have been
favorably impacted by Anacom's shut-down, as Anacom recorded operating losses,
excluding non-cash charges, of $1,676,000 and $1,091,000 for 2000 and 2001,
respectively.

A development stage enterprise involves risks and uncertainties, and there
are no assurances that the Company will be successful in its efforts. Successful
growth of a development stage enterprise, particularly Internet-related
businesses, is costly and highly competitive. The Company's growth depends on
the timely development and market acceptance of its products and services. In
2002, the Company had no significant revenues and utilization of cash resources
continued at a substantial level. The Company anticipates further operating
losses in 2003, but expects the losses will be significantly less than those
incurred in 2002. Non-cash charges in 2003 for stock based compensation and
depreciation and amortization should be substantially less than the
corresponding amounts in 2002.

RESULTS OF OPERATIONS

CONTINUING OPERATIONS

Revenues

The Company is in the development stage and had no significant revenues in
2000, 2001 and 2002. Substantially all of the Company's revenues in 2000 and
2001 were generated by Anacom which ceased operations in June 2001. The Company
first began charging for its products and services in the first quarter of 2001.
Subscription fees received from customers in advance are recorded as deferred
revenue and recognized as revenues ratably over the subscription period.
Revenues for 2002 were primarily comprised of the amortization of subscription
fees generated from U.S. businesses and $936,000, or 56% of annual revenues,
resulting from the pro-rata recognition of the future minimum payments
associated with the Company's Marketing and Distribution Agreement with Entrust.
Entrust is scheduled to pay the Company future minimum annual payments
aggregating $3,750,000 through January 2005, which are being recognized as
revenue ratably over the four year maximum service period ending December 2005.
Additionally, in March 2002, the Company cancelled its agreement with 911
Computer Co., Ltd. ("911"), its exclusive distributor in South Korea, for
failure to pay scheduled installment payments when due. As a result, the
$100,000 minimum payment previously received from 911 was included in 2002
revenues.

Cost of Revenues

Cost of revenues increased from $10,821,000 in 2000 to $14,996,000 in 2001
primarily due to a non-cash charge of $3,000,000 for the write-off of digital
identification certificates in the fourth quarter of 2001, as these certificates
did not enter into the sales and marketing plans established by the Company's
new executive management team. These digital identification certificates were
not a component of the Company's product set, and their write-off had no effect
on future operations. Additionally, depreciation and amortization costs
increased by $558,000 from $7,577,000 in 2000 to $8,135,000 in 2001.

The net decrease in cost of revenues from 2001 to 2002 of $5,997,000
consists primarily of the previously mentioned non-recurring, non-cash charge of
$3,000,000 for the write-off of digital identification certificates in 2001 and
the reduction of $1,969,000 in non-cash charges for depreciation and
amortization of property and equipment resulting from certain data center
equipment becoming fully depreciated during 2002. In early 2003, the Company
organized HealthyEmail, Inc., a nonprofit organization established for the
purpose of promoting the responsible use of email in the healthcare sector.
HealthyEmail, Inc. and the Company have committed to provide ZixMail licenses at
no cost to physicians and two members of their office staff for a two year
period to enable the healthcare industry to meet HIPAA privacy requirements,
which could potentially have an impact on the Company's overall sales margins.

14

Research and Development Expenses

Research and development expenses increased from $8,661,000 in 2000 to
$9,019,000 in 2001 primarily due to increased employee compensation costs of
$1,546,000 resulting from hiring additional technical personnel to support the
development of the Company's various Internet products, substantially offset by
reductions in third party consulting expenditures. Non-cash charges for
depreciation and amortization expense of property and equipment was $1,275,000
and $1,435,000 for 2000 and 2001, respectively.

In 2002, research and development expenses decreased to $6,180,000
primarily due to continued decreases in third party consulting expenditures
totaling $2,333,000 and reduced employee recruitment expenses of $396,000.
Non-cash charges increased $410,000 from $1,435,000 in 2001 to $1,845,000 in
2002 due to a non-recurring charge of $762,000 for the cost to license certain
patents held by Tumbleweed Communications Corp., partially offset by a $352,000
reduction in depreciation and amortization of property and equipment that became
fully depreciated during 2002.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased from $32,162,000 in
2000 to $29,892,000 in 2001 and to $19,335,000 in 2002.

The net decrease from 2000 to 2001 amounted to $2,270,000. Expenses,
excluding non-cash charges, increased $266,000 in 2001 as the Company increased
its development stage efforts, primarily in the areas of direct sales and
marketing support, as the Company began commercially selling and charging for
its ZixMail product and related services in the first quarter of 2001. Changes
in expense levels between 2000 and 2001, excluding non-cash charges, included
the costs for additional personnel added in 2001 totaling $3,406,000 and a
reduction in discretionary advertising costs of $5,815,000 as the Company
re-evaluated the effectiveness of certain advertising mediums previously
utilized and shifted its focus to the commercial markets rather than the
consumer markets. In addition, with the closing of Anacom's business mid-year
2001, selling, general and administrative expenses of Anacom, excluding non-cash
charges, decreased from $779,000 in 2000 to $532,000 in 2001. Other operating
costs increased $2,922,000 due to increased occupancy and other costs related to
the Company's increased employee headcount. Non-cash charges decreased from
$12,876,000 in 2000 to $10,340,000 in 2001 primarily due to a decrease in
stock-based compensation of $3,077,000 which included a $2,000,000 reversal of
previously recorded unvested stock-based compensation expense related to the
ceasing of operations at Anacom in June 2001. See Note 3 to the consolidated
financial statements.

The net decrease in selling, general and administrative expenses from 2001
to 2002 amounted to $10,557,000. Expenses, excluding non-cash charges, decreased
$4,859,000 in 2002 primarily due to reduced discretionary advertising
expenditures of $3,453,000 resulting from the Company's participation in fewer
trade shows in 2002 and the April 2002 cancellation of the Yahoo! Inc.
advertising commitment initiated in 2000, all part of the Company's efforts to
re-evaluate and redirect its advertising and marketing efforts. Also,
contributing to the decrease between years were Anacom expenditures of $532,000
that were eliminated in 2002 following cessation of Anacom's operations in June
2001 and decreased employee recruitment expenditures of $333,000. In the third
quarter of 2002, the Company established an office in Ottawa, Ontario Canada, as
a result of hiring available talent in the region to expand the Company's sales
and professional services capabilities. In late 2002, the Company began
expanding its marketing reach into the healthcare community by adding personnel
to the sales organization. Non-cash charges between 2001 and 2002 decreased by
$5,698,000 primarily due to a decrease in stock-based compensation related to
stock option grants for employees and third party service providers of
$7,886,000, partially offset by $1,935,000 of non-recurring costs in 2002
related to Yahoo! Inc. and a non-recurring reduction in expenses in 2001 of
$1,101,000 related to Anacom, which ceased operations in June 2001.

Investment and Other Income

Investment income decreased from $3,130,000 in 2000 to $2,187,000 in 2001
and further decreased to $319,000 in 2002. The continual decrease between years
is primarily due to the decrease in invested cash and marketable securities and
a continual lowering of interest rates.
15

Interest Expense

Interest expense incurred in 2002 totaled $2,141,000 resulting from the
issuance of $8,000,000 in Convertible Notes. Due to a significant issuance
discount on the Convertible Notes, primarily due to the fair value of associated
warrants totaling $1,148,000 using the Black-Scholes option pricing model, the
Company recorded a non-recurring, non-cash charge of $1,698,000 representing the
beneficial conversion feature resulting from the Convertible Notes being
convertible into 2,116,402 shares of common stock at an effective price less
than the fair market value of the common stock on the date the Convertible Notes
were issued. In the fourth quarter of 2002, the Note holders converted the
Convertible Notes and related accrued interest into 2,141,811 shares of the
Company's common stock, and the Company recorded an increase to common stock and
additional capital equivalent to the carrying value of the converted debt. See
Note 3 to the consolidated financial statements.

Realized and Unrealized Gains (Losses) on Investments

Realized and unrealized losses on investments in 2000 represents an
impairment write-down related to the Company's equity investment in Lante
Corporation ("Lante") of $1,202,000, representing the decline in market value
that management believed was other than temporary. In 2001, realized and
unrealized losses on investments include a realized loss of $391,000 for the
disposition of the Lante shares and an impairment write-off of the Company's
$5,000,000 related party investment in Maptuit Corporation ("Maptuit"). In
October 2002, in connection with the requirements of a $6,000,000 financing
package executed by Maptuit, the Company exchanged its $5,000,000 debt and
equity position in Maptuit for $154,000 in cash, a non-interest bearing $900,000
subordinated promissory note due in 2006 and two million shares of common stock
of Maptuit (presently valued at less than $125,000). Any recovery of the
Company's investment in Maptuit will be recorded in the Company's consolidated
financial statements at the time cash is received. See Note 8 to the
consolidated financial statements.

Income Taxes

The income tax benefit on the loss from continuing operations in 2000, 2001
and 2002 is different from the U.S. statutory rate of 34%, primarily due to
unbenefitted U.S. losses. The Company has fully reserved its net deferred tax
assets in 2000, 2001 and 2002 due to the uncertainty of future taxable income.
The $269,000 current tax benefit recorded in 2002 resulted from legislative
changes extending the net operating loss carry-back period from two years to
five years. There may be limitations on our ability to fully utilize our
substantial net operating loss carryforwards against any future taxable income,
including potential limitations due to ownership changes as defined in Section
382 of the Internal Revenue Code.

Loss from Continuing Operations

As a result of the foregoing, the Company experienced losses from
continuing operations of $49,322,000 in 2000, $56,794,000 in 2001 and
$34,299,000 in 2002.

DISCONTINUED OPERATIONS

The Company sold all of its remaining operating businesses during 1998
realizing follow-on after-tax gains of $441,000, $48,000 and $862,000 in 2000,
2001 and 2002, respectively.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2002, the Company's principal source of liquidity was its
net working capital position of $13,590,000, including cash and marketable
securities of $14,832,000. The Company plans to continue to invest its excess
cash primarily in short-term, high-grade U.S. corporate debt securities, U.S.
government and agency securities or money market funds. The Company's 2002 loss
from continuing operations included significant non-cash expenses, aggregating
$14,741,000, primarily consisting of depreciation and amortization and
stock-based compensation. Net cash used by continuing operations in 2002, 2001
and 2000 totaled $19,759,000, $27,015,000 and $26,382,000, respectively,
primarily representing continued development and
16

operating costs relating to establishing the Company's Internet-related
business. The reduction in 2002 was primarily due to lower selling, general and
administrative expenses discussed above.

The Company currently has no significant revenues and utilization of cash
resources continues at a substantial level. The Company anticipates further
losses in 2003, therefore its near-term liquidity will be negatively impacted as
the Company continues its development stage activities. Under its reseller and
distributor agreements with Entrust and AlphaOmega Soft Co., Ltd., the Company
expects to receive minimum payments of $4,700,000 through January 2005,
including $1,450,000 in 2003. During 2002, 2001 and 2000 purchases of property
and equipment totaled $845,000, $1,174,000 and $7,625,000, respectively. The
recent trend for a reduced level of additions to property and equipment is
expected to reverse in 2003 as the Company upgrades certain computer hardware in
its data center and acquires computer equipment to satisfy customer orders for
the Company's products and services, primarily ZixVPM and ZixWorks.

In September 2002, we completed a capital funding for $16,000,000 through
the issuance of $8,000,000 of Convertible Notes and associated warrants,
$3,250,000 of Series A Convertible Preferred Stock and associated warrants and
$4,750,000 of Series B Convertible Preferred Stock and associated warrants. In
the fourth quarter of 2002, all of the Convertible Notes were converted into
2,141,811 shares of our common stock and $422,000 in Convertible Preferred Stock
was converted into shares of our common stock. At December 31, 2002, the
remaining securities were convertible and exercisable, in the aggregate, into
approximately 3,025,000 shares of our common stock. Upon the occurrence of
certain events, the Company is either permitted or required to redeem
outstanding shares of Convertible Preferred Stock for cash rather than issue
additional shares of its common stock. Separately, at December 31, 2002, there
are additional outstanding warrants and stock options to acquire approximately
9,700,000 shares of the Company's common stock, which if exercised would result
in a significant level of new funding for the Company. See Note 3 to the
consolidated financial statements.

Our future cash requirements depend primarily on the market acceptance of
our products and services and the timing and magnitude of cash flows generated
from new customer orders. Cash flows will also be impacted by capital
expenditure requirements, resources devoted to the additional development of our
products and services and resources devoted to sales and marketing including
discretionary advertising initiatives. The Company expects the market for its
products and services to expand as the business community sees the importance of
privacy and security for their email communications. However, at least as long
as the Company has no significant revenues, the Company will need to raise
additional funds to sustain its operations or initiate reductions in operating
expenses, or both. The Company currently has substantial flexibility in its cost
structure.

We will continue to consider various capital funding alternatives in order
to strengthen our financial position. These capital funding alternatives could
involve one or more types of equity securities, including convertible debt,
common or convertible preferred stock and warrants to acquire common or
preferred stock. Such equity securities could be issued at or below the
then-prevailing market price for our shares of common stock. Additionally, the
Company is considering lease financing options for its increased computer
equipment needs. The Company currently has no existing borrowings or credit
facilities. There can be no assurances that the Company will be able to raise
additional capital on satisfactory terms if and when needed.

CRITICAL ACCOUNTING POLICIES

In preparing its consolidated financial statements in conformity with
accounting principles generally accepted in the U.S., the Company must make a
variety of estimates that affect the reported amounts and related disclosures.
The following accounting policies are currently considered most critical to the
preparation of the Company's consolidated financial statements:

17

SOFTWARE DEVELOPMENT COSTS

Costs incurred in the development and testing of software used in the
Company's Internet products and services related to research, project planning,
training, maintenance and general and administrative activities, and overhead
costs are expensed as incurred. The costs of relatively minor upgrades and
enhancements to the software are also expensed as incurred. Certain costs
incurred during software application development, including costs of materials,
services and payroll and payroll-related costs for employees directly associated
with the development project, qualify for capitalization. Due to the uncertainty
of the amount and timing of future net revenues to be generated from the
Company's Internet products and services, all development costs incurred through
December 31, 2002 have been expensed and are included in research and
development expenses.

PROPERTY AND EQUIPMENT

At December 31, 2002, approximately 17% of the Company's total assets
consisted of property and equipment. The net book value of property and
equipment totaled $3,608,000, of which $1,238,000 was related to equipment in
the ZixSecure Center. The data center equipment is being depreciated over a
three-year useful life. Management performs periodic reviews of the carrying
value of the data center equipment. To date, no impairment write-downs have been
recorded on the data center equipment as it continues to be used in pursuit of
the Company's business goals, and such equipment is believed to have alternative
uses which would allow the Company to realize its carrying value. If the
Company's plans change for the use of this equipment and if such alternative
future uses change, the Company may be required to record an impairment charge.

REVENUE RECOGNITION

To date, the Company's revenues from secure e-messaging services have been
derived principally from subscription fees generated from U.S. businesses and
revenues resulting from the pro rata recognition of the future minimum payments
associated with the Company's Marketing and Distribution Agreement with Entrust.
Subscription fees are initially recorded as deferred revenue and recognized as
revenues ratably over the subscription period. Under arrangements with resellers
and distributors, revenue will generally be recognized as the Company provides
the related services. Determination of the timing of revenue recognition will be
dependent on terms and conditions specified in individual contracts and could
involve a significant level of judgment. See Notes 3 and 4 to the consolidated
financial statements.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). This statement
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". SFAS 146 requires that a
liability be recognized for restructuring costs only when the liability is
incurred, that is, when it meets the definition of a liability in the FASB's
conceptual framework. SFAS 146 also establishes fair value as the objective for
initial measurement of liabilities related to exit or disposal activities and is
effective for exit or disposal activities that are initiated after December 31,
2002, with earlier adoption encouraged. However, the Company does not believe
that the adoption of SFAS 146 will have a material effect on its results of
operations or its financial position.

RISKS AND UNCERTAINTIES

As a development stage company, we have no significant revenues, and we
continue to use significant amounts of cash.

Since 1999 we have been developing and marketing products and services that
bring privacy, security and convenience to Internet users. Successful
development of a development stage enterprise is costly and highly competitive.
A development stage enterprise involves risks and uncertainties, and there are
no assurances that

18

we will be successful in our efforts. We currently have no significant revenues
and utilization of cash resources continues at a substantial level. The Company
anticipates further losses in 2003.

The market may not broadly accept our products and services, which would
prevent us from operating profitably.

We must be able to achieve broad market acceptance for our products and
services in order to operate profitably. We have not yet been able to do this.
To our knowledge, there are currently no secure e-messaging management and
protection businesses similar to ours, that currently operate at the scale that
we would require, at our current expenditure levels and proposed pricing, to
become profitable. There is no assurance that our products and services will
become generally accepted or that they will be compatible with any standards
that become generally accepted, nor is there any assurance that enough paying
users will ultimately be obtained to enable us to operate profitably.

Competition in the secure e-messaging business is expected to increase, which
could cause our business to fail.

Our solutions are targeted to the secure e-messaging management and
protection services market. Although there are many large, well-funded
participants in the information technology security industry, few currently
participate in the secure e-messaging management and protection services market.
Our primary competitors in this market are Tumbleweed Communications, Sigaba
Corporation, Authentica, PostX, Critical Path, ClearSwift, BrightMail,
FrontBridge and MessageLabs. We believe that the secure e-messaging management
and protection services market is immature, and, for the most part,
unpenetrated, unlike many segments of the information technology security
industry -- which are saturated. After several years of infrastructure
development and product development, we believe that we are the only provider
that has made the investments necessary to successfully penetrate the relatively
untapped secure e-messaging management and protection services market. We do not
believe that our primary competitors have made the infrastructure and
development investments required to match our service offerings. Nevertheless,
others may, over time, make the necessary investments in infrastructure and
service offerings. These competitors may develop new technologies that are
perceived as being more secure, effective or cost efficient than our own. If we
are not successful in exploiting the technology advantage we believe we
currently hold, these competitors could successfully garner a significant share
of the market, to the exclusion of ZixCorp. Furthermore, increased competition
could result in pricing pressures, reduced margins or the failure of our
business to achieve or maintain market acceptance, any of which could harm our
business.

Our inability to develop and introduce new products and related services and
to implement technological changes could harm our business.

The emerging nature of the secure e-messaging management and protection
services business and its rapid evolution, require us continually to develop and
introduce new products and services and to improve the performance, features and
reliability of our existing products and services, particularly in response to
competitive offerings. To date, we have achieved no significant revenues from
the sale of any of our products and related services.

We also have under development new feature sets for our current product
line and are considering new secure e-messaging products. The success of new or
enhanced products and services depends on several factors -- primarily, market
acceptance. We may not succeed in developing and marketing new or enhanced
products and services that respond to competitive and technological developments
and changing customer needs. This could harm our business.

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

The market for secure Internet e-messaging is at an early stage of
development. Continued growth of the secure e-messaging management and
protection services market will depend to a large extent on the market

19

recognizing the need for secure e-messaging communications. Failure of this
market to grow could reduce demand for our products and services, which would
harm our business.

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.

While we have ample through-put capacity to handle our customers'
requirements for the medium term, at some point we may be required to expand and
upgrade our technology and network hardware and software. We may not be able to
accurately project the rate of increase in usage on our network. In addition, we
may not be able to expand and upgrade, in a timely manner, our systems and
network hardware and software capabilities to accommodate increased traffic on
our network. If we do not timely and appropriately expand and upgrade our
systems and network hardware and software, we may lose customers and revenues.

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

Our business depends on the uninterrupted operation of our secure data
center. We must protect this center from loss, damage or interruption caused by
fire, power loss, telecommunications failure or other events beyond our control.
Any damage or failure that causes interruptions in our secure data center
operations could materially harm our business, financial condition and results
of operations.

In addition, our ability to issue digitally-signed certified time-stamps
and public encryption codes in connection with our products and services depends
on the efficient operation of the Internet connections between customers and our
data center. We depend on Internet service providers efficiently operating these
connections. These providers have experienced periodic operational problems or
outages in the past. Any of these problems or outages could adversely affect
customer satisfaction.

Furthermore, it is critical that our facilities and infrastructure remain
secure and the market perceives them to be secure. Despite our implementation of
network security measures, our infrastructure may be vulnerable to physical
break-ins, computer viruses, attacks by hackers and similar disruptions from
unauthorized tampering with our computer systems. In addition, we are vulnerable
to coordinated attempts to overload our systems with data, resulting in denial
or reduction of service to some or all of our users for a period of time. We do
not carry insurance to compensate us for losses that may occur as a result of
any of these events; therefore, it is possible that we may have to use
additional resources to address these problems.

Messages sent through our ZixPort and ZixMessage Center messaging portals
will reside, for a user-specified period of time, in our secure data center
network. Any physical or electronic break-ins or other security breaches or
compromises of this information could expose us to significant liability, and
customers could be reluctant to use our Internet-related products and services.

We determined in June 2001 that credit card databases at our independently
operated subsidiary, Anacom, had been improperly accessed. As a result of this
improper access, we shut down the Anacom operations and Anacom ceased doing
business. The ZixMail and ZixMessage Center systems and our secure data center
operations were entirely separate from the systems operated by Anacom. No
ZixCorp technologies or operations were involved in the incident, nor are the
Anacom technologies involved being used in our Zix family of secure e-messaging
products and services. Accordingly, this breach has not had, and will not have,
any effect on the development and deployment of our secure e-messaging products
and related services. No claims have been asserted against us with respect to
this incident. We are unable to assess the amount of liability, if any, to
Anacom or us, which may result from any claims that may be asserted.

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

We may have to defend our intellectual property rights or defend against
claims that we are infringing the rights of others. Intellectual property
litigation and controversies are disruptive and expensive. Infringement

20

claims could require us to develop non-infringing products or enter into royalty
or licensing arrangements. Royalty or licensing arrangements, if required, may
not be obtainable on terms acceptable to us. Our business could be significantly
harmed if we are not able to develop or license the necessary technology.
Furthermore, it is possible that others may independently develop substantially
equivalent intellectual property, thus enabling them to effectively compete
against us.

Our products and services could contain unknown defects or errors.

We subject our products and services to quality assurance testing prior to
product release. To date, we have not become aware after product release of any
defect or error that materially affects their functionality. Nevertheless, our
products and services could contain undetected defects or errors. This could
result in loss of or delay in revenues, failure to achieve market acceptance,
diversion of development resources, injury to our reputation, litigation claims,
increased insurance costs or increased service and warranty costs. Any of these
could prevent us from implementing our business model and achieving the revenues
we need to operate profitably.

Public key cryptography technology is subject to risks.

Our products and services employ, and future products and services may
employ, public key cryptography technology. With public key cryptography
technology, a public key and a private key are used to encrypt and decrypt
messages. The security afforded by this technology depends, in large measure, on
the integrity of the private key, which is dependent, in part, on the
application of certain mathematical principles. The integrity of the private key
is predicated on the assumption that it is difficult to mathematically derive
the private key from the related public key. Should methods be developed that
make it easier to derive the private key, the security of encryption products
using public key cryptography technology would be reduced or eliminated and such
products could become unmarketable. This could require us to make significant
changes to our products, which could damage our reputation and otherwise hurt
our business. Moreover, there have been public reports of the successful
decryption of certain encrypted messages. This, or related, publicity could
adversely affect public perception of the security afforded by public key
cryptography technology, which could harm our business.

We depend on key personnel.

We depend on the performance of our senior management team -- including our
chairman, president and chief executive officer, John A. Ryan, and his direct
reports and other key employees, particularly highly skilled technical
personnel. Our success depends on our ability to attract, retain and motivate
these individuals. There are no binding agreements with any of our employees
which prevent them from leaving ZixCorp at any time. There is competition for
these personnel. In addition, we do not maintain key person life insurance on
any of our personnel. The loss of the services of any of our key employees or
our failure to attract, retain and motivate key employees could harm our
business.

We could be affected by government regulation.

Exports of software products using encryption technology are generally
restricted by the U.S. government. Although we have obtained U.S. government
approval to export our products to almost all countries in the world, the list
of countries to which our products cannot be exported could be revised in the
future. Furthermore, some foreign countries impose restrictions on the use of
encryption products, such as our products. Failure to obtain the required
governmental approvals would preclude the sale or use of our products in
international markets.

Our stock price may be volatile.

The market price of our common stock has fluctuated significantly in the
past and is likely to fluctuate in the future. Also, the market prices of
securities of other Internet-related companies have been highly volatile and, as
is well known, have generally declined substantially and broadly.

21

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

Our directors and executive officers beneficially own shares of our
securities that represent approximately 20.9% of the combined voting power
eligible to vote on matters brought before our shareholders, including
securities and associated warrants beneficially owned by Antonio R. Sanchez,
Jr., a director and current beneficial owner of approximately 12.7% of our
outstanding common stock, and John A. Ryan, our chairman, president and chief
executive officer. Also, Mr. Sanchez and Mr. Ryan collectively beneficially own
approximately 81.8% of the Series A Convertible Preferred Stock. The consent of
the holders of the Series A Convertible Preferred Stock, voting separately as a
class, is required before we may enter into mergers or other business
combination transactions. Therefore, our directors and executive officers, if
they acted together, could exert substantial influence over matters requiring
approval by our shareholders. These matters would include the election of
directors and, as noted above, the approval of mergers or other business
combination transactions. This concentration of ownership and voting power may
discourage or prevent someone from acquiring our business.

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

George W. Haywood, a private investor, beneficially owns approximately
25.5% of our outstanding common stock. Furthermore, Mr. Haywood and an IRA for
the benefit of Mr. Haywood beneficially own approximately 81.2% of our Series B
Convertible Preferred Stock. The consent of the holders of the Series B
Convertible Preferred Stock, voting separately as a class, is required before we
may enter into mergers or other business combination transactions. Therefore,
Mr. Haywood could exert substantial influence over all matters requiring
approval by our shareholders, including the election of directors and, as noted
above, the approval of mergers or other business combination transactions. Mr.
Haywood's interests may not be aligned with the interests of our other
shareholders.

Our private placement of equity securities in 2002 could further dilute the
interests of our shareholders.

In September 2002, we completed a capital funding for $16,000,000 through
the issuance of $8,000,000 of Convertible Notes and associated warrants,
$3,250,000 of Series A Convertible Preferred Stock and associated warrants and
$4,750,000 of Series B Convertible Preferred Stock and associated warrants. In
the fourth quarter of 2002, the Convertible Notes were converted into 2,141,811
shares of our common stock and $422,000 in convertible preferred stock was
converted into shares of our common stock. At December 31, 2002, the remaining
securities were convertible and exercisable, in the aggregate, into
approximately 3,025,000 shares of our common stock.

One-ninth of the shares of our Series A Convertible Preferred Stock and our
Series B Convertible Preferred Stock are to be redeemed at two-month intervals
beginning in May 2003. The redemption amounts payable to the holders of Series A
Convertible Preferred Stock and Series B Convertible Preferred Stock are paid in
shares of our common stock.

The value of the common stock used to determine the number of shares of
common stock to be issued upon redemption of shares of Series A Convertible
Preferred Stock at the final redemption date (that is, September 2004) will be
the lesser of $3.92 per share and the market value of the common stock at the
time of redemption, based on a closing bid price average formula. If the market
price of the common stock declines, the number of shares of common stock
issuable to the holders of Series A Convertible Preferred Stock upon such final
redemption will increase, perhaps substantially. There is no "floor" on the
market value calculation and, therefore, there is no "ceiling" on the number of
shares of common stock that may be issuable by us upon the final Series A
Convertible Preferred Stock redemption. A substantial decline in the market
price of the common stock would result in significant dilution to the existing
holders of common stock if the Series A Convertible Preferred Stock shares are
redeemed at a substantially lower price.

22

The value of the common stock used to determine the number of shares of
common stock to be issued upon redemption of shares of Series B Convertible
Preferred Stock will be the lesser of the Series B Conversion Price and 90% of
the market value of the common stock at the time of redemption, based on a
volume-weighted average formula. If the market price of the common stock
declines, the number of shares of common stock issuable to the holders of Series
B Convertible Preferred Stock upon such automatic redemptions will increase,
perhaps substantially. There is no "floor" on the market value calculation and,
therefore, there is no "ceiling" on the number of shares of common stock that
may be issuable by us upon a Series B Convertible Preferred Stock redemption. A
substantial decline in the market price of the common stock would result in
significant dilution to the existing holders of common stock if the Series B
Convertible Preferred Stock shares are redeemed at a substantially lower price.

The Series A Convertible Preferred Stock and the Series B Convertible
Preferred Stock are convertible by the holders into shares of common stock at
any time. The Series A Conversion Price is initially $4.12 per share and the
Series B Conversion Price is initially $3.78 per share. The conversion prices
could be lowered, perhaps substantially, in a variety of circumstances. In the
event we issue, or are deemed to have issued, shares of common stock at a price
per share that is less than the conversion prices then in effect (other than
certain specified exempt issuances), the conversion prices and the number of
shares issuable upon conversion of the Series A Convertible Preferred Stock and
the Series B Convertible Preferred Stock are subject to weighted average
anti-dilution adjustment. These anti-dilution adjustments do not have a "floor"
that would limit reductions in the conversion price of such shares.
Correspondingly, there is no "ceiling" on the number of shares of common stock
that may be issuable following such anti-dilution adjustments.

We issued four-year warrants (first exercisable in March 2003) to the
purchasers of Series A Convertible Preferred Stock and Series B Convertible
Preferred Stock entitling the warrant holders to purchase an aggregate of
709,528 shares of common stock at an exercise price of $4.51 per share. The
exercise price of these warrants is subject to weighted average anti-dilution
adjustment in the event we issue, or are deemed to have issued, shares of common
stock at a price per share that is less than the exercise price then in effect
(other than certain specified exempt issuances). The "floor" on such
anti-dilution adjustments is set at $3.92 per share.

We issued three-year warrants (the "Notes Warrants") to the holders of
certain 6.5% secured Convertible Notes issued in September 2002 (subsequently
converted into shares of our common stock). The warrants entitle the holders to
purchase an aggregate of 386,473 shares of common stock at an exercise price of
$4.14 per share. The number of shares of common stock for which these warrants
are exercisable and the exercise price of these warrants are subject to full
anti-dilution adjustment in the event we issue, or are deemed to have issued,
shares of common stock at a price per share that is less than the exercise price
then in effect (other than certain specified exempt issuances). These
anti-dilution adjustments do not have a "floor" that would limit reductions in
the exercise price and there is no "ceiling" on the number of shares of common
stock that may be issuable following such anti-dilution adjustments. In March
2003, we entered into an agreement with the holders of the Notes Warrants, which
obligates the holders, subject to certain conditions, to exercise all or any
portion of these warrants on each business day following a trading day on which
the weighted average market price of our common stock is at least $4.50 per
share. See Note 3 to the consolidated financial statements.

Further issuances of equity securities may be dilutive to current
shareholders.

At some point in the foreseeable future we may determine to seek additional
capital funding. This capital funding could involve one or more types of equity
securities, including convertible debt, common or convertible preferred stock
and warrants to acquire common or preferred stock. Such equity securities could
be issued at or below the then-prevailing market price for our common stock. In
addition, we incentivize employees and attract new employees by issuing options
to purchase our shares of common stock. Therefore, the interest of our existing
shareholders could be diluted by future stock option grants to employees and any
equity securities issued in capital funding financings.

23

Stock sales and hedging activities could affect our stock price.

To the extent the holders convert, redeem and exercise, as applicable, the
Series A Convertible Preferred Stock and/or the Series B Convertible Preferred
Stock and related warrants and then sell the shares of our common stock they
receive, our stock price may decrease due to the additional amount of shares
available in the market. The subsequent sales of these shares could encourage
short-sales that could place further downward pressure on our stock price. This
could lead to further increases in the already large short position in our
common stock (6,270,450 shares as of February 14, 2003). Moreover, subject to
applicable law and limitations as set forth in the documents governing the
transactions, the holders of the Series A Convertible Preferred Stock, the
Series B Convertible Preferred Stock and the Notes Warrants may hedge their
positions in our stock by shorting our stock, which could further adversely
affect the stock price. Furthermore, the perception that the holders of the
Series A Convertible Preferred Stock, the Series B Convertible Preferred Stock
and/or the Notes Warrants may sell our common stock "short" may cause others to
sell their shares as well. An increase in the volume of sales of our common
stock, whether short sales or not and whether the sales are by the holders of
Series A Convertible Preferred Stock, the Series B Convertible Preferred Stock
and the Notes Warrants or others, could cause the market price of our common
stock to decline. The effect of these activities on our stock price could
increase the number of shares required to be issued on the next applicable
conversion or redemption of the Series A Convertible Preferred Stock and the
Series B Convertible Preferred Stock.

We may have liability for indemnification claims arising from the sale of our
previous businesses in 1998 and 1997.

We disposed of our previous operating businesses in 1998 and 1997. In
selling those businesses, we agreed to provide customary indemnification to the
purchasers of those businesses for breaches of representations and warranties,
covenants and other specified matters. Although we believe that we have
adequately provided for future costs associated with these indemnification
obligations, indemnifiable claims could exceed our estimates.

We may encounter other unanticipated risks and uncertainties in the secure
e-messaging management and protection services market or in developing new
products and services, and we cannot assure you that we will be successful in
responding to any unanticipated risks or uncertainties.

There are no assurances that we will be successful or that we will not
encounter other, and even unanticipated, risks. We discuss other operating,
financial or legal risks or uncertainties in our periodic filings with the
Securities and Exchange Commission. We are, of course, also subject to general
economic risks.

NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS

This document contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (we refer to it as the "Exchange
Act"). All statements other than statements of historical fact are "forward-
looking statements" for purposes of federal and state securities laws,
including: any projections of future business, market share, earnings, revenues
or other financial items; any statements of the plans, strategies and objectives
of management for future operations; any statements concerning proposed new
products, services or developments; any statements regarding future economic
conditions or performance; any statements of belief; and any statements of
assumptions underlying any of the foregoing. Forward-looking statements may
include the words "may," "will," "predict," "plan," "should," "goal,"
"estimate," "intend," "continue," "believe," "expect" or "anticipate" and other
similar words. Such forward-looking statements may be contained in the "Risks
and Uncertainties" section above, among other places.

Although we believe that the expectations reflected in any of our
forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed in any of our forward-looking
statements. Our future financial condition and results of operations, as well as
any forward-looking

24

statements, are subject to change and to inherent risks and uncertainties, such
as those disclosed in this document. We do not intend, and undertake no
obligation, to update any forward-looking statement.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company does not believe that it faces material market risk with
respect to its cash investments and marketable securities, which totaled
$14,832,000 and $20,065,000 at December 31, 2002 and 2001, respectively. These
investments, which mature at various dates through May 2003, primarily consist
of high-grade U.S. corporate debt securities, daily money market funds and a
U.S. government security, and do not include derivative financial instruments or
derivative commodity instruments, as such terms are defined by the SEC in
applicable regulations. The Company has not undertaken any additional actions to
cover interest rate market risk and is not a party to any interest rate market
risk management activities. A hypothetical ten percent change in market interest
rates over the next year would not materially impact the Company's operating
results or cash flows due to the short-term, high credit quality nature of the
Company's investments.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this Item begins on page F-1 hereof.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated by reference from the
section "OTHER INFORMATION YOU NEED TO MAKE AN INFORMED DECISION -- Who are our
directors, director nominees, executive officers and significant employees?" and
"Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's 2003
Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference from the
section "COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS" in the Company's 2003
Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated by reference from the
section "OTHER INFORMATION YOU NEED TO MAKE AN INFORMED DECISION -- How much
stock do our principal stockholders, directors, director nominees and executive
officers own?" and "COMPENSATION OF DIRECTORS AND EXECUTIVE
OFFICERS -- Non-Stockholder Approved Equity Compensation Arrangements" in the
Company's 2003 Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated by reference from the
section "COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS -- Certain
Relationships and Related Transactions" in the Company's 2003 Proxy Statement.

ITEM 14. CONTROLS AND PROCEDURES

Within the 90-day period prior to the filing of this report, an evaluation
was carried out under the supervision and with the participation of the
Company's management, including its Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures (as defined in Rule 13a-14 and 15d-14 under
the Securities Exchange Act of 1934). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the design

25

and operation of these disclosure controls and procedures were effective. There
have been no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.

ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item is incorporated by reference from the
section "How do our Board and its committees work?" in the Company's 2003 Proxy
Statement.

PART IV

ITEM 16. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) Financial Statements

See Index to Consolidated Financial Statements on page F-1 hereof.

(a)(2) Financial Statement Schedules

All schedules for which provision is made in the applicable accounting
regulations of the SEC have been omitted because of the absence of the
conditions under which they are required or because the information
required is included in the consolidated financial statements or notes
thereto.

(a)(3) Exhibits

- ---------------

* Filed herewith.

** This certification accompanies this report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not be deemed filed, except to the
extent required by the Sarbanes-Oxley Act of 2002, by Zix Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

(b) Reports on Form 8-K

No reports of the Registrant on Form 8-K were filed with the SEC during the
three months ended December 31, 2002. The Registrant recently filed reports on
Form 8-K on January 16, 2003 announcing the voting results of a special meeting
of shareholders held on January 15, 2003 and on March 4, 2003 regarding a
potential warrant exercise and warrant replacement arrangement with the former
holders of the Company's secured convertible notes.

29

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Dallas,
State of Texas, on March 20, 2003.

ZIX CORPORATION

By: /s/ STEVE M. YORK
------------------------------------
Steve M. York
Senior Vice President,
Chief Financial Officer and Treasurer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 20, 2003.

30

CERTIFICATIONS

I, John A. Ryan, certify that:

1. I have reviewed this annual report on Form 10-K of Zix Corporation;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

By: /s/ JOHN A. RYAN
------------------------------------
John A. Ryan
Chairman, President and
Chief Executive Officer

Date: March 20, 2003

31

I, Steve M. York, certify that:

1. I have reviewed this annual report on Form 10-K of Zix Corporation;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

By: /s/ STEVE M. YORK
------------------------------------
Steve M. York
Senior Vice President, Chief
Financial Officer and Treasurer

Date: March 20, 2003

32

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets at December 31, 2002 and 2001... F-3
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000 and for the cumulative
period from January 1, 1999 through December 31, 2002..... F-4
Consolidated Statements of Convertible Preferred Stock and
Stockholders' Equity for the years ended December 31,
2002, 2001 and 2000....................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 and for the cumulative
period from January 1, 1999 through December 31, 2002..... F-6
Notes to Consolidated Financial Statements.................. F-7

F-1

REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Zix Corporation

We have audited the accompanying consolidated balance sheets of Zix
Corporation as of December 31, 2002 and 2001, and the related consolidated
statements of operations, convertible preferred stock and stockholders' equity
and cash flows for each of the three years in the period ended December 31,
2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Zix Corporation
at December 31, 2002 and 2001, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
2002, in conformity with accounting principles generally accepted in the United
States.

/s/ ERNST & YOUNG LLP

Dallas, Texas
March 5, 2003

F-2

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial
statements.
F-3

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial
statements.
F-4

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY

The accompanying notes are an integral part of these consolidated financial
statements.

F-5

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial
statements.

F-6

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation -- The accompanying consolidated financial statements
of Zix Corporation include the accounts of the Company and its wholly-owned
subsidiaries. Intercompany balances and transactions have been eliminated.

During 1998, the Company sold all of its operating businesses and,
accordingly, the assets and liabilities, operating results and cash flows of
these businesses have been classified as discontinued operations in the
accompanying financial statements.

Since 1999, the Company has been developing and marketing products and
services that bring privacy, security and convenience to Internet users.
ZixMail(TM) is a secure desktop email application that enables Internet users to
send and receive encrypted messages to anyone quickly and easily. The Company
did not begin to charge for the use of ZixMail until the first quarter of 2001.
In 2002, the Company began offering additional products. ZixVPM(TM) (Virtual
Private Messenger) is a server-based encryption solution that provides instant
security, control, and flexibility for inbound and outbound corporate email.
ZixAuditor(TM), a unique assessment service, allows organizations to identify,
quantify, and report email vulnerabilities and monitor ongoing communications.
The Company's most recent offering, ZixPort(TM), provides existing company
portals with private and secure communications capabilities while minimizing the
impact to existing IT, Web, or security infrastructure. A development stage
enterprise involves risks and uncertainties, and there are no assurances that
the Company will be successful in its efforts. Successful growth of a
development stage enterprise, particularly Internet-related businesses, is
costly and highly competitive. The Company's growth depends on the timely
development and market acceptance of its products and services. In 2002, the
Company had no significant revenues and utilization of cash resources continued
at a substantial level. At December 31, 2002, the Company's cash and marketable
securities totaled $14,832,000. The Company anticipates further operating losses
in 2003, but expects the losses will be significantly less than those incurred
in 2002. Non-cash charges in 2003 for stock-based compensation and depreciation
and amortization should be substantially less than the corresponding amounts in
2002. The Company's future cash requirements depend primarily on the market
acceptance of its products and services and the timing and magnitude of cash
flows generated from new customer orders. Cash flows will also be impacted by
capital expenditure requirements, resources devoted to the additional
development of products and services and resources devoted to sales and
marketing including discretionary advertising initiatives. The Company expects
the market for its products and services to expand as the business community
sees the importance of privacy and security for their email communications.
However, at least as long as the Company has no significant revenues, the
Company will need to raise additional funds to sustain its operations or
initiate reductions in operating expenses, or both. The Company currently has
substantial flexibility in its cost structure.

Cash investments and marketable securities -- Cash investments with
maturities of three months or less when purchased are considered cash
equivalents. Cash and cash equivalents at December 31, 2002 primarily consist of
high-grade daily money market funds and United States ("U.S.") corporate debt
securities. Marketable securities, which are available-for-sale, are as follows:

F-7

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Cash investments and marketable securities are carried at amortized cost,
which approximates fair market value. Marketable securities held on December 31,
2002 mature on various dates through May 2003. Investment income includes income
from cash investments and marketable securities totaling $289,000, $1,687,000
and $3,130,000 for the years 2002, 2001 and 2000, respectively.

In 2000, the Company exercised a cashless option to acquire 320,802 shares
of Lante Corporation ("Lante") common stock in connection with a third party
services contract whereby Lante assisted the Company in developing software for
its Internet-related business. Realized and unrealized losses on investments in
2000 consists of a write-down of the Company's equity investment in Lante of
$1,202,000, representing the decline in market value that management believed
was other than temporary and in 2001 includes a loss of $391,000 realized upon
the disposition of the Lante shares.

Derivatives and hedging activities -- At December 31, 2002 and 2001, the
Company did not have any instruments or contracts which were classified as
derivatives. Derivatives are financial instruments or contracts with prescribed
characteristics which are recognized on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized in
earnings.

Property and equipment -- Property and equipment are recorded at cost and
depreciated or amortized using the straight-line method over their estimated
useful lives as follows: computer equipment and software -- 3 years; leasehold
improvements -- 5 year lease term; and office equipment, furniture and
fixtures -- 5 years.

Goodwill -- Goodwill of $2,429,000, which resulted from the October 1999
acquisition of Anacom Communications, Inc., was being amortized over two years
using the straight-line method until its carrying value was written-off in June
2001 (Note 3). Goodwill amortization was $894,000 in 2001 and $1,228,000 in
2000.

Software development costs -- Costs incurred in the development and testing
of software used in the Company's Internet products and services related to
research, project planning, training, maintenance and general and administrative
activities, and overhead costs are expensed as incurred. The costs of relatively
minor upgrades and enhancements to the software are also expensed as incurred.
Certain costs incurred during software application development, including costs
of materials, services and payroll and payroll-related costs for employees
directly associated with the development project, qualify for capitalization.
Due to the uncertainty of the amount and timing of future net revenues to be
generated from the Company's Internet products and services, all development
costs incurred through December 31, 2002 have been expensed and are included in
research and development costs.

Long-lived assets -- The Company reviews long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to projected future
undiscounted cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the estimated fair
value of the assets.

Revenue recognition -- Revenues are recorded when services are rendered.
Subscription fees received from customers in advance are recorded as deferred
revenue and recognized as revenues ratably over the subscription period.
Presently, the Company's subscription service includes the delivery of licensed
software, customer support and the secure email solutions. The customer
generally electronically downloads the software over the Internet, receives a
diskette for general enterprise deployment or is provided an appliance
F-8

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

with pre-installed software. Subscriptions to date have generally been annual
non-refundable contracts with no automatic renewal provisions. The subscription
period begins on the date specified by the parties.

Advertising expense -- Advertising costs are expensed as incurred and
totaled $2,898,000 in 2002, $4,452,000 in 2001 and $10,267,000 in 2000.

Stock-based employee compensation -- At December 31, 2002, the Company had
various stock-based compensation plans covering employees and directors as more
fully described in Note 3. As permitted by Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the
Company accounts for stock-based compensation plans under the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations. Compensation expense for
employee stock options, if any, is measured as the excess of the quoted market
price of the Company's stock at the date of grant over the amount an employee
must pay to acquire the stock. SFAS 123 encourages adoption of a fair-value
based method for valuing the cost of stock-based compensation; however, it
allows companies to continue to use the intrinsic value method under APB 25 and
disclose pro forma results and earnings per share in accordance with SFAS 123.
Under SFAS 123, compensation cost is measured at the grant date based upon the
value of the award and is recognized over the vesting period. As required, the
pro forma disclosures include only options granted since January 1, 1995.
Because the Company's stock options have characteristics significantly different
from those of traded options and because changes in the subjective input
assumptions to the option valuation models can materially affect their estimated
fair value, in management's opinion, the existing valuation methods do not
necessarily provide a reliable single measure of the fair value of its stock
options. Had compensation cost for the Company's stock-based compensation been
determined consistent with SFAS 123, the Company's net loss and loss per common
share would have been as follows:

The Company used the Black-Scholes option pricing model to determine the
fair value of grants made during 2002, 2001 and 2000. The following weighted
average assumptions were applied in determining the pro forma compensation cost:

F-9

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Earnings per share -- The amounts presented for basic and diluted loss per
common share in the accompanying statements of operations have been computed by
dividing the losses applicable to common stock by the weighted average number of
common shares outstanding. The two presentations are equal in amounts because
the assumed exercise of common stock equivalents would be antidulutive, because
a loss from continuing operations was reported for each period presented. In
calculating the basic and diluted loss per common share for 2002, the Company's
loss from continuing operations and net loss have been increased by $3,181,000,
representing the preferred stock dividends associated with the Series A and B
convertible preferred stocks. The following table sets forth antidilutive
securities which were outstanding at the dates set forth below and have been
excluded from the computation of diluted earnings (loss) per common share:

Comprehensive income (loss) -- Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income," establishes standards for reporting
comprehensive income (loss) and its components in the financial statements.
Comprehensive income (loss), as defined, includes all changes in equity (net
assets) during a period from non-owner sources. In 2000, the difference between
net loss and total comprehensive net loss was due to an unrealized loss on
marketable securities, which was considered to be temporary. In 2001, the loss
was realized upon the sale of the related marketable securities.

Use of estimates -- The preparation of financial statements in conformity
with accounting principles generally accepted in the U.S. requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Management reviews its estimates on an ongoing basis, including those related to
discontinued operations and the carrying value of long-lived assets, and revises
such estimates based upon currently available facts and circumstances.

Recent accounting pronouncements -- In July 2002, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards No.
146 "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"). This statement nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)". SFAS
146 requires that a liability be recognized for restructuring costs only when
the liability is incurred, that is, when it meets the definition of a liability
in the FASB's conceptual framework. SFAS 146 also establishes fair value as the
objective for initial measurement of liabilities related to exit or disposal
activities and is effective for exit or disposal activities that are initiated
after December 31, 2002, with earlier adoption encouraged. However, the Company
does not believe that the adoption of SFAS 146 will have a material effect on
its results of operations or its financial position.

Reclassifications -- Certain prior year amounts have been reclassified to
conform with the 2002 presentation.

F-10

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. PROPERTY AND EQUIPMENT

The Company's continuing operations include depreciation and amortization
expense related to property and equipment of $7,500,000 in 2002, $9,905,000 in
2001 and $8,700,000 in 2000.

3. STOCKHOLDERS' EQUITY

PRIVATE PLACEMENT OF CONVERTIBLE EQUITY SECURITIES

In September 2002, the Company completed private placements whereby the
Company received an aggregate of $16,000,000 in cash in exchange for convertible
notes, two separate series of convertible redeemable preferred stock and
warrants to purchase the Company's common stock. The Company has registered with
the Securities and Exchange Commission ("SEC"), as required under the financing
agreements, approximately 5,700,000 shares of common stock, representing in the
aggregate the approximate number of common shares potentially issuable, at the
current conversion prices, upon conversion or exercise of the convertible
securities and related warrants.

ISSUANCE AND CONVERSION OF CONVERTIBLE NOTES

The Company issued $8,000,000 in Convertible Notes ("Notes") with a coupon
rate of 6.5% to institutional investors. As part of this placement, the Note
holders received immediately exercisable warrants to purchase 386,473 shares of
the Company's common stock at a price per share of $4.14 for a period of three
years. The Note holders had the right at any time to convert the Notes into
shares of the Company's common stock at a conversion price of $3.78 per share.
In the fourth quarter of 2002, the Note holders converted the Notes and related
accrued interest into 2,141,811 shares of the Company's common stock, and the
Company recorded an increase to common stock and additional capital equivalent
to the carrying value of the converted debt. These conversions eliminated the
six monthly scheduled Note payments of $500,000 each, beginning January 1, 2003,
and a final $5,000,000 payment scheduled for October 2003.

The fair value of the warrants issued to the Note holders, aggregating
$1,148,000 using the Black-Scholes option pricing model, was recorded as an
increase to additional capital with an offsetting reduction in the carrying
value of the Notes. The initial unamortized issuance discount of $1,353,000
represented the sum of the $1,148,000 in warrant value and the issuance costs
allocated to the Notes totaling $205,000. From the date of issuance of the Notes
until the dates of their conversion, the Company recognized non-cash interest
expense of $368,000 from the amortization of the issuance discount. This
issuance discount was being amortized, as interest expense, based upon the
expected redemption dates of the Notes using the effective interest rate method,
resulting in an effective interest rate of 29.5%, including the 6.5% interest
coupon on the Notes. Separately, as a result of the significant issuance
discount on the Notes, in the third quarter of 2002, the Company recorded a
non-recurring, non-cash interest expense charge of $1,698,000, with an
offsetting increase to additional capital, representing the beneficial
conversion feature resulting from the Notes being convertible into shares of
common stock at an effective price less than the fair market value of the

F-11

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

common stock on the date the Notes were issued. Upon completion of the
conversion of the Notes into the Company's common stock, the Company incurred an
additional $250,000 of issuance costs which have been recorded as a reduction to
additional capital.

In March 2003, the Company and the Note holders entered into an agreement
providing for the exercise of the Note holder's existing warrants, subject to
certain conditions, and the Company's issuance of replacement warrants to such
Note holders. The Note holders are obligated, subject to certain conditions, to
exercise all or any portion of their warrants to purchase 386,473 shares of the
Company's common stock at a price per share of $4.14 on each business day
following a trading day on which the weighted average market price of the
Company's common stock is at least $4.50 per share. The extent to which a Note
holder must exercise warrants on such trading day is based on the daily trading
volume in the common stock. Required exercises under the warrant exchange
agreement will occur only during a 90 day period beginning on the date that the
first warrant exercise takes place. The Note holders are also permitted to
exercise all or any portion of their warrants at any time, or from time-to-time,
regardless of the market price or trading volume of the common stock. Once the
existing warrants have been fully exercised or the 90 day period has expired,
the Company will issue replacement warrants to the Note holders. The intention
of the parties is that the replacement warrants will have substantially the same
economic value to the Note holders as the existing warrants that have been
exercised, based on the application of a Black-Scholes formula. The number of
shares of common stock covered by the replacement warrants will be calculated
based on the Black-Scholes formula applied at the time of each exercise of
existing warrants, and the replacement warrants will have an exercise price of
$5.00 per share of common stock, subject to adjustment for certain events. The
company is required to register such replacement warrants within 90 days of the
date of their issuance or be subject to substantial cash damages.

ISSUANCE OF SERIES A CONVERTIBLE PREFERRED STOCK

The Company received total proceeds of $3,250,000 in exchange for shares of
a newly created Series A Convertible Preferred Stock ("Series A") and warrants
to purchase 288,244 shares of the Company's common stock. The Series A accrues
cumulative dividends at the rate of 6.5% per annum and, subject to the terms of
a voting agreement between the Company and Series A investors, votes on an
as-converted basis. Series A investors have the right at any time to convert
their preferred shares and accrued dividends into shares of the Company's common
stock at a conversion price of $4.12 per share of common stock and the Company,
under certain circumstances, has the right to require such conversion if the
Company's common stock trades above $6.18 for specified periods. The Series A
was initially convertible into 780,085 shares of the Company's common stock.
Subsequently, in September 2002, $213,000 of Series A was converted into 51,690
shares of the Company's common stock.

Unless previously converted, beginning May 2003, and every two months
thereafter until September 2004, a pro rata amount of the Series A and related
accrued dividends will be automatically converted into shares of the Company's
common stock at a conversion price of $3.92 per share of common stock unless the
then-current market price of the Company's common stock is less than $3.92, at
which time the Series A investors may elect to defer such conversion to the next
bi-monthly redemption date. In September 2004, at maturity, the Company will
redeem any unconverted Series A by issuing the Company's common stock or by
paying cash, at the sole discretion of the Company. The warrants to purchase
shares of the Company's common stock issued to the Series A investors have an
exercise price per share of $4.51, become exercisable in March 2003 and expire
in September 2006.

The fair value of the warrants issued to the Series A investors,
aggregating $960,000 using the Black-Scholes option pricing model, has been
recorded as an increase to additional capital with an offsetting reduction in
the carrying value of the Series A. At December 31, 2002, the carrying value of
the $3,001,000 in

F-12

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

outstanding Series A was $2,252,000. The unamortized issuance discount of
$749,000 at December 31, 2002 represents the sum of the $960,000 in warrant
value and the issuance costs allocated to the Series A preferred stock totaling
$71,000, reduced by $213,000 of Series A dividends for 2002 and $69,000 for the
unamortized issuance discount associated with the Series A previously converted.
The carrying value of the Series A is being accreted, as preferred stock
dividends, to their redemption value plus accrued dividends at 6.5% based upon
their expected redemption dates using the effective interest rate method,
resulting in an effective dividend rate of 36.4%. When the Series A is converted
into shares of the Company's common stock, the carrying value of the converted
preferred stock is eliminated and a corresponding increase is recorded to common
stock and additional capital. Separately, as a result of the significant
issuance discount on the Series A, in the third quarter of 2002, the Company
recorded a non-recurring, non-cash preferred stock dividend of $897,000, with an
offsetting increase to additional capital, representing the beneficial
conversion feature resulting from the Series A being convertible into 780,085
shares of common stock at an effective price less than the fair market value of
the common stock on the date the Series A was issued. Additionally, the
convertible securities and related warrants contain various provisions regarding
anti-dilution adjustments, early redemption events possibly requiring cash,
liquidation preferences, restrictions on the issuance of certain indebtedness
and the payment of cash dividends.

ISSUANCE OF SERIES B CONVERTIBLE PREFERRED STOCK

The Company received total proceeds of $4,750,000 in exchange for shares of
a newly created Series B Convertible Preferred Stock ("Series B") and warrants
to purchase 421,284 shares of the Company's common stock. The Series B is
non-voting and accrues cumulative dividends at the rate of 6.5% per annum.
Series B investors have the right at any time to convert their preferred shares
and accrued dividends into shares of the Company's common stock at a conversion
price of $3.78 per share of common stock and the Company, under certain
circumstances, has the right to require such conversion if the Company's common
stock trades above $5.67 for specified periods. The Series B was initially
convertible into 1,242,680 shares of the Company's common stock. Subsequently,
in December 2002, $212,000 of Series B was converted into 56,210 shares of the
Company's common stock.

Unless previously converted, beginning May 2003, and every two months
thereafter until September 2004, a pro-rata amount of the Series B will be
automatically converted into shares of the Company's common stock at a
conversion price that is equal to the lesser of the Series B conversion price
then in effect, or 90% of the fair market value of the common stock at the time
of conversion. The warrants to purchase shares of the Company's common stock
issued to the Series B investors have an exercise price per share of $4.51,
become exercisable in March 2003 and expire in September 2006.

The fair value of the warrants issued to the Series B investors,
aggregating $1,403,000 using the Black-Scholes option pricing model, has been
recorded as an increase to additional capital with an offsetting reduction in
the carrying value of the Series B. At December 31, 2002, the carrying value of
the $4,488,000 in outstanding Series B was $3,401,000. The unamortized issuance
discount of $1,087,000 at December 31, 2002 represents the sum of the $1,403,000
in warrant value and the issuance costs allocated to the Series B totaling
$81,000, reduced by $344,000 of Series B dividends for 2002 and $53,000 for the
unamortized issuance discount associated with the Series B previously converted.
The carrying value of the Series B is being accreted, as preferred stock
dividends, to their redemption value plus accrued dividends at 6.5% based upon
their expected redemption dates using the effective interest rate method,
resulting in an effective dividend rate of 36.4%. When the Series B is converted
into shares of the Company's common stock, the carrying value of the converted
preferred stock is eliminated and a corresponding increase is recorded to common
stock and additional capital. Separately, as a result of the significant
issuance discount on the Series B, in the third quarter of 2002, the Company
recorded a non-recurring, non-cash preferred stock dividend of $1,727,000, with
an offsetting increase to additional capital, representing the beneficial
conversion feature resulting from the
F-13

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Series B being convertible into 1,242,680 shares of common stock at an effective
price less than the fair market value of the common stock on the date the Series
B was issued. Additionally, the convertible securities and related warrants
contain various provisions regarding anti-dilution adjustments, early redemption
events possibly requiring cash, liquidation preferences, restrictions on the
issuance of certain indebtedness and the payment of cash dividends.

STOCK ISSUED TO YAHOO! INC.

In the third quarter of 2000, the Company entered into an agreement with
Yahoo! Inc. ("Yahoo!") to provide Yahoo! Mail users with the option to send
encrypted email messages through the Company's ZixMessage Center messaging
portal. The minimum payments of $6,000,000 were being amortized over two years
beginning in December 2000. In April 2002, the Company and Yahoo! entered into
an agreement that terminated the Company's obligation to provide secure
messaging services to users of Yahoo! Mail. The original arrangement primarily
addressed the consumer market for the Company's products and services, rather
than the commercial markets in which the Company is now focusing. In connection
with the termination of the secure messaging services in the second quarter of
2002, the total remaining commitment owed to Yahoo! was reduced by $850,000, the
Company recorded contract termination costs of $600,000, and the Company issued
Yahoo! a 6% promissory note in the amount of $2,500,000, which was payable in
either cash or registered common stock at the option of the Company. In July
2002, upon registration of the applicable common shares with the SEC, the
$2,500,000 promissory note plus accrued interest was converted into 468,514
shares of the Company's common stock at a conversion price of $5.41,
representing the average closing price of the Company's common stock for the
three day period prior to the effective registration of such shares.

STOCK ISSUED TO TUMBLEWEED COMMUNICATIONS CORP.

Research and development expenses in 2002 included a one-time charge of
$762,000, representing the value of 116,833 shares of the Company's common stock
issued to Tumbleweed Communications Corp. ("Tumbleweed"), in connection with an
agreement granting the Company a license to certain Tumbleweed patents and the
right to license future patents at a fixed price.

STOCK ISSUED TO ENTRUST, INC.

In November 2000, the Company entered into an Enterprise and CA Services
Agreement with Entrust, Inc. ("Entrust") whereby the Company issued 222,039
shares of the Company's common stock to Entrust in exchange for licenses to use
certain software packages, future technical support and the right to issue a
specified number of digital identification certificates to users of the
Company's ZixMail products. These shares were subject to transfer restrictions
which lapsed in four equal quarterly installments ending in December 2001. The
agreement provided that if the aggregate value of the shares on the dates the
restrictions lapsed was less than the transaction value of $3,400,000, the
Company would be obligated to fund the deficiency by electing to pay cash or
issue additional shares of stock valued at the then-current fair market value of
the Company's common stock. Accordingly, an additional 296,533 shares of the
Company's common stock were issued in December 2001. The digital identification
certificates valued at $3,000,000 were written-off to cost of revenues in the
fourth quarter of 2001, as these certificates did not enter into sales and
marketing plans established by the Company's new executive management team.
Additionally, under a Marketing and Distribution Agreement with Entrust, the
Company issued 56,850 shares of the Company's common stock to Entrust valued at
$400,000 upon completion of the integration of the ZixMail service option into
the Entrust/ Express(R) product in August 2001, and the Company and Entrust
agreed to share in the related revenues from the integrated product. Although
there have been no revenues from the integrated product, Entrust has

F-14

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

guaranteed the Company minimum annual payments of $500,000 for 2001, $1,000,000
for 2002, $1,250,000 for 2003 and $1,500,000 for 2004.

ANACOM COMMUNICATIONS, INC.

In October 1999, the Company purchased all of the outstanding shares of
Anacom Communications, Inc. ("Anacom"), a privately-held provider of real-time
transaction processing services to Internet merchants. Consideration consisted
of a cash payment of $2,500,000, primarily recorded as goodwill, and common
stock, valued at a minimum of $7,500,000, to be delivered in two annual
installments beginning October 2000, assuming continued employment by the former
owners. The minimum value of the common stock issuable pursuant to the purchase
agreement of $7,500,000 was treated as compensation for financial accounting
purposes and was being charged to selling, general and administrative expenses
over two years with a corresponding increase in stockholders' equity. Financial
accounting rules require the minimum number of common shares issuable be
revalued on each subsequent reporting date until performance is complete with a
cumulative catch-up adjustment recognized for any changes in their intrinsic
value in excess of $7,500,000. Based on the Company's common stock price of
$8.75 per share at December 31, 2000 and $39.63 per share at December 31, 1999,
the intrinsic value of these shares on those dates was $1,662,000 (less than the
minimum $7,500,000) and $7,529,000, respectively. Accordingly, the Company's
results of operations for 2000 and 1999 include non-cash charges of $3,611,000
and $937,000, respectively, for amortization of the market value of the common
shares issuable. In October 2000, 83,663 shares were delivered to the former
owners, which included 13,382 shares in excess of the minimum required for that
delivery date.

On June 20, 2001, the Company reported that the credit card databases at
Anacom had been improperly accessed and fraudulent transactions had been
processed, causing Anacom to advise its merchant customer base to transfer their
electronic commerce transactions to other payment gateways for processing. Since
its acquisition, Anacom had been operated as an independent subsidiary and
managed by its former owners. Later in June 2001, the Company ceased all
operations at Anacom, and the former owners of Anacom separated from employment
with Anacom. As a result, the October 2001 final installment of the Company's
common stock issuable to the former owners in connection with the purchase of
Anacom, which aggregated $4,725,000, was canceled. These events resulted in a
non-recurring net reduction in operating costs of approximately $3,000,000 in
the second quarter of 2001. This reduction was primarily due to the reversal of
previously recorded unvested stock-based compensation expense, including
$1,800,000 previously recorded in 2001, related to the canceled installment
totaling $3,800,000, partially offset by severance costs and asset write-downs,
including goodwill. Substantially all of the Company's revenues in 2000 and 2001
were generated by Anacom.

PRIVATE PLACEMENT OF EQUITY SECURITIES

In May 2000, the Company sold, in a private placement, newly issued equity
securities to an investor group led by H. Wayne Huizenga and received cash
totaling $44,000,000 in three installments. In exchange, the Company issued to
the investor group 916,667 shares of its common stock at $48.00 per share,
ten-year warrants to purchase 916,667 shares of the Company's common stock at
$57.60 per share and four-year warrants to purchase 1,222,223 shares of the
Company's common stock at $12.00 per share. Subsequently, in March 2002, the
investor group was issued warrants to purchase an additional 916,667 shares of
the Company's common stock at $7.00 per share which expire in April 2003. The
$12.00 and $7.00 warrants were reallocated from options with an exercise price
of $7.00 per share previously held by Mr. David P. Cook, the Company's founder
and chief executive officer at the time of the private placement.

F-15

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

EMPLOYEE AND DIRECTOR STOCK OPTIONS

The Company has non-qualified stock options outstanding to employees and
directors under various stock option plans. Options granted under these plans
are generally not less than the fair market value at the date of grant and,
subject to termination of employment, generally expire ten years from the date
of grant. Employee options are generally exercisable in installments over two to
five years or have been accelerated due to the Company's common stock trading at
appreciated price targets. Initial grants to new directors are generally
exercisable six months from the date of the grant, with annual follow-on formula
grants vesting annually over three years. Option grants to employees and
directors generally contain accelerated vesting provisions upon the occurrence
of a change of control, as defined in the applicable option agreements. At
December 31, 2002, 1,187,379 shares of common stock were available for future
grants under the Company's stock option plans.

In April 1998, Mr. Cook entered into an employment arrangement with the
Company whereby he received an option to acquire 4,254,627 shares of the
Company's common stock. The option exercise price is $7.00 per share, which was
twice the closing price of the Company's common stock on the date of grant. The
options vested quarterly over two years and expire in April 2004. During 2000
and 2001, Mr. Cook reallocated options to acquire 807,127 shares of the
Company's common stock to certain of the Company's employees and a director.
These reallocated options have a five-year term, are fully vested and have
exercise prices ranging from $7.00 to $13.75 per share as compared to Mr. Cook's
exercise price of $7.00 per share. Non-cash compensation expense of $16,815,000
has been recognized over the vesting periods ($1,590,000, $9,047,000 and
$6,178,000 in 2002, 2001 and 2000, respectively), representing the intrinsic
value of the reallocated options based upon the difference between the fair
market value of the Company's common stock on the dates the options were
reallocated and the respective option exercise prices.

In November 2001, Mr. John A. Ryan was appointed chairman, president and
chief executive officer of the Company and received a bonus of 152,672 shares of
the Company's common stock valued at $1,000,000. Such stock-based compensation
is being amortized over two years using the straight-line method. In the event
Mr. Ryan is terminated for cause, as defined, or resigns for any reason other
than for good reason, as defined, prior to November 16, 2003, at the time of
such employment termination, Mr. Ryan is required to return to the Company
76,336 shares or $500,000 in cash.

F-16

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following is a summary of stock option transactions for 2002, 2001 and
2000:

Summarized information about stock options outstanding at December 31, 2002
is as follows:

There were 3,794,595 and 2,902,007 exercisable options at December 31, 2001
and 2000, respectively.

4. SIGNIFICANT CUSTOMER

Revenues for 2002 included $936,000, or 56% of annual revenues, resulting
from the pro-rata recognition of the future minimum payments associated with the
Company's Marketing and Distribution Agreement with Entrust (Note 3). Entrust is
scheduled to pay the Company future minimum annual payments aggregating
$3,750,000 through January 2005, which are being recognized as revenue ratably
over the four year maximum service period ending December 2005. Receivables on
the December 31, 2002 consolidated balance sheet include $936,000 from Entrust
which was received by the Company in January 2003.

F-17

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. INCOME TAXES

Components of the income taxes related to continuing operations are as
follows:

A reconciliation of the expected U.S. tax benefit to income taxes related
to continuing operations is as follows:

The $269,000 current tax benefit recorded in 2002 resulted from legislative
changes extending the net operating loss carryback period from two years to five
years.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Components of the
Company's deferred income taxes as of December 31, 2002 and 2001 are as follows:

The Company has fully reserved its net deferred tax assets in 2002 and 2001
due to the uncertainty of future taxable income. The Company has U.S. net
operating loss carryforwards of $131,938,000 which begin to expire in 2019. Tax
credit carryforwards of $2,933,000 consist of research tax credits which are
available through 2022 and alternative minimum tax credits which do not expire.
The net operating loss carryforwards include $9,155,000 resulting from the
exercise of non-qualified stock options for which a tax benefit of $3,113,000
will be credited to additional capital when recognized.
F-18

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. COMMITMENTS

The Company's continuing operations includes office rental expenses of
$779,000, $1,038,000 and $780,000 for 2002, 2001 and 2000, respectively. At
December 31, 2002, future minimum lease payments under noncancelable operating
leases are $897,000 for 2003 and $498,000 for 2004.

7. DISCONTINUED OPERATIONS

Prior to 1999, the Company operated in one industry segment, the provision
of systems and solutions for the intelligent transportation, electronic security
and other markets. The Company's operations included the design, manufacturing,
installation and support of hardware and software products utilizing the
Company's wireless data and security technologies. The businesses comprising
this industry segment, the Transportation Systems Group, Cotag International and
Cardkey Systems, were sold during 1998 in three separate transactions. These
businesses are presented as discontinued operations in the accompanying
financial statements.

The gain on sale of discontinued operations includes $862,000, $48,000 and
$341,000 in 2002, 2001 and 2000, respectively, for the reduction of estimated
future costs for various indemnification issues associated with the disposal of
these businesses. The gain also includes $100,000 in 2000 for contingent sales
proceeds. There were no income taxes recorded on these gains.

Liabilities related to discontinued operations of $275,000 and $1,056,000
at December 31, 2002 and 2001, respectively, consist of estimated future costs
for various indemnification issues associated with the disposal of these
businesses.

8. RELATED PARTY TRANSACTIONS

In September 2002, the Company completed private placements whereby the
Company received an aggregate of $16,000,000 in cash in exchange for convertible
equity securities and warrants to purchase the Company's common stock (Note 3).
The Series A Convertible Preferred Stock investors were comprised of Antonio R.
Sanchez, Jr., a director and 12.7% beneficial owner of the Company's common
stock, and related entities; John A. Ryan, the Company's chairman, president and
chief executive officer; and David P. Cook, founder of the Company, who invested
$2,000,000, $750,000 and $500,000, respectively. The Series B Convertible
Preferred Stock investors included George W. Haywood, a private investor and
25.5% beneficial owner of the Company's common stock, who invested $3,450,000.

In December 2000, the Company purchased approximately 9% of the equity
ownership of Maptuit Corporation ("Maptuit") for $3,000,000 in cash and
committed to make a follow-on investment. Accordingly, in July 2001, the Company
made an additional $2,000,000 cash investment in Maptuit and received a
promissory note convertible into Maptuit equity securities. Maptuit, an early
stage company, is an Internet application service provider that supplies
wireline and wireless Internet location-based services. Mr. Jeffrey P. Papows, a
director of the Company from March 2000 to July 2002 and the Company's chairman
of its board of directors from October 2000 to November 2001, serves as the
president and chief executive officer of Maptuit and holds a minority equity
interest in Maptuit. There is no readily determinable market value for the
Company's investments in Maptuit since Maptuit is privately held. Investments of
this nature are subject to significant fluctuations in fair market value due to
the volatility of the equity markets and the significant business and investment
risks inherent in early stage enterprises. The Company records impairment losses
when, in the Company's judgment, events and circumstances indicate its
investment has been impaired. During 2001, Maptuit began seeking third party
debt or equity financing to sustain its operations. In the last half of 2001,
based upon the uncertainty as to whether Maptuit would be able to raise the
necessary funds required to execute its business plan such that the Company
would be able to recover its investment, the

F-19

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Company wrote off its $5,000,000 investment in Maptuit and recorded a
corresponding investment loss, included in realized and unrealized losses on
investments in the Company's consolidated statement of operations. In October
2002, in connection with the requirements of a $6,000,000 financing package
executed by Maptuit, the Company exchanged its $5,000,000 debt and equity
position in Maptuit for $154,000 in cash, a non-interest bearing $900,000
subordinated promissory note due in 2006 and two million shares of common stock
of Maptuit (presently valued at less than $125,000). Any recovery of the
Company's investment in Maptuit will be recorded in the Company's consolidated
financial statements at the time cash is received.

In January 2001, the Company granted IT Factory, Inc. ("IT Factory") a
performance-based stock option whereby IT Factory could purchase up to 109,529
shares of the Company's common stock, at $9.13 per share, based upon the number
of customer email addresses it secured for the Company in 2001. In addition, the
Company paid IT Factory $300,000 in 2001 and committed to pay $250,000 in 2002
to support IT Factory's marketing efforts. IT Factory did not earn any
performance-based stock options in 2001, and the Company has subsequently
canceled the agreement, including the 2002 commitment for marketing support.
Separately, the Company paid IT Factory $420,000 in 2001 for certain software
development projects. Mr. Papows served as chairman of IT Factory until December
2001.

In the fourth quarter of 2000, the Company and Entrust entered into certain
technology and marketing agreements (Notes 3 and 4). Mr. Ryan, the Company's
chairman, president and chief executive officer, was chief executive officer of
Entrust when such agreements were executed and held a minority equity interest
in Entrust until September 2002.

In 1999, the Company engaged Public Strategies, Inc. ("PSI"), an
international strategic communications firm, to assist in the marketing of the
Company's new Internet products and services. During 2000, the Company paid PSI
$447,000 for services performed and related expenses. The chairman of PSI, Mr.
Jack L. Martin, was a director of the Company from August 1998 to March 2000.

9. EMPLOYEE BENEFIT PLANS

The Company has a retirement savings plan structured under Section 401(k)
of the Internal Revenue Code covering substantially all of its U.S. employees.
Under the plan, contributions are voluntarily made by employees, and the Company
may provide contributions based on the employees' contributions. The Company's
continuing operations includes $78,000, $80,000 and $61,000 in 2002, 2001 and
2000, respectively, for contributions to this plan.

The Company has an employee stock purchase plan for substantially all
employees that meet minimum service requirements. The plan provides for the
purchase of up to 300,000 previously issued shares of the Company's common
stock. The employee contributes 85% of the purchase price through payroll
deduction with the difference paid by the Company. Since inception of the plan
in 1996, a total of 195,624 shares have been purchased including 22,729, 12,856
and 4,608 shares purchased in 2002, 2001 and 2000, respectively.

10. CONTINGENCIES

On December 30, 1999, the Company and ZixCharge.com, Inc. ("ZixCharge"), a
wholly-owned subsidiary of the Company, filed a lawsuit against Visa U.S.A.,
Inc. and Visa International Service Association (collectively "Visa") in the
192nd Judicial District Court of Dallas County, Texas, which alleged that Visa
undertook a series of actions that interfered with the Company's ZixCharge
prospective business relationships and disparaged the Company, its products, its
management and its stockholders. After a three-week jury trial in July 2002, the
jury decided in favor of the Visa defendants.

F-20

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company is involved in legal proceedings that arise in the ordinary
course of business. In the opinion of management, the outcome of pending legal
proceedings will not have a material adverse effect on the Company's
consolidated financial statements.

As discussed in Note 3, in 2001, the Company reported that the credit card
databases at Anacom had been improperly accessed and fraudulent transactions had
been processed, causing Anacom to advise its merchant customer base to transfer
their electronic commerce transactions to other payment gateways for processing.
No claims have been asserted against the Company with respect to this incident.
The Company is unable to assess the amount of liability, if any, to the Company
which may result from any claims that may be asserted.

The Company has severance agreements with certain employees which would
require the Company to pay approximately $3,300,000 if all such employees
separated from employment with the Company following a change of control, as
defined in the severance agreements.

11. INTERNATIONAL DISTRIBUTION AGREEMENTS

In June 2001, the Company entered into an agreement with AlphaOmega Soft
Co., Ltd. ("AlphaOmega"), amended in 2002, whereby AlphaOmega became the
exclusive distributor in Japan for certain of the Company's services, including
ZixMail and ZixVPM, through 2004. A revenue sharing arrangement provides for
AlphaOmega to pay the Company a specified portion of the subscription fees
charged to AlphaOmega's customers. Although the subscription fees generated to
date by AlphaOmega have been nominal, pursuant to the distribution agreement,
the Company is to receive minimum payments totaling $1,200,000 through October
2004, of which $100,000 was received in 2001 and $150,000 in 2002.

In March 2002, the Company cancelled its agreement with 911 Computer Co.,
Ltd. ("911"), its exclusive distributor in South Korea, for failure to pay
scheduled installment payments when due. As a result, the $100,000 minimum
payment previously received from 911 is included in 2002 revenues.

In April 2002, the Company entered into an agreement with Digitopia Co.,
Ltd. ("Digitopia"), whereby Digitopia became the exclusive distributor in South
Korea for certain of the Company's services. After assessing the additional
product and service requirements to compete successfully in South Korea, the
Company and Digitopia mutually agreed to terminate the exclusive agreement in
February 2003 and eliminate the scheduled future minimum payments totaling
$1,170,000.

F-21

ZIX CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the quarterly results of operations for the
years ended December 31, 2002 and 2001:

The quarter ended September 30, 2002 includes a non-cash interest expense
charge of $1,698,000, 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. The quarter ended June 30, 2001 includes a non-recurring
net reduction in operating costs of $3,000,000 as a result of ceasing all
operations at Anacom. The quarter ended September 30, 2001 includes a $1,500,000
write-down of the investment in Maptuit. The quarter ended December 31, 2001
includes a $3,500,000 write-off of the remaining investment in Maptuit and a
$3,000,000 write-off of digital identification certificates. See Notes 3 and 8.

F-22

INDEX TO EXHIBITS