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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File Number: 0-17995

Zix Corporation

2711 N. Haskell Avenue, Suite 2300, LB 36, Dallas, Texas 75204-2960

(214) 370-2000

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

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

Common Stock

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

      Indicate by check mark 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.     o

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

      As of February 23, 2004, there were 30,569,239 shares of Zix Corporation $0.01 par value common stock outstanding. As of June 30, 2003, the aggregate market value of the shares of Zix Corporation common stock held by non-affiliates was $67,284,268.

      Portions of the Registrant’s 2004 proxy statement are incorporated by reference into Parts II and III of this Form 10-K.

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PART I

General Overview

      Zix Corporation (“ZixCorp,” “Company,” “we,” “our,” or “us”) is a global provider of e-messaging protection and transaction services. We offer a range of solutions to protect organizations from viruses, spam, and electronic attack, as well as enabling secure electronic communications, such as email encryption, e-prescribing, online doctor visits, and electronic viewing of medical laboratory test results. We help organizations of any size to streamline operations, mitigate risks, and leverage their investment in electronic communications. We offer our services as a portfolio of advisory, managed, self-managed, and fully hosted solutions that enforce corporate security policies. ZixCorp solutions enable organizations to enhance and optimize communication technology investments and increase productivity.

      Our business operations are supported by the ZixSecure Center^TM, a fully redundant network operations center dedicated to secure e-message processing. The center is staffed 24 hours a day with a proven 99.99% reliability. The ZixSecure Center enables ZixCorp to be a trusted third-party provider with high-bandwidth ability and the capability for various secure communications functions. Whether it’s delivery of email, fax, prescription, lab results, or an online doctor visit, we enable communications to transpire in a trusted, safe, and secure manner. This is our core skill and competitive differentiator. Our services take advantage of this world-class capability to produce products and services that are easily deployed, scalable, and with secure send-to-anyone capability.

      We group our current product offerings into two categories: Communications Protection and Care Delivery Solutions.

Communications Protection Solutions

      Through a portfolio of products and services, we secure the communications of our customers. Email has become a mission-critical means of communications for enterprises. However, if email leaves a secure network environment in clear text, it can be intercepted anywhere along the path between a sender and a recipient, which permits theft, redirection, manipulation, or exposure to unauthorized parties. Electronic communications are also subject to a variety of email-borne threats, such as viruses or spam. Failure to control and manage such risks can result in enforcement penalties for non-compliance with legal mandates, decreased productivity, damaged reputation, competitive disadvantage, loss of intellectual property or other corporate assets, exposure to negligence or liability claims, and diversion of resources to repair such damage.

      As a result of communication threats, corporations need security and privacy, control over inappropriate content, and the ability to prevent or reduce unwelcome email traffic. They require ubiquitous coverage that is cost-effective, quickly deployed, and consistently updated to guard against obsolescence and ineffectiveness. To satisfy this need for enterprise-wide coverage, ZixCorp delivers a comprehensive communications protection product suite. ZixCorp solutions analyze and encrypt Internet communications and address anti-virus, anti-spam, content filtering, reporting, and archiving needs. ZixCorp also provides related advisory, consulting, installation, customization, and training services.

      ZixCorp e-messaging solutions are fully interoperable and linked by a Best Method of Delivery^TM protocol that automatically determines the most direct and 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 messages instantly and securely to anyone with an email address, including those who do not have special encryption software. Best Method of Delivery makes the technology simple to use for end users and provides flexibility and ease of implementation for information technology professionals. We believe that this ability to send the message through different modes of delivery — either by the end user selecting a desired path or as an automated function set by the enterprise — makes our secure e-messaging delivery products and services superior.

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      The ZixCorp Communications Protection Solutions product and services suite includes:

	•	ZixVPM® (Virtual Private Messenger) — an e-messaging gateway solution that provides company-wide privacy protection for inbound and outbound email communications
	•	ZixPortTM — a secure Web-messaging portal
	•	ZixMail® — a desktop solution for encrypting and securely delivering email
	•	ZixAuditor® — an assessment service used to analyze email traffic patterns and monitor compliance with corporate and regulatory policies
	•	Message Inspector® — a comprehensive email filtering software that enables a company to monitor, manage and, if necessary, block unauthorized email communications
	•	Web Inspector® — Web filtering software that helps organizations enforce Internet acceptable use policies by monitoring and blocking inappropriate Web sites

Care Delivery Solutions

      Electronic communications can take other forms besides email. Increasingly, healthcare transactions previously conducted in person or on paper are being converted to electronic methods. Examples include medical prescriptions, lab results, doctor visits, and the distribution of medical information. Due to ZixCorp’s experience and capabilities in secure e-messaging, it was logical to expand our business into care delivery solutions. We continue to add capabilities and products to address this trend in electronic communications.

      ZixCorp began offering e-prescribing in July 2003 following the acquisition of PocketScript. (See “Business Acquisitions” below.) E-prescribing provides the ability for a physician to write prescriptions and transmit them to a pharmacy on a handheld PDA or PDA-enabled cell phone. The device has access to a drug reference guide, insurance formulary data, and the ability to check for drug interactions with previously prescribed drugs. When the prescription is complete, it can be sent electronically to the pharmacy of the patient’s choice. The PocketScript system incorporates the software application that enables all these access points, thus bringing real-time valuable information into the hands of the physician at the point of prescribing.

      Studies have shown that e-prescribing delivers many benefits including reduced calls from the pharmacy to the physician, more prescribing within drug formulary guidelines, and reduced errors in dosage and drug interactions. The device also lends itself to related products and additional services such as the ability for pharmaceutical companies to have messages sent to doctors regarding information on a specific drug. With over 700,000 physicians in the United States and 225,000 of those considered high-prescribing physicians, we believe that the market opportunity for these secure and trusted transactions is significant. The renewed interest in lowering healthcare costs opens up additional opportunities for acceptance of these services and devices.

      ZixCorp’s Care Delivery Solutions designs and develops the applications and directly distributes the devices and applications to physicians and healthcare institutions. We have entered into multiple sponsorship programs whereby third parties, such as pharmacy benefit management companies and insurance carriers, have agreed to provide the devices and services free of charge for various periods of time to associated physicians. Care Delivery Solutions are sold as an annual service or in a transaction fee arrangement. The third-party sponsors have agreed to pay for the physicians’ use of our services because they have a vested benefit in the cost savings associated with technological adoption.

      The products we currently offer under the Care Delivery Solutions banner are: PocketScript®, an e-prescribing technology that applies the benefits of e-messaging to the medical prescription process by enabling providers to write and transmit prescriptions electronically; MyDocOnline Connect, an online doctor visit application that enables doctors to conduct patient visits and diagnoses via the Web; and Dr. Chart®, a Web-based communication tool that connects healthcare providers and laboratories.

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      We expect this product portfolio to grow as more features and services can be offered through PDAs. Additionally, as our installed base of physicians grows, we believe cross selling additional services will become feasible with other interoperable applications.

Healthcare Focus and Expanding into Other Vertical Markets

      In 2002, ZixCorp chose to focus a significant portion of our product development and sales efforts on the healthcare market. We believed that it was a sector with a clear need for secure communications as it has regulatory requirements for strict privacy and protection of data through the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and consequences for non compliance. We have been successful in securing a commanding market share for secure e-messaging products in this market and have demonstrated continuing commitment to healthcare with the development of additional healthcare-specific products such as PocketScript.

      Additional federal regulations like the Gramm-Leach-Bliley Act (GLBA) have enhanced security awareness in general, and have prompted affected organizations to increasingly consider adopting systems to ensure data security and privacy. Even where there are no specific regulations, corporations may require email protection to adhere to evolving industry best practices to protect sensitive information. Therefore in 2003, we began to expand the focus beyond healthcare into other logical vertical markets. These markets include finance, insurance and local governments. Some of the same methodologies used to provide specific solutions for the healthcare community apply to these other verticals. We are also developing solutions specific to these new markets.

Company History

      ZixCorp entered the secure e-messaging market in 1999. In 1998 and prior years, ZixCorp designed, manufactured, marketed, installed, and supported wireless data and security technology solutions through two primary market-oriented groups, each with a core competency in radio frequency technology, comprising products marketed under the “Amtech,” “Cotag,” and “Cardkey” brand names.

      In 1998, the Company determined that its businesses were approaching maturity. Accordingly, the Company decided to exit its businesses, and during 1998 sold all of its operating units. The Company began evaluating new Internet-related business opportunities — which it deemed to offer more prospects for growth and profitability. The Company perceived a need for services that brought privacy, security, and convenience to Internet communications, and in 1999 began to develop secure e-messaging products as well as a shopping portal and Internet payment authorization system.

      We announced our intention to enter these new businesses in 1999, and began to develop secure e-messaging capabilities. In mid-1999, we launched the ZixSecure Center, a world-class data center that centralizes the processing and distribution of public encryption keys and began operations later that year when ZixMail was introduced. The ZixMessage Center was first used for secure messages to and from non-subscribers in July 2000. The Company began charging for ZixMail in the first quarter of 2001 and started to focus its ZixMail sales and marketing efforts toward the business market. ZixMail received PC Magazine’s Editors’ Choice Award in January 2001 for email security.

      In the first quarter of 2002, we expanded our portfolio for the business market with the introduction of our enterprise secure e-messaging solution, ZixVPM. We also began to offer a new assessment service, ZixAuditor, as a means for corporations to examine and analyze their inbound and outbound email communications. In August 2002, we introduced ZixPort, a branded, Web-based, secure e-messaging portal solution that integrates with a company’s existing portal or functions as a standalone site. ZixPort 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 2003, we significantly improved the features and functionality of these three products. Additionally, in 2003 and 2004 we significantly increased our product offering and addressable market with three key acquisitions as described below.

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Business Acquisitions

      In July 2003, we acquired substantially all of the operating assets and business of Ohio-based PocketScript, LLC (“PocketScript”), a provider of electronic prescription solutions for the healthcare industry. This acquisition enabled us to expand our services into the e-prescription marketplace. The PocketScript e-prescribing system enables physicians to create electronic prescriptions from virtually anywhere in about the same amount of time required for paper-based prescriptions. It also aids physicians in identifying drug-to-drug interactions, including a drug reference guide and drug dispense history, while providing an electronic link to pharmacies. During 2003, we completed the integration of PocketScript’s business into our existing business.

      In September 2003, we acquired substantially all of the operating assets and business of Elron Software Inc. (“Elron Software” or “Elron”), a majority-owned subsidiary of Elron Electronic Industries, Ltd. and a provider of anti-spam, email content filtering and Web filtering solutions. This acquisition enabled ZixCorp to enhance our product and service offering by adding a more advanced feature set to our anti-spam, anti-virus, and content filtering solutions while expanding our offerings to include Web filtering. Specifically, we acquired our Web Inspector and Message Inspector products. Web Inspector is a Web filtering and Internet monitoring service that uses a rules-based management to create and maintain a company’s Internet usage policies. Message Inspector complements our existing anti-spam and anti-virus offerings by providing an on-premise method for protecting against unauthorized inbound, outbound, and interoffice communications and virus attacks.

      In January 2004, we announced the acquisition of substantially all of the operating assets and business of MyDocOnline, Inc. (“MyDocOnline”), a subsidiary of Aventis Pharmaceuticals, Inc. based in Round Rock, Texas. MyDocOnline offers a variety of Internet-based healthcare services and is a provider of secure Web-based communications, disease management, and laboratory information solutions. Through the acquisition, we acquired a mature product, an installed base of physicians using the products, and talented employees. These resources will become part of our Care Delivery Solutions and, through expected synergies between the groups, will also fill previously projected employee roles.

Products and Services

      ZixCorp’s centralized key management system implements PKI (Public Key Infrastructure) functionality for email encryption without the implementation burden and cost of typical PKI infrastructures. Most of ZixCorp’s solutions are provided as a service, thereby removing the significant implementation burden and cost that PKI infrastructures or product solutions require. ZixCorp services are focused on ease of use for the senders and recipients of encrypted email, while affording them the option of the strongest methods of encryption, extended feature sets, and the flexibility of a variety of fully integrated and fully interoperable solutions. With ZixCorp’s core secure messaging technology, ZixCorp users obtain:

	•	Privacy with encryption
	•	Authentication
	•	Integrity of messages
	•	Non-repudiation — 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 enables corporations to send electronic content to anyone, at anytime, securely. Due to

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

      ZixCorp’s core technology and Best Method of Delivery are 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.

      ZixVPM (Virtual Private Messenger) is a secure e-messaging management solution that provides company-wide privacy protection for both inbound and outbound email communications. It employs encryption technology for delivering and encrypting email transmissions to and from an enterprise’s corporate firewall. ZixVPM provides secure email for remote employees, customers, and business partners without requiring the enterprise to create, deploy, or manage end-user encryption keys and desktop software.

      Since ZixVPM is installed at the server level within an enterprise, end users are not required to install any software or obtain encryption codes to secure their email messages. We believe this ability to provide secure email without impacting the end user provides a degree of practicality that is highly desirable in the marketplace and necessary to any widespread deployment of secure email. ZixVPM can be seamlessly integrated with a customer’s own scanning and filtering tools, or those offered by ZixCorp. ZixVPM enables customers to automate encryption at the network level in accordance with standard corporate policies and enforce these policies without having to rely on the discretionary judgment of individual employees.

      The newest release of ZixVPM is delivered with built-in policy management features, auditing and reporting functions, in addition to the service’s pre-existing secure email delivery capabilities. ZixVPM Version 2.1 can also 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 comes with a streamlined installation process and is specifically designed to meet the growing requirements from organizations that need to enforce increasingly complex corporate email policies brought on by regulations, risk management considerations, and protection of intellectual property information.

      ZixVPM 2.1 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. These methods permit 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 also be created to force certain actions, such as encryption or branding of messages, based on pre-established content scanning policies.

      ZixAuditor is an 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 to justify and determine the kind of solution needed to safeguard

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      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 is a secure desktop email application that employs encryption technology that enables users to easily send encrypted, digitally signed communications to any email address, even if the recipient does not subscribe to ZixMail. The service works with existing email addresses and systems, and is available in a standalone version or in versions that integrate fully with Microsoft Outlook® and Lotus Notes®. As with ZixVPM, ZixMail does not require the user to manually exchange or manage public encryption keys. ZixCorp’s secure data center, the 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 to exchange 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 at no charge through the ZixMessage Center, which provides a browser-based solution for viewing and composing secure messages. Email 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 enables ZixMail subscribers to send secure messages to non-ZixMail subscribers, which provides a send-to-anyone encryption solution.

      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 or security infrastructures.

      ZixPort 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 employees, customers, and partners with a transparent user experience. The service can be integrated into an existing single sign-on security solution, take advantage of ZixCorp’s application program interfaces for increased efficiency, and can lower support costs and improve customer satisfaction by providing real-time information. ZixPort 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.

      Message Inspector is a multi-level email management tool that combines the most advanced spam and content filtering technologies with enhanced administration tools, resulting in a comprehensive, accurate, and easy-to-manage solution that fully addresses the content filtering needs of organizations. It helps manage, filter, and if necessary, block unauthorized inbound, outbound, and interoffice communications. Message Inspector features include: a comprehensive signature database that contains tens of thousands of signatures supporting multiple languages, which are reviewed and updated daily; automatic white lists that can be

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      Web Inspector is an easy-to-use, reliable, and flexible Internet monitoring and Web content filtering tool for companies seeking to boost employee productivity or reduce network congestion from non-work related Web access. Designed to help organizations enforce Internet acceptable-use policies, Web Inspector enables users to proactively monitor, manage and, if necessary, block access to inappropriate Web sites. Web Inspector can efficiently monitor and manage extremely large volumes of Web traffic — even in environments with multiple gateways. With more than 500 pre-defined and customizable reports, Web Inspector provides the most extensive and relevant reporting capabilities of any Web filtering solution. Users can begin Internet monitoring and Web filtering upon installation, with no up-front customization. Web use can be managed according to individual, group, category, or even time of day with flexible and easy-to-modify rules.

      PocketScript is e-prescribing technology that applies the benefits of e-messaging to the medical prescription process by enabling medical providers to write and transmit prescriptions electronically from the point of care directly to the pharmacy. In addition to enabling providers to write and transmit prescriptions electronically, PocketScript offers point-of-care access to real-time drug formularies and comprehensive drug data. The result is significant time savings from fewer illegible prescriptions, enhanced patient safety, and fewer office resources dedicated to managing prescriptions.

      PocketScript uses handheld wireless PDAs (BlackBerry® or Pocket PC®) or a secure Web site, to provide physicians the ability to write and transmit prescriptions directly to any pharmacy. In addition, providers can view patient drug histories for all past prescriptions to ensure that prescriptions are being filled and no therapies are being duplicated, and offers point-of-care access to continuously updated formulary information. The system identifies generics and preferred drugs for multiple formularies enabling providers to choose the most appropriate option. All information is updated continuously via wireless connection or secure Web site. The comprehensive database, which PocketScript uses under license, provides information on virtually every drug available to providers, including drug-to-drug interactions and drug reference guides.

      MyDocOnline Connect is a Web-based tool that provides a secure communications channel for healthcare providers, their clinical and administrative partners, and their patients. Through MyDocOnline Connect, an array of medical practice functions can be efficiently completed online — patients can schedule appointments, complete doctor visits, receive trusted health information from their physician, and interact with self-help tools for healthy living. In addition, the disease management capability enables patients to have online access to preventative, educational, and counseling resources to aid in the delivery and effectiveness of care. Disease management is a critical component to MyDocOnline as it is considered to be one the greatest opportunities to increase clinical outcome and reduce costs relating to healthcare.

      Dr. Chart is a Web-based communication tool that connects healthcare providers and laboratories. Dr. Chart enables doctors to initiate lab orders, check medical necessity compliance and view results rapidly and accurately using a secure Internet connection. This innovative laboratory order entry and results reporting system benefits both healthcare providers and laboratories alike. Our experience building hundreds of interfaces for specific systems helps ensure that Dr. Chart will integrate seamlessly into a customer’s current lab system.

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      Dr. Chart simplifies the customer service and report delivery process for lab work, helps reduce costly reimbursement denials with automatic compliance and medical necessity checking at the point of order, automatically integrates patient information, enables the lab to enhance reporting with historical analysis, customizes requisition formats for individual practices, automatically prints specimen labels, and facilitates processing of questions and answers for each procedure according to lab rules and requirements.

Competition

      In broad market terms, we operate in two general markets for our products and services: e-messaging management and protection, and healthcare information and productivity. These two broad markets include product vendors and service providers that often compete with one or more of ZixCorp’s products and services. The business acquisitions we made in 2003 and in early 2004 have considerably expanded the potential scope of our addressable market space and the range of our competitors and potential competitors.

      As awareness of the need for privacy and security in electronic communications has increased, a growing number of competitors have entered the market. Although some of these companies have substantial information technology security and email protection products, we do not perceive them to be as attractive to the marketplace as our services. We believe ZixCorp offers a superior suite of bundled services that addresses the complete range of requirements needed for e-messaging protection with full-featured and flexible solutions that are both user friendly and simple to deploy. We may also 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, ZixCorp offers technology solutions that can be made operational quickly 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 external networks, as is the case with the healthcare market — a primary target sector for us. Our registered users become part of a global “white pages” that enables 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 enable secure communications with non-registered users via the 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 services focus on the secure delivery portion of the secure e-messaging market, a sub-segment of the 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 Certified Mail, 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 protocol. We believe that technology alone cannot solve our customers’ challenges and, unlike our competition, we offer several programs that 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 systems prior to deploying our solutions and on an ongoing basis to ensure continued compliance with security best practices.

      Moreover, we do not believe that our competitors have made the investments required to match our infrastructure development and services. We believe that only ZixCorp offers 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 products and services from all other secure e-document delivery and secure e-messaging market participants.

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      In the anti-virus segment of the market, several product companies deliver solutions. Network Associates, Inc. (McAfee), Symantec Corporation, Sophos, Inc. and Trend Micro, Inc. have a high market share position in anti-virus and wield considerable competitive strength over other vendors. The anti-spam segment of the market has considerably more competitors than other areas we serve. Several companies deliver anti-spam products, including CipherTrust, Inc., NetIQ Corp., Postini, Inc. and SurfControl Incorporated. Providers of content scanning solutions include ClearSwift Limited and Tumbleweed Communications Corp. There are a few service-based offerings that deliver anti-virus or anti-spam filtering, including MessageLabs and BrightMail Incorporated. While these competitors are substantial and hold significant market share, none of them offers the combined comprehensiveness of ZixCorp, 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. In the Web content filtering market, there are several product companies competing with Web Inspector including SurfControl, Websense, Inc., Secure Computing Corporation and NetIQ.

      In general, ZixCorp’s Care Delivery Solutions services compete in a less developed market than our other services. However, because of recent advances in healthcare technology, advances in handheld computing, and the civic and legislative mandates to reduce healthcare costs, this market is seeing increases in competitive activity. We believe that we have a “first mover” advantage in these markets, and because of our comprehensive portfolio, we also believe we have a distinct competitive advantage. Additionally, the link between our Care Delivery Solutions and our Communications Protection Solutions is an important element in our competitive strategy. ZixCorp’s secure e-messaging expertise enables us to offer expanded care delivery services to healthcare providers at the point of care. Follow up often requires twenty-four hour a day availability, with high bandwidth capability, via a secure channel and with send to anyone capabilities. These are our core underlying strengths and we believe they are unmatched in the industry segment we serve.

      Even though the e-prescribing market is still emerging, we have several competitors. These include Allscripts Healthcare Solutions, Ramp Corporation, Dr. First, Inc. and iScribe, a division of AdvancePCS. Many of the competitors in this market also focus on other technologies such as patient records automation and practice management solutions, or they act as application service providers in the healthcare market.

      Our business acquisition of MyDocOnline in January 2004 introduced us to new markets and thus new competitors. Dr. Chart faces competing products offered by 4Medica, Inc., Cerner Corporation and Misys plc. The online doctor visit market segment, which we address with MyDocOnline Connect, competes with similar offerings from RelayHealth Corporation, Medem, Inc., MedFusion and WebMD Corporation.

      Companies that do not currently compete with us or only compete with selected products or in selected markets, could become competitors in the future on a larger scale. Such companies would likely offer a broad portfolio of health information technologies for all or some of the pharmaceutical, pharmacy, healthcare provider, and managed care markets. With considerable size and access to capital they could potentially become viable competitors.

Sales and Marketing

      ZixCorp primarily sells services via a direct sales force with some indirect and partner activity in specific markets or with specific products. We currently target 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. Recent acquisitions such as PocketScript and MyDocOnline significantly increased our product offering to this market.

      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 various marketing activities focused on

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      We continue to develop products and product features that increase our sales and marketing edge in the healthcare market. An example is the constantly improving lexicons developed by the ZixResearch Center^TM. The ZixResearch Center provides regular updates and enhancements to ZixCorp’s lexicons based on its own extensive research, as well as input from customers, universities, industry experts, and consultants.

      We are developing our products and turning more sales and marketing attention to other attractive markets. In February 2004 we added the Personal Financial Lexicon. The lexicon was developed to assist financial institutions with implementation of consumer privacy policies that are a part of the Gramm-Leach-Bliley Act of 1999 (GLBA). The lexicon helps financial institutions enact corporate policies by automatically encrypting emails that contain content defined within GLBA as “personally identifiable financial information.”

      For e-prescribing and other care delivery solutions, we sell to physicians directly but have also found that attractive and receptive customers/ partners are other stakeholders in the benefits derived from applying technology to healthcare. In particular, several insurance providers (payors) have purchased our services on behalf of the prescribing doctors in their plans. So great are the potential savings for the insurance providers that they are, in effect, underwriting the cost. After a sponsorship agreement is signed, we work closely with them to deploy the technologies. Such a selling and marketing arrangement provides a win/win scenario for all involved and we believe this approach accelerates adoption and deployment.

Employees

      ZixCorp had 243 employees as of February 27, 2004. The majority of our employees are located in Dallas, Texas; Round Rock, Texas; Cincinnati, Ohio; Boston, Massachusetts; and Ottawa, Ontario, Canada.

Research and Development; Patents and Trademarks

      ZixCorp’s continuing operations incurred research and development expenses of $5,896,000, $6,180,000, and $9,019,000 in 2003, 2002, and 2001, respectively.

      ZixCorp has filed several patent applications covering concepts ZixCorp is employing, or may employ, in implementing its secure e-messaging business. In addition, the following are registered marks of ZixCorp and certain of its subsidiaries: “ZixCorp,” “ZixMail,” “ZixAuditor,” “ZixVPM,” “Message Inspector,” “Web Inspector,” “PocketScript” and “Dr. Chart.”

Customers

      ZixCorp had no significant revenues in 2001. Service 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”). In 2003 service revenues included $764,000 associated with the same agreement, which represented 13% of annual revenues. In July 2003, we agreed with Entrust to terminate the agreement as the structure no longer served our respective business interests. No further revenue will be recognized from this agreement. Separately, in 2003, Cigna Corporation accounted for approximately 10%, or $607,000, of our total revenues. No other single customer accounted for 10% or more of our revenues in 2003 or 2002.

Sales Backlog

      ZixCorp’s end-user order backlog as of January 31, 2004, which includes deferred revenue on the Company’s consolidated balance sheet, increased to approximately $16,900,000 which includes approximately $8,800,000 associated with the PocketScript, Elron and MyDocOnline acquisitions, including a $4,000,000 Master Services Agreement with Aventis Inc., a former affiliate of MyDocOnline. See Note 15 to the consolidated financial statements included herein. As of January 31, 2003, ZixCorp had an end-user order backlog of $2,339,000.

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Geographic Information

      ZixCorp’s operations are based in the United States (“U.S.”) and Canada, and our revenues and orders to date are almost entirely sourced in the U.S. All significant corporate assets at December 31, 2003, were held in the U.S., and were primarily comprised of cash investments and marketable securities invested generally in daily money market funds, commercial paper and asset-backed securities.

Available Information

      Our business involves risks and uncertainties, and there are no assurances that the Company will be successful in its efforts. 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.

      We file annual, quarterly, current and other reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”), pursuant to the Securities Exchange Act of 1934, as amended (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.

      Our Internet address 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/ SEC Filings,” 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.

      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. To replace these subleases, we have entered into a lease that commences upon the expiration of these subleases and expires in December 2014 for approximately 42,912 square feet in the same office facility for our corporate offices and our ZixSecure Center operations. ZixCorp also leases approximately 13,000 square feet of space in Ottawa, Ontario, Canada for our Canadian operations under a sublease that expires in August 2005; approximately 206 square feet of space in Austin, Texas under a co-location facilities lease that expires in June 2006, used for fail-over and staging of new customers of our Zix branded services; approximately 11,733 square feet of space in Burlington, Massachusetts under a sublease that expires in March 2005 for our Elron Software operations; approximately 5,608 square feet of space in the Cincinnati, Ohio area under a lease that expires in August 2009 for our PocketScript operations; and for our MyDocOnline operations approximately 10,423 square feet of space in the Austin, Texas area and 3,600 square feet in Boca Raton, Florida under a lease that expires in December 2004 and a month-to-month sublease, respectively. Through December 31, 2003, ZixCorp has invested approximately $31,300,000 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;

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	•	Dual uninterruptible power supplies;
	•	Back-up diesel generator;
	•	Redundantly configured power distribution units;
	•	Multiple ISPs;
	•	Redundantly configured DS3 fiber connections and redundant routers;
	•	Proven 99.99% reliability;
	•	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; and
	•	SysTrust management controls which are audited for compliance with Security, Availability, Processing Integrity and Confidentiality principles and related criteria, established under the AICPA/CICA Trust Services program.

      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.

      None.

PART II

      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 2003 and 2002. These prices do not include adjustments for retail mark-ups, mark-downs or commissions.

      At February 23, 2004, there were 30,569,239 shares of common stock outstanding held by 489 stockholders of record. On that date, the last reported sales price of the common stock was $10.80.

      ZixCorp has not paid any cash dividends on its common stock since 1995 and does not anticipate doing so in the foreseeable future.

      Certain information pertaining to ZixCorp securities authorized for issuance under equity compensation plans is incorporated by reference from the section “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS — Equity Compensation Plan Information” in the Company’s 2004 Proxy Statement.

      On July 22, 2003, the Company acquired substantially all of the operating assets and the business of Ohio based PocketScript, LLC. The consideration for the acquisition consisted of $50,000 in cash and 362,903 shares of ZixCorp common stock. The shares were issued without registration under the Securities

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      On September 2, 2003, the Company acquired substantially all of the operating assets and the business of Elron Software, a majority-owned subsidiary of Elron Electronic Industries, Ltd., based in Massachusetts. The consideration for the acquisition consisted of 1,709,402 shares of ZixCorp common stock and a 5.75% convertible note for $1,000,000. In November 2003, the note and related accrued interest were converted by the holder into 262,454 shares of the Company’s common stock, at a conversion price of $3.86 per share. The shares and convertible note were issued without registration under the Act as a private placement effected in reliance on the exemption from registration afforded by Rule 506 of Regulation D promulgated under the Act and Section 4(2) of the Act. There is an effective registration statement on Form S-3 relating to the resale of these shares. The Company receives no proceeds from the resale of these shares.

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      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, 2003, which are derived from the audited consolidated financial statements of the Company. The consolidated financial statements and notes thereto as of December 31, 2003 and 2002, and for the years ended December 31, 2003, 2002 and 2001, 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)

During 1998, the Company sold all of its operating businesses and, accordingly, the gains on the sale of these businesses are presented as discontinued operations. The Company acquired substantially all of the operating assets and the businesses of PocketScript and Elron Software in July and September of 2003, respectively. The results of operations of PocketScript and Elron Software are included in the Company’s results of operations from their dates of acquisition.

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(2)	In 2003, 2002, 2001 and 2000, expenses associated with continuing operations include non-cash stock-based compensation of $1.0 million, $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 6 to the consolidated financial statements included herein. Selling, general and administrative expenses include advertising costs of $1.4 million, $2.9 million, $4.5 million and $10.3 million for 2003, 2002, 2001 and 2000, respectively.
(3)	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 6 to the consolidated financial statements included herein.
(4)	In 2001, realized and unrealized losses on investments includes the write-off of the Company’s $5 million related party investment in Maptuit Corporation. In 2003, the Company received $530 thousand in cash as partial recovery of its investment in Maptuit Corporation. See Note 11 to the consolidated financial statements included herein.
(5)	In calculating the basic and diluted loss per common share for 2003 and 2002, the Company’s loss from continuing operations and net loss have been increased by $1.4 million and $3.2 million, respectively, representing the preferred stock dividends associated with the Series A and Series B convertible preferred stocks until their conversion into common stock.

Overview

      Zix Corporation operates in a single industry segment, providing solutions that protect, manage and deliver sensitive electronic information. By offering a comprehensive set of products and services, the Company protects organizations from viruses and spam, provides the management tools needed for Web access control and policy-driven email encryption, and provides care delivery solutions for e-prescribing and e-consulting that enable physicians to leverage technology for better patient care.

      In 1998 and prior years, the Company provided systems and solutions for the intelligent transportation, electronic security and other markets. The Company sold all of its operating units in 1998 and began evaluating new Internet-related business opportunities. 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 toward the business market. In 2002 and 2003, 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 Company has targeted the healthcare sector, where the legislated mandates of the Health Insurance Portability and Accountability Act, a 1996 law that requires Protected Health Information to be safeguarded over open networks, are driving demand. The privacy regulations for this law took effect in April 2003.

      In July 2003, the Company acquired substantially all of the operating assets and the business of Ohio-based PocketScript, LLC (“PocketScript”), a privately-held development stage enterprise which provides electronic prescription solutions for the healthcare industry. This acquisition enables the Company to expand its services into the e-prescription marketplace, which is expected to grow significantly as more physicians are leveraging technology in delivering care, coupled with the fact that the number of prescriptions written annually in the United States continues to increase. In September 2003, the Company acquired substantially all of the operating assets and the business of Elron Software, Inc. (“Elron Software” or “Elron”), a majority-owned subsidiary of Elron Electronic Industries Ltd. and a provider of anti-spam, email content filtering and Web filtering solutions. This acquisition enables the Company to add a robust feature set to its anti-spam, anti-virus, and content filtering services while expanding its offerings to include Web filtering. Both PocketScript and Elron Software have incurred operating losses in recent years.

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      The foundation of the Company’s business model is centered around the financial leverage expected to be generated by its various subscription and transaction based 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. Subscription fees are generally expected to be collected annually at the beginning of the subscription period and are recognized as revenue on a prorated basis over the length 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. Anacom was purchased in conjunction with the Company’s development of a potential product, ZixCharge^TM, which was never commercially released. Operating losses and liquidity have been favorably impacted by Anacom’s shut-down, as Anacom recorded operating losses, excluding non-cash charges, of $1,091,000 for 2001.

      Operating in emerging markets involves risks and uncertainties, and there are no assurances that the Company will be successful in its efforts. Successful growth of an early 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 and 2003, the Company and its recent acquisitions have incurred significant operating losses during their development stage activities and the utilization of cash resources has continued at a substantial level. The Company anticipates further operating losses in 2004.

Results of Operations

      The Company was in the development stage and had no significant revenues in 2001 and 2002. Substantially all of the Company’s revenues in 2001 were generated by Anacom, which ceased operations in June 2001. The Company first began charging for its secure e-messaging products and services in the first quarter of 2001. Revenues from subscription services are recognized as the services are rendered. Subscription fees received from customers in advance are recorded as deferred revenue and recognized as revenues ratably over the subscription period. Revenues for 2002 of $1,672,000 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 (the “Marketing Agreement”) with Entrust, Inc. (“Entrust”). 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.

      Revenues increased from $1,672,000 in 2002 to $5,840,000 in 2003 due primarily to an increase of approximately $2,846,000 in amortization of secure e-messaging subscription fees generated from new U.S. corporate customers primarily in the healthcare sector, $288,000 associated with the cancellation of the Company’s Japanese distributor agreement, and $706,000 in email content and Web filtering software sales as well as $544,000 in related maintenance following the acquisition of Elron Software on September 2, 2003. Deferred maintenance revenue acquired in connection with the acquisition of Elron Software was recorded at $776,000, its fair value on the acquisition date in accordance with generally accepted accounting principles, resulting in a 59% reduction in the pre-acquisition balance. Therefore, assuming the affected product maintenance contracts are renewed, reported maintenance revenue should begin to increase quarter over quarter in the near term as the full contract values of such renewal contracts are amortized ratably to revenue. Elron Software products are offered to customers under perpetual license agreements. The Company recognizes revenue on these arrangements after all of the following occur: persuasive evidence that an arrangement exists, the software is delivered, collection is probable, fees are fixed and determinable, and vendor-specific objective evidence of fair value (VSOE) exists to allocate the total fees to the elements of the arrangement. These software licenses are sold as part of a multiple element arrangement that includes

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      Quarterly service revenues from January 2002 through June 30, 2003 included $234,000 per quarter resulting from the pro-rata recognition of certain minimum payments associated with the Marketing Agreement with Entrust. These minimum payments aggregating $3,750,000 were being recognized as revenue ratably over the four year maximum service period ending in December 2005. Entrust paid the Company a $1,000,000 guaranteed minimum payment in January 2003. In July 2003, the Company and Entrust mutually agreed to terminate their Marketing Agreement, because the Marketing Agreement, as structured, no longer served their respective business interests. In connection with the termination of the Marketing Agreement, Entrust paid the Company $700,000 and the scheduled minimum guaranteed payments to have been made in 2004 and 2005, totaling $2,750,000, were cancelled. As a result of the termination of this contract service revenues for the third quarter of 2003 included $296,000, which represents the final revenues to be recognized under this contract. Entrust accounted for 13% of the Company’s revenues in 2003.

      In 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 revenue opportunities and overall sales margins.

      The Company’s end-user order backlog as of December 31, 2003, which includes deferred revenue on the Company’s consolidated balance sheet, increased to approximately $13,000,000, which includes approximately $4,900,000 associated with its newly acquired products and services including electronic prescription solutions, email content filtering and Web filtering. The Company’s backlog is comprised mainly of service contracts for product maintenance and support, secure messaging, and electronic prescription solutions. Approximately 65% to 75% of this backlog is expected to be recognized as revenue in 2004, reflecting a mix between single and multi-year service contracts and the anticipated timing of the deployment of e-prescribing services.

      The Company currently generates revenues from the sale of perpetual software licenses, transaction fees associated with providing e-prescription solutions, and service-based contracts for product maintenance, secure messaging, and e-prescription solutions which are amortized to revenue ratably over their respective service periods. Management uses several general metrics to estimate future revenue growth. These metrics include: technology adoption rates in the markets served by the Company, overall order input, renewal rate (customer retention) of service contracts, mix of single or multi-year service contracts and deployment statistics for the Company’s products and services. As the market for e-prescription solutions matures, the deployment of e-prescribing devices to physicians and the prescription volume written by such physicians are important metrics, as the device and its use are a platform for various revenue sources.

      Cost of revenues decreased from $14,996,000 in 2001 to $8,999,000 in 2002 primarily due to a 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. The certificates that were written-off did not enter into the sales and marketing plans established by the Company’s then new

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      The net decrease in cost of revenues from 2002 to 2003 of $788,000 consists of a $3,367,000 decrease in non-cash expenses offset by an increase of $2,579,000 in cash expenses. The decrease in non-cash expenses to $2,755,000 was primarily due to a reduction in depreciation and amortization of property and equipment of $3,696,000 resulting from certain data center equipment becoming fully depreciated, which was partially offset by $289,000 for amortization of intangible assets associated with the 2003 acquisitions of PocketScript and Elron Software. The 2003 increase in cash expenses is due primarily to personnel additions totaling $1,676,000 which were necessary to expand the Company’s deployment and client services capabilities to support the order growth of the Company’s secure messaging products and services. Additionally, with the Company’s increased volume of business coupled with the 2003 acquisitions of PocketScript and Elron Software, 2003 cash expenses have increased over 2002 by approximately $270,000 in each of the areas of travel, data center maintenance and support and outside consultants, including professional fees associated with the Company obtaining the AICPA SysTrust^TM certification.

      A significant portion of the Company’s cost of revenues has not been and is not expected to be directly variable to the revenue generated, such as the cost of operating and maintaining the ZixSecure Center which is currently not fully utilized. Accordingly, costs associated with the data center are expected to grow at a much slower pace than revenue. However, cost of revenues also includes the activities of field deployment, professional services and customer service and support, which in the near term are expected to grow at rates substantially equivalent to the Company’s revenue growth rate. Other than the non-cash amortization of the fair value of developed technology acquired with the purchase of Elron Software, cost of revenues related directly to software sales has not been significant.

      Research and development expenses decreased from $9,019,000 in 2001 to $6,180,000 in 2002 primarily due to decreases in third party consulting expenditures totaling $2,333,000 and reduced employee recruitment expenses of $396,000. Non-cash expenses increased $410,000 from $1,435,000 in 2001 to $1,845,000 in 2002 due to a 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.

      The net decrease in research and development expenses from 2002 to 2003 of $284,000 is due primarily to a $1,469,000 reduction in non-cash expenses consisting primarily of a $737,000 decrease in depreciation and amortization of property and equipment resulting from certain computer equipment becoming fully depreciated and a $762,000 charge in 2002 for the cost to license certain patents held by Tumbleweed Communications Corp. These decreases in non-cash expenses were partially offset by increased cash expenses of $1,185,000, most of which consisted of personnel costs resulting from the acquisitions of PocketScript and Elron Software in the third quarter of 2003.

      Selling, general and administrative expenses decreased from $29,892,000 in 2001 to $19,335,000 in 2002, but increased slightly to $19,907,000 in 2003.

      The net decrease in selling, general and administrative expenses from 2001 to 2002 amounted to $10,557,000. Expenses, excluding non-cash expenses, 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

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      The net increase in selling, general and administrative expenses from 2002 to 2003 amounted to $572,000. Expenses, excluding non-cash expenses, increased $3,633,000 in 2003 primarily due to increased personnel costs of approximately $2,900,000 consisting of $1,359,000 resulting from the acquisitions of PocketScript and Elron Software in the third quarter of 2003 and $1,541,000 associated with the Company’s expansion of its sales organization which began in late 2002. In 2003, due to increased sales activity, headcount increases and the acquisitions of PocketScript and Elron Software, additional cost increases were incurred for travel, facility costs and advertising and promotion totaling $732,000, $509,000 and $403,000, respectively, including expenditures associated with the Company’s HealthyEmail initiative. The Company’s legal professional services decreased by $873,000 in 2003 primarily due to the elimination of outside legal fees associated with the Company’s lawsuit with Visa U.S.A., Inc. and Visa International Service Association, which was concluded in 2002. Non-cash charges between 2002 and 2003 decreased by $3,061,000, to $1,580,000, primarily due to a $1,937,000 decrease in stock-based compensation related to stock option grants for employees and third party service providers and $1,935,000 for non-recurring costs recorded in 2002 related to the Yahoo! Inc. advertising arrangement, partially offset by $159,000 for amortization of intangible assets associated with the 2003 acquisitions of PocketScript and Elron Software and $484,000 in non-cash compensation expense resulting from the Company implementing a program in the third quarter of 2003 whereby non-executive employees were paid certain compensation, such as sales commissions, with the Company’s common stock rather than cash.

      Investment income decreased from $2,187,000 in 2001 to $319,000 in 2002 and further decreased to $138,000 in 2003. The continual decrease between years is primarily due to the decrease in invested cash and marketable securities and lower interest rates.

      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 noteholders converted the Convertible Notes and related accrued interest into 2,141,811 shares of the Company’s common stock.

      Realized and unrealized losses on investments in 2001 primarily represents 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. In June 2003, the Company exchanged the $900,000 subordinated promissory note and one million shares of common stock of Maptuit for $530,000 in cash and, in January 2004, the Company exchanged the remaining one million shares of Maptuit’s common stock for $70,000 in cash.

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      Income taxes on the loss from continuing operations in 2001, 2002 and 2003 is different from the U.S. statutory rate of 34%, primarily due to unbenefitted U.S. losses. The Company’s income tax expense for 2003 of $148,000 represents non-U.S. taxes payable resulting from the operations of the Company’s Canadian subsidiary established in late 2002. 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. The Company has fully reserved its U.S. net deferred tax assets in 2001, 2002 and 2003 due to the uncertainty of future taxable income. 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.

      As a result of the foregoing, the Company experienced losses from continuing operations of $56,794,000 in 2001, $34,299,000 in 2002 and $27,667,000 in 2003.

      The Company sold all of its remaining operating businesses during 1998 realizing follow-on gains of $48,000, $862,000 and $89,000 in 2001, 2002 and 2003, respectively.

Liquidity and Capital Resources

      Net cash used by continuing operations was $18,745,000 in 2003 compared to $19,759,000 in 2002. The improvement in operating cash flows in 2003 was primarily due to a 19% reduction in the Company’s loss from continuing operations totaling $6,632,000, a decrease in receivables resulting from the January 2003 collection of $1,000,000 from Entrust, Inc. and an increase in non-acquired deferred revenue of approximately $2,985,000 as a result of increased sales of prepaid service contracts. Substantially offsetting these increases was a $10,548,000 reduction in 2003 non-cash operating expenses in the areas of depreciation and amortization, stock-based compensation, vendor obligations paid in common stock and certain non-cash charges for interest expense associated with the Company’s convertible note outstanding during 2002. Depreciation expense has continued to decrease as the Company’s data center equipment becomes fully depreciated. Net cash used by operating activities in 2003 was funded primarily by existing cash resources and financing activities described below.

      Net cash flows used in investing activities during 2003 of $779,000 were attributable to purchases of property and equipment totaling $2,252,000 partially offset by non-recurring cash flows of $1,000,000 acquired in the purchase of Elron Software and $530,000 received as partial recovery of the Company’s investment in Maptuit Corporation. The recent trend for a reduced level of additions for property and equipment reversed in 2003, as expected, as the Company upgraded certain computer hardware in its data center and acquired computer equipment to satisfy customer orders for the Company’s products and services, primarily ZixVPM and ZixWorks.

      Net cash provided by financing activities in 2003 was comprised of $5,608,000 from a mid-year private placement of common stock and warrants, and proceeds of $12,965,000 from the exercise of stock options and warrants to purchase 2,358,968 shares of the Company’s common stock at an average price per share of $5.50. Separately, on September 30, 2003, the Company elected to convert the remaining $4,925,000 of Series A and Series B convertible preferred stock and related accrued dividends into 1,270,585 shares of the Company’s common stock at $4.07 and $3.76 per share, respectively. Additionally, in 2003, the Company used equity securities valued at $8,719,000 to acquire substantially all of the assets and businesses of PocketScript and Elron Software.

      The Company’s cash requirements consist principally of funding the Company’s operating losses as it pursues a leadership position in the emerging markets in which it operates and capital expenditures, primarily for data center expansion and refurbishment and for computer equipment to support new customer orders. The

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      At December 31, 2003, the Company had cash and marketable securities totaling $13,852,000, no debt and total liabilities, excluding deferred revenue, of $3,738,000. Subsequent to year end, through March 9, 2004, as a result of the exercise of stock options and warrants, the Company’s liquidity improved as it received proceeds of $10,318,000 in exchange for 1,262,023 shares of the Company’s common stock. On March 9, 2004, there are currently exercisable warrants and stock options, with an exercise price per share of $10.00 or less, to acquire approximately 4,100,000 shares of the Company’s common stock, at an average price of approximately $5.35 per share, which if exercised would result in a significant level of additional new funding for the Company. Additionally on January 30, 2004, in connection with the acquisition of MyDocOnline, the Company received $7,000,000 in cash from Aventis, Inc., a former affiliate of MyDocOnline. Aventis loaned the Company $3,000,000, due March 2007, which is payable in either cash or shares of common stock at the option of the Company and may be prepaid by the Company anytime without penalty. Additionally, Aventis entered into a three-year service contract with the Company for a minimum commitment of $4,000,000 for the performance by the Company of various services pursuant to a Master Services Agreement. At Aventis’ discretion, the loan may be paid in the form of additional services provided to Aventis by the Company in accordance with the Master Services Agreement. The loan and the Company’s obligations associated with the Master Services Agreement are secured by a lien on the Company’s accounts receivables and property and equipment. On March 9, 2004, the total of the Company’s cash and marketable securities was approximately $25,800,000.

      The amount of 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 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 recognizes the importance of privacy and security for their electronic communications and as electronic prescription initiatives mature in the marketplace. In the future the Company may need to raise additional funds to sustain its operations or initiate reductions in operating expenses, or both. The Company will continue to consider various capital funding alternatives to strengthen its 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 shares of the Company’s common stock. The Company currently has no existing credit facilities. There can be no assurances that the Company will be able to raise additional capital on satisfactory terms if and when needed.

Off-Balance Sheet Arrangements, Contractual Obligations, and Contingent Liabilities and Commitments

      The following table aggregates the Company’s material contractual cash obligations as of December 31, 2003:

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      The Company has severance agreements with certain employees which would require the Company to pay approximately $3,275,000 if all such employees separated from employment with the Company following a change of control, as defined in the severance agreements.

Critical Accounting Policies and Estimates

      The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements. The preparation of financial statements and related disclosures in accordance with accounting principles generally accepted in the United States requires the Company’s management to make estimates and assumptions that affect the amounts reported in the Company’s consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of the Company’s financial condition and results and require management’s most subjective judgments. The Company’s most critical accounting policies and estimates are described below.

      The Company’s long-lived assets, comprised of intangibles and property and equipment aggregating $6,740,000 or 26% of total assets at December 31, 2003, are periodically reviewed for impairment, by comparing the carrying value of the asset with its estimated fair value. The potential impairment is measured based on a projected discounted cashflow method, using a discount rate that is considered to be commensurate with the risk inherent in the Company’s current business model. Assumptions are made with respect to future net cash flows expected to be generated by the related asset. An impairment charge would be recorded for an amount by which the carrying value of the asset exceeded the discounted projected net cash flows.

      Goodwill, totaling $4,321,000, represents the cost in excess of fair value of net assets acquired in the September 2003 acquisition of Elron Software. The Company will evaluate its goodwill for impairment annually as of October 1, beginning in 2004, or when there is reason to believe that the value has been diminished or impaired. Evaluations for possible impairment are based upon a comparison of the estimated fair value of the business unit to which the goodwill relates to the sum of the carrying value of the assets and liabilities of that unit. The fair values used in this evaluation are estimated based upon discounted future cash flow projections for the unit and market values of comparable businesses where available. An impairment is deemed to exist if the net book value of the unit exceeds its estimated fair value. There has been no change to the carrying amount of goodwill since its origination in September 2003.

      Future changes made to the current estimates or assumptions, including such factors as order volumes and price levels, life spans of purchased technology, continuity of acquired customers, alternative uses for property and equipment and levels of operating expenses, could result in an unanticipated impairment charge from the write-down of the Company’s long-lived assets or goodwill.

      As required by Statement of Financial Accounting Standards No. 109, the Company recognizes deferred tax assets on its consolidated balance sheet if it is “more likely than not” that the subject net operating loss carry forwards and unused tax credits will be realized on future federal income tax returns. At December 31, 2003, the Company continued to provide a full valuation allowance against accumulated U.S. deferred tax assets of $69,822,000, reflecting the Company’s historical losses and the uncertainty of future taxable income. If the Company begins to generate U.S. taxable income in a future period or if the facts and circumstances on which its estimates and assumptions are based were to change, thereby impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied in determining the amount of valuation allowance no longer required. Reversal of all or a part of this valuation allowance could have a significant positive impact on operating results in the period that it becomes more likely than not that certain of the Company’s deferred tax assets will be realized.

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      General. The Company develops, markets, licenses and supports computer software products and services. Certain of the Company’s products and services, such as ZixMail, ZixVPM, ZixPort, ZixWorks and its newly acquired electronic subscription solutions are offered on a subscription basis. The Company’s subscription service includes delivering licensed software and providing customer support and secure email solutions throughout the subscription period. The customer generally is provided an appliance with pre-installed software or contractually subscribes to data center resident service capability and capacity. 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. Revenues from subscription services are recorded as the services are rendered. Subscription fees received from customers in advance are recorded as deferred revenue and recognized as revenues ratably over the subscription period. Transaction fees associated with the electronic prescription service are recognized as revenue when the transaction occurs.

      The Company also sells anti-spam and Web filtering products to customers under perpetual license agreements. The Company recognizes revenue on these arrangements after all of the following occur: persuasive evidence that an arrangement exists, the software is delivered, collection is probable, fees are fixed and determinable, and vendor-specific objective evidence of fair value (VSOE) exists to allocate the total fees to the elements of the arrangement. These software licenses are sold as part of a multiple element arrangement that includes annual maintenance, and often times implementation or training services. Where VSOE has not been established for certain elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined. However, if VSOE is determinable for all of the undelivered elements, and the undelivered elements are not essential to the delivered elements, the Company will defer recognition of the full fair value related to the undelivered elements and recognize as revenue the remaining portion of the arrangement value through application of the residual method. Evidence of VSOE for implementation and training services is based upon standard billing rates and the estimated level of effort for the individuals expected to perform the related services. Installation and training revenues are recognized as the services are rendered. The Company establishes VSOE for maintenance based upon current contract renewal rates. The Company recognizes maintenance revenue over the term of the maintenance agreement, generally one year.

      Multiple element arrangements. In the near term, the Company expects that a larger percentage of its revenues will be derived from customers purchasing a combination of software under perpetual license agreements and related services including product maintenance and secure messaging services. The Company determines the fair value of each of the contract deliverables using VSOE which requires significant judgment when selling and pricing products and services in emerging markets where increasing competition and technology changes are commonplace. VSOE for each element is based on the price for which the Company will sell the element on a stand-alone basis. If the Company determines that it does not have VSOE on an undelivered service element of an arrangement, the Company will delay revenue recognition from the software sale and amortize it to revenue ratably over the service period of the related service deliverable. This occurrence could materially impact our future financial results depending on the significance of software sales to our mix of total revenues.

      During 2003, the Company completed two acquisitions using the purchase method of accounting. The amounts assigned to the identifiable assets and liabilities acquired in connection with these acquisitions were based on estimated fair values as of the date of the acquisition, with the remainder recorded as goodwill. The fair values were determined by management, generally based upon information supplied by the management of the acquired entities and in one instance a valuation prepared by independent appraisal experts. The fair values have been based primarily upon future cash flow projections for the acquired assets, discounted to present value using a risk-adjusted discount rate. In connection with these acquisitions, we have recorded a significant amount of intangible assets and goodwill.

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Recent Accounting Pronouncements

      In July 2002, the Financial Accounting Standards Board 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 companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. This statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not have an effect on the Company’s results of operations or its financial position.

Risks and Uncertainties

      Since 1999, we have been developing and marketing products and services that bring privacy, security and convenience to Internet users, with a particular focus in the healthcare sector. Our businesses operate in emerging markets, and developing these businesses is costly and the market is highly competitive. Emerging market businesses involve risks and uncertainties, and there are no assurances that we will be successful in our efforts. We have experienced significant operating losses in recent years and utilization of cash resources continues at a substantial level. ZixCorp anticipates further losses in 2004.

      In July 2003, we acquired substantially all of the assets of PocketScript, a provider of electronic prescription solutions for the healthcare industry; in September 2003, we acquired substantially all of the assets of Elron Software, a provider of anti-spam, email content filtering and Web filtering solutions; and in late January 2004, we acquired substantially all of the assets of MyDocOnline, a provider of secure Web-based communications and laboratory information solutions. PocketScript and MyDocOnline are start-up ventures in emerging markets. While Elron has been in business for a number of years, its revenues have declined in recent years. PocketScript, Elron, and MyDocOnline have incurred operating losses in recent years. The ability to increase the companies’ revenues in the near future is largely dependent upon, in Elron’s case, whether our efforts to bring enhanced and new products to market are successful, and in the case of PocketScript and MyDocOnline, whether we are able to develop the market for their products and services. Our challenge is to make these new subsidiaries profitable. To do so may require us to invest significant resources, including significant amounts of cash, and there are no assurances that these subsidiaries will become profitable in the near term.

      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 protection and transaction businesses similar to our Zix branded business that currently operates at the scale that we would require, at our current expenditure levels and pricing, to become profitable. As previously noted, PocketScript and MyDocOnline are start-up ventures in emerging markets. 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.

      Our Zix branded solutions are targeted to the secure e-messaging protection and transaction services market. Elron’s product solutions have enabled us to enhance our Zix branded protection management

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      Although there are many large, well-funded participants in the information technology security industry, few currently participate in the secure e-messaging protection and transaction services market in which our Zix branded solutions compete. Most other product-only solutions in this market require extensive increases in overhead to implement and deploy them. In addition, our Zix branded solutions 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. Our service and product offerings are focused on the secure communications market, including secure e-messaging and protection management. Companies that compete with our Zix branded secure e-messaging and protection business include content management and secure delivery companies, such as Authentica, Inc., Certified Mail, Sigaba Corporation and Tumbleweed Communications Corp., and other messaging/spam protection participants such as BrightMail Incorporated, CipherTrust, Inc., ClearSwift Limited, FrontBridge Technologies, Inc., MessageLabs, Postini, Inc., NetIQ Corp. and SurfControl Incorporated.

      Our Zix branded products and Elron products also compete with several product companies that deliver anti-virus solutions that may also contain limited email messaging/spam protection capabilities, including Network Associates, Inc. (McAfee), Sophos, Inc., Symantec Corporation and Trend Micro, Inc. We also compete with companies that offer Web filtering products, such as Secure Computing Corporation, SurfControl Incorporated, Websense, Inc. and NetIQ Corp.

      In addition, we face competition from vendors of Internet server appliances, operating systems, networking hardware, network management solutions and security software, many of which now, or may in the future, develop or bundle secure e-messaging, messaging/spam protection and/or Web filtering capabilities into their products.

      We may face increased competition as these competitors partner with others or develop new product and service offerings to expand the functionality that they can offer to their customers. We believe that the secure e-messaging protection and transaction services market is immature, and, for the most part, unpenetrated, unlike many segments of the information technology security industry — which are saturated. We have spent several years on infrastructure development and product development. Our competitors may, over time, 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 our company. 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 PocketScript electronic prescription management services allow health care payors to effectively deliver drug information to physicians at the point of care, enabling providers to work more effectively within established formularies. Our PocketScript services, targeted to the e-prescription marketplace, are expected to grow as more physicians are leveraging technology in delivering healthcare services, coupled with the fact that the number of prescriptions written annually in the United States continues to increase. Participants in the e-prescribing space include AllScripts Healthcare Solutions, Ramp Corporation, Dr. First, Inc. and iScribe (a division of AdvancePCS).

      Our recently acquired MyDocOnline business offers a variety of Internet-based healthcare services. MyDocOnline Connect is a subscription-based Web service that allows patients and physicians to securely communicate online. Connect helps patients become more active, informed participants in their own health. Communication features offered by the service cover the spectrum of patient needs and include: online doctor visits, administrative questions, appointment requests, billing questions, prescription requests, and referral requests. The service also offers a host of educational, interactive content features that deliver condition-

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      Dr. Chart, also a Web-based communication tool, connects healthcare providers and laboratories by allowing doctors to initiate lab orders, check medical necessity compliance and view results rapidly and accurately using a secure Internet connection. Dr. Chart also automatically integrates patient information, customizes requisition formats for individual practices, automatically prints specimen labels, automatically checks Medicare compliance and provides an up-front Advanced Beneficiary Notification (ABN) at point of order and allows labs to enhance reporting with historical analyses, trending, and graphing. Dr. Chart seamlessly integrates into labs’ current systems and is fully customizable. Competitors include: 4Medica, Inc., Cerner Corporation and Misys plc. All of the competitors offer the same basic services that Dr. Chart offers, although we believe that Dr. Chart is superior to services offered by its competitors because of the flexibility of the product, expertise in interfacing to other systems, and duration and breadth of experience delivering Internet-based orders and solutions to labs nationwide. Nevertheless, we expect to face increasing competition in this arena and our competitors may develop products and services that are perceived to be better than ours.

      The emerging nature of the secure e-messaging protection and transaction 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. Our Elron business, while having a significant customer base and meaningful revenues, has not been profitable in recent years under its prior ownership.

      We also have under development new feature sets for our current Zix branded product line and service offerings and are considering new secure e-messaging products and services. By adding Elron’s product line to our current service offerings, we will be able to accelerate the development time we would have otherwise needed to build additional feature sets into our Zix branded product and service offerings. 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.

      The market for secure electronic communications is a developing market. Continued growth of the secure e-messaging protection and transaction services market will depend to a large extent on the market recognizing the need for secure electronic communications, such as email encryption and e-prescribing. Failure of this market to grow would harm our business.

      Our PocketScript electronic prescription management services and our MyDocOnline services are targeted to the emerging market for providing secure communications among healthcare providers to deliver information in an efficient, economical manner. These are emerging markets, and the success of our

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      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, particularly since we have significantly expanded our potential customer base by our recent acquisition of PocketScript and MyDocOnline, whose service offerings will be supported by our ZixSecure Center, once we transition the data center operations of PocketScript and MyDocOnline to this facility. 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.

      Our business depends on the uninterrupted operation of our centers — currently, our ZixSecure Center located in Dallas, Texas; the Austin, Texas data center used for fail-over and staging of new customers of our Zix branded services; the Dallas, Texas co-location facility that supports the operations of our recently acquired MyDocOnline business; and the data center that supports the PocketScript operations. We must protect these centers 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 data centers’ 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 Zix branded products and services and to support PocketScript’s e-prescribing services and MyDocOnline’s services depends on the efficient operation of the Internet connections between customers and our data centers. 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.

      Secure messages sent through our ZixPort and ZixMessage Center messaging portals, in connection with the operation of our secure e-messaging protection and transaction services, will reside, for a user-specified period of time, in our secure data center network; individual prescription histories transmitted through our PocketScript system will reside in our secure data center network; and the personal healthcare information transmitted through our MyDocOnline system will reside 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.

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      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 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.

      We subject our Zix branded products and services to quality assurance testing prior to product release. There is no assurance that the quality and assurance testing previously conducted by the businesses we recently acquired on their current products and services conform to our standards for quality assurance testing. Regardless of the level of quality assurance testing, any of 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.

      Our Zix branded products and services, the PocketScript e-prescription service and the MyDocOnline businesses 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 the performance of our senior management team — including our chairman and chief executive officer, John A. Ryan; our president and chief operating officer, Richard Spurr and their 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 our company 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.

      Exports of software products using encryption technology, such as our Zix branded products and services, 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

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      Furthermore, boards of pharmacy in the various states in which our PocketScript and MyDocOnline businesses operate regulate the process by which physicians write prescriptions. While regulations in the states in which these businesses currently generally operate permit the electronic writing of prescriptions, such regulations could be revised in the future. Moreover, regulations in states in which these businesses do not currently operate may not be as favorable and may impede our ability to develop business in these states. Furthermore, future state or federal regulation could mandate standards for the electronic writing of prescriptions or for the secure electronic transmittal of personal health information through the Internet that our technology and systems do not comply with, which would require us to modify our technology and systems.

      The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate in the future. Our stock price may decrease as a result of the dilutive effect caused by the additional number of shares that may become available in the market due to the issuances of our common stock in connection with the capital funding and acquisition transactions we completed over the last year. As of February 13, 2004, there was a short position in our common stock of 6,836,222 shares.

      Our directors and executive officers beneficially own shares of our securities that represent approximately 17.6% 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 former director and father of a current director (Antonio R. Sanchez III), and current beneficial owner of approximately 8.7% of our outstanding common stock, and John A. Ryan, our chairman and chief executive officer. 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. This concentration of ownership and voting power may discourage or prevent someone from acquiring our business.

      George W. Haywood, a private investor, beneficially owns approximately 16.0% of our outstanding common stock. Therefore, Mr. Haywood could exert substantial influence over all matters requiring approval by our shareholders, including the election of directors. Mr. Haywood’s interests may not be aligned with the interests of our other shareholders. This concentration of ownership and voting power may discourage or prevent someone from acquiring our business.

      At some point in the future we may determine to seek additional capital funding or to acquire additional businesses. These events could involve the issuance of 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 or business acquisitions.

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      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.

      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 SEC. 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 Act and Section 21E of 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,” “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 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.

      The Company does not believe that it faces material market risk with respect to its cash investments and marketable securities, which totaled $13,852,000 and $14,832,000 at December 31, 2003 and 2002, respectively. These investments, which mature at various dates through June 2004, primarily consist of commercial paper, daily money market funds, asset-backed securities 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 cash investments and marketable securities.

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

      None.

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      Disclosure Controls and Procedures. The Company maintains controls and procedures designed to provide reasonable assurance that it is able to collect the information it is required to disclose in the reports it files with the SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on an evaluation of the Company’s disclosure controls and procedures as of the end of the period covered by this report conducted by the Company’s management, with the participation of the Chief Executive and Chief Financial Officers, the Chief Executive and Chief Financial Officers believe that these controls and procedures are effective to provide reasonable assurance that the Company is able to collect, process and disclose the information it is required to disclose in the reports it files with the SEC within the required time periods.

      Internal Control over Financial Reporting. During the three months ended December 31, 2003, there have been no changes in the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

PART III

      Certain of 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 2004 Proxy Statement.

      The members of the Company’s audit committee are Michael E. Keane, Senior Vice President and Chief Financial Officer, UNOVA, Inc.; James A. Marston, a private investor; and Dr. Ben G. Streetman, Dean, College of Engineering at The University of Texas at Austin. More information about the business experience of Messrs. Keane, Marston, and Streetman can be found in the Company’s 2004 Proxy Statement under the section “OTHER INFORMATION YOU NEED TO MAKE AN INFORMED DECISION — Who are our directors, director nominees, executive officers and significant employees?,” which is incorporated herein by reference. Mr. Keane, chairman of the audit committee, has been determined to be an “audit committee financial expert,” as such term is defined in applicable rules and regulations, by virtue of his business experience, including his current position as Senior Vice President and Chief Financial Officer, UNOVA, Inc. The Company has also determined that Mr. Keane is “independent” as such term is defined in applicable rules and regulations.

      The Company has a code of ethics for the Company’s chief executive officer and senior financial officers. A copy of the code is available on the Company’s Web site www.zixcorp.com under “Corporate Governance.” Any waiver of the code will be publicly disclosed as required by applicable law and regulation.

      The information required by this Item is incorporated by reference from the section “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS” in the Company’s 2004 Proxy Statement.

      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 — Equity Compensation Plan Information” in the Company’s 2004 Proxy Statement.

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      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 2004 Proxy Statement.

      The information required by this Item is incorporated by reference from the section “CORPORATE GOVERNANCE — What is the role of our Board’s committees?” in the Company’s 2004 Proxy Statement.

PART IV

      (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

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*	Filed herewith.

†	Management contract or compensatory plan or arrangement.

      (b) Reports on Form 8-K

      The Registrant filed reports on Form 8-K since September 30, 2003, as follows: Form 8-K, filed October 7, 2003 (relating to the conversion of the Registrant’s Series A and Series B Convertible Preferred Stock into Common Stock and cash proceeds realized by the Registrant upon the exercise of stock options); Form 8-K/ A, filed October 30, 2003 (containing pro forma and historical financial information) and amending Form 8-K filed September 5, 2003 (relating to the acquisition of substantially all of the assets of Elron Software, Inc.); and Form 8-K, filed February 11, 2004 (pertaining to the acquisition of substantially all of the assets and business of MyDocOnline, Inc. and related transactions).

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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 15, 2004.

	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 15, 2004.

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders

      We have audited the accompanying consolidated balance sheets of Zix Corporation as of December 31, 2003 and 2002, 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, 2003. 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, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.

	ERNST & YOUNG LLP

Dallas, Texas

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ZIX CORPORATION

CONSOLIDATED BALANCE SHEETS

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

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ZIX CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

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

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CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY